e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 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
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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2050 Diplomat Drive |
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Dallas, Texas
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75234 |
(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code: (972) 241-4080
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer
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Accelerated filer o |
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Non-accelerated filer o |
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Smaller reporting company
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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
At May 2, 2008, the number of shares outstanding of the registrants common stock was 10,347,126
shares.
NATURAL HEALTH TRENDS CORP.
Quarterly Report on Form 10-Q
March 31, 2008
INDEX
FORWARD-LOOKING STATEMENTS
Certain statements contained in this report constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. All statements included in this report, other than statements of
historical facts, regarding our strategy, future operations, financial position, estimated
revenues, projected costs, prospects, plans and objectives are forward-looking statements. When
used in this report, the words believe, anticipate, intend, estimate, expect, project,
could, would, may, plan, predict, pursue, continue, feel and similar expressions
are intended to identify forward-looking statements, although not all forward-looking statements
contain these identifying words.
We cannot guarantee future results, levels of activity, performance or achievements, and you
should not place reliance on our forward-looking statements. Our 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 our most recent Annual
Report on Form 10-K and in this report, which include the following:
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we may continue to experience substantial negative cash flows; |
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we may need to seek additional debt or equity financing; |
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we face risks related to an SEC investigation and securities and other litigation; |
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we could be adversely affected by additional audit committee investigations; |
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our ability to attract and retain distributors; |
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our ability to recruit and retain key management, directors and consultants; |
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our inability to directly control the marketing of our products; |
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our inability to control our distributors to the same extent as if they were our own
employees; |
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our ability to protect or use our intellectual property rights; |
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claims against us that could arise from the misconduct of some of our former officers
and directors; |
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adverse publicity associated with our products, ingredients or network marketing
programs, or those of similar companies; |
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our ability to maintain or expand the number of our distributors or their productivity
levels; |
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changes to our distributor compensation plan may not be accepted; |
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our dependence on our Hong Kong and China market for most of our revenue; |
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regulatory matters pertaining to direct-selling laws, particularly in China; |
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we could be required to modify our compensation plan in China in a way that could
adversely affect our business; |
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activities of our members in China could adversely affect our Hong Kong e-commerce
model; |
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our inability to obtain a direct-selling license in China; |
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our failure to properly pay business taxes or customs duties, including those of China; |
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risks associated with operating internationally; |
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risks associated with the amount of compensation paid to distributors, which can affect
our profitability; |
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we rely on our suppliers product liability insurance and product liability claims could
hurt our business; |
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our internal controls and accounting methods may require further modification; |
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we could be adversely affected if we fail to maintain an effective system of internal
controls; |
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risks associated with our reliance on information technology systems; |
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risks associated with the extensive regulation of our business and the implications of
changes in such regulations; |
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currency exchange rate fluctuations could lower our revenue and net income; |
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failure of new products to gain distributor or market acceptance; |
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failure of our information technology system could harm our business; |
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we have a limited product line; |
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our reliance on outside manufacturers; |
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the intensely competitive nature of our business; |
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terrorist attacks, cyber attacks, acts of war or other disasters, particularly given the
scope of our international operations; |
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disappointing quarterly revenue or operating results, which could adversely affect our
stock price; |
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our common stock is particularly subject to volatility because of the industry in which
we operate; |
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consequences arising if an active public trading market for our common stock does not
continue; |
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consequences if we fail to regain compliance with applicable Nasdaq requirements; |
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adverse consequences if securities analysts publish adverse research or reports, or
otherwise fail to cover us at all; |
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our failure to wisely apply the proceeds derived from our May and October 2007
financings effectively; |
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adverse cash flow consequences from leverage and debt service obligations; |
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substantial cash payments could be required upon an event of default under our variable
rate convertible debentures; |
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failure to maintain the registration statements covering the resale of shares of common
stock for certain investors will result in liquidated damages; |
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covenants and restrictions in certain investor agreements could restrict our ability to
operate our business; |
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the implications of the actual or anticipated conversion or exercise of our convertible
securities; and |
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future sales by us or our stockholders of shares of common stock could depress the
market price of our common stock. |
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 FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
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December |
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March 31, |
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31, 2007 |
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2008 |
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(Unaudited) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
6,282 |
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$ |
4,657 |
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Restricted cash |
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298 |
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196 |
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Accounts receivable |
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418 |
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357 |
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Inventories, net |
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3,585 |
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2,827 |
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Other current assets |
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1,324 |
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1,740 |
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Total current assets |
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11,907 |
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9,777 |
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Property and equipment, net |
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1,537 |
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1,363 |
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Goodwill |
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1,764 |
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1,764 |
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Intangible assets, net |
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2,600 |
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2,400 |
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Restricted cash |
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4,317 |
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4,356 |
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Deferred tax assets |
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208 |
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196 |
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Other assets |
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2,363 |
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2,204 |
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Total assets |
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$ |
24,696 |
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$ |
22,060 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,168 |
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$ |
1,879 |
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Income taxes payable |
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363 |
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412 |
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Accrued distributor commissions |
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2,018 |
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1,646 |
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Other accrued expenses |
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3,599 |
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3,276 |
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Deferred revenue |
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3,496 |
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2,570 |
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Current portion of convertible debentures,
net of discount of $151 and $382 at December
31, 2007 and March 31, 2008, respectively |
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203 |
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503 |
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Other current liabilities |
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3,254 |
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3,147 |
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Total current liabilities |
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15,101 |
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13,433 |
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Convertible debentures, net of discount of $3,896
and $3,365 at December 31, 2007 and March 31, 2008,
respectively |
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Total liabilities |
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15,101 |
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13,433 |
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Commitments and contingencies |
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Minority interest |
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33 |
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37 |
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Stockholders equity: |
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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 March 31, 2008,
aggregate liquidation value of $250 |
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124 |
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124 |
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Common stock, $0.001 par value; 50,000,000
shares authorized; 10,327,405 and 10,347,126
shares issued and outstanding at December 31,
2007 and March 31, 2008, respectively |
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10 |
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10 |
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Additional paid-in capital |
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79,158 |
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79,322 |
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Accumulated deficit |
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(70,989 |
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(71,697 |
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Accumulated other comprehensive income: |
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Foreign currency translation adjustments |
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1,259 |
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831 |
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Total stockholders equity |
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9,562 |
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8,590 |
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Total liabilities and stockholders equity |
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$ |
24,696 |
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$ |
22,060 |
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See accompanying notes to consolidated financial statements.
1
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In Thousands, Except Per Share Data)
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Three Months Ended |
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March 31, |
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2007 |
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2008 |
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Net sales |
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$ |
21,515 |
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$ |
11,395 |
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Cost of sales |
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5,697 |
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3,090 |
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Gross profit |
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15,818 |
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8,305 |
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Operating expenses: |
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Distributor commissions |
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10,424 |
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3,997 |
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Selling, general and administrative
expenses (including stock-based
compensation expense of $79 and $164 during
2007 and 2008, respectively) |
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9,389 |
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4,596 |
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Depreciation and amortization |
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489 |
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386 |
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Impairment of long-lived assets |
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532 |
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24 |
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Total operating expenses |
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20,834 |
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9,003 |
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Loss from operations |
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(5,016 |
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(698 |
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Other income: |
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Gain on foreign exchange |
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17 |
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371 |
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Interest income |
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179 |
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35 |
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Interest expense (including amortization of
debt issuance costs and accretion of debt
discount of $362 in 2008) |
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(3 |
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(387 |
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Other |
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(4 |
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8 |
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Total other income, net |
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189 |
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27 |
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Loss before income taxes and minority interest |
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(4,827 |
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(671 |
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Income tax provision |
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(210 |
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(37 |
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Minority interest |
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(1 |
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Net loss |
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(5,038 |
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(708 |
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Preferred stock dividends |
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(4 |
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Net loss attributable to common stockholders |
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$ |
(5,038 |
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$ |
(712 |
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Loss per share basic and diluted |
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$ |
(0.61 |
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$ |
(0.07 |
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Weighted-average number of shares outstanding |
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8,200 |
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9,567 |
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See accompanying notes to consolidated financial statements.
2
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
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Three Months Ended |
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March 31, |
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2007 |
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2008 |
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CASH FLOWS FROM OPERATING ACTIVITIES: |
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Net loss |
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$ |
(5,038 |
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$ |
(708 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization of property and equipment |
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289 |
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186 |
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Amortization of intangibles |
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200 |
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200 |
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Amortization of debt issuance costs |
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62 |
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Accretion of debt discount |
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300 |
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Minority interest |
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1 |
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Stock-based compensation |
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79 |
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164 |
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Imputed interest on KGC installment payable |
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(117 |
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Impairment of long-lived assets |
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532 |
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24 |
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Deferred income taxes |
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(6 |
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Changes in assets and liabilities: |
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Accounts receivable |
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184 |
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50 |
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Inventories, net |
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1,471 |
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781 |
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Other current assets |
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(86 |
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(399 |
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Other assets |
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295 |
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59 |
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Accounts payable |
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(411 |
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(293 |
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Income taxes payable |
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188 |
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18 |
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Accrued distributor commissions |
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(1,043 |
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(374 |
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Other accrued expenses |
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758 |
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(389 |
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Deferred revenue |
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(1,301 |
) |
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(938 |
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Other current liabilities |
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(9 |
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(127 |
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Net cash used in operating activities |
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(4,014 |
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(1,384 |
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CASH FLOWS FROM INVESTING ACTIVITIES: |
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Purchases of property and equipment |
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(13 |
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(6 |
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Decrease (increase) in restricted cash |
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(587 |
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93 |
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Decrease in certificate of deposit |
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734 |
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Proceeds from KGC receivable |
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507 |
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Net cash provided by investing activities |
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641 |
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87 |
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CASH FLOWS FROM FINANCING ACTIVITIES |
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Effect of exchange rates on cash and cash equivalents |
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(28 |
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(328 |
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Net decrease in cash and cash equivalents |
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(3,401 |
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(1,625 |
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CASH AND CASH EQUIVALENTS, beginning of period |
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11,936 |
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6,282 |
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CASH AND CASH EQUIVALENTS, end of period |
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$ |
8,535 |
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$ |
4,657 |
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See accompanying notes to consolidated financial statements.
3
NATURAL HEALTH TRENDS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Nature of Operations
Natural Health Trends Corp. (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.
The Companys majority-owned subsidiaries have an active physical presence in the following
markets: North America, which consists of the United States and Canada; Greater China, which
consists of Hong Kong, Macau, Taiwan and China; Southeast Asia, which consists of Singapore, the
Philippines and Indonesia; South Korea; Japan; Latin America, which primarily consists of Mexico;
and Europe, which consists of Italy and Slovenia.
Basis of Presentation
The unaudited interim consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As a result,
certain information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of America have been
condensed or omitted. In the opinion of management, the accompanying unaudited interim
consolidated financial statements contain all adjustments, consisting of normal recurring
adjustments, considered necessary for a fair statement of the Companys financial information for
the interim periods presented. The results of operations of any interim period are not necessarily
indicative of the results of operations to be expected for the fiscal year. These consolidated
financial statements should be read in conjunction with the consolidated financial statements and
related notes included in our 2007 Annual Report on Form 10-K filed with the United States
Securities and Exchange Commission (SEC) on March 31, 2008.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all of its
majority-owned subsidiaries. All significant 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.
4
Income Taxes
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN
48). FIN 48 requires the Company to recognize in its financial statements the impact of a tax
position if that position is more likely than not of being sustained on audit, based on the
technical merits of the position. The adoption of FIN 48 did not materially affect the
consolidated financial statements and, as a result, the Company did not record any cumulative
effect adjustment upon adoption.
As of the date of adoption, the Company does not have any unrecognized tax benefits for
uncertain tax positions. Interest and penalties on tax uncertainties are classified as a component
of income tax expense. The total amount of interest and penalties accrued as of the date of
adoption were not significant. In addition, the total amount of interest and penalties recorded in
the consolidated statements of operations during the three months ended March 31, 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 2004, and is no longer subject to state income tax examinations for
years prior to 2002. No jurisdictions are currently examining any income tax returns of the
Company or its subsidiaries.
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.
5
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:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2008 |
Options to purchase common stock |
|
|
1,041,458 |
|
|
|
70,500 |
|
Warrants to purchase common stock |
|
|
1,080,504 |
|
|
|
6,281,310 |
|
Non-vested restricted stock |
|
|
|
|
|
|
892,478 |
|
Convertible preferred stock |
|
|
|
|
|
|
138,400 |
|
Convertible debentures |
|
|
|
|
|
|
1,700,000 |
|
Options and warrants to purchase 55,167 and 6,281,310 shares of common stock, respectively,
were outstanding at March 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.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles
(GAAP), and expands disclosures about fair value measurements. SFAS No. 157 is effective for
fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for
any other assets and liabilities that are carried at fair value on a recurring basis in financial
statements. In February 2008, the FASB issued FASB Staff Position 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. 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 have not elected 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, 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.
3. SHARE-BASED COMPENSATION
Share-based compensation expense totaled approximately $79,000 and $164,000 for the three
months ended March 31, 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.
6
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, 2007 |
|
|
70,500 |
|
|
$ |
1.80 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited or expired |
|
|
(15,333 |
) |
|
|
1.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2008 |
|
|
55,167 |
|
|
|
1.80 |
|
|
|
3.1 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at March 31, 2008 |
|
|
36,690 |
|
|
|
1.80 |
|
|
|
2.9 |
|
|
|
|
|
Exercisable at March 31, 2008 |
|
|
23,501 |
|
|
|
1.80 |
|
|
|
2.5 |
|
|
|
|
|
|
|
|
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). |
7
As of March 31, 2008, total unrecognized share-based compensation expense related to
non-vested stock options was approximately $197,000, which is expected to be recognized over a
weighted-average period of 0.8 years. All stock options outstanding at March 31, 2008 have an
exercise price of $1.80 per share.
The following table summarizes the Companys restricted stock activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wtd. Avg. |
|
|
|
|
|
|
Price at |
|
|
|
|
|
|
Date of |
|
|
Shares |
|
|
Issuance |
Outstanding at December 31, 2007 |
|
|
768,128 |
|
|
$ |
1.94 |
|
Granted |
|
|
124,350 |
|
|
|
0.86 |
|
Vested |
|
|
(41,499 |
) |
|
|
2.54 |
|
Forfeited |
|
|
(104,629 |
) |
|
|
1.83 |
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2008 |
|
|
746,350 |
|
|
|
1.75 |
|
|
|
|
|
|
|
|
|
|
As of March 31, 2008, total unrecognized share-based compensation expense related to
non-vested restricted stock was approximately $910,000, which is expected to be recognized over a
weighted-average period of 2.3 years.
4. COMPREHENSIVE LOSS (In Thousands)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2007 |
|
|
2008 |
|
Net loss |
|
$ |
(5,038 |
) |
|
$ |
(708 |
) |
Other comprehensive loss, net of tax: |
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
(21 |
) |
|
|
(428 |
) |
|
|
|
|
|
|
|
Total comprehensive loss |
|
$ |
(5,059 |
) |
|
$ |
(1,136 |
) |
|
|
|
|
|
|
|
5. CONTINGENCIES
On or around March 31, 2004, the Companys U.S. subsidiary, NHT Global, Inc. (NHT Global
U.S.) received a letter from John Loghry, a former NHT Global distributor, alleging that NHT
Global U.S. had breached its distributorship agreement with Mr. Loghry and that the Company had
breached an agreement to issue shares of the Companys common stock to Mr. Loghry. On May 13,
2004, NHT Global U.S. and the Company filed an action against Mr. Loghry in the United States
District Court for the Northern District of Texas (the Loghry Case) for disparagement and to
declare that they were not liable to Mr. Loghry on his alleged claims. Mr. Loghry filed
counterclaims against the Company and NHT Global U.S. for fraud and breach of contract, as well as
related claims of fraud, tortuous interference and conspiracy against Mark Woodburn and Terry
LaCore (who were officers and directors at that time) and an NHT Global distributor. On June 2,
2005, the Company and the other counterclaim defendants moved to dismiss the counterclaims on the
grounds that the claims were barred by Mr. Loghrys failure to disclose their existence when he
filed for personal bankruptcy in September 2002. On June 30, 2005, the U.S. Bankruptcy Court for
the District of Nebraska granted Mr. Loghrys request to reopen his bankruptcy case. On September
6, 2005, the United States Trustee filed an action in the U.S. District Court for the District of
Nebraska (the Trustees Case) asserting Loghrys claims against the same defendants. On February
21, 2006, the Trustees Case was transferred to the United States District Court for the Northern
District of Texas. On March 30, 2007, the District Court granted summary judgment against Mr.
Loghry for lack of standing and against the Company on some of its claims. The Company dismissed
its remaining claims against Mr. Loghry and moved for entry of a final judgment against Mr. Loghry.
The Court has declined to enter final judgment against Loghry until the Trustees Case is resolved.
On February 13, 2008, the District Court granted the Companys motion to dismiss certain of the
Trustees fraud and contract claims because the dismissed claims had been filed too late to be
heard. For similar reasons, the District Court also dismissed all claims made in the Trustees
Case against Messrs. Woodburn and LaCore. On March 25, 2008, the court denied the Trustees motion
for reconsideration. The one remaining contract claim against the Company and NHT Global U.S., and
the claims against Lisa Grossmann, are set for trial in October 2008. On April 30, 2008,
the Court consolidated the Trustees Case with a related, pending lawsuit.
8
On September 11, 2006, a putative class action lawsuit was filed in the United States District
Court for the Northern District of Texas by The Rosen Law Firm P.A. purportedly on behalf of
certain purchasers of the Companys common stock to recover damages caused by alleged violations of
federal securities laws. The lawsuit names the Company and certain current and former officers and
directors as defendants. On February 20, 2007, the named plaintiffs filed an amended complaint.
On March 26, 2008, the District Court denied motions to dismiss the amended complaint filed by the
Company and the other defendants. The Company believes that the claims alleged in this lawsuit are
without merit, and the Company intends to vigorously defend this lawsuit.
In August 2006, the Company was advised by the Staff of the SEC that it was conducting an
informal inquiry into matters that are the subject of previously disclosed investigations by the
Companys Audit Committee, including the payments received by Mark Woodburn and Terry LaCore from
an independent distributor. In connection with the inquiry, the Staff of the SEC requested that
the Company voluntarily provide it with certain information and documents, including information
gathered by the independent investigator engaged by the Companys Audit Committee. The Company
voluntarily cooperated with this inquiry. On October 20, 2006, the Company received a formal order
of investigation issued by the SEC regarding possible securities laws violations by the Company
and/or other persons. At this time, it is not possible to predict the outcome of the investigation
nor is it possible to assess its impact on the Company. The Company has been cooperating fully
with the SEC with respect to its investigation.
On March 17, 2008, NHT Global U.S. received a copy of a demand for arbitration filed with the
American Arbitration Association in Dallas, Texas by a former distributor, Team in Motion, Inc., a
company that is believed to be owned or controlled by Kosta Gara (also formerly known as Kosta
Gharagozloo). Prior to the termination of Team in Motion, Inc., Mr. Gara (or Team in Motion, Inc.
or another affiliate of Mr. Gara) became the Master Distributor for bHIP Global, Inc., which
competes with the Company for distributors. Team in Motion, Inc. seeks $1,000,000 in damages plus
interest and attorneys fees against the Companys subsidiary. NHT Global U.S. denies the
allegations and intends to vigorously defend this proceeding.
Currently, there is no 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. RELATED PARTY TRANSACTION
In connection with its acquisition of MarketVision Communications Corporation (MarketVision)
in 2004, the Company entered into a software license agreement (the Software License Agreement),
with MarketVision Consulting Group, LLC, a limited liability company owned by John Cavanaugh, the
President of MarketVision, and Jason Landry, a Vice President of MarketVision (the Licensee).
Upon an Event of Default (as defined), the Software License Agreement grants, among other things,
the Licensee with an irrevocable, exclusive, perpetual, royalty free, fully-paid, worldwide,
transferable, sublicensable right and license to use, copy, modify, distribute, rent, lease,
enhance, transfer, market, and create derivative works to the MarketVision software. An Event of
Default under the Software License Agreement includes a Share Default, which is defined as the
market value per share of the Company failing to equal or exceed $10.00 per share for any one
rolling period of six months for a certain period following the acquisition of MarketVision. The
last time that the Companys stock closed at or above $10.00 per share was February 16, 2006, and a
Share Default would otherwise have occurred on August 17, 2006. The parties to the Software
License Agreement amended that agreement to provide that no Share Default will occur prior to
December 31, 2006. No further amendments have been entered into, and as a result, the Company is
currently in default.
Although an Event of Default has occurred, the Company believes that it continues to have the
right to continue using the MarketVision software for its internal use only and not as an
application service provider or service bureau, but may not rent, lease, license, transfer or
distribute the software without the Licensees prior written consent. Moreover, the Company
believes that it has the right to receive certain application service provider services from
Licensee, if it chooses to do so. The Company does not believe that the occurrence of the Event of
Default has had or will have a material adverse effect on the Company.
7. LIQUIDITY
At March 31, 2008, the Company had cash and cash equivalents of $4.7 million and a working
capital deficit of $3.7 million. During 2006 and 2007, the Company incurred significant, recurring
losses from operations and negative operating cash flows. Sales decreased significantly during
these years and the Company was unable to control the sales decline or cut operating expenses
sufficiently to avoid the negative operating results. The Companys losses attributable to common
stockholders were $11.5 million and $27.0 million during 2006 and 2007, respectively.
9
The Company has taken several actions to ensure that it will continue as a going concern. It
has planned for and executed many cost reduction initiatives since the end of the third quarter of
2007, such as headcount reductions, which include the termination of multiple management-level
positions in Greater China and North America, lease terminations, and reductions in discretionary
expenses. As a result, the Company believes that its current cash breakeven level has been
significantly reduced.
The Company believes that its existing internal liquidity, supported by cash on hand,
anticipated improvement in cash flows from operations with more stabilized revenue and much lower
fixed costs since October 2007, and the proceeds received from the private placements consummated
in May and October 2007 should be adequate to fund normal business operations expected in the near
future, assuming no significant unforeseen expense or further revenue decline.
|
|
|
Item 2. |
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Business Overview
We are an international direct-selling and e-commerce company. Subsidiaries controlled by us
sell personal care, wellness, and quality of life products under the NHT Global brand to an
independent distributor network that either uses the products themselves or resells them to
consumers.
As of March 31, 2008, we are conducting business in at least 13 countries through
approximately 49,000 active distributors. We consider a distributor active if they have placed
at least one product order with us during the preceding year. Although we have in prior years
expended significant efforts to expand into new markets, we do not intend to devote material
resources to opening any additional foreign markets in the near future. Our priority is to focus
our resources in our most promising markets, namely Greater China, South Korea and Europe. Sales
into the European market are currently fulfilled by our North American subsidiaries.
In the first three months of 2007 and 2008, we generated approximately 89% of our revenue from
subsidiaries located outside North America, with sales in Hong Kong representing approximately 62%
and 61% of revenue, respectively. Because of the size of our foreign operations, operating results
can be impacted negatively or positively by factors such as foreign currency fluctuations, and
economic, political and business conditions around the world. In addition, our business is subject
to various laws and regulations, in particular regulations related to direct selling activities
that create certain risks for our business, including improper claims or activities by our
distributors and potential inability to obtain necessary product registrations.
China is currently our most important business development project. In June 2004, NHT Global
obtained a general business license in China. The license stipulates a capital requirement of $12
million over a three-year period, including a $1.8 million initial payment we made in January 2005.
Direct selling is prohibited in China and only permitted with a direct selling license. In
December 2005, we submitted a preliminary application for a direct selling license and fully
capitalized our Chinese entity with the remaining capital necessary to fulfill the $12 million
required cash infusion. In June 2006, we submitted a revised application package in accordance
with new requirements issued by the Chinese government. In June 2007, we launched a new e-commerce
retail platform in China that does not require a direct selling license and is separate from our
current worldwide platform. We believe this model, which offers discounts based on volume
purchases, will encourage repeat purchases of our products for personal consumption in the Chinese
market. The platform is designed to be in compliance with our understanding of current laws and
regulations in China. In November 2007, we filed a new, revised direct selling application
incorporating a name change, our new e-commerce model and other developments. We believe a direct
selling license would compliment our business conducted in China under the e-commerce retail
platform. 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 revenues are derived from the sale of products that are
delivered to members in China. After consulting with outside professionals, the Company believes
that its Hong Kong e-commerce business does not violate any applicable laws in China even though it
is used for the internet purchase of our products by buyers in China. But the government in China
could, in the future, officially interpret its laws and regulations or adopt new laws and
regulations to prohibit some or all of our e-commerce activities with China and, if our members
engage in illegal activities in China, those actions could be attributed to us. In addition, other
Chinese laws regarding how and when members may assemble and the activities that they may conduct,
or the conditions under which the activities may be conducted, in China are subject to
interpretations and enforcement attitudes that sometimes vary from province to province, among
different levels of government, and from time to time. Members sometimes violate one or more of
the laws regulating these activities, notwithstanding training that the Company attempts to
provide. Enforcement measures regarding these violations, which can include arrests, raises the
uncertainty and perceived risk associated with conducting this business, especially among those who
are aware of the enforcement actions but not the specific activities leading to the enforcement.
The Company believes that this has led some existing members in China who are signed up as
distributors in Hong Kong to leave the business or curtail their selling activities and has led
potential members to choose not to participate. Among
10
other things, the Company is combating this issue 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.
Income Statement Presentation
The Company derives its revenue from sales of its products, sales of its enrollment packages,
and from shipping charges. Substantially all of its product sales are to independent distributors
at published wholesale prices. We translate revenue from each markets local currency into U.S.
dollars using average rates of exchange during the period. The following table sets forth revenue
by market and product line for the time periods indicated (dollars in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
|
2008 |
|
|
|
|
North America |
|
$ |
2,275 |
|
|
|
10.6 |
% |
|
$ |
1,215 |
|
|
|
10.7 |
% |
Hong Kong |
|
|
13,346 |
|
|
|
62.0 |
|
|
|
6,927 |
|
|
|
60.8 |
|
China |
|
|
|
|
|
|
|
|
|
|
283 |
|
|
|
2.5 |
|
Taiwan |
|
|
1,244 |
|
|
|
5.8 |
|
|
|
1,104 |
|
|
|
9.7 |
|
Southeast Asia |
|
|
241 |
|
|
|
1.1 |
|
|
|
76 |
|
|
|
0.7 |
|
South Korea |
|
|
2,723 |
|
|
|
12.7 |
|
|
|
1,409 |
|
|
|
12.3 |
|
Australia/New Zealand |
|
|
235 |
|
|
|
1.1 |
|
|
|
|
|
|
|
|
|
Japan |
|
|
741 |
|
|
|
3.4 |
|
|
|
342 |
|
|
|
3.0 |
|
Latin America |
|
|
365 |
|
|
|
1.7 |
|
|
|
39 |
|
|
|
0.3 |
|
Other1 |
|
|
345 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
21,515 |
|
|
|
100.0 |
% |
|
$ |
11,395 |
|
|
|
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. |
11
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 portal based on a buyers-club concept and do not pay any commissions. Distributors are
not paid commissions on purchases or sales of our products made directly by them. This seamless
compensation plan enables a distributor located in one country to sponsor other distributors
located in other countries where we are authorized to do business. Currently, there are basically
two ways in which our distributors can earn income:
|
|
|
Through retail markups on sales of products purchased by distributors at wholesale
prices (in some markets, sales are for personal consumption only and income may not be
earned through retail mark-ups on sales in that market); and |
|
|
|
|
Through commissions paid on product purchases made by their down-line distributors. |
Each of our products is designated a specified number of sales volume points, also called
bonus volume or BV. Commissions are based on total personal and group sales volume points per
sales period. Sales volume points are essentially a percentage of a products wholesale cost. As
the distributors business expands from successfully sponsoring other distributors who in turn
expand their own businesses by sponsoring other distributors, the distributor receives higher
commissions from purchases made by an expanding down-line network. To be eligible to receive
commissions, a distributor may be required to make nominal monthly or other periodic purchases of
our products. Certain of our subsidiaries do not require these nominal purchases for a distributor
to be eligible to receive commissions. In determining commissions, the number of levels of
down-line distributors included within the distributors commissionable group increases as the
number of distributorships directly below the distributor increases. Under our current
compensation plan, certain of our commission 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
the first three months of 2008, represented 46% and 35% 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.
12
Results of Operations
The following table sets forth our operating results as a percentage of net sales for the
periods indicated.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2007 |
|
|
2008 |
|
Net sales |
|
|
100 |
% |
|
|
100 |
% |
Cost of sales |
|
|
26.5 |
|
|
|
27.1 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
73.5 |
|
|
|
72.9 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
Distributor commissions |
|
|
48.4 |
|
|
|
35.1 |
|
Selling, general and administrative expenses |
|
|
43.6 |
|
|
|
40.3 |
|
Depreciation and amortization |
|
|
2.3 |
|
|
|
3.4 |
|
Impairment of long-lived assets |
|
|
2.5 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
96.8 |
|
|
|
79.0 |
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(23.3 |
) |
|
|
(6.1 |
) |
Other income, net |
|
|
0.9 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
Loss before income taxes and minority interest |
|
|
(22.4 |
) |
|
|
(5.9 |
) |
Income tax provision |
|
|
(1.0 |
) |
|
|
(0.3 |
) |
Minority interest |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(23.4 |
)% |
|
|
(6.2 |
)% |
|
|
|
|
|
|
|
Net Sales. Net sales were $11.4 million for the three months ended March 31, 2008 compared to
$21.5 million for the three months ended March 31, 2007, a decrease of $10.1 million, or 47%. This
decrease was primarily due to the Companys lower product sales, primarily resulting from
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. Hong Kong net sales decreased $6.4 million, or
48%, over the comparable period a year ago. Additionally, net sales for North America, South
Korea, Japan and Latin America were down $1.1 million, $1.3 million, $399,000 and $326,000,
respectively. Partly offsetting the decrease, net sales in China from our new e-commerce retail
platform generated $283,000 during the first three months of 2008.
As of March 31, 2008, the operating subsidiaries of the Company had approximately 49,000
active distributors, compared to 82,000 active distributors at March 31, 2007. This decrease is
primarily due to the uncertain regulatory environment in China that is currently impacting the
Companys Hong Kong-based business. Hong Kong experienced a decrease of 19,000 active
distributors, or 39%, from March 31, 2007 to March 31, 2008.
As of March 31, 2008, the Company had deferred revenue of approximately $2.6 million, of which
approximately $435,000 pertained to product sales and approximately $2.1 million pertained to
unamortized enrollment package revenue.
Cost of Sales. Cost of sales was $3.1 million, or 27.1% of net sales, for the three months
ended March 31, 2008 compared with $5.7 million, or 26.5% of net sales, for the three months ended
March 31, 2007. Cost of sales decreased $2.6 million, or 46%, for the three months ended March 31,
2008 over the comparable period in the prior year, due primarily to the decrease in net sales.
Cost of sales as a percentage of net sales increased primarily due to the decline in enrollment
package revenue, specifically in Hong Kong, as this component of net sales does not contain any
corresponding charge to cost of sales, and due to Chinese importation costs incurred in Hong Kong,
as these costs have not declined at the same rate as net product sales.
Gross Profit. Gross profit was $8.3 million, or 72.9% of net sales, for the three months ended
March 31, 2008 compared with $15.8 million, or 73.5% of net sales, for the three months ended March
31, 2007. This decrease of $7.5 million was mainly due to, as stated above, decreased product
sales, the decline in enrollment package revenue, and Chinese importation costs incurred in Hong
Kong that did not decrease relative to sales.
Distributor Commissions. Distributor commissions were $4.0 million, or 35.1% of net sales, for
the three months ended March 31, 2008 compared with $10.4 million, or 48.4% of net sales, for the
three months ended March 31, 2007. Distributor commissions decreased by $6.4 million, or 62%,
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, and fewer commissions earned
in the newer markets of Japan, Latin America, and Europe. The result of the last significant
commission plan change during the second quarter of 2007 was less than satisfying. While the
payout as a
13
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, primarily in the
markets of Hong Kong, the United States, and Taiwan. Additional enhancements were also added at
the same time to improve sales momentum. With these commission changes and enhancements, we are
targeting a commission payout that will eventually settle around low to mid-40% of sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
were $4.6 million, or 40.3% of net sales, for the three months ended March 31, 2008 compared with
$9.4 million, or 43.6% of net sales, for the three months ended March 31, 2007. Selling, general
and administrative expenses decreased by $4.8 million, or 51%, over the comparable period in the
prior year, mainly due to the following:
|
|
|
lower employee-related expense and severance costs ($1.4 million), travel-related costs
($176,000), professional fees ($297,000) and litigation settlement costs ($385,000) in
North America; |
|
|
|
|
lower overall expense in Japan ($662,000) and Mexico ($268,000) due to expense reduction
programs in both markets during the first nine months of 2007; |
|
|
|
|
lower employee-related costs in Hong Kong and China ($471,000), travel-related costs
($163,000), and professional fees ($264,000); |
|
|
|
|
lower employee-related costs, event costs and other office-related costs in Taiwan
($226,000); |
|
|
|
|
lower operating costs due to office closure in Australia ($169,000) and Southeast Asia
($107,000); |
|
|
|
|
lower credit card charges and assessments in Hong Kong ($149,000); partly offset by |
|
|
|
|
cost of expansion into Europe ($134,000). |
The increase in stock-based compensation expense to $164,000 for the three months ended March
31, 2008 from $79,000 for the comparable period in the prior year was due to the Companys issuance
of restricted stock under the 2007 Equity Incentive Plan to executive officers, directors, key
employees and consultants subsequent to March 31, 2007. The Company granted 1,197,020 and 124,350
shares of restricted stock during fiscal 2007 and the three months ended March 31, 2008,
respectively.
Depreciation and Amortization. Depreciation and amortization was $386,000, or 3.4% of net
sales, for the three months ended March 31, 2008 compared with $489,000, or 2.3% of net sales, for
the three months ended March 31, 2007. Depreciation and amortization decreased by $103,000, or
21%, as a result of the Companys slowdown in capital expenditures and impairment charges recorded
in fiscal 2007 related to the Mexico and Japan markets.
Impairment of Long-Lived Assets. Impairment of long-lived assets was $24,000, or 0.2% of net
sales, for the three months ended March 31, 2008 compared with $532,000, or 2.5% of net sales, for
the three months ended March 31, 2007. During the first three months of 2007, an impairment charge
of $273,000 was 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. Additionally, the Company determined that it was in its best interest to discontinue the
use of certain computer software in the Japan office, which resulted in additional impairment
totaling $246,000.
Other Income, Net. Other income was $27,000 for the three months ended March 31, 2008 compared
with $189,000 for the three months ended March 31, 2007. The decline in other income was primarily
due to less interest income as the Company has not recognized any imputed interest on the
receivable from KGC Networks Ptd. Ltd (KGC). KGC became delinquent on its payments to the
Company in August 2007. During the first three months of 2007, the Company recognized $117,000 in
imputed interest on the KGC receivable. During the first three months of 2008, the Company
recorded unrealized gains of $371,000 in foreign currency gains which was substantially offset by
amortization of debt issuance cost and accretion of debt discount aggregating $362,000 on its
convertible debentures issued in October 2007.
Income Taxes. The Company recorded a provision of $210,000 and $37,000 during the three months
ended March 31, 2007 and 2008, respectively, related to its international operations. The Company
did not recognize a tax benefit for U.S. tax purposes due to uncertainty that the benefit will be
realized.
14
Net Loss. Net loss was $708,000, or 6.2% of net sales, for the three months ended March 31,
2008 compared to net loss of $5.0 million, or 23.4% of net sales, for the three months ended March
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.
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 have an
exercise price of $3.52 per share. The placement agent and its assigns also received five-year
warrants to purchase 149,595 shares of the Companys common stock at an exercise price of $3.52 per
share. The Company plans to use the net proceeds from the October 2007 private placement to
provide additional working capital.
At March 31, 2008, the Companys cash and cash equivalents totaled approximately $4.7 million,
including $180,000 in China that may not be freely transferable to other countries because the
Companys Chinese subsidiary is subject to a business license capitalization requirement. Total
cash and cash equivalents decreased by approximately $1.6 million from December 31, 2007 to March
31, 2008.
At March 31, 2008, the ratio of current assets to current liabilities was 0.73 to 1.00 and the
Company had a working capital deficit of approximately $3.7 million. Current liabilities included
deferred revenue of $2.6 million that consisted of amortized enrollment package revenues and
unshipped orders. The ratio of current assets to current liabilities, excluding deferred
revenue, is 0.90 to 1.00. Working capital as of March 31, 2008 decreased $462,000 compared to the
Companys working capital as of December 31, 2007, mainly due to cash used in operations.
Cash used in operations for the three months ended March 31, 2008 was approximately $1.4
million. Cash was mainly utilized due to the incurrence of net losses; decreases in current
liabilities, specifically accounts payable, accrued distributor commissions and other expenses and
deferred revenue; partly offset by a reduction in existing inventories. Deposits totaling
approximately $430,000 were placed during the three months ended March 31, 2008 to replenish
inventories. The aggregate impact on cash resulting from the decrease in current liabilities
totaled $2.1 million. This is due to the Companys efforts to reduce operating expenses during the
latter half of fiscal 2007 and less unamortized deferred enrollment package revenue.
Cash provided by investing activities during the period was approximately $87,000, primarily
due to a decrease in restricted cash maintained as a reserve with certain credit card processing
companies to provide for potential uncollectible amounts and chargebacks. No cash flows were
generated from financing activities during the period.
The Company has planned for and executed many cost reduction initiatives since the end of the
third quarter of 2007, such as headcount reductions, which include the termination of multiple
management-level positions in Greater China and North America, lease terminations, and reductions
in discretionary expenses. As a result, the Company believes that its current cash breakeven level
has been significantly reduced.
The Company believes that its existing internal liquidity, supported by cash on hand,
anticipated improvement in cash flows from operations with more stabilized revenue and much lower
fixed costs since October 2007, together with the proceeds received from the
15
private placements consummated in May and October 2007, should be adequate to fund normal
business operations expected in the near future, assuming no significant unforeseen expense or
further revenue decline. In the first three months of 2007, even though the Company generated much
greater revenue than in the first three months of 2008, the Companys costs were not aligned to
generate excess cash. The Company believes that its current cash flow breakeven level has been
significantly reduced as a result of its recent cost reduction efforts conducted primarily in North
America and Greater China.
The Company does not have any significant unused sources of liquid assets. Potentially the
Company might receive additional external funding if currently outstanding warrants are exercised.
Furthermore, if necessary, the Company will attempt to generate more funding from the capital
markets, but currently does not believe that will be necessary.
We do not intend to devote material resources to opening any additional foreign markets in the
near future. Our priority is to focus our resources in our most promising markets, namely Greater
China, South Korea, and Europe.
Critical Accounting Policies and Estimates
In response to SEC Release No. 33-8040, Cautionary Advice Regarding Disclosure about Critical
Accounting Policies and SEC Release Number 33-8056, Commission Statement about Managements
Discussion and Analysis of Financial Condition and Results of Operations, the Company has
identified certain policies and estimates that are important to the portrayal of its financial
condition and results of operations. Critical accounting policies and estimates are defined as
both those that are material to the portrayal of our financial condition and results of operations
and as those that require managements most subjective judgments. These policies and estimates
require the application of significant judgment by the Companys management.
The most significant accounting estimates inherent in the preparation of the Companys
financial statements include estimates associated with obsolete inventory and the fair value of
acquired intangible assets, including goodwill, and other long-lived assets, as well as those used
in the determination of liabilities related to sales returns, distributor commissions, and income
taxes. Various assumptions and other factors prompt the determination of these significant
estimates. The process of determining significant estimates is fact specific and takes into
account historical experience and current and expected economic conditions. The actual results may
differ materially and adversely from the Companys estimates. To the extent that there are
material differences between the estimates and actual results, future results of operations will be
affected. The Companys critical accounting policies at March 31, 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 March 31, 2008, the Companys inventory value was approximately
$3.6 million and $2.8 million, net of reserves of $1.8 million and $1.4 million, respectively.
Additional reserve of $639,000 was recorded during the first three months of 2007. No significant
reserve was recorded during the first three months of 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 March 31, 2008, goodwill of
approximately $1.8 million was reflected on the Companys balance sheet. No impairment of goodwill
was identified in the three month periods ended March 31, 2007 and 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 the first three months of 2007, the Company decided to
terminate its existing office lease in Mexico City and relocate to a less costly location. As a
result, an impairment charge of $273,000 was recorded for certain office equipment and leasehold
improvements. Additionally, the Company determined that it was in its best interest to discontinue
the use of certain computer software in the Japan office, which resulted in additional impairment
totaling $246,000. These charges are included as a component of selling, general and
administrative expenses. At March 31, 2008, the net book value of the Companys property and
equipment and intangible assets were approximately $1.4 million and $2.4 million, respectively. No
significant impairment was recorded during the first three months of 2008.
16
Allowance for Sales Returns. An allowance for sales returns is provided during the period the
product is shipped. The allowance is based upon the return policy of each country, which varies
from 14 days to one year, and their historical return rates, which range from approximately 1% to
approximately 7% of sales. Sales returns are approximately 5% of sales for the three months ended
March 31, 2007 and 2008. The allowance for sales returns was approximately $754,000 and $814,000
at December 31, 2007 and March 31, 2008, respectively. No material changes in estimates have been
recognized for the three months ended March 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 $435,000 at
December 31, 2007 and March 31, 2008, respectively. Shipping charges billed to distributors are
included in net sales. Costs associated with shipments are included in cost of sales.
Enrollment package revenue, including any nonrefundable set-up fees, is deferred and
recognized over the term of the arrangement, generally twelve months. Enrollment packages provide
distributors access to both a personalized marketing website and a business management system. No
upfront costs are deferred as the amount is nominal. At December 31, 2007 and March 31, 2008,
enrollment package revenue totaling $2.8 million and $2.1 million was deferred, respectively.
Although the Company has no immediate plans to significantly change the terms or conditions of
enrollment packages, any changes in the future could result in additional revenue deferrals or
could cause us to recognize the deferred revenue over a longer period of time.
Tax Valuation Allowance. The Company evaluates the probability of realizing the future
benefits of any of its deferred tax assets and records a valuation allowance when it believes a
portion or all of its deferred tax assets may not be realized. At December 31, 2005, the Company
increased the valuation allowance to equal its net deferred tax assets due to the uncertainty of
future operating results. During 2006, the Company recorded deferred tax assets in foreign
jurisdictions that are expected to be realized and therefore no valuation allowance is necessary.
The valuation allowance will be reduced at such time as management believes it is more likely than
not that the deferred tax assets will be realized. Any reductions in the valuation allowance will
reduce future income tax provisions.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable under smaller reporting company disclosure rules.
Item 4T. 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 March 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 the Companys disclosure controls and
procedures were not effective as of March 31, 2008 due to the material weakness identified as part
of managements evaluation of internal control over financial reporting discussed below. As a
result, the Company performed additional account analysis and reconciliations to ensure the
consolidated financial statements present fairly, in all material respects, its financial position,
results of operations and cash flows for the periods presented.
During managements evaluation of the effectiveness of the internal control over financial
reporting as of December 31, 2007, management determined a combination of deficiencies identified
at the Companys subsidiary in Taiwan results in a material weakness in the Companys internal
control over financial reporting. The deficiencies are due to the lack of evidential documentation
supporting the reconciliation and review of certain account balances. Management believes this
control deficiency results primarily from significant staff and supervisor turnover that occurred
in Taiwan during the fourth quarter of 2007. Accordingly, management concluded that, if not
detected and prevented, this deficiency could have resulted in a material misstatement of the
Companys most
17
significant account balances, such as cash, inventories and accrued distributor
commissions, as well as the related income or expense accounts.
Changes in Internal Control over Financial Reporting
There were no changes in internal control over financial reporting that occurred during the
fiscal quarter ended March 31, 2008 that have materially affected, or are reasonably likely to
materially affect, internal control over financial reporting, except that the Company hired a new
finance manager in Taiwan. The finance manager is responsible for addressing the deficiencies
identified above by completing an action plan for reconciliation and review of each account
balance. Additionally, the action plan includes an initiative to improve efficiency and eliminate
redundant tasks currently performed by the accounting and finance staff in Taiwan.
PART II OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is subject to certain legal proceedings which could have an adverse effect on its
business, results of operations, or financial condition. For information relating to such legal
proceedings, see Note 5 in the Notes to Consolidated Financial Statements contained in Part I, Item
1 of this Quarterly Report on Form 10-Q.
Item 1A. RISK FACTORS
Not applicable under smaller reporting company disclosure rules.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
|
|
|
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). |
|
|
|
31.2
|
|
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act. |
|
|
|
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. |
|
|
|
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. |
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
|
NATURAL HEALTH TRENDS CORP.
|
|
Date: May 14, 2008 |
|
/s/ Chris T. Sharng
|
|
|
|
Chris T. Sharng |
|
|
|
President
(Principal Executive Officer) |
|
19
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
|
|
|
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). |
|
|
|
31.2
|
|
Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act. |
|
|
|
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. |
|
|
|
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. |