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, 2008
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
incorporation or organization)
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(I.R.S. Employer
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 Capital 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.
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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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Small reporting company þ |
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(Do not check if a smaller reporting company) |
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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, 2008: $9,097,167
At March 16, 2009, the number of shares outstanding of the registrants common stock was 10,728,714
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 2009 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, 2008
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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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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covenants and restrictions in certain investor agreements could restrict our ability to
operate and fund our business; |
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we may need to seek additional debt or equity financing on unfavorable terms, if
available at all; |
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our dependence on the Hong Kong and China markets and our vulnerability to sometimes
unpredictable changes in those markets; |
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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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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 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 face risks related to litigation; |
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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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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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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 company
headquartered in Dallas, Texas. Subsidiaries controlled by the Company sell personal care,
wellness, and quality of life products under the NHT Global brand to an independent distributor
network that either uses the products themselves or resells them to consumers.
Our majority-owned subsidiaries have an active physical presence in the following markets:
North America; Greater China, which consists of Hong Kong, Taiwan and China; South Korea; Japan;
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, primarily 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 corporate 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 Capital 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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La Vie is an energy-boosting dietary supplement described as a non-alcoholic red wine. |
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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 MaxTM 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.
1
Operations of the Business
Operating Strategy
Our mission is improving health, beauty and lifestyles and offering a global opportunity
through superior products.
In 2008, we focused our strategy improving the Companys culture, reducing expenses and
stabilizing our revenue base. During 2008 we took a number of steps aimed at enhancing our culture
and some aspects of our operations, including setting the right tone from the top, terminating
employees that either had a conflict of interest or didnt follow the Companys policies and
procedures with respect to ethics, and enhancing internal controls and practices. The Company also
planned and executed many cost reduction and margin improvement initiatives since the end of the
third quarter of 2007, such as (1) reducing headcount, which includes the termination of multiple
management-level positions in Greater China, South Korea and North America; (2) down-sizing offices
in Greater China and South Korea; (3) closing offices in Latin America and Southeast Asia; (4)
renegotiating vendor contracts in Greater China; (5) increasing product pricing in Greater China,
Europe and the U.S.; (6) changing commission plans worldwide; (7) streamlining logistics processes
in Greater China; (8) introducing better margin pre-assortments; and (9) reducing Company-wide
discretionary expenses. Also, we believe that we have taken a number of effective steps toward
stabilizing the Companys revenues on a sequential basis, especially in the Hong Kong market.
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. |
Our top priority markets are Greater China and Europe.
Sourcing of Products
Our corporate 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, 2008. 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. Alix Technologies (for
Skindulgence® and LaVie), 40Js LLC (for Alura®) and Two Harbors Trading Company (for Premium Noni
Juice and TriFusion Max) 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 40Js LLC and Two Harbors Trading Company that have annual renewal
rights. We do not currently have a long term contract with Alix Technologies.
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, parts of 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.
2
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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December 31, |
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2007 |
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2008 |
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North America |
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3,900 |
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1,310 |
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Hong Kong |
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33,470 |
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20,810 |
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Taiwan |
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4,650 |
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3,450 |
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South Korea |
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7,130 |
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3,480 |
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Japan |
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2,440 |
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1,200 |
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Europe |
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2,800 |
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2,170 |
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Other |
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2,610 |
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270 |
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Total |
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57,000 |
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32,690 |
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To become a 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 a proprietary web-based system to process orders and to
communicate business volume activity and commissions to distributors. Other than this proprietary
system, 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, 2008, we employed 136 total employees worldwide, of which 25 were located in
the United States, 66 in Hong Kong and China, 24 in Taiwan, 3 in Europe, 14 in South Korea, and 4
in Japan.
Seasonality
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 significant 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, 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.
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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 obtained or
applied for trademark registration for certain names, logos and various product names in several
countries in which we are doing business or considering expanding into. 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 was awarded a patent for the formulation
of that product.
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.
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.
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.
4
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, generally in their home country 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 retail platform 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 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 product sales. 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 a website at www.nhtglobal.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. |
5
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.nhtglobal.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
consumers and distributors; |
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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. |
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.
6
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 our Hong
Kong-based web site or our e-commerce platform in China. 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 have been required. We expect to
receive continued guidance and direction as we work with regulators to address our business model
and any changes that need to be made to comply with the new direct selling regulations.
In accordance with the new direct selling regulations, we applied for a direct selling license
first in 2005, provided a revised version in June 2006, and then updated again our application in
November 2007. The applications were not approved or rejected by the pertinent authorities, but
did not appear to materially progress. By now, the information contained in our most recent
application is stale. The Company applied to temporarily withdraw the license application in
February 2009 to furnish new information and intends to amend its application with the goal to
re-apply in the future.
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.
As is the case with most companies that operate in our product categories, we might receive
inquiries from time to time 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.
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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 ours. We recently obtained a
temporary injunction that restrains certain activities of bHIP Global, Inc. and Mr. LaCore (see
Item 3. Legal Proceedings). Many of our competitors have greater name recognition and
financial resources than we do and also have 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
We are 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, results of
operations and financial condition.
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, 2007 and
2008, primarily due to declines in our revenues without proportional decreases in expenditures. If
we continue to experience negative cash flows, our 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 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.
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Leverage And Debt Service Obligations 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, which consist of 12 monthly principal payments of
$177,000 beginning November 1, 2008 and a final payment of $2,125,000 on October 19, 2009, plus
interest on the outstanding balance. The degree to which we are leveraged and the terms of this
financing have, among other things:
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required us to dedicate a substantial portion of our cash flows from operations and
other capital resources to debt service; |
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made it difficult for us to obtain other financing in the future for working capital,
acquisitions or other purposes; |
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made us more vulnerable to industry downturns and competitive pressures; and |
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limited our flexibility in planning for, and reacting to changes in, our business. |
Our continued 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.
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.
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 And Fund 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 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
(ii) any agreement to sell securities at a future-determined price; 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 than 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 than 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.
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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 the agreements with the holders of our variable rate convertible
debentures. 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.
Because Our Hong Kong Operations Account For A Majority Of Our Overall Business, and Most Of Our
Hong Kong Business Is Derived From The Sale Of Products To Members In China, Any Material Adverse
Change In Our Business Relating To Either Hong Kong Or China Would Likely Have a Material Adverse
Impact On Our Overall Business.
In 2007 and 2008 approximately 62% and 66% of our revenue, respectively, was generated in Hong
Kong. Most of our Hong Kong revenues are derived from the sale of products that are delivered to
members in China. This geographic concentration in our business means that events or conditions
that could negatively impact this geographic region or our operations in this region would have a
greater adverse impact upon our overall business and financial results than would be the case with
a company having greater geographic diversification.
In contrast to our operations in other parts of the world, we have not implemented a direct
sales model in China. The Chinese government permits direct selling only by organizations that have
a license that we do not have, and has also adopted anti-multilevel marketing legislation. We
operate an e-commerce direct selling model in Hong Kong and recognize the revenue derived from
sales to both Hong Kong and Chinese members as being generated in Hong Kong. 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. In addition, through a Chinese entity we have launched an
e-commerce retail model in China. The Chinese entity operates separately from the Hong Kong
entity, although a Chinese member may elect to participate separately in both.
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, and that our
Chinese entity is operating in compliance with applicable Chinese laws. However, there can be no
assurance that the Chinese authorities will agree with our interpretations of applicable laws and
regulations or that China will not adopt new laws or regulations. Should the Chinese government
determine that our e-commerce activity violates Chinas direct selling or anti-multilevel marketing
legislation, or should new laws or regulations be adopted, there could be a material adverse effect
on our business, financial condition and results of operations.
Although we attempt to work closely with both national and local Chinese governmental
agencies in conducting our business, our efforts to comply with national and local laws may be
harmed by a rapidly evolving regulatory climate, concerns about activities resembling violations of
direct selling or anti-multi-level marketing legislation, subjective interpretations of laws and
regulations, and activities by individual distributors that may violate laws notwithstanding our
strict policies prohibiting such activities. Any determination that our operations or activities,
or the activities of our individual distributors or employee sales representatives, or importers of
record are not in compliance with applicable laws and regulations could result in the imposition of
substantial fines, extended interruptions of business, restrictions on our future ability to obtain
business licenses or expand into new locations, changes to our business model, the termination of
required licenses to conduct business, or other actions, any of which could materially harm our
business, financial condition and results of operations.
Various other factors could harm our business in Hong Kong, such as worsening economic
conditions in Hong Kong or China, adverse local publicity or other events that may be out of our
control. For example, 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 chain 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 or similar actions from time to time in the future, and such periods of reduced activity could
have a material adverse effect on our business.
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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, 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.
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. A series of changes in top management since
November 2005 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 of our confidential
information and trademarks. 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, use or other misappropriation of our confidential information, trademarks and other
intellectual property could enable third parties to benefit from such property without paying us
for it. 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, expensive and result in inadequate remedies. 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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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 in most of our markets. 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.
We experienced a 41% and 43% decrease in active distributors during 2007 and 2008,
respectively. 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.
Changes to Our Distributor Compensation Plan May Not Gain Acceptance
From time we have made, and may in the future make, changes to our compensation plans for
distributors. If we fail to properly analyze these changes, we could experience unanticipated
adverse changes to the level of commissions as a percentage of sales. If distributors fail to
understand these changes, or are unhappy with them, they could slow down or discontinue their sales
efforts or we could lose and fail to attract new distributors. For example, 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.
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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 duties. The failure to properly calculate, report and
pay such taxes or duties when we are subject to them could have a material adverse effect on our
financial condition and results of operations. Moreover, any change in the law or regulations
regarding such taxes or duties, or any interpretation thereof, could result in an increase in the
cost of doing business.
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 46% and 39% of net sales during 2007 and 2008, respectively. We compensate our
distributors by paying commissions, bonuses, and certain awards and prizes. 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. Any increase in compensation payments to distributors as a percentage of net sales
will reduce our profitability.
Our compensation plan includes a cap on distributor compensation paid out as a percentage of
product sales. We have enforced that cap from December 2008, which diluted commissions payable to
certain highly-paid distributors. There can be no assurance that enforcement of this cap will
ensure profitability (which depends on many other factors). Moreover, enforcement of this cap
could cause key distributors affected by the cap to leave and work elsewhere.
We Face Risks Related To Litigation That Could Have A Material Adverse Effect On Financial
Condition And Results Of Operations. We May Face Additional Litigation In The Future That Could
Also Harm Our Business.
We continue to be parties to various lawsuits. We and certain of our current and former
officers and directors are defendants in a class action securities fraud lawsuit that was filed in
September 2006. The parties have reached a settlement that is subject to final court approval
following completion of a fairness hearing. We also continue to defend a lawsuit with the
bankruptcy trustee of John Loghry, which is set for trial in June 2009. After other defendants
settled with the trustee, the amount of the judgment against us if we are found liable in that
lawsuit is limited to the amount necessary to pay $40,000 in creditor claims, as well as an
undetermined
amount of litigation costs, including attorneys fees. In June 2008, we sued Terry LaCore and
bHIP Global, Inc. for actual and punitive damages, as well as injunctive and other equitable
relief. Trial of that claim has been set in November 2009.
13
If we do not finally settle the lawsuits that we are defending, 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.
Prosecuting and 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 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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our products contain contaminants or unsafe ingredients; |
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our products include inadequate instructions as to their uses; or |
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our products include inadequate warnings concerning side effects and interactions with
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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 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 our internal
control over financial reporting was effective at December 31, 2008. 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. Any interruption in these
systems could have a material adverse effect on our business, financial condition, and results of
operations.
14
In 2004, we acquired our software service provider, MarketVision Communications Corporation
(MV Corp.), in part to gain better control over its operations. In connection with that
acquisition, we and MV Corp. entered into a Software License Agreement, with MarketVision
Consulting Group, LLC (MV Consulting), a limited liability company owned by John Cavanaugh, then
the President of MV Corp., and Jason Landry, then a Vice President of MV Corp. Upon an Event of
Default (as defined), the Software License Agreement granted, among other things, MV Consulting 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 included 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 MV Corp. 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 were entered into and,
as a result, an Event of Default occurred on January 1, 2007.
The Company does not believe that the Event of Default, by itself, had or will have a material
adverse effect on the Company. Although an Event of Default occurred, 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, without the right to rent, lease, license, transfer or distribute the
software without the Licensees prior written consent.
On December 1, 2008, we reached an agreement with MV Consulting, Mr. Cavanaugh and Mr. Landry
under which the parties agreed to terminate our employment of Mr. Cavanaugh and Mr. Landry, who
would be made available to us as consultants for six months. As part of that same agreement, MV
Consulting hired the other employees of MV Corp. and agreed to provide limited access to them as
consultants to the Company and its new software development and support team for six months. All
of the remaining members of our software development team were hired in 2008. Although we believe
that they have the qualifications, know-how and experience to perform the software development and
other information technology services previously provided by the former employees of MV Corp.,
there can be no assurance that there will not be delays or interruptions in these services. An
interruption or delay in availability of these services could, if it lasted long enough, prevent us
from making sales, cause distributors to leave our business, or otherwise materially adversely
affect our business.
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.
15
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 proposed rule, if implemented in its
original form, would negatively impact our business in the United States. On March 18, 2008, the
FTC issued for comment a revised proposed rule that would not include multi-level marketing
opportunities like ours in its scope of coverage. There can be no assurance, however, that the
proposed rule will be adopted in this form, or that it will not be amended or new regulations
adopted that would materially adversely impact our business.
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 (the FDA), the 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.
The FDA requires us and our suppliers to meet relevant current good manufacturing practice, or
cGMP, regulations for the preparation, packing and storage of foods and OTC drugs. On June 25,
2007, the FDA published its final rule regulating cGMPs for dietary supplements. The final rule
became effective August 24, 2007, and pertains to manufacturers and holders of dietary supplements,
not to parties that only supply ingredients. This rule requires procedures for personnel,
manufacturing cleanliness, labeling and packaging, testing and distribution. A systematic testing
procedure is also required to be followed. We and certain of our suppliers may have to comply with
these regulations by June 2009 or June 2010, depending upon the size of our suppliers. Failure by
us or our suppliers to comply with these current cGMPs and other applicable regulations and quality
assurance guidelines could lead to temporary manufacturing shutdowns, product shortages and delays
in product manufacturing.
A new law went into effect on December 22, 2007 that requires the reporting of all serious
adverse events occurring within the United States that involve dietary supplements. We are not
aware of any adverse events, and we believe that we are in full compliance with the law.
A foreign jurisdiction may pass laws that would prohibit the use of certain ingredients in
their particular market. If we are not able to satisfy the various regulations, then it would have
to cease sales of that product in that market.
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.
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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.
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 2007 and 2008, approximately 90% and 93%, 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, Japanese
yen, Chinese yuan, and European euro, represented approximately 26% of our revenue in 2008. Our
foreign currency exchange rate exposure may increase in the near future as our China and European
subsidiaries expand operations and as we develop a new market in Russia. 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.
17
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 and human 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 of our information
technology systems and operations, which 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, as well as human error. Despite precautions implemented
by our information technology staff, 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 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 particular, the ongoing economic crisis creates risk for us if any of these third
parties suffer liquidity or operational problems. If a key manufacturer becomes insolvent or is
forced to lay off employees assisting with our projects, our results could suffer. 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 or replacement products. There is no assurance
that we will be able to obtain alternative manufacturing sources or products 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.
Some of our competitors have employed or otherwise contracted for the services of our former
officers, employees, consultants, and distributors, who may try to use information and contacts
obtained while under contract with us for competitive advantage. While we seek to protect our
information through contractual and other means, there can be no assurance that we will timely
learn of such activity, have the resources to attempt to stop it, or have adequate remedies
available to us.
18
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.
If We Fail To Regain Compliance With Nasdaqs Minimum $1.00 Per Share Bid Price Requirement For
Continued Listing, Our Common Stock May Be Delisted From The Nasdaq Capital Market, Which May
Reduce The Price Of Our Common Stock And Levels Of Liquidity Available To Our Stockholders.
On September 2, 2008, we received a deficiency letter from The Nasdaq Stock Market indicating
that we were not in compliance with continued listing requirements on the Nasdaq Capital Market
because, for the previous 30 consecutive business days, the bid price of our common stock had
closed below the $1.00 minimum per share requirement for continued listing. By Nasdaq rule, we
were provided 180 calendar days, or until March 2, 2009, to regain compliance with the bid price
requirement. The letter also stated that we could regain compliance with the bid price requirement
if, at any time before March 2, 2009, the bid price of our common stock closed at or above $1.00
per share for a minimum of ten consecutive business days. We subsequently received a letter from
The Nasdaq Stock Market advising us that it has suspended enforcement of the minimum bid price
requirement until April 20, 2009, after which we will continue to have 137 calendar days (or until
September 3, 2009) to regain compliance. If we cannot demonstrate compliance by that time, Nasdaq
will determine whether we meet the Nasdaq Capital Market initial listing criteria other than the
bid price requirement. If we do, we will be provided an additional 180 calendar-day period to
comply with the bid price requirement. If not, we will be provided written notice that our
securities will be delisted. At that time, we would have the right to appeal Nasdaqs
determination to delist our securities to a listing qualifications panel, which would stay the
effect of the delisting pending a hearing on the matter before the panel. We intend to actively
monitor the bid price for our common stock between now and September 3, 2009, and will consider
implementation of various options if our common stock does not trade at a level that is likely to
regain compliance. There can be no assurance that we will be able to regain compliance.
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 Capital 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 interest, and fewer business development opportunities, any
of which could materially adversely affect our results of operations and financial condition.
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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 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 16, 2009, we had outstanding 10,728, 714 shares of common stock and also (i)
options to purchase an aggregate of 27,500 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 1,345,833 shares of common stock (plus additional
shares of common stock that may be issued in certain circumstances 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.
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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.
Outside the United States, we lease office space in Hong Kong, China, Japan, Taiwan, South
Korea, 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.
Item 3. LEGAL PROCEEDINGS
On or around March 31, 2004, our 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 we had breached an agreement to
issue shares of our common stock to Mr. Loghry. On May 13, 2004, we and NHT Global U.S. 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 us 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 Lisa Grossmann, an NHT
Global distributor. On June 2, 2005, we 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 us on some of our claims. We
dismissed our 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 Mr. Loghry until the Trustees
Case is resolved. On February 13, 2008, the District Court granted our motion to dismiss certain
of the Trustees fraud and contract claims because the dismissed claims had been filed too late to
be heard. In May 2008, the Court consolidated the Trustees Case with a related, pending lawsuit.
Messrs. Woodburn and LaCore and Ms. Grossmann, have now reached settlements with the Trustee and
Mr. Loghry. On February 17, 2009, the Court dismissed some additional claims and limited any
judgment for damages to an amount needed to make Mr. Loghrys creditors whole and pay costs of
litigation, including attorneys fees. The Court calculated that creditor claims total
approximately $40,000, but held that the summary judgment evidence was otherwise inconclusive on
the amount necessary to make creditors whole and pay costs of litigation. Trial is set for June
2009. We continue to believe that all of the defendants have meritorious defenses to the Trustees
remaining claims.
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 our common stock to recover damages caused by alleged violations of federal
securities laws. The lawsuit names us and certain current and former officers and directors as
defendants. At a mediation held on August 23, 2008, the parties reached an agreement in principle
to settle the litigation. The agreement in principle provides that the shareholder class will
receive a total payment of $2.75 million. Of that amount, our directors and officers insurance
carriers have agreed in principal to pay $2.5 million, and we have agreed in principal to pay
$250,000. The settlement is subject to a number of conditions, including final court approval
following completion of a fairness hearing. At this time, there can be no assurance that these
conditions will be met and that the settlement of the securities class action litigation will
receive final court approval. If the settlement is not completed, the parties to this suit may
attempt to reach agreement on alternative settlement terms or resume litigation. We recorded an
accrual for $250,000 related to this matter during the third quarter of 2008 and simultaneously
de-recognized $225,000 of legal fees that existed as of June 30, 2008, but which have now been paid
under our directors and officers insurance policy.
On June 26, 2008, we filed a lawsuit in the 116th District Court, Dallas County,
Texas, against Terry LaCore and bHIP Global, Inc. seeking an unspecified amount in actual and
punitive damages, as well as a temporary and permanent injunction and other equitable relief. We
claim that Mr. LaCore deceived us, breached fiduciary duties, and breached various agreements
regarding the use, disclosure and return of confidential information and other assets and
non-interference with us and our business and relationships. We also claim that Mr. LaCore and
bHIP Global, Inc. are unlawfully taking, disparaging and/or interfering with our reputation,
identity, confidential information, contracts and relationships, products, businesses and other
assets. On March 5, 2009 we obtained a temporary injunction that restrains Mr. LaCore and bHIP
Global, Inc. (and their officers, agents, employees and attorneys, and all persons in active
concert or participation with them) from (1) contracting with, or employing, any former or existing
employee, distributor or supplier of ours if such contract or employment would result in that
person breaching his or her agreement with us; and
(2) obtaining confidential information belonging to us if the defendants know that the
information was obtained in breach of a confidentiality agreement between us and any former or
existing employee, distributor or supplier of ours. The temporary injunction also orders the Mr.
LaCore and bHIP Global, Inc. to locate and return our trade secrets and proprietary and
confidential information. The temporary injunction will remain in place until the trial of the
case, which is currently scheduled for November 9, 2009. We believe that our claims have merit and
intend to vigorously pursue them.
21
On July 16, 2008, Lisa Grossmann, a former distributor and consultant for us, filed a lawsuit
in the Superior Court of California in Sacramento, California, against us, and certain current
officers and directors, purporting to sue individually and on behalf of California distributors,
shareholders, and customers of ours. On behalf of California residents, Ms. Grossmann alleges that
the defendants engaged in, or conspired to engage in, unfair competition and false advertising and
seeks an unspecified amount of restitution and disgorgement, as well as an injunction.
Individually, Ms. Grossmann alleges that we breached a contract to pay distributor commissions to
her, we breached an implied covenant of good faith and fair dealing, all defendants were unjustly
enriched at her expense, the individual defendants breached fiduciary duties to her, all defendants
were negligent in conducting the affairs of the Company, and all defendants committed fraud. Ms.
Grossman seeks in excess of $500,000 in damages on her individual claims. All defendants deny Ms.
Grossmans allegations and intend to vigorously defend them. On February 9, 2009, the Superior
Court granted the defendants motion to quash service of the lawsuit on them for lack of personal
jurisdiction.
Currently, there is no material litigation pending against us other than as disclosed in the
paragraphs above. From time to time, we may become a party to litigation and subject to claims
incident to the ordinary course of our business. Although the results of such litigation and
claims in the ordinary course of business cannot be predicted with certainty, we believe that the
final outcome of such matters will not have a material adverse effect on our business, results of
operations or financial condition. Regardless of the outcome, litigation can have an adverse
impact on us because of defense costs, diversion of management resources and other factors.
22
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Stockholders held on December 30, 2008, four proposals were adopted
by our stockholders: (1) the election of three directors to our Board of Directors to serve until
the next annual meeting of stockholders (Messrs. Randall A. Mason, Stefan W. Zuckut and George K.
Broady were elected as directors), (2) the approval of the potential issuance of shares of common
stock exceeding 19.99% of the number of shares outstanding on October 19, 2007, which shares of
common stock underlie the variable rate convertible debentures and warrants issued in connection
with a private placement financing, for the purpose of complying with applicable Nasdaq Marketplace
Rules and the Securities Purchase Agreement dated October 19, 2007 relating to such private
placement financing, (3) the approval of the increase in the maximum aggregate number of shares of
common stock available for issuance under the Natural Health Trends Corp. 2007 Equity Incentive
Plan by 500,000 shares and (4) the ratification of the appointment of Lane Gorman Trubitt, L.L.P.
as our independent registered public accounting firm for the fiscal year ending December 31, 2008.
The number of shares cast for and against, as well as the number of abstentions as to each of these
matters (other than the election of directors), is as follows:
|
|
|
|
|
|
|
|
|
Election of Directors |
|
Shares For |
|
|
Shares Withheld |
|
|
|
|
|
|
|
|
|
|
Randall A. Mason |
|
|
6,402,124 |
|
|
|
484,985 |
|
Stefan W. Zuckut |
|
|
6,398,044 |
|
|
|
489,065 |
|
George K. Broady |
|
|
6,677,023 |
|
|
|
210,086 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proposal |
|
Shares For |
|
|
Shares Against |
|
|
Abstentions |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approval of the potential
issuance of shares of
common stock exceeding
19.99% of the number of
shares outstanding on
October 19, 2007, which
shares of common stock
underlie the variable rate
convertible debentures and
warrants issued in
connection with a private
placement financing, for
the purpose of complying
with applicable Nasdaq
Marketplace Rules and the
Securities Purchase
Agreement dated October
19, 2007 relating to such
private placement
financing |
|
|
2,010,460 |
|
|
|
89,101 |
|
|
|
14,395 |
|
Approval of the increase
in the maximum aggregate
number of shares of common
stock available for
issuance under the Natural
Health Trends Corp. 2007
Equity Incentive Plan by
500,000 shares |
|
|
1,663,322 |
|
|
|
445,674 |
|
|
|
4,960 |
|
Ratification of Lane
Gorman Trubitt, L.L.P. as
our independent registered
public accounting firm |
|
|
6,748,093 |
|
|
|
64,339 |
|
|
|
74,677 |
|
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 Capital Market under the symbol BHIP. Prior to
April 17, 2008, our common stock was quoted on the Nasdaq Global Market. 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 respective Nasdaq Capital Market or the Nasdaq Global Market.
|
|
|
|
|
|
|
|
|
Quarter Ended: |
|
High |
|
|
Low |
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
March 31, 2008 |
|
$ |
1.31 |
|
|
$ |
0.48 |
|
June 30, 2008 |
|
|
1.77 |
|
|
|
0.77 |
|
September 30, 2008 |
|
|
1.16 |
|
|
|
0.28 |
|
December 31, 2008 |
|
|
0.68 |
|
|
|
0.21 |
|
Holders of Record
At March 16, 2009, 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 $0.32 per share as reported by the Nasdaq Capital 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, 2008 we had accrued unpaid dividends of $107,000 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 and e-commerce company. Subsidiaries controlled by us
sell personal care, wellness, and quality of life products under the NHT Global brand to an
independent distributor network that either uses the products themselves or resells them to
consumers.
As of December 31, 2008, we are conducting business through approximately 33,000 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, Europe, in particular Russia, and South Korea. Additionally, we
have consolidated underperforming markets in Latin America and Southeast Asia to further improve
operating results and free up additional internal resources for our most promising markets.
In 2007 and 2008, we generated approximately 90% and 93% of our net sales from subsidiaries
located outside North America, respectively, with sales in Hong Kong representing approximately 62%
and 66% of net sales, 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 without a direct selling license that we do not have. 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. These direct selling
applications were not approved or rejected by the pertinent authorities, but did not appear to
materially progress. By now, the information contained in the most recent application is stale.
The Company applied to temporarily withdraw the license application in February 2009 to furnish new
information and intends to amend its application with the goal to re-apply in the future. We are
unable to predict whether we will be successful in obtaining a direct selling license to operate in
China, and if we are successful, when we will be permitted to enhance our e-commerce retail
platform with direct selling operations.
Most of the Companys Hong Kong revenue is 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, raise 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. See Risk FactorsBecause our Hong Kong Operations
Account For a Majority of Our Overall Business...
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 for the time periods indicated (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America |
|
$ |
7,743 |
|
|
|
10.1 |
% |
|
$ |
3,247 |
|
|
|
7.1 |
% |
Hong Kong |
|
|
47,240 |
|
|
|
61.8 |
|
|
|
30,272 |
|
|
|
66.1 |
|
China |
|
|
538 |
|
|
|
0.7 |
|
|
|
1,328 |
|
|
|
2.9 |
|
Taiwan |
|
|
5,861 |
|
|
|
7.7 |
|
|
|
4,444 |
|
|
|
9.7 |
|
South Korea |
|
|
9,334 |
|
|
|
12.2 |
|
|
|
3,805 |
|
|
|
8.3 |
|
Japan |
|
|
2,196 |
|
|
|
2.9 |
|
|
|
1,244 |
|
|
|
2.7 |
|
Europe |
|
|
|
|
|
|
|
|
|
|
1,223 |
|
|
|
2.7 |
|
Other1 |
|
|
3,589 |
|
|
|
4.6 |
|
|
|
243 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
76,501 |
|
|
|
100.0 |
% |
|
$ |
45,806 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. Also included
are sales from the Latin America, Australia, New Zealand, and Southeast Asia
markets. |
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 typically 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 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 retail platform 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 payouts may be limited by a fixed ceiling measured 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 fiscal 2007 and
2008, represented 46% and 39% 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, 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.
27
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, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of sales |
|
|
26.5 |
|
|
|
27.7 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
73.5 |
|
|
|
72.3 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
45.9 |
|
|
|
38.5 |
|
Selling, general and administrative expenses |
|
|
41.7 |
|
|
|
37.5 |
|
Depreciation and amortization |
|
|
2.4 |
|
|
|
3.2 |
|
Impairment of goodwill and long-lived assets |
|
|
17.2 |
|
|
|
|
|
Recovery of KGC receivable |
|
|
(0.7 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
106.5 |
|
|
|
79.2 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(33.0 |
) |
|
|
(6.9 |
) |
Other income (expense), net |
|
|
0.2 |
|
|
|
(0.5 |
) |
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(32.8 |
) |
|
|
(7.4 |
) |
Income tax provision |
|
|
(0.3 |
) |
|
|
(1.0 |
) |
Minority interest |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(33.1 |
)% |
|
|
(8.4 |
)% |
|
|
|
|
|
|
|
Net Sales. Net sales were $45.8 million for the year ended December 31, 2008 compared to
$76.5 million for the year ended December 31, 2007, a decrease of $30.7 million, or 40%. Hong Kong
net sales decreased $17.0 million, or 36%, over the prior year. Additionally, net sales for North
America and South Korea were down $4.5 million and $5.5 million, respectively. North American
sales were slightly impacted by the launch of retail product selling in Italy during June 2008.
Prior to the launch, sales into the European market were fulfilled by our North American
subsidiaries. Additionally, net sales in Latin America and Southeast Asia were impacted by our
efforts to consolidate underperforming markets during 2008. Partly offsetting the decrease, net
sales in China from our new e-commerce retail platform increased $790,000 during 2008.
The decrease in net sales was primarily due to the Companys lower product sales as a result
of fewer active distributors. The Companys active distributor count has continually declined from
reduced promotional spending toward distributors that have been deemed loss-incurring, more
competition, the distractions and disruptions caused by management changes in the 18-month period
ending February 2007 and the members reaction to the uncertain regulatory environment in China
that is currently impacting the Companys Hong Kong-based business. As of December 31, 2008, the
operating subsidiaries of the Company had approximately 33,000 active distributors, compared to
57,000 active distributors at December 31, 2007. Hong Kong experienced a decrease of approximately
13,000 active distributors, or 38%, since December 31, 2007.
As of December 31, 2008, the Company had deferred revenue of approximately $2.8 million, of
which approximately $1.9 million pertained to product sales and approximately $964,000 pertained to
unamortized enrollment package revenue.
Cost of Sales. Cost of sales was $12.7 million, or 27.7% of net sales, for the year ended
December 31, 2008 compared with $20.3 million, or 26.5% of net sales, for the year ended December
31, 2007. Cost of sales decreased $7.6 million, or 38%, 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 did not decline at the same rate as net product sales.
Gross Profit. Gross profit was $33.1 million, or 72.3% of net sales, for the twelve months
ended December 31, 2008 compared with $56.2 million, or 73.5% of net sales, for the twelve months
ended December 31, 2007. This decrease of $23.1 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.
28
Distributor Commissions. Distributor commissions were $17.7 million, or 38.5% of net sales,
for the year ended December 31, 2008 compared with $35.1 million, or 45.9% of net sales, for the
year ended December 31, 2007. Distributor commissions decreased by $17.4 million, or 50%, 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, Hong Kong and South Korea, and fewer
commissions earned in the markets of Japan and Europe.
The result of the commission plan change during the second quarter of 2007 was less than
satisfying. While the payout as a percentage of sales was lowered, sales decreased significantly
following the effective date of the change. We implemented certain changes to our commission plan
in March 2008. Additional enhancements were also added at the same time to improve sales momentum.
With these commission changes and enhancements, we targeted a commission payout we expect to
eventually settle around 40% of product sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
were $17.2 million, or 37.5% of net sales, for the year ended December 31, 2008 compared with $31.9
million, or 41.7% of net sales, for the year ended December 31, 2007. Selling, general and
administrative expenses decreased by $14.7 million, or 46%, in the twelve months ended December 31,
2008 mainly due to the following:
|
|
|
lower employee-related expense and severance costs ($1.8 million), travel-related
costs ($269,000), insurance costs ($326,000), credit card fees and assessments
($195,000), facility-related costs ($171,000), professional fees ($1.1 million) and
litigation settlement costs ($231,000) in North America; |
|
|
|
lower overall expense in Japan ($1.0 million), specifically employee-related expense,
due to expense reduction programs during the first nine months of 2007; |
|
|
|
lower employee-related expense ($2.3 million), event costs ($560,000), professional
fees ($1.6 million), public relations expense ($489,000), credit card charges and
assessments ($384,000), and other miscellaneous costs ($504,000) in Hong Kong and China; |
|
|
|
lower employee-related costs, event costs and other office-related costs ($512,000)
in Taiwan; |
|
|
|
lower operating costs due to office closures in Australia ($539,000), Mexico
($725,000), and Southeast Asia ($553,000); |
|
|
|
lower employee-related costs ($561,000), credit card charges and assessments
($220,000), facility-related costs ($156,000), and other miscellaneous costs ($190,000)
in South Korea; |
|
|
|
lower stock-based compensation expense ($291,000); partly offset by |
|
|
|
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 ($244,000). |
Depreciation and Amortization. Depreciation and amortization was $1.5 million, or 3.2% of net
sales, for the year ended December 31, 2008 compared with $1.8 million, or 2.4% of net sales, for
the year ended December 31, 2007. Depreciation and amortization decreased by $352,000 compared to
the prior year, as a result of the Companys slowdown in capital expenditures.
Impairment of Goodwill and Long-Lived Assets. 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 2008.
Impairment of long-lived assets was $30,000 for the year ended December 31, 2008 compared with
$795,000 for the year ended December 31, 2007. The impairment expense during 2007 is primarily
related to an impairment charge of $273,000 recorded for certain office equipment and leasehold
improvements in Mexico as the Company decided to terminate its existing office lease in Mexico City
and relocate to a less costly location, and an impairment charge of $246,000 recorded in Japan as
the Company determined that it was in its best interest to discontinue the use of certain computer
software. Additionally, an impairment charge of $253,000 was recorded as to the overall
recoverability of the remaining long-lived assets in both Mexico and Japan.
Recovery of KGC Receivable. Recovery of KGC receivable has declined as the Company did not
receive any payments on the receivable from KGC Networks Ptd. Ltd. (KGC) during the year ended
December 31, 2008. KGC became delinquent on its monthly payments to the Company in August 2007. A
recovery of KGC receivable was recorded for $565,000 during the year ended December 31, 2007.
29
Other Income (Expense), Net. Other expense was $226,000 for the year ended December 31, 2008
compared with income of $143,000 for the year ended December 31, 2007. The increase in other
expense was primarily due to interest expense of $2.4 million
the Company recorded on its convertible debentures, including amortization of debt issuance
cost and accretion of debt discount aggregating $2.1 million. Offsetting this expense, the Company
de-recognized $2.2 million of commission liabilities in certain of its international markets for
previous years as it determined that it is probable that these commission payments will not be
claimed. Additionally, interest income declined as the Company has not recognized any imputed
interest on the receivable from KGC in 2008. As previously mentioned, KGC became delinquent on its
payments to the Company in August 2007. During the year ended December 31, 2007, the Company
recognized $228,000 in imputed interest on the KGC receivable.
Income Taxes. The provision for income taxes increased to $456,000 for the year ended December
31, 2008 compared with $200,000 for the year ended December 31, 2007 due to a $351,000 deferred tax
liability recorded in Hong Kong upon de-recognition of certain commission liabilities. The Company
did not recognize a tax benefit for U.S. tax purposes due to uncertainty that the benefit will be
realized.
Net Loss. Net loss was $3.9 million, or 8.4% of net sales, for the year ended December 31,
2008 compared to net loss of $25.3 million, or 33.1% of net sales, for the year ended December 31,
2007. The reduction in losses was primarily due to lower distributor commissions and selling,
general and administrative expenses as compared to the comparable period in the prior year and less
goodwill impairment.
Liquidity and Capital Resources
The Company has in recent quarters supported its working capital and capital expenditure needs
with cash generated from operations as well as capital raised from several private placements.
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 has used and plans to continue using the net proceeds from the October 2007 private
placement to provide additional working capital.
At December 31, 2008, the Companys cash and cash equivalents totaled approximately $3.5
million. Total cash and cash equivalents decreased by approximately $2.8 million from December 31,
2007 to December 31, 2008.
At December 31, 2008, the ratio of current assets to current liabilities was 0.63 to 1.00 and
the Company had a working capital deficit of approximately $4.1 million. Current liabilities
included deferred revenue of $2.8 million that consisted of amortized enrollment package revenues
and unshipped orders. The ratio of current assets to current liabilities excluding deferred
revenue would be 0.85 to 1.00. Working capital as of December 31, 2008 decreased $867,000 compared
to that as of December 31, 2007 mainly due to cash used in operations and a $1.3 million net
increase in the Debentures resulting from a $1.7 million accretion of the debt discount, offset by
de-recognition of commission liabilities in certain of our international markets totaling $2.2
million.
Cash used in operations for the twelve months ended December 31, 2008 was approximately $2.7
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,
partly offset by a $1.3 million reduction in existing inventories. The aggregate impact on cash
resulting from the decrease in current liabilities totaled $3.8 million. This is due to the
Companys efforts to reduce operating
expenses during the latter half of fiscal 2007 and lower distributor commission payout. The
reduction in inventories was primarily the result of the Companys intentional efforts to slow down
inventory purchasing and monetize existing inventories.
30
Cash provided by investing activities during the twelve months ended December 31, 2008 was
approximately $198,000, primarily due to a decrease in restricted cash maintained as a reserve with
a certain credit card processing company in South Korea to provide for potential uncollectible
amounts and chargebacks, partially offset by an increase in capital expenditures during the three
months ended June 30, 2008 in Hong Kong for new office space and in China for additional retail
space, and during the three months ended September 30, 2008 in China for additional warehouse
space.
Cash used in financing activities during the twelve months ended December 31, 2008 was
approximately $396,000. This was primarily due to the monthly installments Debentures that began
on November 1, 2008. Additionally, a short-term loan for $145,000 was entered into during 2008 by
our South Korean subsidiary and repaid in July 2008.
The Company has taken numerous actions to ensure that it will continue as a going concern. It
has planned and executed many cost reduction and margin improvement initiatives since the end of
the third quarter of 2007, such as (1) reducing headcount, which includes the termination of
multiple management-level positions in Greater China, South Korea and North America; (2)
down-sizing offices in Greater China and South Korea; (3) closing offices in Latin America and
Southeast Asia; (4) renegotiating vendor contracts in Greater China; (5) increasing product pricing
in Greater China, Europe and the U.S.; (6) changing commission plans worldwide; (7) streamlining
logistics processes in Greater China; (8) introducing better margin pre-assortments; and (9)
reducing Company-wide discretionary expenses. Also, we believe that we have taken a number of
effective steps toward stabilizing the Companys revenues on a sequential basis, especially in the
Hong Kong market. As a result, the Company believes that its current cash breakeven level has been
significantly reduced and is more attainable.
The Company believes that its existing internal liquidity, supported by cash on hand, certain
restricted cash that the Company believes can be unlocked later in 2009 upon the withdrawal of our
direct selling license application in China, anticipated improvement in cash flows from operations
with more stabilized revenue and much lower fixed costs since October 2007 should be adequate to
fund normal business operations and address its financial commitments for at least the next 12
months, assuming no significant unforeseen expense or further revenue decline. If the Companys
foregoing beliefs or assumptions prove to be incorrect, however, the Companys business, results of
operations and financial condition could be materially adversely affected. See Risk Factors.
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 may 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, Europe, in particular Russia, and South Korea.
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 Alura®
product. Pursuant to this agreement, the Company is required to pay the supplier a minimum of
$120,000 per year.
The Company has employment agreements with certain members of its management team which can be
terminated by either the employee or the Company upon four weeks notice. These employment
agreements contain provisions which guarantee the payments of specified amounts in the event of a
change in control, as defined, or if the employee is terminated for reasons other than cause, as
defined in those agreements. As of December 31, 2008, no outstanding obligations existed under any
severance agreements.
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.
31
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, 2008 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, 2007 and 2008, the Companys inventory value was approximately $3.6
million and $2.1 million, respectively, net of reserves of $1.8 million and $239,000, respectively.
Inventory provision of $489,000 was recorded during 2007 related to discontinued and obsolete
products. No significant provision was recorded during 2008.
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, 2008, 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
2008.
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 2007, the Company recorded an aggregate impairment charge of
$795,000 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. At December 31, 2008, the net book value of the
Companys property and equipment and intangible assets were approximately $1.2 million and $1.8
million, respectively. No significant impairment was recorded during 2008.
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 11% of sales. Sales returns were approximately 5% and 4% of sales for the years
ended December 31, 2007 and 2008, respectively. The allowance for sales returns was approximately
$754,000 and $517,000 at December 31, 2007 and 2008, respectively. No material changes in
estimates have been recognized for the year ended December 31, 2008.
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 $705,000 and $1.9 million at
December 31, 2007 and 2008, respectively. Shipping charges billed to distributors are included in
net sales. Costs associated with shipments are included in cost of sales.
32
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, 2007 and 2008, enrollment
package revenue totaling $2.8 million and $1.0 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 were expected to be realized and therefore no valuation allowance was 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 and 2008, no such reduction
in the valuation allowance occurred. Any reductions in the valuation allowance will reduce future
income tax provisions.
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, 2008 and 2007, and the related consolidated statements of operations,
stockholders equity and cash flows for the years then ended. Our audits also included the
financial statement schedule listed in the index at item 15(2). 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 audits 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, 2008
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. Also, in
our opinion, the related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects, the information
set forth therein.
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, 2008 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 23, 2009
35
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
6,282 |
|
|
$ |
3,491 |
|
Restricted cash |
|
|
298 |
|
|
|
340 |
|
Accounts receivable |
|
|
418 |
|
|
|
71 |
|
Inventories, net |
|
|
3,585 |
|
|
|
2,141 |
|
Other current assets |
|
|
1,324 |
|
|
|
735 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
11,907 |
|
|
|
6,778 |
|
Property and equipment, net |
|
|
1,537 |
|
|
|
1,173 |
|
Goodwill |
|
|
1,764 |
|
|
|
1,764 |
|
Intangible assets, net |
|
|
2,600 |
|
|
|
1,800 |
|
Restricted cash |
|
|
4,317 |
|
|
|
3,646 |
|
Deferred tax assets |
|
|
208 |
|
|
|
|
|
Other assets |
|
|
2,363 |
|
|
|
1,464 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
24,696 |
|
|
$ |
16,625 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
2,168 |
|
|
$ |
1,746 |
|
Income taxes payable |
|
|
363 |
|
|
|
187 |
|
Accrued distributor commissions |
|
|
2,018 |
|
|
|
554 |
|
Other accrued expenses |
|
|
3,599 |
|
|
|
2,456 |
|
Deferred revenue |
|
|
3,496 |
|
|
|
2,841 |
|
Current portion of convertible debentures, net of discount of
$151 and $2,320 at December 31, 2007 and 2008, respectively |
|
|
203 |
|
|
|
1,534 |
|
Deferred tax liability |
|
|
|
|
|
|
351 |
|
Other current liabilities |
|
|
3,254 |
|
|
|
1,170 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
15,101 |
|
|
|
10,839 |
|
Convertible debentures, net of discount of $3,896 at December 31, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
|
15,101 |
|
|
|
10,839 |
|
Commitments and contingencies |
|
|
|
|
|
|
|
|
Minority interest |
|
|
33 |
|
|
|
34 |
|
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 and 2008, aggregate liquidation value of $263 |
|
|
124 |
|
|
|
124 |
|
Common stock, $0.001 par value; 50,000,000 shares authorized;
10,327,405 and 10,691,582 shares issued and outstanding at
December 31, 2007 and 2008, respectively |
|
|
10 |
|
|
|
11 |
|
Additional paid-in capital |
|
|
79,158 |
|
|
|
79,711 |
|
Accumulated deficit |
|
|
(70,989 |
) |
|
|
(74,853 |
) |
Accumulated other comprehensive income: |
|
|
|
|
|
|
|
|
Foreign currency translation adjustments |
|
|
1,259 |
|
|
|
759 |
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
9,562 |
|
|
|
5,752 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
24,696 |
|
|
$ |
16,625 |
|
|
|
|
|
|
|
|
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, |
|
|
|
2007 |
|
|
2008 |
|
Net sales |
|
$ |
76,501 |
|
|
$ |
45,806 |
|
Cost of sales |
|
|
20,290 |
|
|
|
12,681 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
56,211 |
|
|
|
33,125 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
35,095 |
|
|
|
17,650 |
|
Selling, general and administrative
expenses (including stock-based
compensation expense of $845 and $554
during 2007 and 2008, respectively) |
|
|
31,921 |
|
|
|
17,171 |
|
Depreciation and amortization |
|
|
1,808 |
|
|
|
1,456 |
|
Impairment of goodwill |
|
|
12,381 |
|
|
|
|
|
Impairment of long-lived assets |
|
|
795 |
|
|
|
30 |
|
Recovery of KGC receivable |
|
|
(565 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
81,435 |
|
|
|
36,307 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(25,224 |
) |
|
|
(3,182 |
) |
Other income (expense), net: |
|
|
|
|
|
|
|
|
Gain (loss) on foreign exchange |
|
|
11 |
|
|
|
(121 |
) |
Interest income |
|
|
477 |
|
|
|
107 |
|
Interest expense (including amortization
of debt issuance costs and accretion of
debt discount of $245 and $2,083 during
2007 and 2008, respectively) |
|
|
(352 |
) |
|
|
(2,424 |
) |
De-recognition of commission liabilities |
|
|
|
|
|
|
2,237 |
|
Other |
|
|
7 |
|
|
|
(25 |
) |
|
|
|
|
|
|
|
Total other income (expense), net |
|
|
143 |
|
|
|
(226 |
) |
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(25,081 |
) |
|
|
(3,408 |
) |
Income tax provision |
|
|
(200 |
) |
|
|
(456 |
) |
Minority interest |
|
|
(6 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(25,287 |
) |
|
|
(3,864 |
) |
|
|
|
|
|
|
|
|
|
Beneficial conversion feature on preferred stock |
|
|
(1,574 |
) |
|
|
|
|
Preferred stock dividends |
|
|
(91 |
) |
|
|
(17 |
) |
|
|
|
|
|
|
|
Net loss attributable to common stockholders |
|
$ |
(26,952 |
) |
|
$ |
(3,881 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share basic and diluted |
|
$ |
(3.15 |
) |
|
$ |
(0.40 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average number of shares outstanding |
|
|
8,555 |
|
|
|
9,677 |
|
|
|
|
|
|
|
|
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, 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 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,864 |
) |
|
|
|
|
|
|
(3,864 |
) |
Foreign currency translation adjustments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(500 |
) |
|
|
(500 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,364 |
) |
Issuance of restricted stock, net |
|
|
|
|
|
|
|
|
|
|
364,177 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
554 |
|
|
|
|
|
|
|
|
|
|
|
554 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2008 |
|
|
138,400 |
|
|
$ |
124 |
|
|
|
10,691,582 |
|
|
$ |
11 |
|
|
$ |
79,711 |
|
|
$ |
(74,853 |
) |
|
$ |
759 |
|
|
$ |
5,752 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
38
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(25,287 |
) |
|
$ |
(3,864 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization of property and equipment |
|
|
1,008 |
|
|
|
656 |
|
Amortization of intangibles |
|
|
800 |
|
|
|
800 |
|
Amortization of debt issuance costs |
|
|
42 |
|
|
|
356 |
|
Accretion of debt discount |
|
|
203 |
|
|
|
1,727 |
|
Minority interest |
|
|
6 |
|
|
|
|
|
Stock-based compensation |
|
|
845 |
|
|
|
554 |
|
Imputed interest on KGC installment payable |
|
|
(228 |
) |
|
|
|
|
Recovery of KGC receivable |
|
|
(565 |
) |
|
|
|
|
Impairment of long-lived assets |
|
|
795 |
|
|
|
30 |
|
Impairment of goodwill |
|
|
12,381 |
|
|
|
|
|
Deferred income taxes |
|
|
7 |
|
|
|
526 |
|
Changes in assets and liabilities: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
47 |
|
|
|
293 |
|
Inventories, net |
|
|
2,312 |
|
|
|
1,328 |
|
Other current assets |
|
|
927 |
|
|
|
581 |
|
Other assets |
|
|
250 |
|
|
|
313 |
|
Accounts payable |
|
|
(1,268 |
) |
|
|
(424 |
) |
Income taxes payable |
|
|
64 |
|
|
|
(185 |
) |
Accrued distributor commissions |
|
|
(1,829 |
) |
|
|
(1,407 |
) |
Other accrued expenses |
|
|
(1,693 |
) |
|
|
(1,174 |
) |
Deferred revenue |
|
|
(2,143 |
) |
|
|
(636 |
) |
Other current liabilities |
|
|
110 |
|
|
|
(2,204 |
) |
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(13,216 |
) |
|
|
(2,730 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(341 |
) |
|
|
(299 |
) |
Decrease (increase) in restricted cash |
|
|
(475 |
) |
|
|
497 |
|
Decrease in certificate of deposit |
|
|
1,283 |
|
|
|
|
|
Proceeds from KGC receivable (see Note 1) |
|
|
1,183 |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by investing activities |
|
|
1,650 |
|
|
|
198 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
|
|
|
Proceeds from issuance of convertible debentures and warrants |
|
|
3,740 |
|
|
|
|
|
Debt issuance costs |
|
|
(442 |
) |
|
|
|
|
Proceeds from short-term debt |
|
|
|
|
|
|
145 |
|
Payments on convertible debentures and other debt |
|
|
|
|
|
|
(541 |
) |
Proceeds from issuance of preferred stock and warrants, net |
|
|
2,560 |
|
|
|
|
|
Proceeds from issuance of common stock |
|
|
90 |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
5,948 |
|
|
|
(396 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rates on cash and cash equivalents |
|
|
(36 |
) |
|
|
137 |
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents |
|
|
(5,654 |
) |
|
|
(2,791 |
) |
CASH AND CASH EQUIVALENTS, beginning of period |
|
|
11,936 |
|
|
|
6,282 |
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period |
|
$ |
6,282 |
|
|
$ |
3,491 |
|
|
|
|
|
|
|
|
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), a Delaware corporation, is an international
direct-selling and e-commerce company headquartered in Dallas, Texas. Subsidiaries controlled by
the Company sell personal care, wellness, and quality of life products under the NHT Global
brand to an independent distributor network that either uses the products themselves or resells
them to consumers.
Our majority-owned subsidiaries have an active physical presence in the following markets:
North America; Greater China, which consists of Hong Kong, Taiwan and China; South Korea; Japan;
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.
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 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.
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 2.
40
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, 2007 and 2008, the reserve
for obsolescence totaled $1.8 million and $239,000, respectively.
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 3.
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 2007, the Company recorded an aggregate impairment charge of $795,000 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.
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). 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 and 2008 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 2005, and is no longer subject to state income tax examinations for
years prior to 2004. No jurisdictions are currently examining any income tax returns of the
Company or its subsidiaries.
41
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.
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, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Options to purchase common stock |
|
|
1,041,458 |
|
|
|
70,500 |
|
Warrants to purchase common stock |
|
|
6,281,310 |
|
|
|
6,281,310 |
|
Non-vested restricted stock |
|
|
1,044,186 |
|
|
|
1,255,478 |
|
Convertible preferred stock |
|
|
1,759,307 |
|
|
|
138,400 |
|
Convertible debentures |
|
|
1,700,000 |
|
|
|
1,700,000 |
|
42
Options and warrants to purchase 42,500 and 6,281,310 shares of common stock, respectively,
were still outstanding at December 31, 2008. 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 2007 and 2008, a substantial portion of the Companys sales were generated in Hong Kong
(see Note 11). Most of the Companys Hong Kong revenue is derived from the sale of products that
are delivered to members in China. In contrast to the Companys operations in other parts of the
world, the Company has not implemented a direct sales model in China. The Chinese government
permits direct selling only by organizations that have a license that the Company does not have,
and has also adopted anti-multilevel marketing legislation. The Company operates an e-commerce
direct selling model in Hong Kong and recognizes the revenue derived from sales to both Hong Kong
and Chinese members as being generated in Hong Kong. Products purchased by members in China are
delivered by the Company to a third party that acts as the importer of record under an agreement to
pay applicable duties. In addition, through a Chinese entity the Company has launched an
e-commerce retail platform in China. The Chinese entity operates separately from the Hong Kong
entity, although a Chinese member may elect to participate separately in both.
The Company believes that the laws and regulations in China regarding direct selling and
multi-level marketing are not specifically applicable to the Companys Hong Kong based e-commerce
activity, and that the Companys Chinese entity is operating in compliance with applicable Chinese
laws. However, there can be no assurance that the Chinese authorities will agree with the
Companys interpretations of applicable laws and regulations or that China will not adopt new laws
or regulations. Should the Chinese government determine that the Companys e-commerce activity
violates Chinas direct selling or anti-multilevel marketing legislation, or should new laws or
regulations be adopted, there could be a material adverse effect on the Companys business,
financial condition and results of operations.
Although the Company attempts to work closely with both national and local Chinese
governmental agencies in conducting the Companys business, the Companys efforts to comply with
national and local laws may be harmed by a rapidly evolving regulatory climate, concerns about
activities resembling violations of direct selling or anti-multi-level marketing legislation,
subjective interpretations of laws and regulations, and activities by individual distributors that
may violate laws notwithstanding the Companys strict policies prohibiting such activities. Any
determination that the Companys operations or activities, or the activities of the Companys
individual distributors or employee sales representatives, or importers of record are not in
compliance with applicable laws and regulations could result in the imposition of substantial
fines, extended interruptions of business, restrictions on the Companys future ability to obtain
business licenses or expand into new locations, changes to the Companys business model, the
termination of required licenses to conduct business, or other actions, any of which could
materially harm the Companys business, financial condition and results of operations.
Four
major product lines Premium Noni Juice, Skindulgence®, Alura® and La Vie generated
a significant majority of the Companys sales for 2007 and 2008. 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 temporarily guaranteed by the Federal Deposit Insurance
Corporation (FDIC) up to $250,000 through December 31, 2009. The guaranteed amount is expected to
decrease to $100,000 thereafter. A portion of the Companys cash balances at December 31, 2008
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, 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 $510,000 as of December 31, 2008.
43
Sale of 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
Networks Ptd. Ltd. (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 was 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 was unsecured, the Company recorded
a reserve totaling $2.8 million, which was reduced as payments were received. KGC has not remitted
the required monthly payment since July 2007 and is currently in default. During 2008, the Company
determined that the receivable was not collectable and wrote off the unpaid balance against the
reserve. Imputed interest income of $228,000 was recorded on the KGC installment payable during
2007.
De-Recognition of Commission Liabilities
The Company de-recognized $2.2 million of commission liabilities in certain of its
international markets, primarily Hong Kong, during 2008 as it determined that it is probable that
these commission payments will not be claimed. These liabilities were previously recorded as other
current liabilities in the consolidated balance sheets.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (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 issued FASB
Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157, which provided a one
year deferral for the implementation of SFAS No. 157 for other non-financial assets and
liabilities. The Company adopted SFAS No. 157 as of January 1, 2008, except as it applies to those
non-financial assets and liabilities affected by the one year deferral. The partial adoption of
SFAS No. 157 did not have a material impact on the Companys consolidated financial position or
results of operations. In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active, which clarifies the application
of SFAS No. 157 as it relates to the valuation of financial assets in a market that is not active
for those financial assets. FSP No. 157-3 became effective for the Company upon issuance, and had
no material impact on the Companys financial position or results of operations. The Company is
currently evaluating the impact, if any, adopting the remaining provisions 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. On January 1, 2008, we adopted SFAS 159 and did not elect to
use fair value measurement on any assets or liabilities under this statement.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements An Amendment of ARB No. 51, which 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.
In April 2008, the FASB issued FSP No. 142-3, Determination of the Useful Life of Intangible
Assets, which amends the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142.
This pronouncement requires enhanced disclosures concerning a companys treatment of costs incurred
to renew or extend the term of a recognized intangible asset. FSP No. 142-3 is effective for
financial statements issued for
fiscal years beginning after December 15, 2008. The Company is currently evaluating the
impact of FSP No. 142-3, but does not expect the adoption to have a material impact on its
consolidated financial statements.
44
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for
selecting the principles to be used in the preparation of financial statements of nongovernmental
entities that are presented in conformity with generally accepted accounting principles in the
United States. The Company does not expect the adoption of SFAS No. 162 to have a material impact
on its consolidated financial position or results of operations.
In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities. The FSP addresses whether
instruments granted in share-based payment transactions are participating securities prior to
vesting and, therefore, need to be included in the earnings allocation in computing earnings per
share under the two-class method. This FSP is effective for financial statements issued for fiscal
years beginning after December 15, 2008. We are currently assessing the impact, if any, of the
guidance on our financial condition or results of operations.
In June 2008, the FASB ratified the consensus on Emerging Issues Task Force (EITF) Issue 07-5,
Determining whether an Instrument (or Embedded Feature) is indexed to an Entitys Own Stock.
This issue addresses whether an instrument (or an embedded feature) is indexed to an entitys own
stock, which is the first part of the scope exception in paragraph 11(a) of SFAS No. 133, for
purposes of determining whether the instrument should be classified as an equity instrument or
accounted for as a derivative instrument. The provisions of EITF Issue No. 07-5 are effective for
financial statements issued for fiscal years beginning after December 15, 2008 and will be applied
retrospectively through a cumulative effect adjustment to retained earnings for outstanding
instruments as of that date. The Company is currently evaluating the impact, if any, adopting EITF
Issue No. 07-5 will have on its financial condition or results of operations.
In June 2008, the FASB ratified the consensus on EITF Issue No. 08-4, Transition Guidance for
Conforming Changes to Issue No. 98-5. The objective of EITF Issue No.08-4 is to provide
transition guidance for conforming changes made to EITF Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, that
result from EITF Issue No. 00-27 Application of Issue No. 98-5 to Certain Convertible
Instruments, and SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity. The guidance provided by EITF Issue No. 08-4 is effective for
financial statements issued for fiscal years ending after December 15, 2008. The Companys
adoption of EITF Issue No. 08-4 did not have a material effect on its financial condition or
results of operations.
2. BALANCE SHEET COMPONENTS
The components of certain balance sheet amounts are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Property and equipment: |
|
|
|
|
|
|
|
|
Office equipment |
|
$ |
1,507 |
|
|
$ |
1,088 |
|
Office software |
|
|
805 |
|
|
|
561 |
|
Furniture and fixtures |
|
|
380 |
|
|
|
197 |
|
Plant equipment |
|
|
185 |
|
|
|
188 |
|
Leasehold improvements |
|
|
1,772 |
|
|
|
1,528 |
|
|
|
|
|
|
|
|
Property and equipment, at cost |
|
|
4,649 |
|
|
|
3,562 |
|
Accumulated depreciation and amortization |
|
|
(3,112 |
) |
|
|
(2,389 |
) |
|
|
|
|
|
|
|
|
|
$ |
1,537 |
|
|
$ |
1,173 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncurrent restricted cash: |
|
|
|
|
|
|
|
|
Funds held for direct selling license application in China |
|
$ |
2,806 |
|
|
$ |
2,941 |
|
Funds held for consumer indemnity insurance in South Korea (see Note 5) |
|
|
641 |
|
|
|
|
|
Reserve for credit card processor in South Korea (see Note 1) |
|
|
870 |
|
|
|
644 |
|
Other |
|
|
|
|
|
|
61 |
|
|
|
|
|
|
|
|
|
|
$ |
4,317 |
|
|
$ |
3,646 |
|
|
|
|
|
|
|
|
45
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
Other accrued expenses: |
|
|
|
|
|
|
|
|
Sales returns |
|
$ |
754 |
|
|
$ |
517 |
|
Employee-related expense |
|
|
1,100 |
|
|
|
281 |
|
Professional fees |
|
|
493 |
|
|
|
47 |
|
Warehousing and inventory-related expense |
|
|
203 |
|
|
|
1,041 |
|
Litigation settlement |
|
|
|
|
|
|
250 |
|
Other |
|
|
1,049 |
|
|
|
320 |
|
|
|
|
|
|
|
|
|
|
$ |
3,599 |
|
|
$ |
2,456 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred revenue: |
|
|
|
|
|
|
|
|
Unshipped product |
|
$ |
705 |
|
|
$ |
1,877 |
|
Enrollment package revenue |
|
|
2,791 |
|
|
|
964 |
|
|
|
|
|
|
|
|
|
|
$ |
3,496 |
|
|
$ |
2,841 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other current liabilities: |
|
|
|
|
|
|
|
|
Unclaimed checks |
|
$ |
2,636 |
|
|
$ |
860 |
|
Other taxes payable |
|
|
351 |
|
|
|
84 |
|
Other |
|
|
267 |
|
|
|
226 |
|
|
|
|
|
|
|
|
|
|
$ |
3,254 |
|
|
$ |
1,170 |
|
|
|
|
|
|
|
|
3. 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 |
|
Impairment loss |
|
|
|
|
|
|
|
|
Balance, December 31, 2008 |
|
$ |
1,764 |
|
|
|
|
|
The Companys goodwill carrying value consists of $11.9 million acquired in connection with
the MarketVision Communication Corp. (MV Corp.) merger in March 2004, as well as $2.2 million
acquired from the purchase of subsidiary minority interests. Due to full integration of MV Corp.
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 such impairment loss was recognized during 2008.
Intangible assets consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007 |
|
|
December 31, 2008 |
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computer software and programs |
|
$ |
5,600 |
|
|
$ |
3,000 |
|
|
$ |
2,600 |
|
|
$ |
5,600 |
|
|
$ |
3,800 |
|
|
$ |
1,800 |
|
Distributor database |
|
|
619 |
|
|
|
619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
6,219 |
|
|
$ |
3,619 |
|
|
$ |
2,600 |
|
|
$ |
5,600 |
|
|
$ |
3,800 |
|
|
$ |
1,800 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
46
Amortization expense for intangible assets was $800,000 during each of 2007 and 2008. Future
estimated amortization expense is as follows (in thousands):
|
|
|
|
|
2009 |
|
$ |
800 |
|
2010 |
|
|
800 |
|
2011 |
|
|
200 |
|
|
|
|
|
|
|
$ |
1,800 |
|
|
|
|
|
4. 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).
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. At December 31, 2008,
the outstanding principal amount of the debentures totaled $3.9 million.
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.
47
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 has 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.
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 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 $900,000, including the warrants
valued at $433,000 issued to the placement agent, which will also be recognized in interest expense
over the contractual term of the debt. Unamortized debt issuance cost included in other assets
totaled $502,000 as of December 31, 2008.
5. 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 $2.7 million and $2.1 million during 2007 and 2008,
respectively.
48
Future minimum lease obligations as of December 31, 2008, are as follows (in thousands):
|
|
|
|
|
2009 |
|
$ |
1,296 |
|
2010 |
|
|
762 |
|
2011 |
|
|
593 |
|
2012 |
|
|
261 |
|
2013 |
|
|
261 |
|
Thereafter |
|
|
396 |
|
|
|
|
|
Total minimum lease obligations |
|
$ |
3,569 |
|
|
|
|
|
Purchase Commitments
The Company maintains a purchase commitment with one of its suppliers to purchase its Alura®
product. Pursuant to this agreement, the Company is required to pay the supplier a minimum of
$120,000 per year.
Employment Agreements
The Company has employment agreements with certain members of its management team which can be
terminated by either the employee or the Company upon four weeks notice. These employment
agreements contain provisions which guarantee the payments of specified amounts in the event of a
change in control, as defined, or if the employee is terminated for reasons other than cause, as
defined in those agreements. As of December 31, 2008, no outstanding obligations existed under any
severance agreements.
Consumer Indemnity
As required by the Door-to-Door Sales Act in South Korea, the Company 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 31.2 million KRW (USD $25,000) as of December
31, 2008. Depending on the sales volume, the Company may be required to increase or decrease the
amount of the security deposit. During the second quarter of 2008, the Company withdrew the entire
KRW 600 million deposit. The term of the remaining contract is considered indefinite since it must
remain in place as long as the Company operates within South Korea. 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. At December 31, 2008, non-current
other assets include 600 million KRW (USD $474,000) underlying the remaining contract, 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.
Registration Payment Arrangements
Pursuant to the agreement with the original investors and the placement agent in the May 2007
financing for the sale of 1,759,307 shares of Series A preferred stock and warrants representing
the right to purchase 1,759,307 shares of common stock (see Note 6), the Company is obligated for a
specified period of time to maintain the effectiveness of the registration statement that was 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 the Company fails
to maintain the effectiveness of such registration statement due to an intentional and willful act
without immediately causing a subsequent registration statement to be filed with the SEC, then it
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.
49
Pursuant to the agreement with the investors in the October 2007 financing of variable rate
convertible 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 (see Note 4), the Company is obligated to (i) file a
registration statement covering the resale of certain of the shares of common stock underlying
the securities issued in the financing with the Commission on or prior to November 18, 2007, (ii)
cause the registration statement to be declared effective within certain specified periods of time
and (iii) maintain the effectiveness of the registration statement and the ability of the investors
to use the prospectus forming a part thereof for a specified period. If we fail to comply with
these or certain other provisions, 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. The
registration statement was declared effective on March 17, 2008 with respect to 1,700,000 shares of
common stock issuable upon conversion of the variable rate convertible debentures and up to
1,495,952 shares issuable upon exercise of warrants held by the selling stockholders.
As of December 31, 2008, no contingent obligations have been recognized under registration
payment arrangements.
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 Lisa Grossmann, 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 our 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 Mr. 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. In May 2008, the Court consolidated the
Trustees Case with a related, pending lawsuit. Messrs. Woodburn and LaCore and Ms. Grossmann,
have now reached settlements with the Trustee and Mr. Loghry. On February 17, 2009, the Court
dismissed some additional claims and limited any judgment for damages to an amount needed to make
Mr. Loghrys creditors whole and pay costs of litigation, including attorneys fees. The Court
calculated that creditor claims total approximately $40,000, but held that the summary judgment
evidence was otherwise inconclusive on the amount necessary to make creditors whole and pay costs
of litigation. Trial is set for June 2009. The Company continues to believe that all of the
defendants have meritorious defenses to the Trustees remaining claims.
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. At a mediation held on August 23, 2008, the parties reached an agreement
in principle to settle the litigation. The agreement in principle provides that the shareholder
class will receive a total payment of $2.75 million. Of that amount, the Companys directors and
officers insurance carriers have agreed in principal to pay $2.5 million, and the Company has
agreed in principal to pay $250,000. The settlement is subject to a number of conditions,
including final court approval following completion of a fairness hearing. At this time, there can
be no assurance that these conditions will be met and that the settlement of the securities class
action litigation will receive final court approval. If the settlement is not completed, the
parties to this suit may attempt to reach agreement on alternative settlement terms or resume
litigation. The Company recorded an accrual for $250,000 related to this matter during the third
quarter of 2008 and simultaneously de-recognized $225,000 of legal fees that existed as of June 30,
2008, but which have now been paid under its directors and officers insurance policy.
50
On June 26, 2008, the Company filed a lawsuit in the 116th District Court, Dallas
County, Texas, against Terry LaCore and bHIP Global, Inc. seeking an unspecified amount in actual
and punitive damages, as well as a temporary and permanent injunction and other equitable relief.
The Company claims that Mr. LaCore deceived the Company, breached fiduciary duties, and breached
various agreements regarding the use, disclosure and return of confidential information and other
assets and non-interference with the
Company and its business and relationships. The Company also claims that Mr. LaCore and bHIP
Global, Inc. are unlawfully taking, disparaging and/or interfering with the Companys reputation,
identity, confidential information, contracts and relationships, products, businesses and other
assets. On March 5, 2009, the Company obtained a temporary injunction that restrains Mr. LaCore
and bHIP Global, Inc. (and its officers, agents, employees and attorneys and all persons in active
concert or participation with them) from (1) contracting with, or employing, any former or existing
employee, distributor or supplier of the Company if such contract or employment would result in
that person breaching his or her agreement with the Company, and (2) obtaining confidential
information belonging to the Company if the defendants know that the information was obtained in
breach of a confidentiality agreement between the Company and any former or existing employee,
distributor or supplier of the Company. The temporary injunction also orders Mr. LaCore and bHIP
Global, Inc. to locate and return the Companys trade secrets and proprietary and confidential
information. The temporary injunction will remain in place until the trial of the case, which is
currently scheduled for November 9, 2009. The Company believes that its claims have merit and
intends to vigorously pursue them.
On July 16, 2008, Lisa Grossmann, a former distributor and consultant for the Company, filed a
lawsuit in the Superior Court of California in Sacramento, California, against the Company, and
certain current officers and directors, purporting to sue individually and on behalf of California
distributors, shareholders, and customers of the Company. On behalf of California residents, Ms.
Grossmann alleges that the defendants engaged in, or conspired to engage in, unfair competition and
false advertising and seeks an unspecified amount of restitution and disgorgement, as well as an
injunction. Individually, Ms. Grossmann alleges that the Company breached a contract to pay
distributor commissions to her, the Company breached an implied covenant of good faith and fair
dealing, all defendants were unjustly enriched at her expense, the individual defendants breached
fiduciary duties to her, all defendants were negligent in conducting the affairs of the Company,
and all defendants committed fraud. Ms. Grossman seeks in excess of $500,000 in damages on her
individual claims. All defendants deny Ms. Grossmans allegations and intend to vigorously defend
them. On February 9, 2009, the Superior Court granted the defendants motion to quash service of
the lawsuit on them for lack of personal jurisdiction.
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.
6. 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. |
51
|
|
|
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, 2008 was $108,000 and $263,000, 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
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.
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 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, 2008,
138,400 shares of Series A preferred stock remain outstanding.
52
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, 2008, 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 4). The warrants consist of
seven-year warrants to purchase 1,495,952 shares of common 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, 2008, 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, 2008 was
3.2 years.
7. 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. At our Annual Meeting of Stockholders held on December 30, 2008, the
Companys stockholders approved an increase in the maximum number of shares available for issuance
under
the 2007 Plan by 500,000 shares. As such, the maximum aggregate number of shares available
for issuance under the 2007 Plan totals 2,050,000 shares.
53
The Company granted 951,190 and 487,350 shares of restricted stock under the Companys 2007
Equity Incentive Plan to the Companys executive officers, directors, key employees and consultants
during 2007 and 2008, respectively. 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 during 2007 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 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, 2008, stock options for 42,500 shares of common stock
remain outstanding under the 2002 Plan. As of December 31, 2008, 596,647 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. Woodburn and 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 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 Escrowed 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 promissory note entered into as part
of the Settlement Agreements. As provided in the promissory note, the value of the surrendered
shares for purposes of determining the credit to be given against the principal and interest
accrued on the promissory 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 10.
54
Valuation and Expense Information under SFAS No. 123(R)
Share-based compensation expense totaled approximately $845,000 and $554,000 for 2007 and
2008, 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. No stock options were granted during 2007 and 2008.
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, 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 |
|
|
|
|
|
|
|
|
|
Cancelled, forfeited or expired |
|
|
(28,000 |
) |
|
|
1.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008 |
|
|
42,500 |
|
|
|
1.80 |
|
|
|
2.9 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at December 31, 2008 |
|
|
34,918 |
|
|
|
1.80 |
|
|
|
2.9 |
|
|
|
|
|
Exercisable at December 31, 2008 |
|
|
28,334 |
|
|
|
1.80 |
|
|
|
2.9 |
|
|
|
|
|
|
|
|
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). |
55
Stock options for 60,000 shares of common stock were exercised during 2007 with an intrinsic
value of $184,000. The total fair value of stock options vested during 2007 and 2008 was $85,000
and $17,000, respectively. As of December 31, 2008, total unrecognized share-based compensation
expense related to stock options was approximately $19,000, which is expected to be recognized over
a weighted-average period of 0.7 years. All stock options outstanding at December 31, 2008 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 |
|
Granted |
|
|
487,350 |
|
|
|
0.54 |
|
Vested |
|
|
(324,834 |
) |
|
|
1.77 |
|
Forfeited |
|
|
(123,173 |
) |
|
|
1.87 |
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2008 |
|
|
807,471 |
|
|
|
1.18 |
|
|
|
|
|
|
|
|
|
As of December 31, 2008, total unrecognized share-based compensation expense related to
non-vested restricted stock was approximately $730,000, which is expected to be recognized over a
weighted-average period of 1.8 years.
8. INCOME TAXES
The components of loss before income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Domestic |
|
$ |
(16,881 |
) |
|
$ |
(10,014 |
) |
Foreign |
|
|
(8,200 |
) |
|
|
6,606 |
|
|
|
|
|
|
|
|
Loss before income taxes |
|
$ |
(25,081 |
) |
|
$ |
(3,408 |
) |
|
|
|
|
|
|
|
The components of the provision for income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Current taxes: |
|
|
|
|
|
|
|
|
Federal |
|
$ |
|
|
|
$ |
63 |
|
State |
|
|
|
|
|
|
9 |
|
Foreign |
|
|
200 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
200 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
Deferred taxes |
|
|
|
|
|
|
351 |
|
|
|
|
|
|
|
|
Provision for income taxes |
|
$ |
200 |
|
|
$ |
456 |
|
|
|
|
|
|
|
|
56
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, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Income tax at federal statutory rate |
|
$ |
(8,527 |
) |
|
$ |
(1,159 |
) |
Effect of permanent differences |
|
|
4,171 |
|
|
|
(23 |
) |
Increase in valuation allowance |
|
|
4,479 |
|
|
|
3,234 |
|
Foreign rate differential |
|
|
|
|
|
|
(2,244 |
) |
State income taxes, net of federal benefit |
|
|
|
|
|
|
(168 |
) |
Change in enacted foreign rates |
|
|
|
|
|
|
792 |
|
Other reconciling items |
|
|
77 |
|
|
|
24 |
|
|
|
|
|
|
|
|
Income tax provision |
|
$ |
200 |
|
|
$ |
456 |
|
|
|
|
|
|
|
|
Deferred income taxes consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Net operating losses |
|
$ |
8,258 |
|
|
$ |
11,327 |
|
Stock-based compensation |
|
|
88 |
|
|
|
207 |
|
Accrued expenses |
|
|
503 |
|
|
|
69 |
|
Tax credits |
|
|
95 |
|
|
|
501 |
|
Provision for KGC receivable |
|
|
268 |
|
|
|
268 |
|
Impairment of long-lived assets |
|
|
91 |
|
|
|
90 |
|
Other |
|
|
6 |
|
|
|
81 |
|
|
|
|
|
|
|
|
Total deferred tax assets |
|
|
9,309 |
|
|
|
12,543 |
|
Valuation allowance |
|
|
(8,131 |
) |
|
|
(11,791 |
) |
|
|
|
|
|
|
|
|
|
|
1,178 |
|
|
|
752 |
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
Intangible assets |
|
|
(884 |
) |
|
|
(655 |
) |
Accrued expenses |
|
|
|
|
|
|
(351 |
) |
Depreciation |
|
|
(15 |
) |
|
|
(36 |
) |
Prepaids |
|
|
(71 |
) |
|
|
(49 |
) |
Other |
|
|
|
|
|
|
(12 |
) |
|
|
|
|
|
|
|
Total deferred tax liabilities |
|
|
(970 |
) |
|
|
(1,103 |
) |
|
|
|
|
|
|
|
Net deferred tax assets (liability) |
|
$ |
208 |
|
|
$ |
(351 |
) |
|
|
|
|
|
|
|
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 were expected to be realized and therefore no
valuation allowance was 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, 2008, the Company has net operating loss carryforwards of approximately $18.2
million that begin to expire in 2021, if not utilized. We have foreign net operating loss
carryforwards totaling $24.2 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, 2008. 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.
57
9. SUPPLEMENTAL CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
|
(In Thousands) |
|
Cash paid during the year for: |
|
|
|
|
|
|
|
|
Income taxes, net of refunds |
|
$ |
288 |
|
|
$ |
(89 |
) |
Interest |
|
|
9 |
|
|
|
483 |
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
10. RELATED PARTY TRANSACTIONS
On March 21, 2007, the Company entered into a temporary week-to-week agreement with Mr. Terry
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. 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 a
promissory note entered into on October 31, 2006 as part of a group of settlement agreements with
the Company. As provided in the promissory note, the value of the surrendered shares for purposes
of determining the credit to be given against the principal and interest accrued on the promissory
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.
On and effective as of December 1, 2008, John Cavanaugh and the Company entered into a Going
Forward Agreement (the Going Forward Agreement) in which they mutually agreed to terminate the
Employment Agreement dated as of December 8, 2006, between the Company and Mr. Cavanaugh, who was
until then the President of the Companys subsidiary MarketVision Communications Corp. (MV
Corp.). As a result of the Going Forward Agreement, the Company is no longer obligated under the
Employment Agreement to make any severance payments to Mr. Cavanaugh, but shares of restricted
stock previously granted to Mr. Cavanaugh continue to vest during the six-month period referenced
below (and may vest earlier under some circumstances).
Pursuant to the Going Forward Agreement, the Company and MarketVision Consulting Group, LLC
(MV Consulting), a company controlled by Mr. Cavanaugh, have also entered into a new agreement
under which MV Consulting will provide the Company with up to 30 hours per month of consulting
services by each of Mr. Cavanaugh and another former MV Corp. employee, Jason Landry, for six
months. As part of that same agreement, MV Consulting has hired the other employees of MV Corp.
and will provide limited access to them as consultants to the Company and its software development
and support team for six months. In return, the Company agreed to pay MV Consulting $65,000 per
month for the first three months and $50,000 per month for the last three months, plus $150 per
hour for services in excess of the allotted hours per month. In addition, the Company agreed to
pay MV Consulting a one-time $15,000 incentive bonus, which was paid in January 2009.
In 2004, as part of a merger between the Company and MV Corp., the Company granted to MV
Consulting 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 of the software and documentation owned by MV Corp. that was
dormant unless and until an Event of Default occurred. The Going Forward Agreement acknowledges
that an Event of Default occurred on January 1, 2007, under the Software License Agreement. The
Company does not believe that the Event of Default, by
itself, has had or will have a material adverse effect on the Company. The Company continues
to own its version of the software and documentation and has the right to use its version of the
software and documentation 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 and
documentation without MV Consultings prior written consent.
58
Under the Going Forward Agreement and Transition Service Agreement, the Company also agreed to
(a) pay to MV Consulting the amounts paid by bHIP Global, Inc. to MV Corp. for services in the
months of September, October, and November 2008 under a previously disclosed Service Bureau Hosting
Agreement, which payments totaled $57,000, (b) transfer certain domain names and property rights in
the name MarketVision to MV Consulting, (c) pay $15,000 in certain legal fees incurred by Mr.
Cavanaugh and MV Consulting Corp., (d) sublease certain facilities in Eden Prairie, Minnesota to MV
Consulting at no cost until expiration of the lease on March 31, 2009 (lease payments are $3,300
per month), (e) transfer certain equipment used in the Eden Prairie office to MV Consulting, and
(f) reimburse certain expenses if incurred under the Transition Services Agreement. The Going
Forward Agreement also contains certain mutual releases by and among the Company and MV Corp., Mr.
Cavanaugh and Mr. Landry. The Transition Services Agreement also contains the agreement of Mr.
Cavanaugh and Mr. Landry not to solicit the Companys customers and distributors during the
six-month term of the Transition Services Agreement and for one year thereafter.
11. 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, |
|
|
|
2007 |
|
|
2008 |
|
Net sales to external customers: |
|
|
|
|
|
|
|
|
North America |
|
$ |
7,743 |
|
|
$ |
3,247 |
|
Hong Kong |
|
|
47,240 |
|
|
|
30,272 |
|
China |
|
|
538 |
|
|
|
1,328 |
|
Taiwan |
|
|
5,861 |
|
|
|
4,444 |
|
South Korea |
|
|
9,334 |
|
|
|
3,805 |
|
Japan |
|
|
2,196 |
|
|
|
1,244 |
|
Europe |
|
|
|
|
|
|
1,223 |
|
Other1 |
|
|
3,589 |
|
|
|
243 |
|
|
|
|
|
|
|
|
Total net sales |
|
$ |
76,501 |
|
|
$ |
45,806 |
|
|
|
|
|
|
|
|
|
|
|
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. Also included
are sales from the Latin America, Australia, New Zealand, and Southeast Asia
markets. |
59
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
Long-lived assets: |
|
|
|
|
|
|
|
|
North America |
|
$ |
5,660 |
|
|
$ |
4,353 |
|
Hong Kong |
|
|
260 |
|
|
|
346 |
|
China |
|
|
3,702 |
|
|
|
3,630 |
|
Taiwan |
|
|
150 |
|
|
|
130 |
|
South Korea |
|
|
2,879 |
|
|
|
1,321 |
|
Japan |
|
|
44 |
|
|
|
51 |
|
Europe |
|
|
13 |
|
|
|
16 |
|
Other |
|
|
81 |
|
|
|
|
|
|
|
|
|
|
|
|
Total long-lived assets |
|
$ |
12,789 |
|
|
$ |
9,847 |
|
|
|
|
|
|
|
|
Due to system constraints, it is impracticable for the Company to separately disclose product
and enrollment package revenue for the years presented.
12. LIQUIDITY
At December 31, 2008, the Company had cash and cash equivalents of $3.5 million and a working
capital deficit of $4.1 million, or $1.2 million excluding deferred revenue. During 2007 and 2008,
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 cut
operating expenses sufficiently to avoid the negative operating results, though we did successfully
manage to decelerate the losses in 2008 compared to 2007. The Companys losses attributable to
common stockholders were $27.0 million and $3.9 million during 2007 and 2008, respectively.
The Company has taken numerous actions to ensure that it will continue as a going concern. It
has planned and executed many cost reduction and margin improvement initiatives since the end of
the third quarter of 2007, such as (1) reducing headcount, which includes the termination of
multiple management-level positions in Greater China, South Korea and North America; (2)
down-sizing offices in Greater China and South Korea; (3) closing offices in Latin America and
Southeast Asia; (4) renegotiating vendor contracts in Greater China; (5) increasing product pricing
in Greater China, Europe and the U.S.; (6) changing commission plans worldwide; (7) streamlining
logistics processes in Greater China; (8) introducing better margin pre-assortments; and (9)
reducing Company-wide discretionary expenses. Also, the Company believes that it has taken a
number of effective steps toward stabilizing its revenues on a sequential basis, especially in the
Hong Kong market. As a result, the Company believes that its current cash breakeven level has been
significantly reduced and is more attainable.
The Company believes that its existing internal liquidity, supported by cash on hand, certain
restricted cash that the Company believes can be unlocked later in 2009 upon the withdrawal of our
direct selling license application in China, anticipated improvement in cash flows from operations
with more stabilized revenue and much lower fixed costs since October 2007 should be adequate to
fund normal business operations and address its financial commitments for at least the next 12
months, assuming no significant unforeseen expense or further revenue decline. If the Companys
foregoing beliefs or assumptions prove to be incorrect, however, the Companys business, results of
operations and financial condition could be materially adversely affected.
60
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
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, 2008. 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, as of December 31, 2008, the Companys
disclosure controls and procedures were effective.
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). Based on this
criteria, management concluded that the Companys internal control over financial reporting as of
December 31, 2008 was effective.
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 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 fiscal quarter ended December 31, 2008 as part of managements evaluation of the
effectiveness of internal control over financial reporting, the control deficiencies that resulted
in material weakness as of December 31, 2007 were found to be corrected. Specifically, the
deficiencies related to lack of evidential documentation supporting the reconciliation and review
of certain account balances that were noted during 2007 were corrected. The resolution is due in
large part to the stability throughout 2008 of
the accounting and finance staff supervised by the finance manager in Taiwan hired during the
first quarter of 2008. The finance manager addressed certain items from the action plan for the
reconciliation and review of each account balance and no control deficiencies were identified that
would result in a material weakness during managements evaluation of the effectiveness of internal
control over financial reporting as of December 31, 2008.
61
Item 9B. OTHER INFORMATION
None.
Part III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference to the Companys definitive
proxy statement to be filed with the SEC 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.
62
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 and |
|
|
|
|
|
|
|
|
|
|
Beginning |
|
|
Expenses/Against |
|
|
|
|
|
|
Balance at End |
|
Description |
|
of Period |
|
|
Net Sales (1) |
|
|
Deductions (2) |
|
|
of Period |
|
|
|
(In Thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for obsolete inventory |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2008 |
|
$ |
1,822 |
|
|
$ |
(86 |
) |
|
$ |
(1,497 |
) |
|
$ |
239 |
|
Year ended December 31, 2007 |
|
$ |
3,320 |
|
|
$ |
489 |
|
|
$ |
(1,987 |
) |
|
$ |
1,822 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for KGC receivable |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2008 |
|
$ |
789 |
|
|
$ |
|
|
|
$ |
(789 |
) |
|
$ |
|
|
Year ended December 31, 2007 |
|
$ |
1,354 |
|
|
$ |
|
|
|
$ |
(565 |
) |
|
$ |
789 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual for sales returns |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2008 |
|
$ |
754 |
|
|
$ |
1,474 |
|
|
$ |
(1,711 |
) |
|
$ |
517 |
|
Year ended December 31, 2007 |
|
$ |
1,797 |
|
|
$ |
2,898 |
|
|
$ |
(3,941 |
) |
|
$ |
754 |
|
|
|
|
(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. |
63
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 23, 2009 |
/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 23, 2009 |
|
|
|
|
|
/s/ Timothy S. Davidson
Timothy S. Davidson
|
|
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
|
|
March 23, 2009 |
|
|
|
|
|
/s/ Randall A. Mason
Randall A. Mason
|
|
Chairman of the Board and Director
|
|
March 23, 2009 |
|
|
|
|
|
/s/ Stefan W. Zuckut
Stefan W. Zuckut
|
|
Director
|
|
March 23, 2009 |
|
|
|
|
|
/s/ George K. Broady
George K. Broady
|
|
Director
|
|
March 23, 2009 |
64
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 |
|
|
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). |
|
+10.13 |
|
|
2002 Stock Plan, as amended (incorporated by reference to Appendix C to Definitive Proxy Statement filed on
April 27, 2005). |
|
+10.14 |
|
|
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). |
|
+10.15 |
|
|
2007 Annual Incentive Plan (incorporated by reference to Appendix A to Definitive Proxy Statement filed on
October 20, 2006). |
|
+10.16 |
|
|
2007 Equity Incentive Plan, as amended and restated as of November 13, 2008 (incorporated by reference to
Appendix A to Definitive Proxy Statement filed on November 25, 2008). |
|
+10.17 |
|
|
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). |
|
+10.18 |
|
|
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). |
|
|
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
|
+10.19 |
|
|
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). |
|
+10.20 |
|
|
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). |
|
+10.21 |
|
|
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). |
|
+10.22 |
|
|
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). |
|
+10.23 |
|
|
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). |
|
+10.24 |
|
|
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 |