UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the fiscal year ended December 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
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class
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Name of each exchange on which registered |
Common Stock, $0.001 par value
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The Nasdaq Stock Market LLC |
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(Nasdaq Global Market) |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
The aggregate market value of the voting and non-voting common equity held by non-affiliates
computed by reference to the closing price of such common equity on June 30, 2007: $26,614,106
At March 12, 2008, the number of shares outstanding of the registrants common stock was 10,290,276
shares.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required for Part III of this report is incorporated by reference from the
registrants definitive proxy statement for the 2008 annual meeting of stockholders to be filed
with the Securities and Exchange Commission within 120 days after the registrants fiscal year end.
NATURAL HEALTH TRENDS CORP.
Annual Report on Form 10-K
December 31, 2007
TABLE OF CONTENTS
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 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 forward-looking
statements include the risks described under the caption Risk Factors in this report, which
include the following:
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we may continue to experience substantial negative cash flows; |
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we may need to seek additional debt or equity financing; |
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we face risks related to an SEC investigation and securities and other litigation; |
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we could be adversely affected by additional audit committee investigations; |
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our ability to attract and retain distributors; |
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our ability to recruit and retain key management, directors and consultants; |
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our inability to directly control the marketing of our products; |
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our inability to control our distributors to the same extent as if they were our own
employees; |
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our ability to protect or use our intellectual property rights; |
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claims against us that could arise from the misconduct of some of our former officers
and directors; |
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adverse publicity associated with our products, ingredients or network marketing
programs, or those of similar companies; |
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our ability to maintain or expand the number of our distributors or their productivity
levels; |
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changes to our distributor compensation plan may not be accepted; |
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our dependence on our Hong Kong and China market for most of our revenue; |
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regulatory matters pertaining to direct-selling laws, particularly in China; |
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we could be required to modify our compensation plan in China in a way that could
adversely affect our business; |
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activities of our members in China could adversely affect our Hong Kong e-commerce
model; |
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our inability to obtain a direct-selling license in China; |
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our failure to properly pay business taxes or customs duties, including those of China; |
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risks associated with operating internationally; |
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risks associated with the amount of compensation paid to distributors, which can affect
our profitability; |
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we rely on our suppliers product liability insurance and product liability claims could
hurt our business; |
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our internal controls and accounting methods may require further modification; |
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we could be adversely affected if we fail to maintain an effective system of internal
controls; |
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risks associated with our reliance on information technology systems; |
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risks associated with the extensive regulation of our business and the implications of
changes in such regulations; |
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currency exchange rate fluctuations could lower our revenue and net income; |
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failure of new products to gain distributor or market acceptance; |
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failure of our information technology system could harm our business; |
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we have a limited product line; |
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our reliance on outside manufacturers; |
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the intensely competitive nature of our business; |
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terrorist attacks, cyber attacks, acts of war or other disasters, particularly given the
scope of our international operations; |
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disappointing quarterly revenue or operating results, which could adversely affect our
stock price; |
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our common stock is particularly subject to volatility because of the industry in which
we operate; |
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consequences arising if an active public trading market for our common stock does not
continue; |
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consequences if we fail to regain compliance with applicable Nasdaq requirements; |
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adverse consequences if securities analysts publish adverse research or reports, or
otherwise fail to cover us at all; |
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our failure to wisely apply the proceeds derived from our May and October 2007
financings effectively; |
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adverse cash flow consequences from leverage and debt service obligations; |
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substantial cash payments could be required upon an event of default under our variable
rate convertible debentures; |
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failure to maintain the registration statements covering the resale of shares of common
stock for certain investors will result in liquidated damages; |
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covenants and restrictions in certain investor agreements could restrict our ability to
operate our business; |
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the implications of the actual or anticipated conversion or exercise of our convertible
securities; and |
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future sales by us or our stockholders of shares of common stock could depress the
market price of our common stock. |
Market data and other statistical information used throughout this report is based on
independent industry publications, government publications, reports by market research firms or
other published independent sources and on our good faith estimates, which are derived from our
review of internal surveys and independent sources. Although we believe that these sources are
reliable, we have not independently verified the information and cannot guarantee its accuracy or
completeness.
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 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
Item 1. BUSINESS
Overview of Business
Natural Health Trends Corp. is an international direct-selling and e-commerce organization
headquartered in Dallas, Texas. 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. Prior to June 1, 2006, we
marketed our NHT Global branded products under the name Lexxus International.
Our 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; South Korea; Japan; Latin America, which primarily consists of Mexico; and Europe,
which consists of Italy and Slovenia.
We seek to be a leader in the direct selling industry serving the health and wellness
marketplace by selling our products into many markets through our direct selling marketing
operations. Our objectives are to enrich the lives of the users of our products and enable our
distributors to benefit financially from the sale of our products.
We were originally incorporated as a Florida corporation in 1988. We merged into one of our
subsidiaries and re-incorporated in the State of Delaware effective June 29, 2005. We maintain
executive offices at 2050 Diplomat Drive, Dallas, Texas 75234 and our telephone number is (972)
241-4080. We maintain a website located at
www.naturalhealthtrendscorp.com. Our annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such
reports are available, free of charge, on our website as soon as reasonably practicable after we
file electronically such material with, or furnish it to, the United States Securities and Exchange
Commission, or SEC. Our Code of Ethics for Senior Financial Officers can also be found on our
website. The information provided on our website should not be considered part of this report.
Our common stock is traded on the Nasdaq Global Market under the ticker symbol BHIP.
Our Principal Products
We offer a line of NHT Global branded products that include:
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Skindulgence® is a skin care system that includes a 30-Minute Non-Surgical FaceLift as
well as a spa collection for hands, feet and all-over body. The 30-Minute Non-Surgical
FaceLift is designed to create a more youthful appearance by helping to tone and firm
facial muscles, by helping to diminish fine lines and wrinkles and by helping to improve
skin tone and color. The facelift masque is coupled with a cleanser and moisturizer. |
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Alura® is an intimacy enhancing cream for women. |
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Premium Noni Juice is a reconstituted morinda citrifolia fruit juice, made from organic
noni puree. Noni is a fruit native in the Samoan Islands of the South Pacific. Marketed as
a refreshing and energizing beverage, its natural flavor has been enhanced with white grape
concentrate, concord grape concentrate, pineapple juice puree and other natural flavors. |
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LexLips is a lip enhancing gloss designed to create the effect of fuller lips and to
help reduce fine lines and wrinkles around the mouth. |
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La Vie is an energy-boosting dietary supplement described as a non-alcoholic red wine. |
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180° Life System® CarbBlocker is a weight management product. |
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Triotein is a lactose-free whey protein powder that provides amino acid substrates
needed to stimulate the bodys production of an anti-oxidant, intracellular glutathione
peroxidase, in an effort to optimize the bodys ability to heal itself. |
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Cluster Concentrate is a product created for increased and more efficient cell
hydration. |
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TriFusion PlusTM is a beverage with a unique blend of exotic fruits and
berries rich in antioxidants, lycopene, and more. Its main ingredients are Acai berry,
Goji berry, the Mangosteen fruit, and the Gac fruit; each containing phytonutrients.
Phytonutrients are compounds having antioxidative properties found naturally in plant-based
foods such as fruit and vegetables. |
In addition, some our subsidiaries offer products specific to their local markets.
Operations of the Business
Operating Strategy
Our mission is to help people develop a successful home-based business by offering superior
products and services.
Operationally, our strategy in the short term is to reduce our overhead and improve commission
payout to stabilize our revenue base. Our top priority markets are Greater China, South Korea, and
Europe.
Our long term strategy is to build a sustainable, steady-growth facilitating business model
that is based on:
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Regularly introducing consumable products; |
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Offering attractive commission plans; and |
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Supporting the field with superior customer services. |
After cost reductions in 2006, we underwent a major restructuring, removing redundant top and
mid-level management positions, in the fourth quarter of 2007. We will continue to look for cost
reduction opportunities, but believe that the material cost reductions have all been completed.
A major commission plan change was implemented in the second quarter of 2007. The result was
less than satisfying. While the payout as a percentage of sales was lowered, sales have decreased
significantly since the effective date of the change. We decided to reverse some of the changes in
March 2008, primarily in the markets of Hong Kong, the United States, and Taiwan. Additional
enhancements were also added at the same time to improve sales momentum. We are so far encouraged
by recent progress in this area.
Sourcing of Products
Our executive staff works with research and development personnel of our manufacturers and
other prospective vendors to create product concepts and develop the product ideas into actual
products. Each of our three current major product lines Skindulgence®, Alura® and Premium Noni
Juice - were originally conceived by our manufacturing vendors. We or certain of our subsidiaries
then enter into supply agreements with the vendors pursuant to which we obtain rights to sell the
products under private labels (or trademarks) that are owned by us. Because our current main
products all came to us originally as proposals from our vendors, we have incurred minimal
out-of-pocket research and development costs through December 31, 2007. In addition, some of our
local markets introduce their own products from time to time and these products are sometimes
adopted by our other markets.
We or certain of our subsidiaries generally purchase finished goods from manufacturers and
sell them to our distributors for their resale or personal consumption. Aloe Commodities
International (for Skindulgence®), 40Js LLC (for Alura®) and Two Harbor Trading (for Premium Noni
Juice) are our three most significant vendors, accounting for a majority of our product purchases.
We believe that, in the event we are unable to source products from our current or alternate
suppliers, our revenue, income and cash flow could be adversely and materially impacted. We have
contracts with Aloe Commodities International and Two Harbor Trading that have annual renewal
rights. We do not have a long term contract with 40Js LLC.
Marketing and Distribution
Our distributors are independent full-time or part-time contractors who purchase products
directly from our subsidiaries via the Internet for resale to retail consumers (other than in
China, Europe, and certain other markets) or for their own personal consumption. Purchasers of our
products in China, Europe and certain other markets may purchase only for their own personal
consumption and not for resale. The growth of a distributors business depends largely upon their
ability to recruit a down-line network of distributors and the popularity of our products in the
marketplace.
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The following table sets forth the number of active distributors by market for the time
periods indicated. We consider a distributor active if they have placed at least one product
order with us during the preceding year.
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Year Ended December 31, |
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2006 |
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2007 |
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North America |
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8,840 |
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3,900 |
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Hong Kong |
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59,970 |
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33,470 |
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Taiwan |
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3,620 |
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4,650 |
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Southeast Asia |
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1,380 |
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860 |
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South Korea |
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9,250 |
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7,130 |
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Australia/New Zealand |
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570 |
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340 |
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Japan |
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6,240 |
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2,440 |
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Latin America |
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4,300 |
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1,410 |
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Europe |
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1,880 |
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2,800 |
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Total |
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96,050 |
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57,000 |
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To become an NHT Global distributor, a prospective distributor must agree to the terms and
conditions of our distributor agreement posted on our website. NHT Global distributors generally
pay an annual enrollment fee. The distributor agreement sets forth our policies and procedures,
and we may elect to terminate a distributor for non-compliance.
We pay commissions to eligible NHT Global distributors based on sales by such distributors
down-line distributors during a given commission period. To be eligible to receive commissions,
distributors in some countries may be required to make nominal monthly or other periodic purchases
of products. We believe that the uniqueness and desirability of our NHT Global products, combined
with a high commission rate, creates a highly desirable business opportunity and work environment
for our NHT Global distributors. See Working with Distributors.
Distributors generally place orders through the Internet and pay by credit card prior to
shipment. Accordingly, we carry minimal accounts receivable and credit losses are historically
minimal.
We sponsor promotional meetings and motivational training events in key cities in our markets
for current and potential NHT Global distributors. These events are designed to inform prospective
and existing distributors about both existing and new product lines as well as selling techniques.
Distributors typically share their direct selling experiences, their individual selling styles and
their recruiting methods at these promotional or training events. Prospective distributors are
educated about the structure, dynamics and benefits of the direct selling industry. We are
continually developing or updating our marketing strategies and programs to motivate our
distributors. These programs are designed to increase distributors monthly product sales and the
recruiting of new distributors in their down-lines.
Management Information Systems
The NHT Global business uses our proprietary web-based MarketVision system to process orders
and to communicate business volume activity and commissions to distributors. Other than
MarketVision, we have not fully automated and integrated other critical business processes such as
inventory management. We automated a substantial amount of our financial reporting processes with
the implementation of Oracles E-Business Suite in the fourth quarter of 2005. We expect to
implement further functionality provided we have adequate operating cash flows to reinvest.
Employees
At December 31, 2007, we employed 168 total employees world-wide, of which 31 were located in
the United States, 77 in Hong Kong and China, 25 in Taiwan, one in the Philippines, one in Europe,
18 in South Korea, 12 in Mexico, and three in Japan.
Seasonality
Historically our sales have not been impacted by seasonality on any significant basis. From
quarter to quarter, we are somewhat impacted by seasonal factors and trends such as major cultural
events and vacation patterns. For example, most Asian markets celebrate their respective local New
Year in the first quarter, which generally has a negative impact on that quarter. We believe that
direct selling is also generally negatively impacted during the third quarter, when many
individuals, including our distributors,
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traditionally take time off for vacations. In addition, the national holidays in Hong Kong,
China and Taiwan in early October tend to have a significant adverse effect on sales in those
markets.
Our spending is materially affected by the major events planned for at different times of the
year. A major promotional event could significantly increase the reported expenses during the
quarter in which the event actually takes place, while the revenue that might be generated by the
event may not occur in the same reporting period.
Intellectual Property
Most of our products are packaged under a private label arrangement. We have applied for
trademark registration for names, logos and various product names in several countries in which we
are doing business or considering expanding into. We currently have three trademark registrations
in the United States, with several more applications approved and pending publication. We also
rely on common law trademark rights to protect our unregistered trademarks. These common law
trademark rights do not provide us with the same level of protection as afforded by a United States
federal registration trademark. Common law trademark rights are limited to the geographic area in
which the trademark is actually utilized, while a United States federal registration of a trademark
enables the registrant to discontinue the unauthorized use of the trademark by a third party
anywhere in the United States even if the registrant has never used the trademark in the geographic
area where the trademark is being used; provided, however, that the unauthorized third party user
has not, prior to the registration date, perfected its common law rights in the trademark within
that geographic area.
In November 2001, the inventor of our Alura® product, from whom we have a license to
distribute Alura®, was awarded a patent for the formulation of that product.
As a result of a settlement agreement with Toyota Motor Sales, U.S.A., the Company changed the
name of Lexxus International, Inc. to NHT Global, Inc. and the terms Lexxus and Lexxus
International were replaced in all other uses by us and our subsidiaries by the terms NHT Global
or a variation that includes NHT or Natural Health Trends. In connection with this name
change, we applied for registration of rights in these names and related marks in several countries
in which we do business.
In 2005, we implemented a foreign holding and operating company structure for our non-United
States businesses, which involved the division of our United States and non-United States
operations. As part of implementing this structure, we and some of our United States subsidiaries
granted an exclusive license to some of our non-United States subsidiaries to use outside of the
United States all of their intangible property, including trademarks, trade secrets and other
proprietary information. See Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations Income Statement Presentation.
Insurance
We currently carry general liability insurance in the amount of $1,000,000 per occurrence and
$2,000,000 in the aggregate as well as customary cargo and other insurance coverage, including
coverage for international subsidiaries. We do not carry product liability insurance, but may be
covered by the insurance maintained by our principal suppliers. There can be no assurance,
however, that product liability insurance would be available, and if available, that it would be
sufficient to cover potential claims or that an adequate level of coverage would be available in
the future at a reasonable cost, if at all. A successful product liability claim could have a
material adverse effect on our business, financial condition and results of operations.
Working with Distributors
Sponsorship
Sponsoring new distributors creates multiple levels in the direct selling structure of NHT
Global. The persons that a distributor sponsors within the network are referred to as sponsored
distributors. Persons newly recruited are assigned by distributors into network positions that can
be under other distributors, thus they can be called down-line distributors. If down-line
distributors also sponsor new distributors, they create additional levels within the structure, but
their down-line distributors remain in the same down-line network as their original sponsoring
distributor.
We rely on our distributors to recruit and sponsor new distributors. Our top up-line
distributors tend to focus on building their network of down-line distributors and assisting them
with the sale of our products. While we provide product samples, brochures and other sales
materials, distributors are primarily responsible for recruiting and educating their new
distributors with respect to products, the compensation plan and how to build a successful
distributorship network.
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Distributors are not required to sponsor other distributors as their down-line, and we do not
pay any commissions for sponsoring new distributors. However, because of the financial incentives
provided to those who succeed in building a distributor network that consumes and resells products,
we believe that many of our distributors attempt, with varying degrees of effort and success, to
sponsor additional distributors. Because they are seeking new opportunities for income, people are
often attracted to become distributors after using our products or after attending introductory
seminars. Once a person becomes a distributor, he or she is able to purchase products directly
from us at wholesale prices via the Internet. The distributor is also entitled to sponsor other
distributors in order to build a network of distributors and product users.
Compensation Plans
NHT Global employs what is commonly referred to as a binary compensation plan. We believe
that one of our key competitive advantages within the direct selling industry is our compensation
plan for distributors. Under the NHT Global compensation plan, distributors are paid weekly
commissions in the market in which the distributor signed up, in that 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,
but instead earn a spread between the wholesale price paid by the distributor and the retail price
received by the distributor. This seamless compensation plan enables a distributor located in
one country to sponsor other distributors located in other countries where we are authorized to
conduct our business.
Currently, there are basically two ways in which NHT Global distributors can earn income:
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Through retail markups on sales of products purchased by distributors at wholesale
prices (in some markets, sales are for personal consumption only and income may not be
earned through retail mark-ups on sales in that market); and |
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Through commissions paid on product purchases made by their down-line distributors. |
Each of our products is designated a specified number of sales volume points, also called
bonus volume or BV. Commissions are based on total personal and group sales volume points per
sales period. Sales volume points are essentially a percentage of a products wholesale price. As
the distributors business expands from successfully sponsoring other distributors who in turn
expand their own businesses by sponsoring other distributors, the distributor receives higher
commissions from purchases made by an expanding down-line network. To be eligible to receive
commissions, a distributor may be required to make nominal monthly or other periodic 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. Under our current
compensation plan, certain of our commission payout may be limited to a hard cap in terms of a
specific percentage of the total bonus value points. In some markets, commissions may be further
limited. 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.
Distributor Support
We are committed to providing a high level of support services tailored to the needs of our
distributors in each marketplace we are serving. We attempt to meet the needs and build the
loyalty of distributors by providing personalized distributor services and by maintaining a
generous product return policy (see Product Warranties and Returns). Because many of our
distributors are working on a part-time basis and have only a limited number of hours each week to
concentrate on their business, we believe that maximizing a distributors efforts by providing
effective distributor support has been, and could continue to be, important to our success.
Through training meetings, annual conventions, web-based messages, distributor focus groups,
regular telephone conference calls and other personal contacts with distributors, we seek to
understand and satisfy the needs of our distributors. Via our websites, we provide product
fulfillment and tracking services that result in user-friendly and timely product distribution.
Most of our offices maintain meeting rooms, which our distributors may utilize for training and
sponsoring activities.
To help maintain communication with our distributors, we offer the following support programs:
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Teleconferences we hold teleconferences with company management and associate
field leadership on various subjects such as technical product discussions, distributor
organization building and management techniques. |
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Internet we maintain our main website at www.naturalhealthtrendscorp.com.
On this website, the user can read company news, learn more about various products, sign
up to be a distributor, place orders, and track the fulfillment and delivery of their
order. |
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Product Literature we offer a variety of literature to distributors, including
product catalogs, informational brochures, pamphlets and posters for individual
products. |
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Toll Free Access we offer live consumer support where a customer service
representative can address general questions or concerns. |
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Broadcast E-mail we send announcements via e-mail to all active distributors. |
Technology and Internet Initiatives
We believe that the Internet has become increasingly important to our business as more
consumers communicate online and purchase products over the Internet as opposed to traditional
retail and direct sales channels. As a result, we have committed significant resources to our
e-commerce capabilities and the abilities of our distributors to take advantage of the Internet.
Substantially all of our sales have occurred via the Internet. NHT Global offers a global web page
that allows a distributor to have a personalized website through which he or she can sell products
in all of the countries in which we do business. Links to these websites can be found at our main
website at www.naturalhealthtrendscorp.com. The information provided on these websites
should not be considered part of this report.
Rules Affecting Distributors
Our distributor policies and procedures establish the rules that distributors must follow in
each country. We also monitor distributor activity in an attempt to provide our distributors with
a level playing field so that one distributor may not be disadvantaged by the activities of
another. We require our distributors to present products and business opportunities in an ethical
and professional manner. Distributors further agree that their presentations to customers must be
consistent with, and limited to, the product claims and representations made in our literature.
We require that we produce or pre-approve all sales aids used by distributors such as
videotapes, audiotapes, brochures and promotional clothing. Further, distributors may not use any
form of media advertising to promote products unless it is pre-approved by us. Products may be
promoted only by personal contact or by literature produced or approved by us. Distributors are
not entitled to use our trademarks or other intellectual property without our prior consent.
Our compliance department reviews reports of alleged distributor misbehavior. If we determine
that a distributor has violated our distributor policies or procedures, we may terminate the
distributors rights completely. Alternatively, we may impose sanctions, such as warnings,
probation, withdrawal or denial of an award, suspension of privileges of the distributorship,
fines, withholding commissions, until specified conditions are satisfied or other appropriate
injunctive relief. Our distributors are independent contractors, not employees, and may act
independently of us. Further, our distributors may resign or terminate their distributorship at any
time without notice. See Item 1A. Risk Factors.
Government Regulations
Direct Selling Activities
Direct selling, or multi-level marketing, activities are regulated by various federal, state
and local governmental agencies in the United States and foreign countries. These laws and
regulations are generally intended to prevent fraudulent or deceptive schemes, often referred to as
pyramid schemes, which compensate participants for recruiting additional participants
irrespective of product sales, use high-pressure recruiting methods and/or do not involve
legitimate products. The laws and regulations in our current markets often:
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impose cancellation/product return, inventory buy-backs and cooling-off rights for
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require us or our distributors to register with governmental agencies; |
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impose reporting requirements; and |
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impose upon us requirements, such as requiring distributors to maintain levels of retail
sales to qualify to receive commissions, to ensure that distributors are being compensated
for sales of products and not for recruiting new distributors. |
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The laws and regulations governing direct selling are modified from time to time, and, like
other direct selling companies, we are subject from time to time to government investigations in
our various markets related to our direct selling activities. This can require us to make changes
to our business model and aspects of our global compensation plan in the markets impacted by such
changes and investigations.
Based on advice of our engaged outside professionals in existing markets, the nature and scope
of inquiries from government regulatory authorities and our history of operations in those markets
to date, we believe our method of distribution complies in all material respects with the laws and
regulations related to direct selling of the countries in which we currently operate.
As a result of restrictions in China on direct selling activities, we are not conducting
direct selling in China. Consumers and members purchase the Companys products via a Hong
Kong-based web site. The regulatory environment in China is complex. Because we operate a direct
selling model outside of China, our operations in China have attracted constant and significant
regulatory and media scrutiny. At the end of 2005, China adopted new direct selling and
anti-pyramiding regulations that are restrictive and contain various limitations, including a
restriction on the ability to pay multi-level compensation to independent distributors.
Regulations are subject to discretionary interpretation by municipal and provincial level
regulators. Interpretations of what constitutes permissible activities by regulators can vary from
province to province and can change from time to time because of the lack of clearly defined rules
regarding direct selling activities.
Because of the Chinese governments significant concerns about direct selling activities, it
scrutinizes very closely activities of direct selling companies. The scrutiny has increased
following adoption of the new direct selling and anti-pyramiding regulations and our business
continues to be subject to reviews and investigations by municipal and provincial level regulators.
At times, investigations and related actions by government regulators have caused an obstruction
to our members activities in certain locations, and have resulted in a few cases of enforcement
actions. In each of these cases, we helped our members with their defense in the legality of their
conduct. So far, no material changes to our business model were required. We expect to receive
continued guidance and direction as we work with regulators to address our business model and any
changes we make to comply with the new direct selling regulations.
In accordance with the new direct selling regulations, we have applied for a direct selling
license. It is not clear when direct selling licenses will be issued and how the government in
China is processing these applications. If and when we receive a direct selling license, we plan
to augment our current business model by conducting direct selling activities within China.
Regulation of Our Products
Our products and related promotional and marketing activities are subject to extensive
governmental regulation by numerous governmental agencies and authorities in the United States,
including the FDA, the FTC, the Consumer Product Safety Commission, the United States Department of
Agriculture, State Attorneys General and other state regulatory agencies. In our foreign markets,
the products are generally regulated by similar government agencies, such as the Ministry of Health
and Welfare in Japan and the Department of Health in Taiwan. In the event a product, or an
ingredient in a product, is classified as a drug or pharmaceutical product in any market, we will
generally not be able to distribute that product in that market through our distribution channel
because of strict restrictions applicable to drug and pharmaceutical products.
Most of our major markets also regulate advertising and product claims regarding the efficacy
of products. This is particularly true with respect to our dietary supplements because we typically
market them as foods or health foods. For example, in the United States, we are unable to claim
that any of our nutritional supplements will diagnose, cure, mitigate, treat or prevent disease. In
the United States, the Dietary Supplement Health and Education Act, however, permits substantiated,
truthful and non-misleading statements of nutritional support to be made in labeling, such as
statements describing general well-being resulting from consumption of a dietary ingredient or the
role of a nutrient or dietary ingredient in affecting or maintaining a structure or a function of
the body. Most of the other markets in which we operate have not adopted similar legislation and we
may be subject to more restrictive limitations on the claims we can make about our products in
these markets.
Other Regulatory Issues
As a United States entity operating through subsidiaries in foreign jurisdictions, we are
subject to foreign exchange control, transfer pricing and custom laws that regulate the flow of
funds between our subsidiaries and us for product purchases, management services and contractual
obligations, such as the payment of distributor commissions.
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As is the case with most companies that operate in our product categories, we might receive
from time to time inquiries from government regulatory authorities regarding the nature of our
business and other issues, such as compliance with local direct selling, transfer pricing, customs,
taxation, foreign exchange control, securities and other laws. Negative publicity resulting from
inquiries into our operations by United States and state government agencies in the early 1990s,
stemming in part from alleged inappropriate product and earnings claims by distributors could
adversely harm our business.
Product Warranties and Returns
NHT Global refund policies and procedures closely follow industry and country-specific
standards, which vary greatly by country. For example, in the United States, the Direct Selling
Association recommends that direct sellers permit returns during the twelve-month period following
the sale, while in Hong Kong the standard return policy is 14 days following the sale. Our return
policies have conformed to local laws or the recommendation of the local direct selling
association. In most cases, distributors who timely return unopened product that is in resalable
condition may receive a refund. The amount of the refund may be dependent on the country in which
the sale occurred, the timeliness of the return, and any applicable re-stocking fee. NHT Global
must be notified of the return in writing and such written requests would be considered a
termination notice of the distributorship. From time to time, we may alter our return policy in
response to special circumstances.
Our Industry
We are engaged in the direct selling industry, selling lifestyle enhancement products,
cosmetics, personal care and dietary supplements. More specifically, we are engaged in what is
called network marketing or multi-level marketing. This type of organizational structure and
approach to marketing and sales include companies selling lifestyle enhancement products, cosmetics
and dietary supplements, or selling other types of consumer products, such as Tupperware
Corporation and Amway Corp. Generally, direct selling is based upon an organizational structure in
which independent distributors of a companys products are compensated for sales made directly to
consumers.
NHT Global distributors are compensated for sales generated by distributors they have
recruited and all subsequent distributors recruited by their down-line network of distributors.
The experience of the direct selling industry has been that once a sizeable network of distributors
is established, new and alternative products and services can be offered to those distributors for
sale to consumers and additional distributors. The successful introduction of new products can
dramatically increase sales and profits for both distributors and the direct selling marketing
organization.
Competition
We compete with a significant number of other retailers that are engaged in similar lines of
business, including sellers of health-related products and other direct sellers such as Nu Skin
Enterprises, Inc., USANA Health Sciences, Inc., Mannatech, Inc., Reliv International, Inc, and
Herbalife, Ltd.. Additionally, our competitors include bHIP Global, Inc., a company recently
founded by Terry LaCore, a former executive officer and director of the Company who also provided
master distributor services to the Company during part of 2007. Many of the competitors have
greater name recognition and financial resources than us as well as many more distributors. The
direct selling channel tends to sell products at a higher price compared to traditional retailers,
which poses a degree of competitive risk. There is no assurance that we would continue to compete
effectively against retail stores, Internet- based retailers or other direct sellers.
Item 1A. RISK FACTORS
The Company is exposed to a variety of risks that are inherent in our business and industry.
The following are some of the more significant factors that could affect our business and results
of operations.
We May Continue To Experience Substantial Negative Cash Flows, Which May Have A Significant Adverse
Effect On Our Business And Could Threaten Our Solvency.
We experienced substantial negative cash flows during the years ended December 31, 2006 and
2007, primarily due to declines in our revenues without proportional decreases in expenditures. If
this trend continued, the decreasing cash balance could impair our ability to support our
operations and, eventually, threaten our solvency, which would have a material adverse effect on
our business, results of operations and financial condition as well as our stock price. Negative
cash flows and the related adverse market perception associated therewith may have negatively
affected, and may in the future negatively affect, our ability to attract new distributors and/or
sell our products. There can be no assurance that we will be successful in maintaining an adequate
level of cash resources and
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we could be forced to act more aggressively in the area of expense reduction in order to
conserve cash resources as we look for alternative solutions.
If We Continue To Experience Negative Cash Flows, We May Need To Seek Additional Debt Or Equity
Financing, Which May Not Be Available On Acceptable Terms Or At All. If Available, It Could Have A
Dilutive Effect On The Holdings Of Existing Stockholders.
Unless we are able to stabilize or grow revenues, control expenses and achieve positive cash
flows, our ability to support our obligations could be impaired and our liquidity could be
adversely affected and our solvency and our ability to repay our debts when they come due could be
threatened. We may need to seek additional debt or equity financing on acceptable terms in order
to improve our liquidity. However, our ability to obtain additional debt or equity financing is
restricted by the terms of some agreements with our investors. In any case, we may not be able to
obtain additional debt or equity financing on satisfactory terms, or at all, and any new financing
could have a dilutive effect to our existing stockholders.
We Face Risks Related To An SEC Investigation, Securities Litigation and Other Litigation That
Could Have A Material Adverse Effect On Our Relationships With Our Distributors, Business,
Financial Condition And Results Of Operations. We May Face Additional Litigation In The Future That
Could Also Harm Our Business.
In October 2006, the SEC issued a formal order of investigation to determine whether there
have been violations of the federal securities laws by us and/or others involved with us. Although
we have fully cooperated with the SEC in this matter and intend to continue to fully cooperate, we
cannot predict when this investigation will be completed or its outcome. We could face sanctions
in connection with any resolution of the SEC investigation, including but not limited to,
significant monetary penalties and injunctive relief.
In addition, we and certain of our directors and former officers have been named as defendants
in a securities class action lawsuit. Due to the volatility of the stock market and particularly
the stock prices of network marketing companies, it is possible that we will face additional class
action lawsuits in the future. The findings and outcome of the SEC investigation may affect the
class action and other lawsuits that are pending and any future litigation that we may face.
In addition, we continue to defend a lawsuit with the bankruptcy estate of John Loghry, a
former master distributor for our NHT Global business. Trial of the trustees lawsuit has been set
for October 2008.
Any settlement of the class action and other litigation or any resolution of the SEC
investigation may involve significant cash payments that could create or increase negative cash
flows. If we are unable to achieve a settlement of the class action and other litigation, we could
be liable for large damage awards. There can be no assurance that damage awards, if any, and the
costs of litigation will be covered by insurance. If not, this could have a material adverse
effect on our business, results of operations and financial condition.
Defending against existing and potential litigation and other governmental proceedings may
continue to require significant expense and attention of our management. There can be no assurance
that the significant money, time and effort spent will not adversely affect our business, financial
condition and results of operations.
We Could Be Adversely Affected By Additional Audit Committee Investigations.
From time to time, the Audit Committee of our Board of Directors may investigate, or employ an
independent investigator to investigate, reported or suspected violations of laws, ethics, or
policies by our officers, directors, employees or consultants. Any discovery of wrongdoing
resulting from any such investigation, or any disclosure of any such investigation or its results,
could have material adverse consequences for us.
Continued Adverse News About Us Could Have A Material Adverse Effect On Our Ability To Attract And
Maintain Distributors.
Our recent operating performance, changes in management, volatility in stock price, SEC
investigation of us and lawsuits filed against us may have negatively affected, and may continue to
negatively affect, our ability to attract and retain distributors, without whom we would be unable
to sell our products and generate revenues.
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We Could Be Adversely Affected By Additional Management Changes Or An Inability To Attract And
Retain Key Management, Directors And Consultants.
Our future success depends to a significant degree on the skills, experience and efforts of
our top management, directors and key consultants, particularly our management personnel
responsible for our Hong Kong and MarketVision subsidiaries. In November 2005, we terminated two
top employees, 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, due to
misconduct. Although we settled our disputes with these individuals in 2006, continued changes in
senior management may have had, and may in the future have, a material adverse effect on our
business, results of operations and financial condition. We also depend on the ability of our
executive officers and other members of senior management to work effectively as a team. The loss
of one or more of our executive officers, members of our senior management, directors or key
consultants could have a material adverse effect on our business, results of operations and
financial condition. Moreover, as our business evolves, we may require additional or different
management members, directors or consultants, and there can be no assurance that we will be able to
locate, attract and retain them if and when they are needed.
As A Network Marketing Company, We Rely On An Independent Sales Force And We Do Not Have Direct
Control Over The Marketing Of Our Products.
We rely on non-employee, independent distributors to market and sell our products. We have a
large number of distributors and a relatively small corporate staff to implement our marketing
programs and to provide motivational support and training to our distributors. Distributors may
voluntarily terminate their agreements with us at any time, and there is typically significant
turnover in our distributor ranks.
Since We Cannot Exert The Same Level Of Influence Or Control Over Our Independent Distributors As
We Could Were They Our Own Employees, Our Distributors Could Fail To Comply With Our Distributor
Policies And Procedures, Which Could Result in Claims Against Us That Could Harm Our Financial
Condition And Operating Results.
Our distributors are independent contractors and, accordingly, we are not in a position to
directly provide the same direction, motivation and oversight as we would if distributors were our
own employees. As a result, there can be no assurance that our distributors will participate in
our marketing strategies or plans, accept our introduction of new products, or comply with our
distributor policies and procedures. Extensive federal, state and local laws regulate our
business, our products and our network marketing program. Because we have expanded into foreign
countries, our policies and procedures for our independent distributors differ due to the different
legal requirements of each country in which we do business. While we have implemented distributor
policies and procedures designed to govern distributor conduct and to protect the goodwill
associated with our trademarks and trade names, it can be difficult to enforce these policies and
procedures because of the large number of distributors and their independent status. Given the
size and diversity of our distributor force, we experience problems with distributors from time to
time, especially with respect to our distributors in foreign markets. Distributors often desire to
enter a market, before we have received approval to do business, to gain an advantage in the
marketplace. Improper distributor activity in new geographic markets could result in adverse
publicity and can be particularly harmful to our ability to ultimately enter these markets.
Violations by our distributors of applicable law or of our policies and procedures in dealing with
customers could reflect negatively on our products and operations, and harm our business
reputation. In addition, it is possible that a court could hold us civilly or criminally
accountable based on vicarious liability because of the actions of our independent distributors.
If any of these events occur, the value of an investment in our common shares could be impaired.
We May Be Unable To Protect Or Use Our Intellectual Property Rights.
We rely on trade secret, copyright and trademark laws and confidentiality agreements with
employees and third parties, all of which offer only limited protection. Moreover, the laws of
some countries in which we market our products may afford little or no effective protection of our
intellectual property rights. The unauthorized copying or other misappropriation of our
intellectual property could enable third parties to benefit from such property without paying us
for it. For example, limited protection of intellectual property is available under Chinese law,
and the local manufacturing of our products may subject us to an increased risk that unauthorized
parties may attempt to copy or otherwise obtain or use our product formulations. This could have a
material adverse effect on our business, operating results and financial condition. If we resort
to legal proceedings to enforce our intellectual property rights, the proceedings could be
burdensome and expensive and could involve a high degree of risk. It is also possible that our use
of our intellectual property rights could be found to infringe on prior rights of others and, in
that event, we could be compelled to stop or modify the infringing use, which could be burdensome
and expensive.
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Claims May Arise Against Us From Unknown Oral Agreements And Misconduct of Former Officers and
Directors.
We have investigated oral agreements entered into and misconduct by Mark Woodburn, former
President and director of the Company, and Terry LaCore, former Chief Executive Officer of NHT
Global and former director of the Company. There can be no assurance that all such oral agreements
and misconduct have been discovered. Additional discoveries could lead to claims and proceedings
against us, our subsidiaries and their officers and directors. If it is determined that any
conduct by Messrs. Woodburn and LaCore or any other current or former employee, officer or agent
violated any law, there can be no assurance that we or one or more of our subsidiaries would not be
subjected to prosecution or adverse proceedings. Any such claims, prosecutions or other
proceedings and the cost of their defense could have a material adverse impact on our reputation,
business and financial condition.
Adverse Publicity Associated With Our Products, Ingredients Or Network Marketing Program, Or Those
Of Similar Companies, Could Harm Our Financial Condition And Operating Results.
Adverse publicity concerning any actual or claimed failure by us or our distributors to comply
with applicable laws and regulations regarding product claims and advertising, good manufacturing
practices, the regulation of our network marketing program, the licensing of our products for sale
in our target markets or other aspects of our business, whether or not resulting in enforcement
actions or the imposition of penalties, could have an adverse effect on our goodwill and could
negatively affect our ability to attract, motivate and retain distributors, which would negatively
impact our ability to generate revenue. We cannot ensure that all distributors will comply with
applicable legal requirements relating to the advertising, labeling, licensing or distribution of
our products.
In addition, our distributors and consumers perception of the safety and quality of our
products and ingredients as well as similar products and ingredients distributed by other companies
can be significantly influenced by national media attention, publicized scientific research or
findings, widespread product liability claims and other publicity concerning our products or
ingredients or similar products and ingredients distributed by other companies. Adverse publicity,
whether or not accurate or resulting from consumers use or misuse of our products, that associates
consumption of our products or ingredients or any similar products or ingredients with illness or
other adverse effects, questions the benefits of our or similar products or claims that any such
products are ineffective, inappropriately labeled or have inaccurate instructions as to their use,
could negatively impact our reputation or the market demand for our products.
Network marketing systems such as ours are frequently subject to laws and regulations directed
at ensuring that product sales are made to consumers of the products and that compensation,
recognition, and advancement within the marketing organization are based on the sale of products
rather than investment in the sponsoring company. We are subject to the risk that, in one or more
of our present or future markets, our marketing system could be found not to comply with these laws
and regulations or may be prohibited. Failure to comply with these laws and regulations or such a
prohibition could have a material adverse effect on our business, financial condition, and results
of operations. Further we may simply be prohibited from distributing products through a
network-marketing channel in some foreign countries, or be forced to alter our compensation plan.
Our Failure To Maintain And Expand Our Distributor Relationships Could Adversely Affect Our
Business.
We distribute our products through independent distributors, and we depend upon them directly
for all of our sales. Accordingly, our success depends in significant part upon our ability to
attract, retain and motivate a large base of distributors. Our direct selling organization is
headed by a relatively small number of key distributors. The loss of a significant number of
distributors, including any key distributors, could materially and adversely affect sales of our
products and could impair our ability to attract new distributors. Moreover, the replacement of
distributors could be difficult because, in our efforts to attract and retain distributors, we
compete with other direct selling organizations, including but not limited to those in the personal
care, cosmetic product and nutritional supplement industries. Our distributors may terminate their
services with us at any time and, in fact, like most direct selling organizations, we have a high
rate of attrition.
Following a 97% and 33% increase in active distributors in 2004 and 2005, we experienced a 19%
decrease in active distributors during 2006 (excluding KGC and the Kaire Entities which were sold
during 2005 and 2006, respectively) and a 41% decrease in active distributors during 2007. The
number of active distributors or their productivity may not increase and could further decline in
the future. Distributors may terminate their services at any time, and, like most direct selling
companies, we experience a high turnover in our distributor ranks. We cannot accurately predict
any fluctuation in the number and productivity of distributors because we primarily rely upon
existing distributors to sponsor and train new distributors and to motivate new and existing
distributors. Operating results could be adversely affected if our existing and new business
opportunities and products do not generate sufficient economic incentive or interest to retain
existing distributors and to attract new distributors.
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Changes to Our Distributor Compensation Plan May Not Gain Acceptance
We completed implementation of a change in our compensation plan for distributors during the
second quarter of 2007. Among other things, this change introduced a new bonus value builder
feature allowing independent distributors to customize their product packages, as opposed to having
to select assortments pre-determined by us, and reduced certain thresholds for earning commissions
so that they can be earned earlier and quicker. This change also eliminated a direct bonus feature
of the plan.
This change did not gain wide acceptance and, in March 2008, we reverted to a modified version
of our previous compensation plan for distributors. Thresholds for earning commissions and a
direct bonus feature were re-introduced and the payout ratio of certain commissions was increased.
If distributors fail to understand the compensation plan or are unhappy with it, we could lose
distributors and fail to attract new distributors.
Because Our Hong Kong Operations Account For A Majority Of Our Business, Any Adverse Changes In Our
Business Operations In Hong Kong Would Materially Harm Our Business.
In 2006 and 2007 approximately 67% and 62% of our revenue, respectively, was generated in Hong
Kong. Various factors could harm our business in Hong Kong, such as worsening economic conditions
or other events that are out of our control. For example, on April 12, 2004, a television program
was aired in China with respect to the operations of our Hong Kong subsidiary and our
representative office located in Beijing. The television program alleged that our Hong Kong
operations engaged in fraudulent activities and sold products without proper permits. Due to the
adverse publicity caused by the airing of the television program, revenues from Hong Kong declined
significantly. There have been other isolated cases of alleged misconduct by our members in China.
If the alleged misconduct of our members in China is finally determined to be illegal and
attributable to us or our subsidiaries, then this could have a material adverse effect on our
financial condition and results of operations. In July 2007, we were advised to voluntarily
suspend marketing activities in China during the third quarter of 2007 when the Chinese government
was expected to impose a more intense enforcement program against illegal chained sales activities.
We did not want to run the risk of being inadvertently entangled in the government enforcement
actions and voluntarily withdrew all marketing activities from China during that period. It may be
necessary or advisable to repeat this action from time to time in the future, and such self-imposed
periods of reduced activity could have a material adverse effect on our financial condition and
results of operations.
Our Business In Hong Kong, Which Represented 62% Of Our Revenue In 2007, May Be Harmed By The
Results Of Increased Government Scrutiny Of Our Current And Proposed Operations In China.
From 1998 to 2005, direct selling was restricted in China to ten companies that had an
approval that we do not currently have. In November 2005, the Chinese government adopted
anti-multilevel marketing legislation ahead of its December 2005 adoption of legislation to
legalize direct selling. Since December 2005, additional companies have been granted a direct
selling license, though based on our understanding not all granted licenses were activated and some
had been revoked. Meanwhile, the government has rigorously monitored multi-level marketing
activities and somewhat inconsistently enforced these laws. In the past, the government has taken
significant actions against certain companies, including at least one that has obtained a direct
selling license, that the government found in violation of applicable laws. Governmental actions
included shutting down their businesses and arresting alleged perpetrators. Consequently, a few of
our direct selling peer companies have modified their business models and started selling to
Chinese consumers through owned, leased or franchised retail outlets. We have not implemented a
direct sales model in China although we have applied for a direct selling license. Instead, we
have launched an e-commerce retail model. We cannot conduct direct selling operations in China
until such time as we have a direct selling license. Further, the Chinese entity operates
separately from the Hong Kong entity, though a Chinese consumer may elect to participate separately
in both. While it is not certain if the Chinese government will render the same opinion as we do
regarding this model, we believe that the China entity will be compliant as it will not be
operating a direct selling model in China until it receives a direct selling license.
We Could Be Required To Modify Our Compensation Plan In China In A Way That Could Make It Less
Attractive To Members, And This Could Have A Significant Adverse Effect On Our Revenue.
We could be required to modify our compensation plan in China in a way that could make it less
attractive to members. Any such modification to our compensation plan could, therefore, have a
material adverse effect on revenue. Moreover, the business model that we are implementing in China
will likely involve costs and expenses that we do not generally incur in the e-commerce business
that we have historically operated in other markets, including Hong Kong. As a result, the
business that we ultimately are able to conduct in China could be materially less profitable than
the e-commerce business that we have historically operated in Hong Kong.
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Our E-Commerce Business In Hong Kong, Which Represents A Significant Portion Of Our Total Revenue,
Could Be Adversely Affected By The Activities Of The Members in China, If Members In China Engage
In Activities That Are Deemed To Violate Chinas Anti-Multilevel Marketing Laws.
While we have strictly forbidden any of our members in China to engage in activities that
violate Chinas anti-multilevel marketing laws, some of our members in China have engaged in such
activities. In Dongguan, four of our members were detained for questioning in October 2005 with
regard to possible violation of Chinese law regarding the maximum number of people who can attend a
meeting as well as possible improper network marketing business activity. Charges were never filed
and all individuals were released. In April, 2006, a media report indicated that someone was
detained by Public Security in Changsha for investigation of similar allegations. We have not been
able to determine if the individual in question is, in fact, a member and whether or not any laws
were actually broken. Initial inquiries made by retained Chinese counsel indicate that no one is
still being detained or has been charged. Reviews and investigations of such activities by
government regulators, if any are commenced, could restrict our ability to conduct business.
Most of our Hong Kong revenues are derived from the sale of products that are delivered to
members in China. We operate an e-commerce direct selling model in Hong Kong and recognize this
revenue as being generated in Hong Kong. Orders are taken in Hong Kong. Commissions are earned by
members in China based on the same binary model used by us throughout the world and are recorded
and paid in Hong Kong and denominated in Hong Kong Dollars. Commission incomes are declared to the
tax authorities in Hong Kong. Members who order the products register themselves with a Hong Kong
address and tax identification number. None of the servers on which our Hong Kong e-commerce
activities are conducted are located in China. Products purchased by members in China are
delivered by us to a third party that acts as the importer of record under an agreement to pay
applicable duties. From April 2005 through December 2005, the importer of record was a related
party. See Note 12 in the accompanying consolidated financial statements.
We believe that the laws and regulations in China regarding direct selling and multi-level
marketing are not specifically applicable to our Hong Kong based e-commerce activity. Nor are we
aware of any specific laws or regulations in China, or any official interpretation thereof, that
govern this Hong Kong centered e-commerce activity. However, there can be no assurance that such
laws, regulations or interpretations will not be adopted in the future. Should such laws, rules or
interpretations be adopted or should the government determine that our e-commerce activity violates
Chinas anti-multilevel marketing legislation, there could be a material adverse effect on our
business, cash flow and financial statements. There is no way we can estimate the effect of such
an adverse effect.
Although we would attempt to work closely with both national and local governmental agencies
in implementing our plans, our efforts to comply with national and local laws may be harmed by a
rapidly evolving regulatory climate, concerns about activities resembling violations of
anti-multi-level marketing legislation and any subjective interpretation of laws. Any determination
that our operations or activities, or the activities of our employee sales representatives,
distributors living outside of China or importers of record are not in compliance with applicable
regulations could result in the imposition of substantial fines, extended interruptions of
business, restrictions on our future ability to obtain business license or expand into new
locations, substantially diminishing our ability to retain existing sales representatives and
attract new sales representatives, changes to our business model, the termination of required
licenses to conduct business, or other actions, all of which would harm our business.
If We Fail To Obtain A Direct Selling License In China, Our Future Business Could Be Harmed.
The Chinese government has adopted new direct selling legislation as of December 1, 2005. We
submitted an application for a direct selling license in December 2005 and, after rules changes,
re-submitted an application package in June 2006. In November 2007, we filed a new, revised direct
selling application incorporating a name change, our new e-commerce model and other developments.
We think we meet all of the legal requirements, including capitalizing our Chinese entity with a
$12.0 million cash infusion, but there can be no assurance that a license will be granted. We
currently operate an e-commerce retail model in China that is linked to a members position in Hong
Kong. If we are able to obtain a direct selling license in China, the license would provide us
with more options to do business. If we do not obtain the license, we will be impacted but we do
not believe that we would be materially adversely affected under our current model.
Failure To Properly Pay Business Taxes Or Customs Duties, Including Those In China, Could Have A
Material Adverse Effect.
In the course of doing business we may be subject to various taxes, such as sales and use,
value-added, franchise, income, and import duty. The failure to properly calculate, report and pay
such taxes when we are subject to them could have a material adverse
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effect on our financial condition and results of operations. Moreover, any change in the law
or regulations regarding such taxes, or any interpretation thereof, could result in an increase in
the cost of doing business.
Between April and December 2005, our Hong Kong subsidiary engaged a service provider to
facilitate product importation into China and act, or engage another party to act, as the importer
of record. The individual that owns that service provider was one of the directors of our
wholly-owned Chinese subsidiary. We believe that the amount of duty paid to Chinese Customs on the
imported goods by the importer of record was paid at the negotiated rate. However, there can be no
assurance that Chinese Customs will not elect, in the future, to examine the duty paid, and if they
conduct such examination, they may conclude that the valuation established was insufficient,
resulting in an underpayment of duties. As a consequence, the importer of record could be required
to pay additional duties and possible penalties to Chinese Customs. Additional duties could range
between zero and $46.0 million, plus penalties. The extreme worst case was calculated using the
highest possible assessment to the highest possible declared value and assuming that negotiated
valuation practices do not apply. We believe that any such future assessment of additional duties
or penalties would be made against and become the responsibility of the importer of record. There
can be no assurance that we or our subsidiaries would not be assessed with such liability in the
event that the importer of record is unable to pay all or part of such amount.
If We Continue To Operate In Foreign Markets Our Business Becomes Increasingly Subject To Political
And Economic Risks. Changes In These Markets Could Adversely Affect Our Business.
We believe that our ability to achieve future growth is dependent in part on our ability to
continue our international expansion efforts. However, there can be no assurance that we would be
able to grow in our existing international markets, enter new international markets on a timely
basis, or that new markets would be profitable. We must overcome significant regulatory and legal
barriers before we can begin marketing in any foreign market.
Also, it is difficult to assess the extent to which our products and sales techniques would be
accepted or successful in any given country. In addition to significant regulatory barriers, we may
also encounter problems conducting operations in new markets with different cultures and legal
systems from those encountered elsewhere. We may be required to reformulate certain of our
products before commencing sales in a given country. Once we have entered a market, we must adhere
to the regulatory and legal requirements of that market. No assurance can be given that we would
be able to successfully reformulate our products in any of our current or potential international
markets to meet local regulatory requirements or attract local customers. The failure to do so
could have a material adverse effect on our business, financial condition, and results of
operations. There can be no assurance that we would be able to obtain and retain necessary permits
and approvals.
In many markets, other direct selling companies already have significant market penetration,
the effect of which could be to desensitize the local distributor population to a new opportunity,
or to make it more difficult for us to recruit qualified distributors. There can be no assurance
that, even if we are able to commence operations in foreign countries, there would be a
sufficiently large population of potential distributors inclined to participate in a direct selling
system offered by us. We believe our future success could depend in part on our ability to
seamlessly integrate our business methods, including distributor compensation plan, across all
markets in which our products are sold. There can be no assurance that we would be able to further
develop and maintain a seamless compensation program.
An Increase In The Amount Of Compensation Paid To Distributors Would Reduce Profitability.
A significant expense is the payment of compensation to our distributors, which represented
approximately 51% and 46% of net sales during 2006 and 2007, respectively. Factors impacting the
overall commission payout include the growth and depth of the distributor network, the distributor
retention rate, the level of promotions, local promotional programs and business development
agreements. We compensate our distributors by paying commissions, bonuses, and certain awards and
prizes. We closely monitor the amount of compensation paid to distributors as a percentage of net
sales and have recently implemented adjustments to our compensation plan to provide, in our view, a
more viable and sustainable business model for both us and our distributors. There can be no
assurance that these changes or future changes to our compensation plan or product pricing would be
successful in maintaining the level of distributor compensation expense as a percentage of net
sales. Furthermore, these changes may make it difficult to recruit and retain qualified and
motivated distributors. An increase in compensation payments to distributors as a percentage of
net sales will reduce our profitability.
We Do Not Have Product Liability Insurance And Product Liability Claims Could Hurt Our Business.
Currently, we do not have product liability insurance, although the insurance carried by our
suppliers may cover certain product liability claims against us. As a marketer of nutraceuticals,
cosmetics and other products that are ingested by consumers or applied to their bodies, we may
become subjected to various product liability claims, including that:
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If our suppliers product liability insurance fails to cover product liability claims or other
product liability claims, or any product liability claims exceeds the amount of coverage provided
by such policies or if we are unsuccessful in any third party claim against the manufacturer or if
we are unsuccessful in collecting any judgment that may be recovered by us against the
manufacturer, we could be required to pay substantial monetary damages which could materially harm
our business, financial condition and results of operations. As a result, we may become required to
pay higher premiums and accept higher deductibles in order to secure adequate insurance coverage in
the future. Especially since we do not have direct product liability insurance, it is possible
that product liability claims and the resulting adverse publicity could negatively affect our
business.
Our Internal Controls And Accounting Methods May Require Further Modification.
We modified certain of our accounting policies and made other adjustments to our accounting
for past transactions, which resulted in the restatement of our financial statements for each
quarter in 2001, 2002, and 2003, for the years ended December 31, 2001, 2002, 2003, and 2005, as
well as the first quarter in 2004. In connection with the restatement of our financial statements,
many of the restatement items were the result of material weaknesses in our internal controls and
procedures. Also, in November 2005, our top two officers at the time, Mark Woodburn and Terry
LaCore, our President and the Chief Executive Officer of NHT Global, Inc., our United States
subsidiary (NHT Global U.S.), respectively, were terminated due to management misconduct.
We continue to develop controls and procedures and plan to implement additional controls and
procedures sufficient to accurately report our financial performance on a timely basis in the
foreseeable future. If we are unable to develop and implement effective controls and procedures,
we may not be able to report our financial performance on a timely basis and our business and stock
price would be adversely affected.
If We Fail To Maintain An Effective System Of Internal Controls In The Future, We May Not Be Able
To Accurately Report Our Financial Results Or Prevent Fraud. As A Result, Investors May Lose
Confidence In Our Financial Reporting.
The Sarbanes-Oxley Act of 2002 requires that we report annually on the effectiveness of our
internal control over financial reporting. Among other things, we must perform systems and
processes evaluation and testing. We must also conduct an assessment of our internal controls to
allow management to report on our assessment of our internal control over financial reporting, as
required by Section 404 of the Sarbanes-Oxley Act. We are required to provide managements
assessment of internal controls in conjunction with the filing of this report and we expect that we
and other non-accelerated filers will be required to provide an auditors attestation on our
internal controls as of December 31, 2009, in the Form 10-K to be filed in the first quarter of
2010. As disclosed under Item 9A(T) of this report, our management concluded that in light of a
combination of deficiencies at our subsidiary in Taiwan, our internal control over financial
reporting was not effective at December 31, 2007. In the future, our continued assessment, or the
assessment by our independent registered public accounting firm, could reveal significant
deficiencies or material weaknesses in our internal controls, which may need to be disclosed in
future Annual Reports on Form 10-K. We believe, at the current time, that we are taking
appropriate steps to mitigate these risks. However, disclosures of this type can cause investors
to lose confidence in our financial reporting and may negatively affect the price of our common
stock. Moreover, effective internal controls are necessary to produce reliable financial reports
and to prevent fraud. Deficiencies in our internal controls over financial reporting may
negatively impact our business and operations.
We Rely On And Are Subject To Risks Associated With Our Reliance Upon Information Technology
Systems.
Our success is dependent on the accuracy, reliability, and proper use of information
processing systems and management information technology. Our information technology systems are
designed and selected to facilitate order entry and customer billing, maintain distributor records,
accurately track purchases and distributor compensation payments, manage accounting operations,
generate reports, and provide customer service and technical support. Although we acquired
MarketVision Communications Corporation (MarketVision), our distributor software service
provider, during the first half of 2004, in part, to gain greater control over its operations, any
interruption in these systems could have a material adverse effect on our business, financial
condition, and results of operations.
In connection with our acquisition of MarketVision in 2004, we and MarketVision entered into a
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
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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 our market value per share 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 our 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 would occur
prior to December 31, 2006. No further amendments have been entered into, and as a result, we are
currently in default.
Although an Event of Default has occurred, we believe that we continue to have the right to
use the MarketVision software for 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, we believe that we have the right to receive certain
application service provider services from Licensee, if it chooses to do so. We do not believe
that the occurrence of the Event of Default has had or will have a material adverse effect on us.
Regulatory Matters Governing Our Industry Could Have A Significant Negative Effect On Our Business.
In both our United States and foreign markets, we are affected by extensive laws, governmental
regulations, administrative determinations, court decisions and similar constraints. Such laws,
regulations and other constraints may exist at the federal, state or local levels in the United
States and at all levels of government in foreign jurisdictions. There can be no assurance that we
or our distributors are in compliance with all of these regulations. Our failure or our
distributors failure to comply with these regulations or new regulations could lead to the
imposition of significant penalties or claims and could negatively impact our business. In
addition, the adoption of new regulations or changes in the interpretations of existing regulations
may result in significant compliance costs or discontinuation of product sales and may negatively
impact the marketing of our products, resulting in significant loss of sales revenues.
Direct Selling System
Our direct selling system is subject to a number of federal and state regulations administered
by the Federal Trade Commission (the FTC) and various state agencies as well as regulations in
foreign markets administered by foreign agencies. Regulations applicable to direct selling
organizations generally are directed at ensuring that product sales ultimately are made to
consumers and that advancement within the organizations is based on sales of the organizations
products rather than investments in the organizations or other non-retail sales related criteria.
We are subject to the risk that, in one or more markets, our marketing system could be found not to
be in compliance with applicable regulations. The failure of our direct selling system to comply
with such regulations could have a material adverse effect on our business in a particular market
or in general.
We are also subject to the risk of private party challenges to the legality of our direct
selling system. The regulatory requirements concerning direct selling systems do not include
bright line rules and are inherently fact-based. An adverse judicial determination with respect
to our direct selling system, or in proceedings not involving us directly but which challenge the
legality of other direct selling marketing systems, could have a material adverse effect on our
business.
On April 12, 2006 the FTC issued a notice of proposed rulemaking which, if implemented, will
regulate all sellers of business opportunities in the United States. The proposed rule would,
among other things, require all sellers of business opportunities, which would likely include us,
to (i) implement a seven day waiting period before entering into an agreement with a prospective
business opportunity purchaser, and (ii) provide all prospective business opportunity purchasers
with substantial information in writing at the beginning of the waiting period regarding the
business opportunity, including information relating to: representations made as to the earnings
experience of other business opportunity purchasers, the names and telephone numbers of recent
purchasers in their geographic area, cancellation or refund policies and requests within the prior
two years, certain legal actions against the company, its affiliated companies and company
officers, directors, sales managers and certain others. The Direct Selling Association (the DSA)
and other interested parties have filed over 17,000 comments with the FTC that are publicly
available regarding the proposed rule through the FTCs website at
http://www.ftc.gov/os/comments/businessopprule/index.htm. The DSA and other interested parties
also filed rebuttal comments with the FTC in September 2006. Based on information currently
available, we anticipate that the final rule may require several years to become final and
effective, and may differ substantially from the rule as originally proposed. Nevertheless the
proposed rule, if implemented in its original form, would negatively impact our business in the
United States.
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Product Regulations
The formulation, manufacturing, packaging, labeling, distribution, importation, sale and
storage of certain of our products are subject to extensive regulation by various federal agencies,
including the U.S. Food and Drug Administration (FDA), FTC, the Consumer Product Safety
Commission and the United States Department of Agriculture and by various agencies of the states,
localities and foreign countries in which our products are manufactured, distributed and sold.
Failure by our distributors or us to comply with those regulations could lead to the imposition of
significant penalties or claims and could materially and adversely affect our business. In
addition, the adoption of new regulations or changes in the interpretation of existing regulations
may result in significant compliance costs or discontinuation of product sales and may adversely
affect the marketing of our products, resulting in significant loss of sales revenues.
On March 7, 2003, the FDA proposed a new regulation to require current Good Manufacturing
Practices (cGMPs), affecting the manufacture, packing, and holding of dietary supplements. The
proposed regulation would establish standards to ensure that dietary supplements and dietary
ingredients are not adulterated with contaminants or impurities, and are labeled to accurately
reflect the active ingredients and other ingredients in the products. It also includes proposed
requirements for designing and constructing physical plants, establishing quality control
procedures, and testing manufactured dietary ingredients and dietary supplements, as well as
proposed requirements for maintaining records and for handling consumer complaints related to
cGMPs. We are evaluating this proposal with respect to its potential impact upon the various
contract manufacturers that we use to manufacture our products, some of whom might not meet the new
standards.
Product Claims, Advertising and Distributor Activities
Our failure to comply with FTC or state regulations, or with regulations in foreign markets
that cover our product claims and advertising, including direct claims and advertising by us, as
well as claims and advertising by distributors for which we may be held responsible, may result in
enforcement actions and imposition of penalties or otherwise materially and adversely affect the
distribution and sale of our products. Distributor activities in our existing markets that violate
applicable governmental laws or regulations could result in governmental or private actions against
us in markets where we operate. Given the size of our distributor force, we cannot assure that our
distributors would comply with applicable legal requirements.
Transfer Pricing and Similar Regulations
In many countries, including the United States, we are subject to transfer pricing and other
tax regulations designed to ensure that appropriate levels of income are reported as earned by our
United States or local entities and are taxed accordingly. In addition, our operations are subject
to regulations designed to ensure that appropriate levels of customs duties are assessed on the
importation of our products.
Our principal domicile is the United States. Under tax treaties, we are eligible to receive
foreign tax credits in the United States for taxes paid abroad. If our operations expand outside
the United States, taxes paid to foreign taxing authorities may exceed the credits available to us,
resulting in the payment of a higher overall effective tax rate on our worldwide operations.
We have adopted transfer pricing agreements with our subsidiaries to regulate inter-company
transfers, which agreements are subject to transfer pricing laws that regulate the flow of funds
between the subsidiaries and the parent corporation for product purchases, management services, and
contractual obligations, such as the payment of distributor compensation. In 2005, we implemented
a foreign holding and operating company structure for our non-United States businesses, although we
have since discontinued our operational use of this structure to reduce costs and because we
determined that our United States operating losses will lower our overall effective tax rate.
We believe that we operate in compliance with all applicable transfer pricing laws and we
intend to continue to operate in compliance with such laws. However, there can be no assurance
that we will continue to be found to be operating in compliance with transfer pricing laws, or that
those laws would not be modified, which, as a result, may require changes in our operating
procedures.
Taxation Relating To Distributors
Our distributors are subject to taxation, and in some instances legislation or governmental
agencies impose an obligation on us to collect the taxes, such as value added taxes, and to
maintain appropriate records. In addition, we are subject to the risk in some jurisdictions of
being responsible for social security and similar taxes with respect to our distributors.
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Other Regulations
We are also subject to a variety of other regulations in various foreign markets, including
regulations pertaining to employment and severance pay requirements, import/export regulations and
antitrust issues. Our failure to comply or assertions that we fail to comply with these
regulations could have a material adverse effect on our business in a particular market or in
general.
To the extent we decide to commence or expand operations in additional countries, government
regulations in those countries may prevent or delay entry into or expansion of operations in those
markets. In addition, our ability to sustain satisfactory levels of sales in our markets is
dependent in significant part on our ability to introduce additional products into the markets.
However, government regulations in both our domestic and international markets can delay or prevent
the introduction, or require the reformulation or withdrawal, of some of our products.
Currency Exchange Rate Fluctuations Could Lower Our Revenue And Net Income.
In 2006 and 2007, approximately 89% and 90%, respectively, 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 almost all inventories in U.S. dollars.
Our foreign currency exchange rate exposure, mainly to Korean won, New Taiwan dollar, Singapore
dollar, Japanese yen, Mexican peso, Chinese yuan, and European euro, represented approximately 26%
of our revenue in 2007. Our foreign currency exchange rate exposure may increase in the near
future as our China and European subsidiaries expand 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.
Given our inability to predict the degree of exchange rate fluctuations, we cannot estimate
the effect these fluctuations may have upon future reported results, product pricing or our overall
financial condition. Further, to date we have not attempted to reduce our exposure to short-term
exchange rate fluctuations by using foreign currency exchange contracts.
Failure Of New Products To Gain Distributor And Market Acceptance Could Harm Our Business.
An important component of our business is our ability to develop new products that create
enthusiasm among our distributor force. If we fail to introduce new products on a timely basis,
our distributor productivity could be harmed. In addition, if any new products fail to gain market
acceptance, are restricted by regulatory requirements, or have quality problems, this would harm
our results of operations. Factors that could affect our ability to continue to introduce new
products include, among others, limited capital resources, government regulations, proprietary
protections of competitors that may limit our ability to offer comparable products and any failure
to anticipate changes in consumer tastes and buying preferences.
System Failures Could Harm Our Business.
Because of our diverse geographic operations and our internationally applicable distributor
compensation plans, our business is highly dependent on efficiently functioning information
technology systems provided by MarketVision. The MarketVision systems and operations are
vulnerable to damage or interruption from fires, earthquakes, telecommunications failures, computer
viruses and worms, hacking, disruption of service attacks, software defects and other events. They
are also subject to break-ins, sabotage, acts of vandalism and similar misconduct. Despite
precautions implemented by the staff of MarketVision, problems could result in interruptions in
services and materially and adversely affect our business, financial condition and results of
operations.
We Have A Limited Product Line.
We offer a limited number of products under our NHT Global brand. Our Premium Noni Juice ,
Skindulgence ® , Alura ® and La Vie products each account for a significant
portion of our total sales and, together, account for a significant majority of our total sales.
If demand for any of these four products
decreases significantly, government regulation restricts the sale of these products, we are
unable to adequately source or deliver these products (we currently source two of these products
from a single supplier and the
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other two products from two other suppliers), or we cease offering any of these products for
any reason without a suitable replacement, our business, financial condition and results of
operations could be materially and adversely affected.
We Do Not Manufacture Our Own Products So We Must Rely On Independent Third Parties For The
Manufacturing And Supply Of Our Products.
All of our products are manufactured by independent third parties. There is no assurance that
our current manufacturers will continue to reliably supply products to us at the level of quality
we require. In the event any of our third-party manufacturers become unable or unwilling to
continue to provide the products in required volumes and quality levels at acceptable prices, we
will be required to identify and obtain acceptable replacement manufacturing sources. There is no
assurance that we will be able to obtain alternative manufacturing sources or be able to do so on a
timely basis. An extended interruption in the supply of our products will result in a substantial
loss of sales. In addition, any actual or perceived degradation of product quality as a result of
our reliance on third party manufacturers may have an adverse effect on sales or result in
increased product returns and buybacks.
The High Level Of Competition In Our Industry Could Adversely Affect Our Business.
The business of marketing personal care, cosmetic, nutraceutical, and lifestyle enhancement
products is highly competitive. This market segment includes numerous manufacturers, distributors,
marketers, and retailers that actively compete for the business of consumers both in the United
States and abroad. The market is highly sensitive to the introduction of new products, which may
rapidly capture a significant share of the market. Sales of similar products by competitors may
materially and adversely affect our business, financial condition and results of operations.
We are subject to significant competition for the recruitment of distributors from other
direct selling organizations, including those that market similar products. Many of our
competitors are substantially larger than we are, offer a wider array of products, have far greater
financial resources and many more active distributors than we have. Our ability to remain
competitive depends, in significant part, on our success in recruiting and retaining distributors
through an attractive compensation plan and other incentives. We believe that our compensation and
incentive programs provide our distributors with significant earning potential. However, we cannot
be sure that our programs for recruitment and retention of distributors would be successful.
Terrorist Attacks, Cyber Attacks, Acts Of War, Epidemics Or Other Communicable Diseases Or Any
Other Natural Disasters May Seriously Harm Our Business.
Terrorist attacks, cyber attacks, or acts of war or natural disasters may cause damage or
disruption to us, our employees, our facilities and our customers, which could impact our revenues,
expenses and financial condition. The potential for future terrorist attacks, the national and
international responses to terrorist attacks, and other acts of war or hostility, such as the
Chinese objection to the Taiwan independence movement and its resultant tension in the Taiwan
Strait, could materially and adversely affect our business, results of operations, and financial
condition in ways that we currently cannot predict. Additionally, natural disasters less severe
than the Indian Ocean tsunami that occurred in December 2004 may adversely affect our business,
financial condition and results of operations.
Disappointing Quarterly Revenue Or Operating Results Could Cause The Price Of Our Common Stock To
Fall.
Our quarterly revenue and operating results are difficult to predict and may fluctuate
significantly from quarter to quarter. If our quarterly revenue or operating results fall below
the expectations of investors or securities analysts, the price of our common stock could fall
substantially.
Our Common Stock Is Particularly Subject To Volatility Because Of The Industry In Which We Operate.
The market prices of securities of direct selling companies have been extremely volatile, and
have experienced fluctuations that have often been unrelated or disproportionate to the operating
performance of such companies. These broad market fluctuations could adversely affect the market
price of our common stock.
There Is No Assurance That An Active Public Trading Market Will Continue.
There can be no assurance that an active public trading market for our common stock will be
sustained. If for any reason an active public trading market does not continue, purchasers of the
shares of our common stock may have difficulty in selling their securities should they desire to do
so and the price of our common stock may decline.
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If We Fail To Regain Compliance With Nasdaqs Independent Director, Audit Committee And
Compensation Committee Requirements, Our Common Stock May Be Delisted From The Nasdaq Global
Market, Which May Reduce The Price Of Our Common Stock And Levels Of Liquidity Available To Our
Stockholders.
Our continued listing on the Nasdaq Global Market requires us to comply with Nasdaq
independent director, audit committee and compensation committee requirements. As disclosed in
prior filings, Anthony B. Martino resigned from our board of directors on October 19, 2007, leaving
us with one independent director on our two member board of directors, and compensation and audit
committees comprised of two members each (one independent and the other serving under exceptional
and limited circumstances). As a result, we received a letter from The Nasdaq Stock Market (the
Nasdaq Letter) stating that we are not in compliance with the independent director, audit
committee and compensation committee requirements for continued listing. As set forth in the
Nasdaq Letter, Nasdaq provided us with a cure period in order to regain compliance with these
Nasdaq requirements until the earlier of our next annual stockholders meeting or October 19, 2008,
or, if our next annual stockholders meeting is held before April 16, 2008, then we must have it in
compliance by that date. We intend to regain compliance within this cure period, but if we fail to
do so, our common stock may be delisted from the Nasdaq Global Market. If our common stock is
delisted, it may become more difficult for our stockholders to sell our stock in the public market
and the price of our common stock may be adversely affected. Delisting from the Nasdaq Global
Market could also result in other negative implications including the potential loss or reduction
of confidence by customers, creditors, suppliers and employees, the potential loss or reduction of
investor interests, and fewer business development opportunities, any of which could materially
adversely affect our results of operations and financial condition.
If Securities Analysts Do Not Publish Research Or Reports About Our Business Or If They Downgrade
Our Stock, The Price Of Our Stock Could Decline.
The trading market for our shares of common stock could rely in part on the research and
reporting that industry or financial analysts publish about us or our business. We do not control
these analysts. We are unaware of any analyst currently following our stock. Furthermore, if one
or more of the analysts who do cover us downgrades our stock, the price of our stock could decline.
If one or more of these analysts ceases coverage of our company, we could lose visibility in the
market, which in turn could cause our stock price to decline.
We Have Broad Discretion To Use The Proceeds Of Our Recent Private Placement Financings.
We have broad discretion in spending the net proceeds generated by our May 2007 and October
2007 private placements. We may spend most of the net proceeds from the private placements in ways
that ultimately prove unsuccessful. Our failure to apply these funds effectively could have a
material adverse effect on our business, results of operations and financial condition, and may
also require further funding, which could dilute stockholders ownership and cause a decline in the
share price of our common stock.
Leverage And Debt Service Obligations May Adversely Affect Our Cash Flows.
In connection with our sale of variable rate convertible debentures in October 2007, we
incurred new indebtedness of $4,250,000. As a result of this indebtedness, we incurred significant
principal and interest payment obligations. The degree to which we are leveraged could, among
other things:
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require us to dedicate a substantial portion of our future cash flows from operations
and other capital resources to debt service, especially if the debentures are not converted
into shares of common stock or we are otherwise unable to make payments of principal and
interest in shares of common stock; |
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make it difficult for us to obtain necessary financing in the future for working
capital, acquisitions or other purposes on favorable terms, if at all; |
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make it more difficult for us to be acquired; |
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make us more vulnerable to industry downturns and competitive pressures; and |
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limit our flexibility in planning for, or reacting to changes in, our business. |
Our ability to meet our debt service obligations will depend upon our future performance,
which will be subject to financial, business and other factors affecting our operations, many of
which are beyond our control.
20
We Could Be Required To Make Substantial Cash Payments Upon An Event Of Default Under Our Variable
Rate Convertible Debentures.
Our variable rate convertible debentures provide for events of default including, among
others, payment defaults not timely cured, failure to perform other covenants not timely cured,
cross-defaults not timely cured having a material adverse effect on us, representations or
warranties are untrue when made, certain bankruptcy-type events involving us or one of our
significant subsidiaries, acceleration of more than $150,000 in indebtedness for borrowed money or
under a long-term leasing or factoring agreement, our common stock is no longer listed on an
eligible market, we are subject to certain changes in control or we sell or dispose of more than
40% of our assets in a single or series of related transactions, the registration statement
covering the shares of common stock underlying the debentures and warrants issued in our October
2007 financing is not declared effective, lapses or otherwise cannot be used beyond specified
periods, failure to timely deliver certificates for converted shares, and a judgment in excess of
$250,000 against us, any subsidiary or our respective assets that is not timely vacated, bonded or
stayed. Upon an event of default, the holders of the debentures may elect to accelerate the
payment of all amounts due under the debentures and require that 115% of the outstanding debenture
principal be paid. If an event of default occurs, our available cash could be seriously depleted
and our ability to fund operations could be materially harmed.
We Are Responsible For Maintaining The Effectiveness of Registration Statements Covering The Resale
Of Shares Of Common Stock Underlying Certain of Our Convertible Securities Issued In Our 2007
Private Placement Financings And Will Incur Liquidated Damage Payment Obligations And May Be
Subject To Other Liabilities If They Are Not Maintained or If We Fail To Perform Certain Other
Obligations In The Related Registration Rights Agreements.
Pursuant to our registration rights agreement with the investors in our October 2007
financing, we are obligated to maintain (a) the effectiveness of the registration statement
covering the resale of certain of the shares of our common stock underlying the securities issued
in the financing and (b) the ability of the investors to use the prospectus forming a part thereof
for a specified period. If we fail to comply with this or certain other provisions in the
registration rights agreement, then we will be required to pay liquidated damages of 2.0% per month
of the aggregate purchase price paid with respect to the unregistered shares of common stock by the
investors in the October 2007 financing until the first anniversary of the closing date of the
financing and 1.0% per month thereafter through the second anniversary of the closing date.
Pursuant to our registration rights agreement with the investors in our May 2007 financing, we
are obligated for a specified period of time to maintain the effectiveness of the registration
statement that we filed with the SEC covering the resale of the shares of common stock issuable
upon the conversion of Series A preferred stock or the exercise of warrants issued in the
financing. If we fail to maintain the effectiveness of such registration statement due to our
intentional and willful act without immediately causing a subsequent registration statement to be
filed with the Commission, then we will be obligated to pay in cash an amount equal to 2% of the
product of $1.70 times the number of shares of Series A preferred stock sold in the financing to
the relevant purchasers.
The Agreements Governing The Variable Rate Convertible Debentures And Related Warrants Issued In
Our October 2007 Financing Contain Various Covenants And Restrictions That May Limit Our Ability To
Operate Our Business.
The agreements governing the variable rate convertible debentures and related warrants issued
in our October 2007 financing contain various covenants and restrictions, including, among others:
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until the first anniversary of the closing of the October 2007 financing, we are
required to offer to the investors participating therein the opportunity to participate in
subsequent equity securities offerings by us, subject to certain exceptions for, among
other things, strategic investments; |
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until 60 days after the effective date of the registration statement covering the resale
of the related shares of common stock (May 16, 2008), we cannot issue shares of common
stock or equivalent securities, subject to certain exceptions for, among other things,
strategic investments and the issuance of shares of common stock covered by the
registration statement of which this prospectus forms a part; |
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until such time as no investor participating in the financing holds any of the
securities purchased therein, we are prohibited from effecting or entering into an
agreement to effect any financing involving (i) the issuance or sale of common stock or
equivalent securities with an effective price or number of underlying shares that floats or
resets or otherwise varies or is subject to adjustment based on trading prices of or
quotations for shares of common stock, the market for the common stock, or our business or
(iii) any agreement to sell securities at a future-determined price; |
21
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until the earlier of the date that we obtain stockholder approval of the issuance of all
of the shares of common stock underlying the debentures and warrants issued in the October
2007 financing or none of such debentures or warrants are any longer outstanding, neither
we nor any of our subsidiaries may issue common stock or equivalent securities at an
effective price that is less than $3.52 per share; and |
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for so long as any of the debentures issued in the October 2007 financing remain
outstanding, neither we nor any of our subsidiaries may incur indebtedness for borrowed
money other than permitted indebtedness, create or suffer liens other then some permitted
liens, amend our charter documents in certain circumstances, repurchase shares of common
any of our equity securities other then in certain permitted circumstances, repay certain
indebtedness before its due date, pay cash dividends on stock other then our Series A
preferred stock, or enter into certain transactions with affiliates. |
These restrictions could limit our ability to plan for or react to market conditions or meet
extraordinary capital needs or otherwise restrict corporate activities, any of which could have a
material adverse impact on our business.
The Conversion Of Our Variable Rate Convertible Debentures, The Exercise Of Our Warrants Or The
Exercise Or Conversion Of Our Other Convertible Securities May Result In Substantial Dilution And
May Depress The Market Price Of Our Common Stock.
As of March 12, 2008, we had outstanding 10,290,276 shares of common stock and also (i)
options to purchase an aggregate of 55,167 shares of our common stock, all with an exercise price
of $1.80, (ii) warrants outstanding from our October 2004 private placement exercisable for
1,080,504 shares of our common stock at an exercise price equal to $12.47 per share, (iii) warrants
outstanding from our May 2007 private placement exercisable for 2,059,307 shares of our common
stock at an exercise price ranging from $3.80 to $5.00 per share, depending on the time of
exercise, (iv) 138,400 shares of Series A preferred stock, convertible into the same number of
shares of common stock, (v) variable rate convertible debentures issued in our October 2007 private
placement that are currently convertible into 1,700,000 shares of common stock (plus up to an
additional 314,862 shares of common stock that may be issued in certain circumstances under the
terms of the debentures, which additional number of shares would increase in the event that we
obtain stockholder approval of the issuance of all of the shares of common stock potentially
issuable under the terms of the debentures), and (vi) warrants issued in our October 2007 private
placement exercisable for 3,141,499 shares of common stock at an exercise price of $3.52 per share.
If these convertible securities are exercised or converted, and the shares of common stock issued
upon such exercise or conversion are sold, our common stockholders may experience substantial
dilution and the market price of our shares of common stock could decline. Further, the perception
that such convertible securities might be exercised or converted could adversely affect the market
price of our shares of common stock. In addition, holders of our warrants and options are likely to
exercise them when, in all likelihood, we could obtain additional capital on terms more favorable
to us than those provided by the warrants and options. Further, during the time that the foregoing
convertible securities are outstanding, they may adversely affect the terms on which we could
obtain additional capital.
Future Sales By Us Or Our Existing Stockholders Could Depress The Market Price Of Our Common Stock.
If we or our existing stockholders sell a large number of shares of our common stock, the
market price of our common stock could decline significantly. Further, even the perception in the
public market that we or our existing stockholders might sell shares of common stock could depress
the market price of the common stock.
Item 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
Item 2. PROPERTIES
We lease approximately 53,375 square feet in Dallas, Texas for our headquarters and warehouse
space. The warehouse primarily stores products that are bound for international markets. Our
subsidiary, MarketVision, leases office space in Minnesota for its employees.
Outside the United States, we lease office space in Hong Kong, China, Japan, Taiwan,
Singapore, South Korea, Mexico, Italy and Slovenia. In China, we also lease a manufacturing
facility and retail space for our experience centers where prospective consumers sample our
products. We contract with third parties for fulfillment and distribution operations in most of
our international markets. We believe that our existing properties are in good condition, suitable
and adequate for the conduct of our business.
22
Item 3. LEGAL PROCEEDINGS
On or around March 31, 2004, 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 and Terry LaCore (who were officers and directors at that time) and an NHT Global
distributor. 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 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 March 30, 2007, the District Court granted summary
judgment against Mr. Loghry for lack of standing and against the Company on some of its claims.
The Company dismissed its remaining claims against Mr. Loghry and moved for entry of a final
judgment against Mr. Loghry. The Court has declined to enter final judgment against Loghry until
the Trustees Case is resolved. On February 13, 2008, the District Court granted the Companys
motion to dismiss certain of the Trustees fraud and contract claims because the dismissed claims
had been filed too late to be heard. For similar reasons, the District Court also dismissed all
claims made in the Trustees Lawsuit against Messrs. Woodburn and LaCore. A motion for
reconsideration by the Trustee is currently pending. If the motion for reconsideration is denied,
one contract claim will remain against the Company. The Company continues to deny that this claim
has any merit and intends to continue vigorously contesting it. Trial of the Trustees Lawsuit has
been set for October 2008.
On September 11, 2006, a putative class action lawsuit was filed in the United States District
Court for the Northern District of Texas 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 names the Company and certain current and former officers and
directors as defendants. On February 20, 2007, the named plaintiffs filed an amended complaint.
On March 26, 2008, the District Court denied motions to dismiss the amended complaint filed by the
Company and the other defendants. The Company believes that the claims alleged in this lawsuit are
without merit, and the Company intends to vigorously defend this lawsuit.
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 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.
On March 17, 2008, NHT Global U.S. received a copy of a demand for arbitration filed with the
American Arbitration Association in Dallas, Texas by a former distributor, Team in Motion, Inc., a
company that is believed to be owned or controlled by Kosta Gara (also formerly known as Kosta
Gharagozloo). Prior to the termination of Team in Motion, Inc., Mr. Gara (or Team in Motion, Inc.
or another affiliate of Mr. Gara) became the Master Distributor for bHIP Global, Inc., which
competes with the Company for distributors. Team in Motion, Inc. seeks $1,000,000 in damages plus
interest and attorneys fees against the Companys subsidiary. NHT Global U.S. denies the
allegations and intends to vigorously defend this proceeding.
Currently, there is no other material 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.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
23
Part II
Item 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES
Our common stock is quoted on the Nasdaq Global Market under the symbol BHIP. The following
table sets forth the range of high and low intra-day sales prices for our common stock for each of
the periods indicated as reported on the Nasdaq Global Market.
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Quarter Ended: |
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High |
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Low |
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March 31, 2006
|
|
$ |
12.09 |
|
|
$ |
6.35 |
|
June 30, 2006
|
|
|
7.45 |
|
|
|
3.25 |
|
September 30, 2006
|
|
|
3.99 |
|
|
|
2.35 |
|
December 31, 2006
|
|
|
2.75 |
|
|
|
1.26 |
|
|
|
|
|
|
|
|
|
|
March 31, 2007
|
|
$ |
3.15 |
|
|
$ |
1.48 |
|
June 30, 2007
|
|
|
3.87 |
|
|
|
1.71 |
|
September 30, 2007
|
|
|
5.33 |
|
|
|
1.95 |
|
December 31, 2007
|
|
|
7.31 |
|
|
|
1.00 |
|
Holders of Record
At March 12, 2008, there were approximately 250 record holders of our common stock (although
we believe that the number of beneficial owners of our common stock is substantially greater), and
the closing price of our common stock was $0.83 per share as reported by the Nasdaq Global Market.
Dividend Policy
We have never declared or paid any cash dividend on our common stock. We currently intend to
retain earnings, if any, to finance the growth and development of our business. We do not expect
to pay any dividends in the foreseeable future. Payment of any future dividends on shares of our
common stock will be at the discretion of our Board of Directors, subject to a provision contained
in our variable rate convertible debentures prohibiting the payment of any cash dividends on our
equity securities except with respect to cash dividends payable to holders of our shares of our
Series A preferred stock. At December 31, 2007 we had accrued unpaid dividends of $91,000 with
respect to the Series A preferred stock, but such dividends have not been declared and we are under
no obligation to pay such accrued dividends except in certain extraordinary circumstances.
Item 6. SELECTED FINANCIAL DATA
Not applicable under smaller reporting company disclosure rules.
24
Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Overview
We are an international direct-selling organization. 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. Prior to June 1, 2006, we marketed NHT Global branded products under the name,
Lexxus International.
As of December 31, 2007, we are conducting business in at least 13 countries through
approximately 57,000 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 in prior years
expended significant efforts to expand into new markets, we do not intend to devote material
resources to opening any additional foreign markets in the near future. Our priority 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.
In 2006 and 2007, we generated approximately 89% and 90% of our revenue from subsidiaries
located outside North America, respectively, 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 our most important business development project. In June 2004, NHT Global
obtained a general business license in China. The license stipulates a capital requirement of $12
million over a three-year period, including a $1.8 million initial payment we made in January 2005.
Direct selling is prohibited in China and only permitted with a direct selling license. In
December 2005, we submitted a preliminary application for a direct selling license and fully
capitalized our Chinese entity with the remaining capital necessary to fulfill the $12.0 million
required cash infusion. In June 2006, we submitted a revised application package in accordance
with new requirements issued by the Chinese government. In June 2007, we launched a new e-commerce
retail platform in China that does not require a direct selling license and is separate 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. In November 2007, we filed a new, revised direct selling application
incorporating a name change, our new e-commerce model and other developments. We believe a direct
selling license would compliment the business conducted in China under the proposed e-commerce
retail platform, and we plan to submit a new application for a direct selling license in order to
provide certain new information. We are unable to predict whether we will be successful in
obtaining a direct selling license to operate in China, and if it is successful, when we will be
permitted to enhance our 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 its
Hong Kong e-commerce business does not violate any applicable laws in China even though it is used
for the internet purchase 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. In addition, other Chinese
laws regarding how and when members may assemble and the activities that they may conduct, or the
conditions under which the activities may be conducted, in China are subject to interpretations and
enforcement attitudes that sometimes vary from province to province, among different levels of
government, and from time to time. Members sometimes violate one or more of the laws regulating
these activities, notwithstanding training that the Company attempts to provide. Enforcement
measures regarding these violations, which can include arrests, raises the uncertainty and
perceived risk associated with conducting this business, especially among those who are aware of
the enforcement actions but not the specific activities leading to the enforcement. The Company
believes that this has led some existing members in China who are signed up as distributors in
Hong Kong to leave the business or curtail their selling activities and has led potential members
to choose not to participate. Among other things, the Company is combating this with more training
and public relations efforts that are designed, among other things, to distinguish the Company from
businesses that make no attempt to comply with the law. This environment creates uncertainty about
the future of doing this type of business in China generally and under our business model,
specifically.
25
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).
|
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|
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|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
$ |
13,637 |
|
|
|
10.2 |
% |
|
$ |
7,743 |
|
|
|
10.1 |
% |
Hong Kong |
|
|
88,835 |
|
|
|
66.6 |
|
|
|
47,240 |
|
|
|
61.8 |
|
China |
|
|
|
|
|
|
|
|
|
|
538 |
|
|
|
0.7 |
|
Taiwan |
|
|
4,367 |
|
|
|
3.3 |
|
|
|
5,861 |
|
|
|
7.7 |
|
Southeast Asia |
|
|
1,710 |
|
|
|
1.3 |
|
|
|
883 |
|
|
|
1.1 |
|
South Korea |
|
|
12,538 |
|
|
|
9.4 |
|
|
|
9,334 |
|
|
|
12.2 |
|
Australia/New Zealand |
|
|
1,100 |
|
|
|
0.8 |
|
|
|
686 |
|
|
|
0.9 |
|
Japan |
|
|
6,761 |
|
|
|
5.1 |
|
|
|
2,196 |
|
|
|
2.9 |
|
Latin America |
|
|
3,496 |
|
|
|
2.6 |
|
|
|
990 |
|
|
|
1.3 |
|
Other1 |
|
|
293 |
|
|
|
0.2 |
|
|
|
1,030 |
|
|
|
1.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total NHT Global |
|
|
132,737 |
|
|
|
99.5 |
|
|
|
76,501 |
|
|
|
100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
|
507 |
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
Australia/New Zealand |
|
|
184 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total eKaire2 |
|
|
691 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
133,428 |
|
|
|
100 |
% |
|
$ |
76,501 |
|
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Represents product sales to KGC Networks Ptd Ltd. as
part of a separate agreement entered into effective December 31, 2005 upon the
sale of the Companys 51% interest in KGC to Bannks Foundation. |
|
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. |
26
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, generally in their
home country and local currency, for product sold by their down-line distributor network across all
geographic markets, except China, where in the second quarter of 2007 we launched an e-commerce
portal based on a buyers-club concept and do not pay any commissions. 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 basically
two ways in which our distributors can earn income:
|
|
|
Through retail markups on sales of products purchased by distributors at wholesale
prices (in some markets, sales are for personal consumption only and income may not be
earned through retail mark-ups on sales in that market); and |
|
|
|
|
Through commissions paid on product purchases made by their down-line distributors. |
Each of our products is designated a specified number of sales volume points, also called
bonus volume or BV. Commissions are based on total personal and group sales volume points per
sales period. Sales volume points are essentially a percentage of a products wholesale cost. As
the distributors business expands from successfully sponsoring other distributors who in turn
expand their own businesses by sponsoring other distributors, the distributor receives higher
commissions from purchases made by an expanding down-line network. To be eligible to receive
commissions, a distributor may be required to make nominal monthly or other periodic 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. Under our current
compensation plan, certain of our commission payout may be limited to a hard cap in terms of a
specific percentage of total bonus value points. In some markets, commissions may be further
limited. Distributor commissions are dependent on the sales mix and, for 2006 and 2007,
represented 51% and 46% 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. In October 2007, we discontinued our
operational use of this structure to reduce costs and because we determined that our United States
operating losses will lower our overall effective tax rate. We believe that we operate in
compliance with all applicable transfer pricing laws and we intend to continue to operate in
compliance with such laws. However, there can be no assurance that we will continue to be found to
be operating in compliance with transfer pricing laws, or that those laws would not be modified,
which, as a result, may require changes in our operating procedures. 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.
27
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 December 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 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. At December 31, 2006 and 2007, the Companys inventory value was approximately $5.9
million and $3.6 million, respectively, net of reserves of $3.3 million and $1.8 million,
respectively. Due to declining sales, particularly in Mexico and Japan, and the discontinuation of
the Gourmet Coffee Café TM product line, the Company conducted a thorough review of its
inventory during 2006. As a result, a provision for inventory losses of $2.8 million was recorded
to write down inventory to its net realizable value. This provision was based on product
expiration dates, the Companys best estimates of estimated product demand, as well as its future
plans. An additional reserve of $0.5 million was recorded during fiscal 2007 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 December 31, 2007, goodwill of
approximately $1.8 million was reflected on the Companys balance sheet. Goodwill was reduced by
$12.4 million during 2007 as the Company recognized an impairment loss upon completion of its
annual impairment analysis. The annual impairment analysis was based on revised expected future
sales and earnings due to the Companys less than expected operating performance during the latter
half of 2007. The fair value of the Company was estimated using the expected present value of
future cash flows, as well as market capitalization. No impairment of goodwill was recorded during
2006.
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 2006, the Company determined that it was in its best interest
to abandon its Japan distributor gallery. As a result, an impairment charge of $0.9 million was
recorded for certain furniture and fixture, office equipment, and leasehold improvements. Also
during 2006, the Company recorded an impairment charge of $171,000 for its acquired distributor
database. During 2007, the Company recorded an aggregate impairment charge of $0.8 million related
to its Mexico and Japan markets. The charge results from terminating the office lease in Mexico
City and relocating to a less costly location, discontinuing the use of certain computer software
in the Japan office, and an overall impairment as to the recoverability of the remaining long-lived
assets in these markets. These charges are included as a component of selling, general and
administrative expenses. At December 31, 2007, the net book value of the Companys property and
equipment and intangible assets were approximately $1.5 million and $2.6 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 7% of sales. Sales returns are approximately 5% of sales for the years ended
December 31, 2006 and 2007. The allowance for sales returns was approximately $1.8 million and
$0.8 million at December 31, 2006 and 2007, respectively. No material changes in estimates have
been recognized for the year ended December 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 $0.7 million
at December 31, 2006
28
and 2007, respectively. Shipping charges billed to distributors are included in net sales.
Costs associated with shipments are included in cost of sales.
During April 2005, the Company launched a new product line, Gourmet Coffee Café TM,
which consisted of coffee machines and the related coffee and tea pods, in the North American
market. As Gourmet Coffee Café TM was a very different product than the Companys other
products and no reliable information on the Companys sales returns or warranty obligation existed,
the Company deferred all revenue generated from the sale of coffee machines and the related coffee
and tea pods until sufficient return and warranty experience on the product was established. The
deferral totaled approximately $1.6 million and $1.2 million in revenue and related costs,
respectively, for product shipped through December 31, 2005. The deferred costs were recorded in
other current assets, as the sales return period for North American distributors is only for one
year. During 2006, the Company recognized revenue of $1.7 million since the sales return period
had substantially expired and the estimated additional sales returns were considered insignificant.
Upon revenue recognition, the Company also recorded the related cost of sales and distributor
commissions of $1.0 million and $0.3 million, respectively. Also during 2006, the Company decided
to discontinue sales of Gourmet Coffee Café TM products and recorded a charge of $0.5
million to cost of sales for its remaining inventories.
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. At December 31, 2006 and 2007, enrollment
package revenue totaling $4.6 million and $2.8 million was deferred, respectively. 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. During fiscal 2007, no such reduction in the
valuation allowance occurred. Any reductions in the valuation allowance will reduce future income
tax provisions.
Results of Operations
The following table sets forth our operating results as a percentage of net sales for the
periods indicated.
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
100 |
% |
|
|
100 |
% |
Cost of sales |
|
|
24.8 |
|
|
|
26.5 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
75.2 |
|
|
|
73.5 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
51.2 |
|
|
|
45.9 |
|
Selling, general and administrative expenses |
|
|
34.3 |
|
|
|
45.1 |
|
Impairment
of goodwill |
|
|
|
|
|
|
16.2 |
|
Provision for KGC receivable |
|
|
(1.1 |
) |
|
|
(0.7 |
) |
|
|
|
|
|
|
|
Total operating expenses |
|
|
84.4 |
|
|
|
106.5 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(9.2 |
) |
|
|
(33.0 |
) |
Other income, net |
|
|
0.7 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(8.5 |
) |
|
|
(32.8 |
) |
Income tax provision |
|
|
(0.1 |
) |
|
|
(0.3 |
) |
Minority interest |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(8.6 |
)% |
|
|
(33.1 |
)% |
|
|
|
|
|
|
|
Net Sales. Net sales were $76.5 million for the twelve months ended December 31, 2007
compared to $133.4 million for the twelve months ended December 31, 2006, a decrease of $56.9
million, or 43%. This decrease was primarily due to the Companys lower product sales, primarily
resulting from a lower marketing profile during the third quarter of 2007, distractions and
disruptions caused by management changes in the last 18 months through February 2007, a
shareholders demand for action involving some of the
29
Companys Chinese members, and 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 $41.6 million, or 47%, over a year ago. Additionally, net sales for North America, South
Korea, Japan and Latin America were down $5.9 million, $3.2 million, $4.6 million, and $2.5
million, respectively, over the prior year. Partly offsetting the decrease, Taiwan net sales
increased $1.5 million, or 34%, compared to fiscal 2006, and our China subsidiary generated $0.5
million in net sales.
As of December 31, 2007, the operating subsidiaries of the Company had approximately 57,000
active distributors, compared to 96,000 active distributors at December 31, 2006. This decrease is
primarily due to the uncertain regulatory environment in China that is currently impacting the Hong
Kong-based business. Hong Kong experienced a decrease of approximately 27,000 active distributors
since December 31, 2006.
As of December 31, 2007, the Company had deferred revenue of approximately $3.5 million, of
which approximately $0.7 million pertained to product sales and approximately $2.8 million
pertained to unamortized enrollment package revenue.
Cost of Sales. Cost of sales was $20.3 million, or 26.5% of net sales, for the twelve months
ended December 31, 2007 compared with $33.1 million, or 24.8% of net sales, for the twelve months
ended December 31, 2006. Cost of sales decreased $12.8 million, or 39%, over the prior year, due
primarily to the decrease in net sales. Cost of sales as a percentage of net sales increased
primarily due to the decline in enrollment package revenue, specifically in Hong Kong, as this
component of net sales does not contain any corresponding charge to cost of sales, and due to
Chinese importation costs incurred in Hong Kong, as these costs have not declined at the same rate
as net product sales. Alternatively, certain charges recognized in fiscal 2006 were not repeated
during 2007. During 2006, the Company recognized $1.0 million in Gourmet Coffee Café TM
costs previously deferred upon revenue recognition and recorded a charge for additional inventory
reserve of $2.8 million recorded to write down inventory to its net realizable value. This
provision was based on product expiration dates, the Companys best estimates of estimated product
demand, as well as its future plans.
Gross Profit. Gross profit was $56.2 million, or 73.5% of net sales, for the twelve months
ended December 31, 2007 compared with $100.4 million, or 75.2% of net sales, for the twelve months
ended December 31, 2006. This decrease of $44.2 million was mainly due to, as stated above,
decreased product sales, the decline in enrollment package revenue, and Chinese importation costs
incurred in Hong Kong that did not decrease relative to sales.
Distributor Commissions. Distributor commissions were $35.1 million, or 45.9% of net sales,
for the twelve months ended December 31, 2007 compared with $68.3 million, or 51.2% of net sales,
for the twelve months ended December 31, 2006. Distributor commissions decreased by $33.2 million,
or 49%, mainly due to the decrease in product sales, as well as a decrease in the overall
commission rate that resulted from the implementation of a significant commission plan change
during the second quarter of 2007, less supplemental commissions paid in North America, fewer
commissions earned in the newer markets of Japan, Latin America, and Europe, and efforts to align
the overall commission payout in South Korea with our other markets. The result of the last
significant commission plan change during the second quarter of 2007 was less than satisfying.
While the payout as a percentage of sales was lowered, sales have decreased significantly since the
effective date of the change. We decided to reverse some of the changes in March 2008, primarily
in the markets of Hong Kong, the United States, and Taiwan. Additional enhancements were also
added at the same time to improve sales momentum. With these commission changes and enhancements,
we are still targeting that the commission payout will eventually settle around low to mid-40% of
sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
were $34.5 million, or 45.1% of net sales, for the twelve months ended December 31, 2007 compared
with $45.7 million, or 34.3% of net sales, for the twelve months ended December 31, 2006. Selling,
general and administrative expenses decreased by $11.2 million, or 25%, in the twelve months ended
December 31, 2007 mainly due to the following:
|
|
|
lower credit card charges and assessments ($1.0 million) in Hong Kong; |
|
|
|
|
lower employee-related expense ($0.5 million), travel-related costs ($0.4 million),
legal and accounting fees ($2.9 million), litigation settlement costs ($0.1 million),
credit card charges and assessments ($0.2 million), and other general expenses (0.9
million) in North America; |
|
|
|
|
lower convention costs in North America primarily due to the North American
Convention held in the first quarter of 2006 ($1.1 million); |
|
|
|
|
lower overall expense, including impairment loss, in Japan ($4.4 million) and Mexico
($1.3 million) due to expense reduction programs executed in both markets during the
first nine months of 2007; |
|
|
|
|
lower operating costs in Australia due to office closure ($0.3 million); |
|
|
|
|
the elimination of operating expense incurred by the Kaire Entities, which was sold
effective July 1, 2006 ($0.3 million); |
30
|
|
|
the reversal of the reserve established in fiscal 2004 with respect to the
allegations made by the South Korean customs agency regarding importation of Alura into
South Korea ($0.2 million); partly offset by |
|
|
|
|
cost of expansion into Europe ($1.0 million); and |
|
|
|
|
higher professional fees ($1.0 million) and distributor-related costs ($0.5 million)
in Asia. |
Recovery of KGC Receivable. Recovery of KGC receivable was $0.6 million for the year ended
December 31, 2007 compared with $1.4 million a year ago. The decrease in the recovery was due to
the delinquency of KGC on its monthly payments due to the Company since August 2007.
Other Income, Net. Other income was $0.1 million for the year ended December 31, 2007
compared with income of $0.9 million a year ago. The decline in other income was primarily due to
$0.7 million less imputed interest on the KGC receivable as compared to the prior year. KGC became
delinquent on its monthly payments to the Company in August 2007. Additionally, the Company
recognized interest expense on its convertible debentures issued in October 2007 of $0.3 million,
inclusive of debt discount and debt issuance cost amortization.
Income Taxes. The Company recorded a provision of $0.2 million during each of the years ended
December 31, 2006 and 2007 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 did not have any unrecognized tax benefits
for uncertain tax positions.
Net Loss. Net loss was $25.3 million, or 33.1% of net sales, for the twelve months ended
December 31, 2007 compared to net loss of $11.5 million, or 8.6% of net sales, for the twelve
months ended December 31, 2006. The increased losses were primarily due to lower sales in Hong
Kong, and goodwill impairment of $12.4 million, partly offset by a reduction in distributor
commission payout and selling, general and administrative expenses.
Liquidity and Capital Resources
The Company supported its working capital and capital expenditure needs with cash generated
from operations as well as capital raised from several private placements. The Company raised
approximately $16.0 million, net of transaction fees, through a private equity placement in October
2004. On May 4, 2007, the Company consummated a private equity placement generating gross proceeds
of approximately $3.0 million. The May 2007 financing consisted of the sale of 1,759,307 shares of
the Companys Series A convertible preferred stock and the sale of warrants evidencing the right to
purchase 1,759,307 shares of the Companys common stock. As partial consideration for placement
agency services, the Company issued warrants evidencing the right to purchase an additional 300,000
shares of the Companys common stock to the placement agent that assisted in the financing. The
warrants are exercisable at any time through the sixth anniversary following their issuance. The
exercise price of the warrants varies from $3.80 to $5.00 per share, depending on the time of
exercise.
More recently, on October 19, 2007, the Company raised gross proceeds of $3.7 million in a
private placement of variable rate convertible debentures (the Debentures) having an aggregate
face amount of $4,250,000, seven-year warrants to purchase 1,495,952 shares of the Companys common
stock, and one-year warrants to purchase 1,495,952 shares of the Companys common stock. The
Debentures are convertible by their holders into shares of our common stock at a conversion price
of $2.50, subject to adjustment in certain circumstances. The Debentures bear interest at the
greater of LIBOR plus 4%, or 10% per annum. Interest is payable quarterly beginning on January 1,
2008. One-half of the original principal amount of the Debentures is payable in 12 equal monthly
installments beginning on November 1, 2008, and the balance is payable on October 19, 2009, unless
extended by the holders to October 19, 2012. Under certain conditions, the Company may be able to
pay principal and interest in shares of its common stock. Under certain conditions, the Company
also has certain rights to force conversion or redemption of the debentures. The warrants are
exercisable beginning six months and one day after their respective issuance and have an exercise
price of $3.52 per share. The placement agent and its assigns also
received five-year warrants to purchase 149,595 shares of the
Companys common stock at an exercise price of $3.52 per share. The Company plans to use the net proceeds from the October 2007 private
placement to provide additional working capital. No significant financing activities occurred during fiscal 2006.
At December 31, 2007, the Companys cash and cash equivalents totaled approximately $6.3
million, including $0.4 million in China that may not be freely transferable to other countries
because the Companys Chinese subsidiary is subject to a business license
31
capitalization requirement. Total cash and cash equivalents decreased by approximately $5.7
million from December 31, 2006 to December 31, 2007.
At December 31, 2007, the ratio of current assets to current liabilities was 0.79 to 1.00 and
the Company had a working capital deficit of approximately $3.2 million. Current liabilities
included deferred revenue of $3.5 million that consisted of amortized enrollment package revenues
and unshipped orders. The ratio of current assets to current liabilities excluding deferred
revenue would be 1.03 to 1.00. Working capital as of December 31, 2007 decreased $4.2 million
compared to that as of December 31, 2006 mainly due to cash used in operations and an additional
investment of $0.6 million into a consumer protection fund in South Korea, offset mainly by the
proceeds received from the KGC receivable and both of the financing transactions that occurred
during the year.
Cash used in operations for the twelve months ended December 31, 2007 was approximately $13.2
million. Cash was mainly utilized due to the incurrence of net losses and decreases in current
liabilities, specifically accounts payable, accrued distributor commissions and other expenses and
deferred revenue, partly offset by a reduction in existing inventories. The aggregate impact on
cash resulting from the decrease in current liabilities totaled $6.8 million. This is due to the
Companys efforts to reduce operating expenses during the latter half of fiscal 2007, lower
distributor commission payout, and less unamortized deferred enrollment package revenue.
Cash provided by investing activities during the twelve months ended December 31, 2007 was
approximately $1.7 million, which primarily resulted from proceeds received on the KGC receivable
of $1.2 million and $1.3 million received from a certificate of deposit, offset by an increase in
restricted cash of approximately $0.5 million. This increase in restricted cash reflects an
additional investment of $0.6 million into a consumer protection fund in South Korea.
Cash provided by financing activities during the twelve months ended December 31, 2007 was
approximately $5.9 million, which primarily resulted from the net proceeds received in the May and
October 2007 private placements discussed above.
The Company has planned for and executed many cost reduction initiatives since the end of the
third quarter of 2007, such as headcount reductions, which include the termination of multiple
management-level positions in Greater China and North America, lease terminations, and reductions
in discretionary expenses. As a result, the Company believes that its current cash breakeven level
has been significantly reduced.
The Company believes that its existing internal liquidity, supported by cash on hand,
anticipated improvement in cash flows from operations with more stabilized revenue and much lower
fixed costs since October 2007, and the proceeds received from the private placements consummated
in May and October 2007 should be adequate to fund normal business operations expected in the near
future, assuming no significant unforeseen expense or further revenue decline. In 2006, even
though the Company generated much greater revenue, the Companys costs were not aligned to generate
excess cash. The Company believes that its current cash flow breakeven level has been
significantly reduced as a result of its recent cost reduction efforts conducted primarily in North
America and Greater China.
The Company does not have any significant unused sources of liquid assets. Potentially the
Company might receive additional external funding if currently outstanding warrants are exercised.
Furthermore, if necessary, the Company will attempt to generate more funding from the capital
markets, but currently does not believe that will be necessary.
We do not intend to devote material resources to opening any additional foreign markets in the
near future. Our priority is to focus our resources in our most promising markets, namely Greater
China, South Korea, and Europe.
The Company has entered into non-cancelable operating lease agreements for locations within
the United States and for its international subsidiaries, with expirations through May 2015.
The Company maintains a purchase commitment with one of its suppliers to purchase its Cluster
Concentrate product. Pursuant to this agreement, the Company is required to purchase from this
supplier a minimum volume of 20,000 bottles of product per year. The total annual product cost is
$138,800 before any volume discounts.
The Company has employment agreements with certain members of its management team, the terms
of which expire at various times through December 2009. Such agreements provide minimum salary
levels, as well as incentive bonuses that are payable if specified management goals are attained.
The aggregate commitment for future salaries at December 31, 2007, assuming continued employment
and excluding incentive bonuses, was approximately $1.1 million. Although the Company has the
ability to terminate such agreements with notice, it would be required to pay severance to the
respective employee. As of December 31, 2007, the aggregate commitment under existing severance
agreements totaled $369,000. Such amounts are payable during 2008.
32
Inventories were reduced $7.1 million during the twelve months ended December 31, 2006. This
reduction was primarily the result of the Companys intentional efforts to slow down inventory
purchasing and monetize existing inventories. Additionally, inventories were reduced $2.8 million
to write down inventories to their net realizable value. The majority of the inventory write down
was due to slow moving inventories in Japan and Mexico as well as the Gourmet Coffee Café
TM product line.
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
fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for
any other assets and liabilities that are carried at fair value on a recurring basis in financial
statements. In February 2008, the FASB provided a one year deferral for the implementation of SFAS
No. 157 for other non-financial assets and liabilities. The Company is currently evaluating the
impact, if any, the adoption of SFAS No. 157 will have on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, which permits entities to choose to measure many financial instruments,
and certain other items, at fair value. SFAS No. 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS No. 159 applies to reporting periods
beginning after November 15, 2007. The Company is currently evaluating the impact, if any, of
adopting SFAS No. 159.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements An Amendment of ARB No. 51, establishes accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS
No. 160 is effective on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008, which begins January 1, 2009 for the Company. The adoption of the
provision of SFAS No. 160 is not expected to have a material effect on the Companys consolidated
financial statements.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable under smaller reporting company disclosure rules.
33
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NATURAL HEALTH TRENDS CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Natural Health Trends Corp.
Dallas, Texas
We have audited the accompanying consolidated balance sheets of Natural Health Trends Corp. (the
Company) as of December 31, 2006 and 2007, and the related consolidated statements of operations,
stockholders equity and cash flows for the years then ended. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States of America). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Natural Health Trends Corp. as of December 31, 2006
and 2007, and the results of its operations and its cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, 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) effective January 1, 2007.
We were not engaged to examine managements assertion about the effectiveness of Natural Health
Trends Corps internal control over financial reporting as of December 31, 2007 included in the
accompanying Managements Report on Internal Control Over Financial Reporting and, accordingly, we
do not express an opinion thereon.
/s/ Lane Gorman Trubitt, L.L.P.
Dallas, Texas
March 31, 2008
35
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
11,936 |
|
|
$ |
6,282 |
|
Restricted cash |
|
|
455 |
|
|
|
298 |
|
Certificates of deposit |
|
|
1,277 |
|
|
|
|
|
Accounts receivable |
|
|
462 |
|
|
|
418 |
|
Inventories, net |
|
|
5,857 |
|
|
|
3,585 |
|
Other current assets |
|
|
2,639 |
|
|
|
1,324 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
22,626 |
|
|
|
11,907 |
|
Property and equipment, net |
|
|
2,944 |
|
|
|
1,537 |
|
Goodwill |
|
|
14,145 |
|
|
|
1,764 |
|
Intangible assets, net |
|
|
3,400 |
|
|
|
2,600 |
|
Restricted cash |
|
|
3,503 |
|
|
|
4,317 |
|
Deferred tax assets |
|
|
208 |
|
|
|
208 |
|
Other assets |
|
|
1,759 |
|
|
|
2,363 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
48,585 |
|
|
$ |
24,696 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
3,424 |
|
|
$ |
2,168 |
|
Income taxes payable |
|
|
281 |
|
|
|
363 |
|
Accrued distributor commissions |
|
|
3,852 |
|
|
|
2,018 |
|
Other accrued expenses |
|
|
5,255 |
|
|
|
3,599 |
|
Deferred revenue |
|
|
5,641 |
|
|
|
3,496 |
|
Current portion of convertible debentures, net of discount of $151 |
|
|
|
|
|
|
203 |
|
Other current liabilities |
|
|
3,135 |
|
|
|
3,254 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
21,588 |
|
|
|
15,101 |
|
Convertible debentures, net of discount of $3,896 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
21,588 |
|
|
|
15,101 |
|
Commitments and contingencies |
|
|
|
|
|
|
|
|
Minority interest |
|
|
22 |
|
|
|
33 |
|
Stockholders equity: |
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value; 5,000,000 shares authorized;
1,761,900 shares designated Series A convertible preferred stock,
138,400 shares issued and outstanding at December 31, 2007,
aggregate liquidation value of $246 |
|
|
|
|
|
|
124 |
|
Common stock, $0.001 par value; 50,000,000 shares authorized;
8,199,933 and 10,327,405 shares issued and outstanding at
December 31, 2006 and 2007, respectively |
|
|
8 |
|
|
|
10 |
|
Additional paid-in capital |
|
|
70,042 |
|
|
|
79,158 |
|
Accumulated deficit |
|
|
(44,128 |
) |
|
|
(70,989 |
) |
Accumulated other comprehensive income: |
|
|
|
|
|
|
|
|
Foreign currency translation adjustments |
|
|
1,053 |
|
|
|
1,259 |
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
26,975 |
|
|
|
9,562 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
48,585 |
|
|
$ |
24,696 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
36
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
133,428 |
|
|
$ |
76,501 |
|
Cost of sales |
|
|
33,066 |
|
|
|
20,290 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
100,362 |
|
|
|
56,211 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
68,265 |
|
|
|
35,095 |
|
Selling, general and administrative expenses |
|
|
45,735 |
|
|
|
34,524 |
|
Impairment of goodwill |
|
|
|
|
|
|
12,381 |
|
Recovery of KGC receivable |
|
|
(1,405 |
) |
|
|
(565 |
) |
|
|
|
|
|
|
|
Total operating expenses |
|
|
112,595 |
|
|
|
81,435 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(12,233 |
) |
|
|
(25,224 |
) |
Other income, net |
|
|
946 |
|
|
|
143 |
|
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(11,287 |
) |
|
|
(25,081 |
) |
Income tax provision |
|
|
(182 |
) |
|
|
(200 |
) |
Minority interest |
|
|
9 |
|
|
|
(6 |
) |
|
|
|
|
|
|
|
Net loss |
|
|
(11,460 |
) |
|
|
(25,287 |
) |
|
|
|
|
|
|
|
|
|
Beneficial conversion feature on preferred stock |
|
|
|
|
|
|
(1,574 |
) |
Preferred stock dividends |
|
|
|
|
|
|
(91 |
) |
|
|
|
|
|
|
|
Net loss attributable to common stockholders |
|
$ |
(11,460 |
) |
|
$ |
(26,952 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share basic and diluted |
|
$ |
(1.42 |
) |
|
$ |
(3.15 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average number of shares outstanding |
|
|
8,079 |
|
|
|
8,555 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
37
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In Thousands, Except Share Data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
Preferred Stock |
|
|
Common Stock |
|
|
Paid-In |
|
|
Accumulated |
|
|
Comprehensive |
|
|
|
|
|
|
Shares |
|
|
Amount |
|
|
Shares |
|
|
Amount |
|
|
Capital |
|
|
Deficit |
|
|
Income |
|
|
Total |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2005 |
|
|
|
|
|
$ |
|
|
|
|
7,108,867 |
|
|
$ |
7 |
|
|
$ |
69,417 |
|
|
$ |
(32,668 |
) |
|
$ |
413 |
|
|
$ |
37,169 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,460 |
) |
|
|
|
|
|
|
(11,460 |
) |
Foreign currency translation adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
640 |
|
|
|
640 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,820 |
) |
Exercise of stock options |
|
|
|
|
|
|
|
|
|
|
1,091,066 |
|
|
|
1 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
18 |
|
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
608 |
|
|
|
|
|
|
|
|
|
|
|
608 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
8,199,933 |
|
|
|
8 |
|
|
|
70,042 |
|
|
|
(44,128 |
) |
|
|
1,053 |
|
|
|
26,975 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,287 |
) |
|
|
|
|
|
|
(25,287 |
) |
Foreign currency translation adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
206 |
|
|
|
206 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,081 |
) |
Issuance of preferred stock and common stock warrants |
|
|
1,759,307 |
|
|
|
1,574 |
|
|
|
|
|
|
|
|
|
|
|
986 |
|
|
|
|
|
|
|
|
|
|
|
2,560 |
|
Beneficial conversion feature on preferred stock |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,574 |
|
|
|
(1,574 |
) |
|
|
|
|
|
|
|
|
Conversion of preferred stock |
|
|
(1,620,907 |
) |
|
|
(1,450 |
) |
|
|
1,620,907 |
|
|
|
2 |
|
|
|
1,448 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Receipt of common stock upon settlement of promissory
note |
|
|
|
|
|
|
|
|
|
|
(642,611 |
) |
|
|
(1 |
) |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock warrants in conjunction with
convertible debentures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,491 |
|
|
|
|
|
|
|
|
|
|
|
2,491 |
|
Beneficial conversion feature on convertible debentures |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,682 |
|
|
|
|
|
|
|
|
|
|
|
1,682 |
|
Issuance of restricted stock, net |
|
|
|
|
|
|
|
|
|
|
1,089,176 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Exercise of stock options |
|
|
|
|
|
|
|
|
|
|
60,000 |
|
|
|
|
|
|
|
90 |
|
|
|
|
|
|
|
|
|
|
|
90 |
|
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
845 |
|
|
|
|
|
|
|
|
|
|
|
845 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2007 |
|
|
138,400 |
|
|
$ |
124 |
|
|
|
10,327,405 |
|
|
$ |
10 |
|
|
$ |
79,158 |
|
|
$ |
(70,989 |
) |
|
$ |
1,259 |
|
|
$ |
9,562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
38
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(11,460 |
) |
|
$ |
(25,287 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization of property and equipment |
|
|
1,152 |
|
|
|
1,008 |
|
Amortization of intangibles |
|
|
958 |
|
|
|
800 |
|
Amortization of debt issuance costs |
|
|
|
|
|
|
42 |
|
Accretion of debt discount |
|
|
|
|
|
|
203 |
|
Minority interest |
|
|
(9 |
) |
|
|
6 |
|
Stock-based compensation |
|
|
608 |
|
|
|
845 |
|
Imputed interest on KGC installment payable |
|
|
(671 |
) |
|
|
(228 |
) |
Recovery of KGC receivable |
|
|
(1,405 |
) |
|
|
(565 |
) |
Impairment of long-lived assets |
|
|
1,063 |
|
|
|
795 |
|
Impairment of goodwill |
|
|
|
|
|
|
12,381 |
|
Deferred income taxes |
|
|
(215 |
) |
|
|
7 |
|
Changes in assets and liabilities, net of dispositions: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(136 |
) |
|
|
47 |
|
Inventories, net |
|
|
7,067 |
|
|
|
2,312 |
|
Other current assets |
|
|
780 |
|
|
|
927 |
|
Other assets |
|
|
(120 |
) |
|
|
250 |
|
Accounts payable |
|
|
1,446 |
|
|
|
(1,268 |
) |
Income taxes payable |
|
|
(1,036 |
) |
|
|
64 |
|
Accrued distributor commissions |
|
|
(122 |
) |
|
|
(1,829 |
) |
Other accrued expenses |
|
|
(1,599 |
) |
|
|
(1,693 |
) |
Deferred revenue |
|
|
(4,280 |
) |
|
|
(2,143 |
) |
Other current liabilities |
|
|
575 |
|
|
|
110 |
|
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(7,404 |
) |
|
|
(13,216 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(1,815 |
) |
|
|
(341 |
) |
Decrease (increase) in restricted cash |
|
|
363 |
|
|
|
(475 |
) |
Decrease in certificate of deposit |
|
|
105 |
|
|
|
1,283 |
|
Proceeds from KGC receivable (see Note 5) |
|
|
2,028 |
|
|
|
1,183 |
|
Net cash reduction from sale of subsidiary |
|
|
(28 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by investing activities |
|
|
653 |
|
|
|
1,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
|
|
|
Proceeds from issuance of convertible debentures and warrants |
|
|
|
|
|
|
3,740 |
|
Debt issuance costs |
|
|
|
|
|
|
(442 |
) |
Payments on debt |
|
|
(23 |
) |
|
|
|
|
Proceeds from issuance of preferred stock and warrants, net |
|
|
|
|
|
|
2,560 |
|
Proceeds from issuance of common stock |
|
|
18 |
|
|
|
90 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
(5 |
) |
|
|
5,948 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rates on cash and cash equivalents |
|
|
222 |
|
|
|
(36 |
) |
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents |
|
|
(6,534 |
) |
|
|
(5,654 |
) |
CASH AND CASH EQUIVALENTS, beginning of period |
|
|
18,470 |
|
|
|
11,936 |
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period |
|
$ |
11,936 |
|
|
$ |
6,282 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
39
NATURAL HEALTH TRENDS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Natural Health Trends Corp. (the Company) is an international direct-selling organization
headquartered in Dallas, Texas. The Company was originally incorporated as a Florida corporation
in 1988. The Company merged into one of its subsidiaries and re-incorporated in the State of
Delaware effective June 29, 2005. 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. Prior to June 1,
2006, the Company marketed its NHT Global branded products under the name Lexxus International.
Our 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; South Korea; Japan; Latin America, which primarily consists of Mexico; and Europe,
which consists of Italy and Slovenia.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all of its
majority-owned subsidiaries. All significant inter-company 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).
The results of operations of the Kaire Entities for the first six months of 2006 are included in
the Companys consolidated statement of operations for the year ended December 31, 2006.
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 (see Notes
5 and 12), 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.
Reclassification
Certain balances have been reclassified in the prior year consolidated financial statements to
conform to current year presentation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months
or less, when purchased, to be cash equivalents.
40
Restricted Cash
The Company maintains a cash reserve with certain credit card processing companies to provide
for potential uncollectible amounts and chargebacks. Those cash reserves calculated as a
percentage of sales over a rolling monthly time period and eligible for rebate are included in
current assets.
In addition, non-current assets include the Companys deposit as part of its direct selling
license application in China. See Note 3.
Certificates of Deposit
During 2006, the Company had invested in a series of one year certificates of deposit which
had maturities through November 30, 2007. No such investments were held at December 31, 2007.
Inventories
Inventories consist primarily of finished goods and are stated at the lower of cost or market,
using the first-in, first-out method. The Company reviews its inventory 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. At December 31, 2006 and 2007, the reserve
for obsolescence totaled $3.3 million and $1.8 million, respectively. Due to declining sales,
particularly in Mexico and Japan, and the discontinuation of the Gourmet Coffee Café TM
product line, the Company conducted a thorough review of its inventory during 2006. As a result, a
provision for inventory losses of $2.8 million was recorded to write down inventory to its net
realizable value. This provision was based on product expiration dates, the Companys best
estimates of estimated product demand, as well as its future plans.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation is computed using the straight-line method over the estimated useful lives of the
assets, generally three to five years for office equipment and software, five to seven years for
furniture and equipment, and five years for plant equipment. Leasehold improvements are amortized
over the shorter of the lease term or the estimated useful life of the assets.
Goodwill and Other Intangible Assets
Under the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill
and Other Intangible Assets, the Companys goodwill and intangible assets with indefinite useful
lives no longer are amortized, but instead tested for impairment at least annually. The Companys
policy is to test for impairment annually during the fourth quarter. See Note 4.
SFAS No. 142 also requires that intangible assets with definite lives be amortized over their
estimated useful lives. The Company is currently amortizing its acquired intangible assets with
definite lives over seven years.
Impairment of Long-Lived Assets
The Company reviews property and equipment and intangible assets with definite lives for
impairment whenever events or changes in circumstances indicate the carrying amount of an asset 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 2006, the Company determined that it was in its best interest to abandon its Japan
distributor gallery. As a result, an impairment charge of $0.9 million was recorded for certain
furniture and fixture, office equipment, and leasehold improvements. Also during 2006, the Company
recorded an impairment charge of $171,000 for its acquired distributor database (see Note 4).
During 2007, the Company recorded an aggregate impairment charge of $0.8 million related to its
Mexico and Japan markets. The charge results from terminating the office lease in Mexico City and
relocated to a less costly location, discontinuing the use of certain computer software in the
Japan office, and an overall impairment as to the recoverability of the remaining long-lived assets
in these markets. These charges are included as a component of selling, general and administrative
expenses.
41
Income Taxes
The Company recognizes income taxes under the liability method of accounting for income taxes.
Deferred income taxes are recognized for differences between the financial reporting and tax bases
of assets and liabilities at enacted statutory tax rates in effect for the years in which the
differences are expected to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be ultimately 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 did 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 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 2004, and is no longer subject to state income tax examinations for
years prior to 2002. No jurisdictions are currently examining any income tax returns of the
Company or its subsidiaries.
Foreign Currency
The functional currency of the Companys international subsidiaries is generally the local
currency. Local currency assets and liabilities are translated at the rates of exchange on the
balance sheet date, and local currency revenues and expenses are translated at average rates of
exchange during the period. The resulting translation adjustments are recorded directly into a
separate component of stockholders equity and represents the only component of accumulated other
comprehensive income.
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.
During April 2005, the Company launched a new product line, Gourmet Coffee Café TM,
which consisted of coffee machines and the related coffee and tea pods, in the North American
market. As the Gourmet Coffee Café TM was a very different product than the Companys
other products and no reliable information on the Companys sales returns or warranty obligation
existed, the Company deferred all revenue generated from the sale of coffee machines and the
related coffee and tea pods until sufficient return and warranty experience on the product was
established. The deferral totaled approximately $1.6 million and $1.2 million in revenue and
related costs, respectively, for product shipped through December 31, 2005. The deferred costs were
recorded in other current assets, as the sales return period for North American distributors is
only for one year. During 2006, the Company recognized revenue of $1.7 million since the sales
return period had substantially expired and the estimated additional sales returns were considered
insignificant. Upon revenue recognition, the Company also recorded the related cost of sales and
distributor commissions of $1.0 million and $0.3 million, respectively. Also during 2006, the
Company decided to discontinue sales of Gourmet Coffee Café TM product and recorded a
charge of $0.5 million to cost of sales for its remaining inventories.
42
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 non-vested
restricted stock and shares that might be issued upon the exercise of outstanding stock options and
warrants and the conversion of preferred stock and debentures.
The dilutive effect of non-vested restricted stock, 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.
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 following
securities were not included for the time periods indicated as their effect would have been
anti-dilutive:
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
2006 |
|
2007 |
|
|
|
|
|
|
|
|
|
Options to purchase common stock |
|
|
2,295,624 |
|
|
|
1,041,458 |
|
Warrants to purchase common stock |
|
|
1,080,504 |
|
|
|
6,281,310 |
|
Non-vested restricted stock |
|
|
|
|
|
|
1,044,186 |
|
Convertible preferred stock |
|
|
|
|
|
|
1,759,307 |
|
Convertible debentures |
|
|
|
|
|
|
1,700,000 |
|
Options and warrants to purchase 70,500 and 6,281,310 shares of common stock, respectively,
were still outstanding at December 31, 2007. Such options expire on November 17, 2011. The
warrants have expirations through April 21, 2015. The convertible debentures mature on October 19,
2009.
Certain Risks and Concentrations
In 2006 and 2007, a substantial portion of the Companys sales were generated in Hong Kong
(see Note 13). Various factors could harm the Companys business in Hong Kong, such as worsening
economic conditions or other events that are out of the Companys control. The Companys financial
results could be harmed if its products, business opportunity or planned growth initiatives fail to
retain and generate continued interest among distributors and consumers in this market. Moreover,
most of the Companys Hong Kong revenue is derived from the sale of products that are delivered to
members in China. We have plans to obtain additional licenses to conduct direct selling business
in China; however, at this time there are no guarantees that the Company will obtain these
licenses. If the Company is successful in obtaining these licenses, it is possible that sales in
Hong Kong could migrate to China. If that were to happen the Company could experience a material
reduction in sales from Hong Kong. The Company could be required to modify its compensation plan
in China in a way that could make it less attractive to members. Any such modification to the
compensation plan could, therefore, have a material adverse effect on sales. Moreover, the
business model that the Company anticipates implementing in China will likely involve costs and
expenses that are not generally incurred in the e-commerce business
43
that it has historically operated in other markets, including Hong Kong. As a result, the
business that the Company ultimately is able to conduct in China could be materially less
profitable than the e-commerce business that it has historically operated in Hong Kong.
Four major product lines Premium Noni Juice, Skindulgence®, Alura® and La Vie - generated
a significant majority of the Companys sales for 2006 and 2007. The Company obtains Skindulgence®
and La Vie product from a single supplier, and Premium Noni Juice and Alura® from two other
suppliers. The Company believes that, in the event it is unable to source products from these
suppliers or other suppliers of its products, its revenue, income and cash flow could be adversely
and materially impacted.
The Company maintains its cash in bank accounts which, at times, may exceed federally insured
limits. Accounts in the United States are guaranteed by the Federal Deposit Insurance Corporation
(FDIC) up to $100,000. A portion of the Companys cash balances at December 31, 2007 exceed the
insured limits. The Company has not experienced any losses in such accounts.
Fair Value of Financial Instruments
The carrying amounts of the Companys financial instruments, including cash and cash
equivalents, certificates of deposit, accounts receivable, accounts payable, and accrued expenses,
approximate fair value because of their short maturities. The carrying amount of the noncurrent
restricted cash approximates fair value since, absent the restrictions, the underlying assets would
be included in cash and cash equivalents.
Due to the Companys recent history of operating losses, its incremental borrowing rate has
increased substantially. As such, it is not practicable to estimate the fair value of the
Companys convertible debentures utilizing discounted cash flow analysis. The intrinsic value of
the debentures conversion feature approximates $2.1 million as of December 31, 2007.
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
fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for
any other assets and liabilities that are carried at fair value on a recurring basis in financial
statements. In February 2008, the FASB provided a one year deferral for the implementation of SFAS
No. 157 for other non-financial assets and liabilities. The Company is currently evaluating the
impact, if any, the adoption of SFAS No. 157 will have on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, which permits entities to choose to measure many financial instruments,
and certain other items, at fair value. SFAS No. 159 also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS No. 159 applies to reporting periods
beginning after November 15, 2007. The Company is currently evaluating the impact, if any, of
adopting SFAS No. 159.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements An Amendment of ARB No. 51, establishes accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS
No. 160 is effective on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008, which begins January 1, 2009 for the Company. The adoption of the
provision of SFAS No. 160 is not expected to have a material effect on the Companys consolidated
financial statements.
2. OTHER INCOME, NET
The components of other income, net are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Gain (loss) on foreign exchange |
|
$ |
(204 |
) |
|
$ |
11 |
|
Interest income |
|
|
1,154 |
|
|
|
477 |
|
Interest expense (see Note 6) |
|
|
(9 |
) |
|
|
(352 |
) |
Other |
|
|
5 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
$ |
946 |
|
|
$ |
143 |
|
|
|
|
|
|
|
|
44
Imputed interest income of $671,000 and $228,000 was recorded on the KGC installment payable
during 2006 and 2007. See Note 5.
3. BALANCE SHEET COMPONENTS
The components of certain balance sheet amounts are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Property and equipment: |
|
|
|
|
|
|
|
|
Office equipment |
|
$ |
1,640 |
|
|
$ |
1,507 |
|
Office software |
|
|
1,062 |
|
|
|
805 |
|
Furniture and fixtures |
|
|
457 |
|
|
|
380 |
|
Plant equipment |
|
|
149 |
|
|
|
185 |
|
Leasehold improvements |
|
|
2,025 |
|
|
|
1,772 |
|
|
|
|
|
|
|
|
Property and equipment, at cost |
|
|
5,333 |
|
|
|
4,649 |
|
Accumulated depreciation and amortization |
|
|
(2,389 |
) |
|
|
(3,112 |
) |
|
|
|
|
|
|
|
|
|
$ |
2,944 |
|
|
$ |
1,537 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncurrent restricted cash: |
|
|
|
|
|
|
|
|
Funds held for direct selling license application in China |
|
$ |
2,587 |
|
|
$ |
2,806 |
|
Funds held for consumer indemnity insurance in South Korea (see Note 7) |
|
|
|
|
|
|
641 |
|
Reserve for credit card processor in South Korea (see Note 1) |
|
|
867 |
|
|
|
870 |
|
Other |
|
|
49 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
3,503 |
|
|
$ |
4,317 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other accrued expenses: |
|
|
|
|
|
|
|
|
Sales returns |
|
$ |
1,797 |
|
|
$ |
754 |
|
Employee-related expense |
|
|
1,283 |
|
|
|
1,100 |
|
Professional fees |
|
|
478 |
|
|
|
493 |
|
Warehousing and inventory-related expense |
|
|
525 |
|
|
|
203 |
|
Other |
|
|
1,172 |
|
|
|
1,049 |
|
|
|
|
|
|
|
|
|
|
$ |
5,255 |
|
|
$ |
3,599 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue: |
|
|
|
|
|
|
|
|
Unshipped product |
|
$ |
1,059 |
|
|
$ |
705 |
|
Enrollment package revenue |
|
|
4,582 |
|
|
|
2,791 |
|
|
|
|
|
|
|
|
|
|
$ |
5,641 |
|
|
$ |
3,496 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other current liabilities: |
|
|
|
|
|
|
|
|
Unclaimed checks |
|
$ |
2,349 |
|
|
$ |
2,636 |
|
Other taxes payable |
|
|
496 |
|
|
|
351 |
|
Other |
|
|
290 |
|
|
|
267 |
|
|
|
|
|
|
|
|
|
|
$ |
3,135 |
|
|
$ |
3,254 |
|
|
|
|
|
|
|
|
45
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amount of goodwill for the year are as follows (in thousands):
|
|
|
|
|
Balance, December 31, 2006 |
|
$ |
14,145 |
|
Impairment loss |
|
|
(12,381 |
) |
|
|
|
|
Balance, December 31, 2007 |
|
$ |
1,764 |
|
|
|
|
|
The Companys goodwill carrying value consists of $11.9 million acquired in connection with
the MarketVision Communication Corp. (MarketVision) merger in March 2004, as well as $2.2 million
acquired from the purchase of subsidiary minority interests. Due to full integration of
MarketVision into the Company and the seamless nature of the Companys operations from market to
market, the entire carrying amount of goodwill was evaluated at the enterprise level. As a result
of the Companys less than expected operating performance during the latter half of 2007, the
annual impairment analysis was based on revised expected future sales and earnings. The fair value
of the Company was estimated using the expected present value of future cash flows, as well as
market capitalization. Based on these impairment tests, a goodwill impairment loss of $12.4
million was recognized during 2007.
No changes occurred in the carrying amount of goodwill during 2006.
Intangible assets consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2006 |
|
|
December 31, 2007 |
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computer software and programs |
|
$ |
5,600 |
|
|
$ |
2,200 |
|
|
$ |
3,400 |
|
|
$ |
5,600 |
|
|
$ |
3,000 |
|
|
$ |
2,600 |
|
Distributor database |
|
|
619 |
|
|
|
619 |
|
|
|
|
|
|
|
619 |
|
|
|
619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6,219 |
|
|
$ |
2,819 |
|
|
$ |
3,400 |
|
|
$ |
6,219 |
|
|
$ |
3,619 |
|
|
$ |
2,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During 2006, the Company determined that the sum of the expected undiscounted cash flows
attributable to the distributor database was less than its carrying value and that an impairment
write-down was required as the fair value estimate resulted in only nominal value. The impairment
write-down totaled $171,000.
Amortization expense for intangible assets was $958,000 and $800,000 for 2006 and 2007,
respectively. Future estimated amortization expense is as follows (in thousands):
|
|
|
|
|
2008 |
|
$ |
800 |
|
2009 |
|
|
800 |
|
2010 |
|
|
800 |
|
2011 |
|
|
200 |
|
|
|
|
|
|
|
$ |
2,600 |
|
|
|
|
|
46
5. SALE OF SUBSIDIARY STOCK
KGC
Networks
Effective December 31, 2005, the Company entered into a stock purchase agreement with Bannks
Foundation (Bannks), a Lichtenstein foundation and owner of 49% of the common shares of KGC, a
Singapore corporation, pursuant to which the Company sold to Bannks 51,000 common shares
representing the Companys 51% of the outstanding shares of capital stock of KGC for a total cash
purchase price of $350,000. At the same time and as a condition of the sale, the Company entered
into a separate agreement pursuant to which KGC is obligated to pay to the Company 24 monthly
payments of approximately $169,000 each, including interest at 2.5%, to settle an outstanding
inter-company payable in the amount of approximately $2.1 million and to pay for inventories
ordered and partially delivered totaling approximately $884,000, as well as the Companys
undertaking to continue to supply KGC with certain products for a period of at least 48 months.
The Company discounted the 24 monthly payments based on its cost of capital and recorded the
receivable at $3.1 million. Since the receivable from KGC is unsecured, the Company recorded a
reserve totaling $2.8 million, which is reduced as payments are received. KGC has not remitted the
required monthly payment since July 2007 and is currently in default. As such, as of December 31,
2007 the Company maintains a full reserve of $789,000 against the receivable.
Kaire Entities
Effective July 1, 2006, the Company entered into a stock purchase agreement with Kaire
International (Canada) Ltd. (Kaire International) pursuant to which the Company sold to Kaire
International 1,000 common shares of eKaire.com (eKaire), a Delaware corporation, representing
100% of the total number of common shares of eKaire outstanding; 510 common shares of Kaire
Nutraceuticals Australia Pty. Limited (Kaire Australia), an Australian company, representing the
Companys 51% of the total number of common shares of Kaire Australia outstanding; and 510 common
shares of Kaire Nutraceuticals New Zealand Limited (Kaire New Zealand), a New Zealand company,
representing the Companys 51% of the total number of common shares of Kaire New Zealand
outstanding for book value, which approximated $112,000.
Upon the effective date of the transaction, the Company no longer consolidates the financial
statements of the Kaire Entities. The Company does not believe the historical revenues and
expenses of the Kaire Entities or the actual sale transaction are significant, and therefore, the
transaction does not warrant discontinued operation presentation. As such, the results of the
Kaire Entities for the first six months of 2006 have been reported in the Companys consolidated
results from operations.
6. CONVERTIBLE DEBENTURES
On October 19, 2007, the Company entered into a Securities Purchase Agreement with certain
institutional investors (the Purchasers) pursuant to which the Purchasers agreed to provide an
aggregate of $3,740,000 million in financing to the Company in a private placement of variable rate
convertible debentures having an aggregate face amount of $4,250,000 (the Debentures), seven-year
warrants to purchase 1,495,952 shares of the Companys common stock, and one-year warrants to
purchase 1,495,952 shares of the Companys common stock (collectively, the Securities).
Significant provisions of the Securities Purchase Agreement include, among others:
|
|
|
until the one year anniversary of the closing of the sale of the Securities the Company
shall offer to the Purchasers the opportunity to participate in subsequent securities
offerings by the Company (up to 100% of such offerings), subject to certain exceptions for,
among other things, strategic investments; |
|
|
|
|
for 60 days after the effective date of the initial registration statement covering the shares of common stock underlying the Securities, the Company will not issue common stock
or equivalent securities, subject to certain exceptions for, among other things, strategic
investments; |
|
|
|
|
until such time as no Purchaser holds any of the Securities, the Company is prohibited
from effecting or entering into an agreement to effect any financing involving (a) the
issuance or sale of common stock or equivalent securities with an effective price or number
of underlying shares that floats or resets or otherwise varies or is subject to adjustment
based upon trading prices of or quotations for shares of common stock, the market for the
common stock, or the business of the Company or (b) any agreement to sell securities at a
future determined price; |
47
|
|
|
until the earlier of the date that shareholder approval is obtained or the Securities
are no longer outstanding, neither the Company nor any of its subsidiaries may issue common
stock or equivalent securities at an effective price that is less than $3.52; |
|
|
|
|
until the one year anniversary of the effective date of the initial registration
statement, the Company shall not undertake a reverse or forward stock split or
reclassification of the common stock without the prior written consent of the Purchasers
holding a majority in principal amount outstanding of the debentures; and |
|
|
|
|
the Companys agreement to seek shareholder approval of the issuance of all of the shares of common stock underlying the Securities no later than the date of the Companys
2008 annual shareholder meeting. |
The Debentures are convertible by their holders into the Companys common stock at a
conversion price of $2.50. The conversion price is subject to adjustment for stock splits, stock
dividends, distributions, combinations, rights offerings, mergers, consolidations, sales of all or
substantially all assets, tender offers, exchange offers, reclassifications or compulsory share
exchanges. In addition, subject to certain exceptions, (a) the conversion price for the debentures
is subject to anti-dilution adjustments from time to time if the Company issues its common stock or
convertible securities at a purchase price below conversion price and (b) the Company has agreed
not to make a dilutive issuance without shareholder approval.
After one year, the Company can force conversion of the Debentures at the conversion price if
the daily volume weighted average price (VWAP) of the common stock for each of the 20 trading
days prior to the forced conversion date exceeds $7.50 per share, subject to adjustment, provided
that a registration statement covering the stock is then effective and certain trading volume
requirements and other conditions are met.
The debentures bear interest at the greater of (i) LIBOR plus 4% and (ii) 10% per annum.
Interest is payable quarterly beginning on January 1, 2008. Fifty percent of the original
principal amount of the debentures is payable in 12 equal monthly installments beginning on
November 1, 2008, and the balance is payable on October 19, 2009, unless extended by the holders to
October 19, 2012. Payments of principal and interest may be made in cash or, at the option of the
Company if certain conditions are met, in shares of registered common stock.
Future maturities at December 31, 2007 are as follows (in thousands):
|
|
|
|
|
2008 |
|
$ |
354 |
|
2009 |
|
|
3,896 |
|
|
|
|
|
|
|
$ |
4,250 |
|
|
|
|
|
If interest is paid in shares of common stock, the conversion price per share will be set at
90% of the VWAP for the 20 consecutive trading days immediately prior to the applicable payment
date or, if less, the average of the VWAPs for the 20 consecutive trading days immediately prior to
the date the applicable shares are issued and delivered if such delivery is after the payment date.
If principal is paid in shares of common stock during a specified period immediately prior to
the extended maturity date, the conversion price shall be equal to 90% of the average of the VWAPs
for the 20 consecutive trading days ending on the trading day that is immediately prior to the
applicable payment date.
The Debentures contain certain limitations on optional and mandatory conversion and payment in
shares of common stock, including that, absent shareholder approval, (a) the Company may not issue
shares of common stock in payment of principal or interest on the debentures that, when aggregated
with prior such payments (excluding payments of principal with shares not in excess of the number
issuable at the Conversion Price) exceed 5% of the Companys outstanding shares on the trading day
immediately preceding the date of Securities Purchase Agreement and (b) the Company may not issue
shares of common stock upon conversion of or payment of interest or liquidated damages on the
debentures that, in the aggregate, exceed 19.99% of the Companys outstanding shares on the trading
day immediately preceding the date of Securities Purchase Agreement. Moreover, neither the Company
nor the holders may effect any conversion of a debenture to the extent that it would result in the
holder and its affiliates owning more than 4.99% of the Companys outstanding common stock, unless
this limitation is increased or decreased by the holder (increased up to a maximum of 9.99%) of the
Companys outstanding common stock upon not less than 61 days prior notice. The Company may, under
certain circumstances, redeem the debentures for cash equal to 115% of the aggregate outstanding
principal amount plus any accrued and unpaid interest.
48
The Debentures contain certain negative covenants that, among other things, for so long as any
Debentures remain outstanding, prohibit the Company and its subsidiaries from incurring
indebtedness for borrowed money, creating or suffering liens other than certain permitted liens,
amending charter documents to materially adversely harm the debenture holders, repurchasing shares
of its common stock (with certain exceptions), repaying certain indebtedness before its due date,
paying cash dividends on stock other than the Companys Series A preferred stock, and entering into
certain transactions with affiliates.
Events of default under the Debentures include, among others, payment defaults not timely
cured, failure to perform other covenants not timely cured, cross-defaults not timely cured having
a material adverse effect on the Company, representations or warranties are untrue when made,
certain bankruptcy-type events involving the Company or any significant subsidiary, acceleration of
more than $150,000 in indebtedness for borrowed money or under a long-term leasing or factoring
agreement, the Companys common stock is no longer listed on an eligible market, the Company is
subject to certain changes in control or sells or disposes of more than 40% of its assets a single
or series of related transactions, the registration statement is not declared effective for more
than 270 days after the closing date, the effectiveness of the registration statement lapses beyond
a specified period, failure to timely deliver certificates for converted shares, and a judgment in
excess of $250,000 against the Company, any subsidiary or their respective assets that is not
timely vacated, bonded or stayed. Upon an event of default, the holders may elect to require the
Company to repurchase all or any portion of the outstanding principal amount of the Debentures for
a purchase price equal to 115% of such outstanding principal amount, plus all accrued but unpaid
interest.
The term for each of the warrants begins six months and one day after their respective
issuance and have an exercise price of $3.52 per share. The exercise price and the number of
shares underlying the warrants are subject to adjustment for stock dividends and splits,
combinations, and reclassifications, certain rights offerings and distributions to common
stockholders, and mergers, consolidations, sales of all or substantially all assets, tender offers,
exchange offers, reclassifications or compulsory share exchanges. In addition, subject to certain
exceptions, the exercise price and number of shares underlying both types of warrants are subject
to anti-dilution adjustments from time to time if the Company issues its common stock or equivalent
securities at below the exercise price for the warrants; provided that the exercise price cannot be
adjusted lower than $3.52 prior to shareholder approval. If, at any time after the earlier of
October 19, 2008 and the completion of the then applicable holding period under Rule 144, there is
no effective registration statement for the underlying shares of common stock that are then
required to be registered, the warrants may be exercised by means of a cashless exercise.
The Company and the Purchasers also entered into a Registration Rights Agreement pursuant to
which the Company agreed to file an initial registration statement within 30 calendar days from the
closing date and use its best efforts to have such registration statement declared effective within
120 calendar days (or 150 day in the event of a full review). If all of the shares underlying the
Securities cannot be included in the initial registration statement, in some circumstances the
Company must also timely file subsequent registration statements or otherwise include such shares
in other registration statements on a piggy-back basis. If the registration statements are not
timely filed or declared effective, the Company is required to pay the Purchasers a cash fee of 2%
per month of the purchase price for the unregistered securities until the first anniversary of the
closing date and 1% per month thereafter until the second anniversary of the closing date.
In addition, Dawson James Securities, Inc. (Dawson James) acted as placement agent in
connection with the private placement. In addition to a cash transaction fee of approximately
$280,500, Dawson James and its assigns received five-year warrants to purchase 149,595 shares of
the common stock at an exercise price of $3.52 per share. Other than its five-year term, the terms
of the warrants issued to Dawson James are identical to the terms of the one-year and seven-year
warrants. The warrants were valued at $433,000 using a lattice valuation model.
In accordance with Emerging Issues Task Force (EITF) Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, and Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments,
the Company allocated proceeds of approximately $3,740,000, between the convertible debentures and
warrants based on their relative fair values. The fair value of the warrants was estimated at
approximately $7,488,000 using a lattice valuation model. The proceeds allocated to the
convertible debentures and warrants were approximately $1,682,000 and $2,058,000, respectively.
The Company measured the intrinsic value of the embedded beneficial conversion feature of the
convertible debentures at an amount greater than the proceeds allocated to the convertible
debentures. As such, the beneficial conversion feature recognized upon issuance was limited to the
proceeds allocated to the convertible debentures, or approximately $1,682,000. The debt discount
resulting from the allocation of proceeds to the warrants and the beneficial conversion feature
will be recognized in interest expense over the contractual term of the debt of two years using the
effective interest method. The Company incurred debt issuance costs of approximately $875,000,
including the warrants valued at $433,000 issued to the placement agent, which will also be
recognized in
49
interest expense over the contractual term of the debt. Unamortized debt issuance cost
included in other assets totaled $833,000 as of December 31, 2007.
7. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has entered into non-cancelable operating lease agreements for locations within
the United States and for its international subsidiaries, with expirations through May 2015. Rent
expense in connection with operating leases was $2.8 million and $2.7 million during 2006 and 2007,
respectively.
Future minimum lease obligations as of December 31, 2007, are as follows (in thousands):
|
|
|
|
|
2008 |
|
$ |
1,556 |
|
2009 |
|
|
703 |
|
2010 |
|
|
537 |
|
2011 |
|
|
509 |
|
2012 |
|
|
245 |
|
Thereafter |
|
|
592 |
|
|
|
|
|
Total minimum lease obligations |
|
$ |
4,142 |
|
|
|
|
|
Purchase Commitments
The Company maintains a purchase commitment with one of its suppliers to purchase its Cluster
Concentrate product. Pursuant to this agreement, the Company is required to purchase from this
supplier a minimum volume of 20,000 bottles of product per year. The total annual product cost is
$138,800 before any volume discounts.
Employment Agreements
The Company has employment agreements with certain members of its management team, the terms
of which expire at various times through December 2009. Such agreements provide minimum salary
levels, as well as incentive bonuses that are payable if specified management goals are attained.
The aggregate commitment for future salaries at December 31, 2007, assuming continued employment
and excluding incentive bonuses, was approximately $1.1 million. Although the Company has the
ability to terminate such agreements with notice, it would be required to pay severance to the
respective employee. As of December 31, 2007, the aggregate commitment under existing severance
agreements totaled $369,000. Such amounts are payable during 2008.
Consumer Indemnity
As required by the Door-to-Door Sales Act in South Korea, the Company has obtained insurance
for consumer indemnity claims with a mutual aid cooperative by entering into two mutual aid
contracts with Mutual Aid Cooperative & Consumer (the Cooperative). The initial contract entered
into on January 1, 2005 required the Company to invest 600 million KRW in the Cooperative, and the
subsequent contract entered into on January 9, 2007, required the Company to deposit 600 million
KRW with a financial organization as security on behalf of the Cooperative. The contracts secure
payment to distributors in the event that the Company is unable to provide refunds to distributors.
Typically, requests for refunds are paid directly by the Company according to the Companys normal
Korean refund policy, which requires that refund requests be submitted within three months.
Accordingly, the Company estimates and accrues a reserve for product returns based on this policy
and its historical experience. The accrual totaled 62.2 million KRW (USD $66,000) as of December
31, 2007. The term of these contracts is considered indefinite since at least one of the contracts
must remain in place as long as the Company operates within South Korea. Depending on the sales
volume, the Company may be required to increase or decrease the amount of the security deposit.
The maximum potential amount of future payments the Company could be required to make to address
actual distributor claims under these contracts is equivalent to three months of rolling sales, or
approximately 1.5 billion KRW at December 31, 2007. At December 31, 2007, non-current restricted
cash and non-current other assets each include 600 million KRW (USD $641,000) underlying the two
contracts, which can be utilized by the Cooperative to fund any outstanding distributor claims.
The Company believes that the likelihood of utilizing these funds to provide for distributors
claims is remote.
50
Legal Matters
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 and Terry
LaCore (who were officers and directors at that time) and an NHT Global distributor. 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 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 March 30, 2007, the District Court granted summary judgment against Mr.
Loghry for lack of standing and against the Company on some of its claims. The Company dismissed
its remaining claims against Mr. Loghry and moved for entry of a final judgment against Mr. Loghry.
The Court has declined to enter final judgment against Loghry until the Trustees Case is
resolved. On February 13, 2008, the District Court granted the Companys motion to dismiss certain
of the Trustees fraud and contract claims because the dismissed claims had been filed too late to
be heard. For similar reasons, the District Court also dismissed all claims made in the Trustees
Lawsuit against Messrs. Woodburn and LaCore. A motion for reconsideration by the Trustee is
currently pending. If the motion for reconsideration is denied, one contract claim will remain
against the Company. The Company continues to deny that this claim has any merit and intends to
continue vigorously contesting it. Trial of the Trustees Lawsuit has been set for October 2008.
On September 11, 2006, a putative class action lawsuit was filed in the United States District
Court for the Northern District of Texas 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 names the Company and certain current and former officers and
directors as defendants. On February 20, 2007, the named plaintiffs filed an amended complaint.
On March 26, 2008, the District Court denied motions to dismiss the amended complaint filed by the
Company and the other defendants. The Company believes that the claims alleged in this lawsuit are
without merit, and the Company intends to vigorously defend this lawsuit.
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 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.
On March 17, 2008, NHT Global U.S. received a copy of a demand for arbitration filed with the
American Arbitration Association in Dallas, Texas by a former distributor, Team in Motion, Inc., a
company that is believed to be owned or controlled by Kosta Gara (also formerly known as Kosta
Gharagozloo). Prior to the termination of Team in Motion, Inc., Mr. Gara (or Team in Motion, Inc.
or another affiliate of Mr. Gara) became the Master Distributor for bHIP Global, Inc., which
competes with the Company for distributors. Team in Motion, Inc. seeks $1,000,000 in damages plus
interest and attorneys fees against the Companys subsidiary. NHT Global U.S. denies the
allegations and intends to vigorously defend this proceeding.
Currently, there is no other material 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.
51
8. STOCKHOLDERS EQUITY
Authorized Shares
The Company is authorized to issue two classes of capital stock consisting of up to 5,000,000
shares of preferred stock, $0.001 par value, and 50,000,000 shares of common stock, $0.001 par
value. On May 4, 2007, the Board of Directors designated up to 1,761,900 shares of preferred stock
as Series A preferred stock with the following rights and preferences:
|
|
|
Priority the Series A preferred stock shall rank, in all respects, including the
payment of dividends and upon liquidation, senior and prior to the common stock and other
equity of the Company not expressly made senior or pari passu with the Series A preferred
stock. |
|
|
|
|
Dividends dividends at the rate per annum of $0.119 per share shall accrue from the
date of issuance of any shares of Series A preferred stock, payable upon declaration by the
Board of Directors. Accruing dividends shall be cumulative; provided , however , that
except as set forth below for the liquidation preference, the Corporation shall be under no
obligation to pay such dividends. |
|
|
|
|
Liquidation preference in the event of any voluntary or involuntary liquidation,
dissolution or winding up of the affairs of the Company, then, before any distribution or
payment shall be made to the holders of any junior securities, the holders of the Series A
preferred stock then outstanding shall be entitled to be paid in cash out of the assets of
the Company available for distribution to its stockholders (on a pari passu basis with the
holders of any series of preferred stock ranking on liquidation on a parity with the Series
A preferred stock) an amount per share equal to the sum of the Series A Original Issue
Price plus any dividends accrued but unpaid thereon, whether or not declared, together with
any other dividends declared but unpaid thereon. If the assets of the Company are
insufficient to pay the aggregate liquidation preference and the liquidation preference of
any series of preferred stock ranking on liquidation on a parity with the Series A
preferred stock, the holders of the Series A preferred stock and the holders of any series
of preferred stock ranking on liquidation on a parity with the Series A preferred stock
shall share ratably with one another in any such distribution or payment in proportion to
the full amounts to which they would otherwise be respectively entitled before any
distribution shall be made to the holders of the junior securities. The Series A Original
Issue Price shall mean $1.70 per share, subject to adjustment. |
|
|
|
|
Voting rights the holders of shares of Series A preferred stock shall be entitled to
vote with the holders of the common stock, and with the holders of any other series of
preferred stock, voting together as a single class, upon all matters submitted to a vote of
stockholders of the Company. Each holder of shares of Series A preferred stock shall be
entitled to the number of votes equal to the product (rounded down to the nearest number of
whole shares) of 0.729 times the largest number of shares of common stock into which all
shares of Series A preferred stock held of record by such holder could then be converted. |
|
|
|
|
Conversion each share of Series A preferred stock shall be convertible, subject to
adjustment only in the event of stock splits, stock dividends, recapitalizations and
similar events that would affect all of stockholders, at the option of the holder thereof,
at any time and from time to time, into such number of fully paid and nonassessable shares
of common stock as determined by dividing the Series A Original Issue Price by the Series A
Conversion Price (as defined) in effect at the time of conversion. The Series A
Conversion Price shall initially be equal to $1.70. |
Private Equity Placement
On May 4, 2007, the Company consummated a private placement financing generating gross
proceeds of approximately $3.0 million. The financing consisted of the sale of 1,759,307 shares of
Series A preferred stock at a price of $1.70 per share, and warrants representing the right to
purchase 1,759,307 shares of common stock at a purchase price of $0.00001 per underlying share.
Cumulative unpaid dividends and the liquidation preference relating to the Series A preferred stock
at December 31, 2007 was $91,000 and $246,000, respectively.
The warrants are exercisable at any time during the period beginning November 4, 2007 (six
months after their issuance) and ending May 4, 2013 (six years after their issuance). The exercise
price for the warrants varies from $3.80 to $5.00 per share, depending on the time of exercise. If
the exercise date is less than three years after the warrant issuance date, the exercise price
shall be $3.80 per share. If the exercise date is at least three years, but less than four years
and six months, after the warrant issuance date, the exercise price shall be $4.35 per share. If
the exercise date is at least four years and six months after the warrant issuance date, the
52
exercise price shall be $5.00 per share. The number of shares of common stock for which the
warrants are exercisable, and the related exercise price per share, are subject to adjustment only
in the event of stock splits, stock dividends, recapitalizations and similar events that would
affect all stockholders.
The terms of the financing agreements entered into included the granting of certain
registration rights to the original investors and the placement agent in the financing. The
Company was obligated to file a registration statement no later than 60 days after the closing date
of the financing. The Company filed such registration statement on Form S-3 on June 29, 2007 and,
in response to SEC comments, an amended registration on Form S-3 on August 4, 2007. The
registration statement became effective on August 27, 2007. Additionally, the Company is required
to file such additional amendments and supplements to the registration statement as may be
necessary to keep the registration statement current and effective until the earlier of the date
when all of the shares covered by the registration statement are sold or the stockholders may sell
the shares under Rule 144(k) (the Effectiveness Period).
The Company will be subject to certain financial penalties if it does not fully comply with
the registration obligations. If the registration statement ceases to be effective prior to the
expiration of the Effectiveness Period due to an intentional and willful act by the Company without
being succeeded immediately by a subsequent registration statement filed with the SEC covering the
shares into which the Series A preferred stock are convertible and for which the warrants are
exercisable, the Company will be obligated to pay in cash an amount equal to 2% of the product of
$1.70 times the number of shares of Series A preferred stock purchased by the holder.
In connection with the financing, the Company issued to the placement agent as partial
consideration for its placement services, a warrant covering 300,000 shares of our common stock on
the same terms as those set forth in the warrants issued in the financing. The warrant was valued
at $255,000 using a lattice valuation model.
In accordance with Emerging Issues Task Force (EITF) Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, and Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments,
the Company allocated proceeds of approximately $2,537,000, net of approximately $454,000 in cash
and equity consideration paid to the placement agent, between the Series A preferred stock and
warrants based on their relative fair values. The fair value of the warrants was estimated at
$1,494,000 using a lattice valuation model. The proceeds, net of issuance costs of $177,000,
allocated to the Series A preferred stock and warrants were $1,574,000 and $786,000, respectively.
The Company measured the intrinsic value of the embedded beneficial conversion feature of the
Series A preferred stock at an amount greater than the proceeds allocated to the preferred stock.
As such, the beneficial conversion feature recognized upon issuance was limited to the proceeds
allocated to the preferred stock, or $1,574,000. The beneficial conversion feature was recorded as
a discount to the Series A preferred stock and recognized immediately as a dividend to preferred
stockholders since the Series A preferred stock was convertible at the date of issuance.
During September and October 2007, an aggregate of 1,620,907 shares of Series A preferred
stock were converted into an equivalent number of shares of common stock. As of December 31, 2007,
138,400 shares of Series A preferred stock remain outstanding.
Common
Stock Purchase Warrants
On October 6, 2004, the Company issued warrants to purchase 1,369,704 shares of common stock
in connection with a units offering. The warrants have an exercise price of $12.47 per share and
may be exercised at any time through October 6, 2009. At December 31, 2007, warrants to purchase
1,080,504 shares of common stock remain outstanding from the units offering.
On May 4, 2007, the Company issued warrants to purchase 2,059,307 shares of common stock as a
component of the May 2007 private equity placement (see
Private Equity Placement). The warrants
are exercisable at any time during the period beginning November 4, 2007 (six months after their
issuance) and ending May 4, 2013 (six years after their issuance). The exercise price for the
warrants varies from $3.80 to $5.00 per share, depending on the time of exercise. If the exercise
date is less than three years after the warrant issuance date, the exercise price shall be $3.80
per share. If the exercise date is at least three years, but less than four years and six months,
after the warrant issuance date, the exercise price shall be $4.35 per share. If the exercise date
is at least four years and six months after the warrant issuance date, the exercise price shall be
$5.00 per share. The number of shares of common stock for which the warrants are exercisable, and
the related exercise price per share, are subject to adjustment only in the event of stock splits,
stock dividends, recapitalizations and similar events that would affect all stockholders.
On October 19, 2007, the Company issued warrants to purchase 3,141,499 shares of common stock
in connection with a convertible debentures financing (see Note 6). The warrants consist of
seven-year warrants to purchase 1,495,952 shares of common
53
stock, one-year warrants to purchase 1,495,952 shares of common stock, and five-year warrants
to purchase 149,595 shares of common stock. The term for each of the warrants begins six months
and one day after their respective issuance and each have an exercise price of $3.52 per share.
The exercise price and the number of shares underlying the warrants are subject to adjustment for
stock dividends and splits, combinations, and reclassifications, certain rights offerings and
distributions to common stockholders, and mergers, consolidations, sales of all or substantially
all assets, tender offers, exchange offers, reclassifications or compulsory share exchanges. In
addition, subject to certain exceptions, the exercise price and number of shares underlying the
warrants are subject to anti-dilution adjustments from time to time if the Company issues its
common stock or equivalent securities at below the exercise price for the warrants; provided that
the exercise price cannot be adjusted lower than $3.52 prior to shareholder approval. If, at any
time after the earlier of October 19, 2008 and the completion of the then applicable holding period
under Rule 144, there is no effective registration statement for the underlying shares of common
stock that are then required to be registered, the warrants may be exercised by means of a cashless
exercise.
At December 31, 2007, warrants to purchase 6,281,310 shares of common stock were outstanding.
The weighted-average remaining contractual life of outstanding warrants as of December 31, 2007 was
4.2 years.
9. SHARE-BASED COMPENSATION
The 2002 Stock Option Plan (the 2002 Plan) provided for the granting of incentive and
nonqualified stock options to employees, officers of the Company, members of the Board of
Directors, or consultants. The terms of any particular grant were determined by the Board of
Directors or a committee appointed by the Board of Directors. Historically, the terms ranged from
five to ten years. Stock options granted to employees and officers of the Company generally vested
over three years, and stock options granted to members of the Board of Directors generally vested
immediately.
On August 18, 2006, the Compensation Committee of Companys Board of Directors approved,
subject to stockholder approval, the Natural Health Trends Corp. 2007 Equity Incentive Plan (the
2007 Plan). Under the 2007 Plan, the Company may grant (i) incentive stock options, (ii)
nonqualified stock options, (iii) restricted stock, (iv) restricted stock units, (v) stock
appreciation rights either in tandem with an option or alone and unrelated to an option, or SARs,
(vi) performance shares, (vii) award shares, or (viii) stock awards. The 2007 Plan replaces in its
entirety the 2002 Plan which was deemed terminated on November 17, 2006, the date the Companys
stockholders approved the 2007 Plan. Awards made under the 2002 Plan, however, shall continue to
be subject to the terms of the 2002 Plan, except to the extent that either there is no conflict
between the terms of the 2002 Plan and the terms of the 2007 Plan with respect to such awards or
the recipient consents to the applicability of the terms of the 2007 Plan to such awards.
The purpose of the 2007 Plan is to enable the Company to attract and retain employees,
officers, directors, consultants and advisors; to provide an incentive for them to assist in
achieving long-range performance goals; and to enable them to participate in the long-term growth
of the Company. The terms of any particular grant are determined by the Board of Directors or a
committee appointed by the Board of Directors. The maximum number of shares available for issuance
under the 2007 Plan of 1,550,000 shares of common stock replaces those 1,550,000 shares available
under the 2002 Plan.
The Company granted 951,190 shares of restricted stock under the Companys 2007 Equity
Incentive Plan to the Companys executive officers, directors, key employees and consultants during
2007. Generally, the grants of restricted stock vest quarterly on a pro rata basis over a
three-year period. Certain of the restricted stock granted to the Companys directors vested
immediately.
On May 25, 2007, the Company filed Schedule TO offering eligible option holders the
opportunity to exchange outstanding stock options with an exercise price greater than $9.00 per
share, which were originally granted under the Companys 2002 Stock Option Plan, for shares of
restricted stock that would be awarded under the 2007 Equity Incentive Plan upon the terms and
subject to the conditions set forth in the Offer to Exchange. The number of restricted stock awards
that the Company offered in exchange for each eligible stock option was determined by an exchange
ratio established for that specific stock option. The exchange ratio was determined based on a
number of factors, including the value of outstanding eligible stock options based on the
Black-Scholes option pricing model. The aggregate value of the restricted stock awards that were
offered was roughly comparable to the aggregate Black-Scholes value of the eligible options
surrendered for exchange. The offering period expired on June 25, 2007, and pursuant to the Offer
to Exchange, the Company accepted for cancellation stock options to purchase an aggregate of
499,124 shares of common stock in exchange for 197,896 shares of restricted stock. All restricted
stock awards issued in exchange for eligible stock options vest quarterly on a pro rata basis over
a three-year period.
On July 23, 2007, the Company accepted for cancellation stock options to purchase an aggregate
of 75,000 shares of common stock in exchange for 47,934 shares of restricted stock issued to two
directors of the Company under the Companys 2007 Equity
54
Incentive Plan. These restricted stock awards issued in exchange for eligible stock options
vested immediately upon issuance. The number of restricted stock awards that the Company offered in
exchange for each eligible stock option was determined by an exchange ratio established for that
specific stock option. The exchange ratio for options that had an exercise price greater than
$10.00 per share was determined based on a number of factors, including the value of outstanding
eligible stock options based on the Black-Scholes option pricing model. For these options, which
were issued under the Companys 2002 Stock Option Plan, the aggregate value of the restricted stock
awards that were offered is roughly comparable to the aggregate Black-Scholes value of the eligible
options surrendered for exchange. For options that had an exercise price of $2.00 per share or less
(which were granted in 2002 before the adoption of the 2002 Stock Option Plan), the exchange ratio
was determined by multiplying the number of shares for which the options could be exercised by the
difference between the closing price per share on the last trading day preceding the exchange and
the exercise price per share of the options, and then dividing that product by the closing price
per share on the last trading day preceding the exchange. As of December 31, 2007, stock options
for 70,500 shares of common stock remain outstanding under the 2002 Plan. As of December 31, 2007,
460,824 shares remain available to be granted under the 2007 Plan.
From January 2001 through April 2003, the Company granted 1,331,500 stock options outside of
the 2002 Plan. The grant included 570,000 options granted to the LaCore and Woodburn Partnership,
an entity controlled by Messrs. Mark Woodburn and Terry LaCore; 600,000 options granted to Mr.
LaCore; 30,000 options granted to Benchmark Consulting Group (which was subsequently assigned to
the LaCore and Woodburn Partnership); 120,000 options granted to members of the Companys Board of
Directors; 1,500 options granted to an employee; and 10,000 options granted to then unrelated
parties.
On February 10, 2006, the Company entered into an escrow agreement (the Agreement) with
Messrs. Woodburn and LaCore, the LaCore and Woodburn Partnership, and Krage and Janvey LLP, as
escrow agent (the Agent). Pursuant to the 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 issued 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 was 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 pursuant to Section 4(2) of the Securities Act of 1933, as
amended, to the Agent upon receipt from the Agent of an irrevocable proxy to the Company to vote
the Escrowed Shares on all matters presented at meetings of stockholders or any written consent
executed in lieu thereof. On October 31, 2006, the Company entered into various agreements (the
Settlement Agreements) with Messrs. Woodburn and LaCore in settlement of certain claims and, as a
part of that agreement, agreed that the Escrowed Shares would be reissued to Messrs. Woodburn and
LaCore and then pledged to the Company to secure certain obligations of Messrs. Woodburn and LaCore
to the Company under the Settlement Agreements. On August 30, 2007, the Company accepted the
surrender of 642,611 shares of the Companys common stock by Messrs. Woodburn and LaCore in payment
of the principal and accrued interest on the Note. As provided in the Note, the value of the
surrendered shares for purposes of determining the credit to be given against the principal and
interest accrued on the Note was equal to the average of the closing prices for the 20 consecutive
trading days preceding the date the shares were tendered for surrender. See Note 12.
55
Valuation and Expense Information under SFAS No. 123(R)
Share-based compensation expense totaled approximately $608,000 and $845,000 for 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.
The Company continues to use the Black-Scholes option pricing model to estimate fair value of
equity awards, which requires the input of highly subjective assumptions. Due to the plain
vanilla characteristics of the Companys stock options, the simplified method, as permitted by the
guidance provided in SAB No. 107, is used to determine expected life. Expected volatility is based
on the historical volatility of the Companys common stock computed over a period generally
commensurate with the expected life of the stock options. The risk-free interest rate is based on
the U.S. Treasury yield at the time of grant. Forfeitures are
estimated based on historical experience. Compensation cost is recognized on a
straight-line basis over the awards vesting periods.
During 2006, the Company granted 373,500 stock options with a weighted-average fair value of
$1.69 per share. The fair value of each stock option grant was estimated on the date of grant with
the following weighted-average assumptions: expected life of 4 years, risk-free interest rate of
4.8%, expected volatility of 96%, and dividend yield of zero. No stock options were granted during
2007.
The following table summarizes the Companys stock option activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
Remaining |
|
Aggregate |
|
|
|
|
|
|
Exercise |
|
Contractual |
|
Intrinsic |
|
|
Shares |
|
Price |
|
Life |
|
Value1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2005 |
|
|
1,922,124 |
|
|
$ |
5.17 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
373,500 |
|
|
|
2.60 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(1,091,066 |
) |
|
|
1.01 |
|
|
|
|
|
|
|
|
|
Forfeited or expired |
|
|
(163,100 |
) |
|
|
3.45 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2006 |
|
|
1,041,458 |
|
|
|
8.88 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(60,000 |
) |
|
|
1.50 |
|
|
|
|
|
|
|
|
|
Cancelled, forfeited or expired |
|
|
(910,958 |
) |
|
|
9.91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007 |
|
|
70,500 |
|
|
|
1.80 |
|
|
|
3.9 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at December 31, 2007 |
|
|
43,076 |
|
|
|
1.80 |
|
|
|
3.9 |
|
|
|
|
|
Exercisable at December 31, 2007 |
|
|
23,501 |
|
|
|
1.80 |
|
|
|
3.9 |
|
|
|
|
|
|
|
|
1 |
|
Aggregate intrinsic value is defined as the positive
difference between the current market value and the exercise price and is
estimated using the closing price of the Companys common stock on the last
trading day of the periods ended as of the dates indicated (in thousands). |
56
Stock options for 1,091,066 and 60,000 shares of common stock were exercised during 2006 and
2007, respectively, with an intrinsic value of $9,701,000 and $184,000, respectively. The total
fair value of stock options vested during 2006 and 2007 was $568,000 and $85,000, respectively. As
of December 31, 2007, total unrecognized share-based compensation expense related to stock options
was approximately $0.3 million, which is expected to be recognized over a weighted-average period
of 1.1 years. All stock options outstanding at December 31, 2007 have an exercise price of $1.80
per share.
A following table summarizes the Companys restricted stock activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
|
|
|
|
|
Price at |
|
|
|
|
|
|
Date of |
|
|
Shares |
|
Issuance |
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2006 |
|
|
|
|
|
$ |
|
|
Granted |
|
|
1,197,020 |
|
|
|
2.18 |
|
Vested |
|
|
(321,048 |
) |
|
|
2.69 |
|
Forfeited |
|
|
(107,844 |
) |
|
|
2.28 |
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007 |
|
|
768,128 |
|
|
|
1.94 |
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007, total unrecognized share-based compensation expense related to
non-vested restricted stock was approximately $1.1 million, which is expected to be recognized over
a weighted-average period of 2.5 years.
10. INCOME TAXES
The components of loss before income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Domestic |
|
$ |
(2,279 |
) |
|
$ |
(16,881 |
) |
Foreign |
|
|
(9,008 |
) |
|
|
(8,200 |
) |
|
|
|
|
|
|
|
Loss before income taxes |
|
$ |
(11,287 |
) |
|
$ |
(25,081 |
) |
|
|
|
|
|
|
|
The components of the provision for income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
Current taxes: |
|
|
|
|
|
|
|
|
Federal |
|
$ |
29 |
|
|
$ |
|
|
State |
|
|
(176 |
) |
|
|
|
|
Foreign |
|
|
537 |
|
|
|
200 |
|
|
|
|
|
|
|
|
|
|
|
390 |
|
|
|
200 |
|
Deferred taxes |
|
|
(208 |
) |
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes |
|
$ |
182 |
|
|
$ |
200 |
|
|
|
|
|
|
|
|
57
A reconciliation of the reported provision for income taxes to the amount that would result
from applying the domestic federal statutory tax rate to pretax income is as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
Income tax at federal statutory rate |
|
$ |
(3,838 |
) |
|
$ |
(8,527 |
) |
Effect of permanent differences |
|
|
1,558 |
|
|
|
4,171 |
|
Increase in valuation allowance |
|
|
1,630 |
|
|
|
4,479 |
|
Foreign rate differential |
|
|
1,093 |
|
|
|
|
|
State income taxes, net of federal benefit |
|
|
(116 |
) |
|
|
|
|
Other reconciling items |
|
|
(145 |
) |
|
|
77 |
|
|
|
|
|
|
|
|
Income tax provision |
|
$ |
182 |
|
|
$ |
200 |
|
|
|
|
|
|
|
|
Deferred income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Net operating losses |
|
$ |
2,761 |
|
|
$ |
8,258 |
|
Stock-based compensation |
|
|
488 |
|
|
|
88 |
|
Accrued expenses |
|
|
645 |
|
|
|
503 |
|
Tax credits |
|
|
124 |
|
|
|
95 |
|
Provision for KGC receivable |
|
|
460 |
|
|
|
268 |
|
Impairment of long-lived assets |
|
|
|
|
|
|
91 |
|
Other |
|
|
12 |
|
|
|
6 |
|
|
|
|
|
|
|
|
Total deferred tax assets |
|
|
4,490 |
|
|
|
9,309 |
|
Valuation allowance |
|
|
(2,949 |
) |
|
|
(8,131 |
) |
|
|
|
|
|
|
|
|
|
|
1,541 |
|
|
|
1,178 |
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
Intangible assets |
|
|
(1,156 |
) |
|
|
(884 |
) |
Depreciation |
|
|
(16 |
) |
|
|
(15 |
) |
Prepaids |
|
|
(161 |
) |
|
|
(71 |
) |
|
|
|
|
|
|
|
Total deferred tax liabilities |
|
|
(1,333 |
) |
|
|
(970 |
) |
|
|
|
|
|
|
|
Deferred tax assets, net |
|
$ |
208 |
|
|
$ |
208 |
|
|
|
|
|
|
|
|
The Company increased the valuation allowance to equal its net deferred tax assets at December
31, 2005, 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.
At December 31, 2006, the Company has net operating loss carryforwards of approximately $9.4
million that begin to expire in 2024, if not utilized. We have foreign net operating loss
carryforwards totaling $21.8 million in various jurisdictions with various expirations. The
Company has not provided for U.S. federal and foreign withholding taxes on the undistributed
earnings of its foreign subsidiaries as of December 31, 2007. Such earnings are intended to be
reinvested indefinitely.
The foreign holding and operating company re-organization that occurred during December 2005
resulted in an increase to the 2006 effective tax rate due to a buy-in payment for foreign
intellectual property rights. In October 2007, we discontinued our operational use of this
structure to reduce costs and because we determined that our United States operating losses will
lower our overall effective tax rate.
58
11. SUPPLEMENTAL CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
|
|
(In Thousands) |
|
Cash paid during the year for: |
|
|
|
|
|
|
|
|
Income taxes |
|
$ |
1,453 |
|
|
$ |
288 |
|
Interest |
|
|
1 |
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities: |
|
|
|
|
|
|
|
|
Warrants issued to placement agent in connection with private equity placement |
|
|
|
|
|
|
255 |
|
Beneficial conversion feature on preferred stock |
|
|
|
|
|
|
1,574 |
|
Conversion of preferred stock |
|
|
|
|
|
|
1,450 |
|
Warrant issued to placement agent in conjunction with convertible debentures |
|
|
|
|
|
|
433 |
|
Beneficial conversion feature on convertible debentures |
|
|
|
|
|
|
1,682 |
|
12. 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 former 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 $18,000 during 2006. No amounts were paid during
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, 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 would 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 $207,000 and $340,000 were paid to Access and Info during 2006,
respectively. Services provided by Access were
59
transitioned to a third-party transportation and logistics company at the beginning of 2006.
Payments totaling approximately $304,000 were paid to Info during 2007. At December 31, 2007,
approximately $25,000 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 $3.6 million and $1.8
million during 2006 and 2007, respectively. At December 31, 2007, approximately $84,000 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 were 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 was 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 would hold
the Escrowed Shares and the Cash Deposit until it received (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 LaCore signed a Non-Recourse Promissory Note (the 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.
(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.
60
(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 was 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
temporarily administered by Mr. LaCore. In return, the Company agreed to pay the commissions
generated by these positions under the Companys distributor compensation plan to Mr. LaCore, who
in turn agreed to pay some or all of the commissions to other distributors downline. The amount
of gross commissions paid to Mr. LaCore for temporary administration of these positions during 2007
was $741,000. The Company terminated the week-to-week agreement with Mr. LaCore on October 26,
2007.
On August 30, 2007, the Company accepted the surrender of 642,611 shares of the Companys
common stock by Messrs. Woodburn and LaCore in payment of the principal and accrued interest on the
Note. As provided in the Note, the value of the surrendered shares for purposes of determining the
credit to be given against the principal and interest accrued on the Note was equal to the average
of the closing prices for the 20 consecutive trading days preceding the date the shares were
tendered for surrender.
61
13. SEGMENT INFORMATION
The Company sells products to a distributor network that operates in a seamless manner from
market to market, except for the Chinese market. The Company believes that each of its operating
segments should be aggregated into a single reportable segment as they have similar economic
characteristics. In making this determination, the Company believes that each of the operating
segments are similar in the nature of the products sold, the product acquisition process, the types
of customers products are sold to, the methods used to distribute the products, and the nature of
the regulatory environment.
The Companys e-commerce retail business launched in China during June 2007 does not require a
direct selling license and allows for discounts on volume purchases. There is no separate segment
manager who is held accountable by our chief operating decision-makers, or anyone else, for
operations, operating results and planning for the Chinese market on a stand-alone basis.
Accordingly, we consider ourselves to be in a single reporting segment and operating unit
structure.
The Companys net sales and long-lived assets by market are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2006 |
|
|
2007 |
|
Net sales to external customers: |
|
|
|
|
|
|
|
|
North America |
|
$ |
14,144 |
|
|
$ |
7,743 |
|
Hong Kong |
|
|
88,835 |
|
|
|
47,240 |
|
China |
|
|
|
|
|
|
538 |
|
Taiwan |
|
|
4,367 |
|
|
|
5,861 |
|
Southeast Asia |
|
|
1,710 |
|
|
|
883 |
|
South Korea |
|
|
12,538 |
|
|
|
9,334 |
|
Australia/New Zealand |
|
|
1,284 |
|
|
|
686 |
|
Japan |
|
|
6,761 |
|
|
|
2,196 |
|
Latin America |
|
|
3,496 |
|
|
|
990 |
|
Other1 |
|
|
293 |
|
|
|
1,030 |
|
|
|
|
|
|
|
|
Total net sales |
|
$ |
133,428 |
|
|
$ |
76,501 |
|
|
|
|
|
|
|
|
|
|
|
1 |
|
Represents product sales to KGC Networks Ptd Ltd. as
part of a separate agreement entered into effective December 31, 2005 upon the
sale of the Companys 51% interest in KGC to Bannks Foundation. |
62
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2006 |
|
|
2007 |
|
Long-lived assets: |
|
|
|
|
|
|
|
|
North America |
|
$ |
18,259 |
|
|
$ |
5,660 |
|
Hong Kong |
|
|
393 |
|
|
|
260 |
|
Taiwan |
|
|
157 |
|
|
|
150 |
|
Southeast Asia |
|
|
151 |
|
|
|
65 |
|
China |
|
|
3,550 |
|
|
|
3,702 |
|
South Korea |
|
|
2,200 |
|
|
|
2,879 |
|
Australia/New Zealand |
|
|
26 |
|
|
|
|
|
Japan |
|
|
649 |
|
|
|
44 |
|
Latin America |
|
|
562 |
|
|
|
16 |
|
Other |
|
|
12 |
|
|
|
13 |
|
|
|
|
|
|
|
|
Total long-lived assets |
|
$ |
25,959 |
|
|
$ |
12,789 |
|
|
|
|
|
|
|
|
Due to system constraints, it is impracticable for the Company to separately disclose product
and enrollment package revenue for the years presented.
14. LIQUIDITY
At December 31, 2007, the Company had cash and cash equivalents of $6.3 million and a working
capital deficit of $3.2 million. During 2006 and 2007, the Company incurred significant, recurring
losses from operations and negative operating cash flows. Sales decreased significantly during
these years and the Company was unable to control the sales decline or cut operating expenses
sufficiently to avoid the negative operating results. The Companys losses attributable to common
stockholders were $11.5 million and $27.0 million during 2006 and 2007, respectively.
The Company has taken several actions to ensure that it will continue as a going concern. It
has planned for and executed many cost reduction initiatives since the end of the third quarter of
2007, such as headcount reductions, which include the termination of multiple management-level
positions in Greater China and North America, lease terminations, and reductions in discretionary
expenses. As a result, the Company believes that its current cash breakeven level has been
significantly reduced.
The Company believes that its existing internal liquidity, supported by cash on hand,
anticipated improvement in cash flows from operations with more stabilized revenue and much lower
fixed costs since October 2007, and the proceeds received from the private placements consummated
in May and October 2007 should be adequate to fund normal business operations expected in the near
future, assuming no significant unforeseen expense or further revenue decline.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
63
Item 9A(T). CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Management, with the participation of the Companys principal executive officer and principal
financial officer, evaluated the effectiveness of the design and operation of the Companys
disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of
1934, as amended (the Exchange Act)) as of December 31, 2007. The Companys disclosure controls
and procedures are designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commission rules and
forms, and that such information is accumulated and communicated to management, including the
Companys principal executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosure. Based on this evaluation, the principal executive
officer and principal financial officer concluded that the Companys disclosure controls and
procedures were not effective as of December 31, 2007 due to the material weakness identified as
part of managements evaluation of internal control over financial reporting discussed below. As a
result, the Company performed additional account analysis and reconciliations to ensure the
consolidated financial statements present fairly, in all material respects, its financial position,
results of operations and cash flows for the periods presented.
Managements Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting is a process designed by, or under
the supervision of, the Companys principal executive and principal financial officers and effected
by the Companys Board of Directors, management and other personnel 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 and includes those
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 generally accepted accounting
principles, and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; and |
|
|
|
|
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 financial statements. |
Because of inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Projections of any evaluation of effectiveness to future periods are subject
to the risks that controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management evaluated the effectiveness of the Companys internal control over financial
reporting by using the criteria established in Internal Control Integrated Framework, issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As a result of
the material weakness described below, and based on the criteria set forth in Internal Control
Integrated Framework issued by the COSO, management concluded that the Companys internal control
over financial reporting was not effective as of December 31, 2007.
A material weakness is a deficiency, or a combination of deficiencies, in internal control
over financial reporting, such that there is a reasonable possibility that a material misstatement
of the Companys annual or interim financial statements will not be prevented or detected on a
timely basis. As of December 31, 2007, management determined the combination of deficiencies
identified at the Companys subsidiary in Taiwan results in a material weakness in the Companys
internal control over financial reporting. The deficiencies are due to the lack of evidential
documentation supporting the reconciliation and review of certain account balances. Management
believes this control deficiency results primarily from significant staff and supervisor turnover
that occurred in Taiwan during the fourth quarter of 2007. Accordingly, management concluded that,
if not detected and prevented, this deficiency could have resulted in a material misstatement of
the Companys most significant account balances, such as cash, inventories, accrued distributors
commissions as well as the related income or expense accounts.
This annual report does not include an attestation report of the Companys registered public
accounting firm regarding internal control over financial reporting. Managements report was not
subject to attestation by the Companys registered public accounting
64
firm pursuant to temporary rules of the Securities and Exchange Commission that permit the
Company to provide only managements report in this annual report.
Changes in Internal Control over Financial Reporting
During the most recently completed fiscal quarter, each of the following changes in the
Companys internal control over financial reporting occurred that has materially affected, or is
reasonable likely to materially affect, the Companys internal control over financial reporting:
|
|
|
Significant staff and supervisor turnover of the accounting and finance staff in Taiwan
resulted in the deficiency described above. Management believes the employee turnover was
due to a poorly defined reporting relationship within the region. A new line of reporting
was established during December 2007. The Company is currently taking steps to remediate
the deficiency by hiring a new, qualified finance manager and developing an action plan for
reconciliation and review of each account balance. Additionally, management believes the
action plan will include an initiative to improve efficiency and eliminate redundant tasks
currently performed by the accounting and finance staff in Taiwan. |
|
|
|
|
As part of the Companys efforts to reduce operating costs and regain profitability, the
Company eliminated management-level positions in Greater China, terminated certain of its
Corporate accounting and finance staff and discontinued its subscription to compliance
training programs provided by WeComply, Inc. concerning fraud awareness, insider trading,
and the Foreign Corrupt Practices Act. Management believes that the cost savings from such
actions outweigh any increase in control risk. |
In connection with the application of Section 404 of the Sarbanes-Oxley Act of 2002 to the
Company, the Company addressed the material weaknesses in internal control over financial reporting
disclosed in its prior year Form 10-K. The Company implemented additional controls and control
enhancements for certain of these material weaknesses, including the following.
|
|
|
Control Environment the Companys control environment is overseen by its principal
executive officer and principal financial officer whose appointments, as well as the new
policies since instituted, have set the tone for a greater level of emphasis on business
ethics and internal control. Both of these individuals were responsible for detecting and
reporting improper activities committed by two of the Companys previous executive officers
prior to fiscal 2006. |
|
|
|
|
Internal Audit Function Management has determined that its existing corporate
governance controls are sufficient and do not warrant supplementing with an internal audit
function. |
|
|
|
|
Related Party Transactions the Company has not allowed any additional related party
transactions since fiscal 2005. The Companys new procedure for director and officer
questionnaires is to annually survey its directors and officers for the existence of any
related party transactions or conflicts-of-interest. |
|
|
|
|
Subsidiary Operations the Company incorporated subsidiary period-end checklists and
questionnaires into its financial reporting close process to ensure that subsidiary
operating activity is recorded, processed, summarized and reported within the appropriate
time period. |
|
|
|
|
Expense Reimbursement Procedures the Company has enhanced its policies and procedures
regarding expense reimbursement procedures at its corporate office. Scrutiny of expense
reimbursement procedures have been tightened to require multiple approvals for each
submitted expense report and corporate credit cards involving executive officers have been
cancelled. |
|
|
|
|
Independent Distributor Relationships from time to time the Company enters into
agreements for business or market development, which may result in additional compensation
to specific distributors. The Company requires that each of these arrangements is
substantiated by documentation which includes the underlying terms and conditions. |
Item 9B. OTHER INFORMATION
None.
65
Part III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference to Natural Health Trends
Corp.s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant
to Regulation 14A within 120 days after the end of the fiscal year covered by this report (the
Annual Proxy Statement).
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the Annual Proxy
Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The information required by this Item is incorporated by reference to the Annual Proxy
Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated by reference to the Annual Proxy
Statement.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is incorporated by reference to the Annual Proxy
Statement.
66
Part IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Documents filed as part of this Form 10-K:
|
1. |
|
Financial Statements. See Index to Consolidated Financial Statements under
Item 8 of Part II. |
|
|
2. |
|
Financial Statement Schedules. Except as provided below, all financial
statement schedules have been omitted because they are not required, not applicable, or
because the required information is shown in the financial statements or notes thereto. |
Schedule II Valuation and Qualifying Accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Column A |
|
Column B |
|
Column C |
|
Column D |
|
Column E |
|
|
Balance at |
|
Charged to Costs |
|
|
|
|
|
|
|
|
Beginning |
|
and Expenses/ |
|
|
|
|
|
Balance at End |
Description |
|
of Period |
|
Against Net Sales (1) |
|
Deductions (2) |
|
of Period |
|
|
(In Thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for obsolete inventory |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2007
|
|
$ |
3,320 |
|
|
$ |
489 |
|
|
$ |
(1,987 |
) |
|
$ |
1,822 |
|
Year ended December 31, 2006 |
|
$ |
693 |
|
|
$ |
2,823 |
|
|
$ |
(196 |
) |
|
$ |
3,320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for KGC receivable |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2007
|
|
$ |
1,354 |
|
|
$ |
|
|
|
$ |
(565 |
) |
|
$ |
789 |
|
Year ended December 31, 2006 |
|
$ |
2,759 |
|
|
$ |
|
|
|
$ |
(1,405 |
) |
|
$ |
1,354 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual for sales returns |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2007
|
|
$ |
1,797 |
|
|
$ |
2,898 |
|
|
$ |
(3,941 |
) |
|
$ |
754 |
|
Year ended December 31, 2006 |
|
$ |
1,743 |
|
|
$ |
6,472 |
|
|
$ |
(6,418 |
) |
|
$ |
1,797 |
|
|
|
|
(1) |
|
Additions to the reserve for obsolete inventory are charged to cost of sales. Additions to the accrual for sales returns
are recorded as a reduction to net sales. |
|
(2) |
|
Deductions to the reserve for obsolete inventory reflect disposals of obsolete inventory. Deductions to the accrual for
sales returns reflect amounts refunded. |
|
3. |
|
Exhibits. The exhibits listed on the accompanying Exhibit Index are filed as a
part of, and are incorporated by reference into, this Report. |
67
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the
undersigned, thereunto duly authorized.
|
|
|
|
|
|
NATURAL HEALTH TRENDS CORP.
|
|
Date: March 31, 2008 |
/s/ Chris T. Sharng
|
|
|
Chris T. Sharng |
|
|
President
(Principal Executive Officer) |
|
|
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each of Natural Health Trends Corp., a Delaware
corporation, and the undersigned directors and officers of Natural Health Trends Corp., hereby
constitutes and appoints Chris T. Sharng and Gary C. Wallace, or any one of them, its, his or her
true and lawful attorney-in-fact and agent, for it, him or her and in its, his or her name, place
and stead, in any and all capacities, with full power to act alone, to sign any and all amendments
to this Report, and to file each such amendment to the Report, with all exhibits thereto, and any
and all other documents in connection therewith, with the Securities and Exchange Commission,
hereby granting unto said attorney-in-fact and agent full power and authority to do and perform any
and all acts and things requisite and necessary to be done in and about the premises as fully to
all intents and purposes as it, he or she might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and on the dates
indicated.
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
/s/ Chris T. Sharng
Chris T. Sharng
|
|
President
(Principal Executive Officer)
|
|
March 31, 2008 |
|
|
|
|
|
/s/ Timothy S. Davidson
Timothy S. Davidson
|
|
Senior Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer)
|
|
March 31, 2008 |
|
|
|
|
|
/s/ Randall A. Mason
|
|
Chairman of the Board and Director
|
|
March 31, 2008 |
Randall A. Mason |
|
|
|
|
|
|
|
|
|
/s/ Stefan W. Zuckut
|
|
Director
|
|
March 31, 2008 |
Stefan W. Zuckut |
|
|
|
|
68
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
3.1
|
|
Certificate of Incorporation of Natural Health Trends Corp. (incorporated by reference to Exhibit 3.01 to
Current Report on Form 8-K filed on July 12, 2005). |
|
|
|
3.2
|
|
Certificate of Designations, Rights and Preferences of the Series A Convertible Preferred Stock of the Company
(incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed on May 9, 2007). |
|
|
|
3.3
|
|
By-Laws of Natural Health Trends Corp. (incorporated by reference to Exhibit 3.02 to Current Report on Form 8-K
filed on July 12, 2005). |
|
|
|
4.1
|
|
Specimen Certificate for shares of common stock, $.001 par value per share, of Natural Health Trends Corp.
(incorporated by reference to Exhibit 4.01 to Annual Report on Form 10-K filed on May 8, 2006). |
|
|
|
10.1
|
|
Form of Common Stock Purchase Warrant issued in October 2004 Private Placement (incorporated by reference to
Exhibit 4.1 to Quarterly Report on Form 10-Q filed on November 12, 2004). |
|
|
|
10.2
|
|
Form of Stock and Warrant Purchase Agreement (U.S. Purchaser) dated May 4, 2007 between the Company and certain
Purchasers (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on May 9, 2007). |
|
|
|
10.3
|
|
Form of Stock and Warrant Purchase Agreement (Non-U.S. Purchaser) dated May 4, 2007 between the Company and
certain Purchasers (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed on May 9,
2007). |
|
|
|
10.4
|
|
Form of Warrant to Purchase Shares of Common Stock of the Company, dated May 4, 2007 and issued to certain
Purchasers (incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed on May 9, 2007). |
|
|
|
10.5
|
|
Securities Purchase Agreement dated October 19, 2007 between the Company and certain Purchasers (incorporated by
reference to Exhibit 10.1 to Current Report on Form 8-K filed on October 22, 2007). |
|
|
|
10.6
|
|
Form of Registration Rights Agreement signed by the Company and the Purchasers named in the Securities Purchase
Agreement dated October 19, 2007 between the Company and the Purchasers named therein (incorporated by reference
to Exhibit 10.2 to Current Report on Form 8-K filed on October 22, 2007). |
|
|
|
10.7
|
|
Form of Variable Rate Convertible Debenture issued to the Purchasers named in the Securities Purchase Agreement
dated October 19, 2007 between the Company and the Purchasers named therein (incorporated by reference to
Exhibit 10.3 to Current Report on Form 8-K filed on October 22, 2007). |
|
|
|
10.8
|
|
Form of Seven Year and One Year Warrants to Purchase Shares of Common Stock of the Company issued by the Company
to the Purchasers named in the Securities Purchase Agreement dated October 19, 2007 between the Company and the
Purchasers named therein (incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed on
October 22, 2007). |
|
|
|
10.9
|
|
Settlement agreement dated as of October 31, 2006, by and among Terry LaCore, Mark D. Woodburn and Natural
Health Trends Corp. (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on November
1, 2006). |
|
|
|
10.10
|
|
Indemnification agreement effective as of October 31, 2006 by and among Natural Health Trends Corp., Terry
LaCore and Mark D. Woodburn (incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed on
November 1, 2006). |
|
|
|
10.11
|
|
Voting agreement, dated as of October 31, 2006, by and among Natural Health Trends Corp., Terry L. LaCore and
Mark D. Woodburn (incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed on November 1,
2006). |
|
|
|
10.12
|
|
Stockholders Agreement, dated as of March 31, 2004, by and among the Company, John Cavanaugh, Terry LaCore and
Jason Landry (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed on April 15, 2004). |
|
|
|
10.13
|
|
Lease by and between CLP Properties Texas, LLP and Natural Health Trends Corp. dated as of June 18, 2005
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on June 24, 2005). |
|
|
|
10.14
|
|
Agreement dated December 21, 2005 between Natural Health Trends Corp. and KGC Networks Pte Ltd. (incorporated by
reference to Exhibit 10.2 to Current Report on Form 8-K filed on December 28, 2005). |
|
|
|
+10.15
|
|
2002 Stock Plan, as amended (incorporated by reference to Appendix C to Definitive Proxy Statement filed on
April 27, 2005). |
|
|
|
+10.16
|
|
Form of Notice of Grant of Stock Option Agreement under the Companys 2002 Stock Option Plan (incorporated by
reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 1, 2005). |
|
|
|
+10.17
|
|
2007 Annual Incentive Plan (incorporated by reference to Appendix A to Definitive Proxy Statement filed on
October 20, 2006). |
|
|
|
+10.18
|
|
2007 Equity Incentive Plan (incorporated by reference to Appendix B to Definitive Proxy Statement filed on
October 20, 2006). |
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
+10.19
|
|
Form of Notice of Restricted Stock Grant and Restricted Stock Agreement under the Companys 2007 Equity
Incentive Plan (incorporated by reference to Exhibit 10.5 to Quarterly Report on Form 10-Q filed on May 11,
2007). |
|
|
|
+10.20
|
|
Employment Agreement (including form of Non-Competition and Proprietary Rights Assignment Agreement) for Chris
Sharng, dated April 23, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on
April 26, 2007). |
|
|
|
+10.21
|
|
Employment Agreement (including form of Non-Competition and Proprietary Rights Assignment Agreement) for Timothy
S. Davidson dated April 23, 2007 (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed
on April 26, 2007). |
|
|
|
+10.22
|
|
Employment Agreement (including form of Non-Competition and Proprietary Rights Assignment Agreement) for Gary C.
Wallace dated April 23, 2007 (incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed on
April 26, 2007). |
|
|
|
+10.23
|
|
Employment letter agreement dated as of December 8, 2006 between Natural Health Trends Corp. and John Cavanaugh
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 13, 2006). |
|
|
|
+10.24
|
|
Non-competition and proprietary rights assignment agreement dated as of December 8, 2006 between Natural Health
Trends Corp. and John Cavanaugh (incorporated by reference to Exhibit 10.2to Current Report on Form 8-K filed on
December 13, 2006). |
|
|
|
+10.25
|
|
Form of Indemnification Agreement dated December 13, 2005, between Natural Health Trends Corp. and each of its
directors (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 13, 2005). |
|
|
|
+10.26
|
|
Employment Agreement (including form of Non-Competition and Proprietary Rights Assignment Agreement) for Curtis
Broome dated April 23, 2007 (incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed on
April 26, 2007). |
|
|
|
+10.27
|
|
Employment letter agreement dated as of July 31, 2006 between Natural Health Trends Corp. and Stephanie Hayano
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on August 3, 2006). |
|
|
|
+10.28
|
|
Non-competition and proprietary rights assignment agreement dated as of July 31, 2006 between Natural Health
Trends Corp. and Stephanie Hayano (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed
on August 3, 2006). |
|
|
|
+10.29
|
|
Severance Agreement dated as of February 21, 2007 between Natural Health Trends Corp. and Stephanie Hayano
(incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on February 26, 2007). |
|
|
|
+10.30
|
|
Letter agreement dated as of March 1, 2006 between Natural Health Trends Corp. and Robert H. Hesse (incorporated
by reference to Exhibit 10.2 to Current Report on Form 8-K filed on March 16, 2006). |
|
|
|
+10.31
|
|
Founder Compensation Agreement by and among Lexxus International, Inc., Natural Health Trends Corp., Rodney
Sullivan and Pam Sullivan, Michael Bray, and Jeff Provost (incorporated by reference to exhibit to Annual Report
on Form 10-KSB filed on April 16, 2002). |
|
|
|
+10.32
|
|
Amendment No. 1 to Founder Compensation Agreement by and among Lexxus International, Inc., Natural Health Trends
Corp., Rodney Sullivan and Pam Sullivan, Michael Bray, and Jeff Provost (incorporated by reference to Exhibit
10.7 to Annual Report on Form 10-K filed on March 31, 2005). |
|
|
|
14.1
|
|
Worldwide Code of Business Conduct, as revised (incorporated by reference to Exhibit 14.1 to Annual Report on
Form 10-K filed on March 28, 2007). |
|
|
|
14.2
|
|
Code of Ethics for Senior Financial Officers (incorporated by reference to Exhibit 14.2 to Annual Report on Form
10-K filed on March 31, 2005). |
|
|
|
21.1
|
|
Subsidiaries of the Company (filed herewith). |
|
|
|
23.1
|
|
Consent of Lane Gorman Trubitt, L.L.P. (filed herewith). |
|
|
|
24.1
|
|
Power of Attorney (see signature page). |
|
|
|
31.1
|
|
Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of
1934, as amended (the Exchange Act) (filed herewith). |
|
|
|
31.2
|
|
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act (filed herewith). |
|
|
|
32.1
|
|
Certification of the Principal Executive 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 (filed herewith). |
|
|
|
32.2
|
|
Certification of the Principal 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 (filed herewith). |
|
|
|
+ |
|
Management contract or compensatory plan |