UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
Or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the fiscal year ended December 31, 2003
Commission file number 0-011228
NATURAL HEALTH TRENDS CORP.
(Name of Small Business Issuer in Its Charter)
Florida 59-2705336
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
12901 Hutton Drive, Dallas, Texas 75234
(Address of principal executive office) (Zip Code)
Issuer's Telephone Number, Including Area Code: (972) 241-4080
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, par value $.001
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this Form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year: $62,885,830
The aggregate market value of the voting stock held by non-affiliates of
the Issuer as of March 31, 2004 was approximately $97,919,000 (based upon a
closing price of $18.27 per share).
The number of shares of the Common Stock of the issuer outstanding as of
March 31, 2004 was 5,446,409.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III incorporates certain information by reference from the
Registrant's Definitive Proxy Statement for the Registrant's Annual Meeting to
be held during the second quarter of 2004.
Natural Health Trends Corp.
Form 10-KSB
2003 Annual Report
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS..............................................................2
ITEM 2. PROPERTIES...........................................................29
ITEM 3. LEGAL PROCEEDINGS....................................................31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................31
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.............32
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................35
ITEM 7. FINANCIAL STATEMENTS.................................................49
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................................49
ITEM 8A. CONTROLS AND PROCEDURES..............................................49
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS.....................................51
ITEM 10. EXECUTIVE COMPENSATION...............................................51
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT...........................................................51
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................51
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.....................................52
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...............................53
SIGNATURES ...................................................................54
CERTIFICATIONS................................................................55
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-KSB
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 Annual 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 Annual Report, the
words "will," "believe," "anticipate," "intend," "estimate," "expect," "project"
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 undue reliance on our forward-looking
statements. Our actual results could differ materially from those anticipated in
these forward-looking statements as a result of various factors, including the
risks described in Part I - Risk Factors, and elsewhere in this Annual Report.
Our forward-looking statements do not reflect the potential impact of any future
acquisitions, mergers, dispositions, joint ventures or strategic investments. In
addition, any forward-looking statements represent our expectation only as of
the day this Annual Report was first filed with the SEC 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 Annual Report. Important factors
that could cause our actual results, performance and achievements, or industry
results to differ materially from estimates or projections contained in
forward-looking statements include, among others, the following:
. our relationship with our distributors;
. our need to continually recruit new distributors;
. our internal controls and accounting methods may require further
modification;
. regulatory matters governing our products and network marketing
system;
. adverse publicity associated with our products or network
marketing organizations;
. product liability claims;
. our reliance on outside manufacturers;
. risks associated with operating internationally, including foreign
exchange risks;
. product concentration;
. dependence on increased penetration of existing markets;
. the competitive nature of our business; and
. our ability to generate sufficient cash to operate and expand our
business.
Market data and other statistical information used throughout this
report is based on independent industry publications, government publications,
reports by market research firms or other published independent sources and on
our good faith estimates, which are derived from our review of internal surveys
and independent sources. Although we believe that these sources are reliable, we
have not independently verified the information and cannot guarantee its
accuracy or completeness.
1
PART I
ITEM 1. BUSINESS.
We are Natural Health Trends Corp. ("NHTC" or "the Company"), an
international network marketing organization. We control subsidiaries that
distribute products through three separate direct selling networks that promote
health, wellness and vitality. Lexxus International, Inc., our majority-owned
subsidiary and other Lexxus subsidiaries (collectively, "Lexxus") sell certain
cosmetic products as well as "quality of life" products, which constituted
approximately ninety-six percent (96%) of our consolidated revenues in 2003.
eKaire.com, Inc., our wholly-owned subsidiary ("eKaire"), distributes
nutritional supplements aimed at general health and wellness. In 2003, we
commenced the operations of I Luv My Pet, Inc., ("ILMP"), our wholly owned
subsidiary that distributes nutritional supplements for dogs and cats. Lexxus
commenced operations in January 2001 and has experienced tremendous growth, as
we are currently conducting business in at least 30 countries through
approximately 80,000 active distributors. While eKaire's business is
significantly smaller, it has been in business since 2000 and is doing business
in four countries through approximately 4,400 active distributors. Sales from
ILMP were negligible since it commenced operations during the fourth quarter of
2003.
Total net sales for fiscal 2003 increased to approximately $62.9 million
from approximately $37.0 million for fiscal 2002, an increase of approximately
70%. Income before discontinued operations for fiscal 2003 increased to
approximately $5.4 million from a loss of approximately $261,000 for fiscal
2002. Net income for fiscal 2003 increased to approximately $5.4 million from
$2.1 million for fiscal 2002, an increase of approximately 157%.
Through our subsidiaries, Lexxus, eKaire and ILMP, we seek to be a
leader in the network marketing industry serving the health and wellness
marketplace by driving our products into as many venues and into as many markets
as possible through our multi-level marketing operations. Our objectives are to
enrich the lives of the users of our products while enabling distributors to
benefit financially from the sale of our products.
In March 2003, in order to enhance the price of our Common Stock and to
enable us to better use our capital stock to compensate management and motivate
employees, as well as consideration for future acquisition transactions, our
stockholders approved and we effected a 1-for-100 reverse stock split with
respect to our outstanding shares of Common Stock. As a result, on March 19,
2003, the number of outstanding shares of Common Stock declined from 462,873,100
to 4,628,731 and the closing price per share increased from $0.01 on March 18,
2003 to $1.50 on March 19, 2003, as reported on the OTC Bulletin Board. In
addition, the trading symbol for the shares of our Common Stock changed from
"NHTC" to "NHLC". All share references in this annual report will give effect to
the reverse stock split. On March 31, 2004, the closing price per share as
reported on the OTC Bulletin Board was $18.27.
We maintain executive offices at 12901 Hutton Drive, Dallas, Texas 75234
and our telephone number is (972) 241-4080. Our website is located at
www.naturalhealthtrendscorp.com, but the information provided there should not
be considered part of this Annual Report on Form 10-KSB.
2
Recent Developments
Restatement of Previously Issued Financial Statements:
During the quarters ended September 30 and December 31, 2003, the
Company re-evaluated its financial statements for the years ended December 31,
2002 and 2001, the quarterly periods included in such years and the quarterly
periods ended March 31, June 30 and September 30, 2003. As a result of such
review, the Company determined that it inadvertently applied the incorrect
accounting treatment with respect to the following items (the "Restatement
Items"):
(i) revenue recognition with respect to administrative enrollment fees;
(ii) revenue cut-off between 2002 and 2003;
(iii) accounts receivable reconciliation to supporting documents;
(iv) reserves established for product returns and refunds;
(v) the gain recorded in connection with the sale of a subsidiary in 2001;
(vi) income tax provisions; and
(vii) stock option based compensation.
Consequently, the Company is amending and restating its financial
statements for each quarter in 2001, 2002 and 2003 as well as for the years
ended December 31, 2001 and 2002.
In connection with the review of the Company's financial statements, the
Company has revised its accounting treatment for administrative enrollment and
membership fees received from distributors in accordance with the principles
contained in Staff Accounting Bulletin No. 104, "Revenue Recognition", ("SAB
104") and related guidance. The Company determined that under SAB 104, such fees
actually received and recorded as current sales in prior quarters should have
been deferred and recognized as revenue on a straight-line basis over the
twelve-month term of the membership. The restatement resulted in net sales for
the year ended December 31, 2002 being decreased by approximately $1,336,000.
The restatement in net sales resulted in a corresponding adjustment to cost of
sales for direct costs paid to a third party associated with the administrative
enrollment fees received from distributors. Compared to amounts previously
reported, the restatement decreased cost of sales by approximately $336,000 for
the year ended December 31, 2002.
The Company also reviewed its revenue cut-off as of the beginning of
2003. It was noted that approximately $1,008,000 of sales originally recorded in
2002 were not actually shipped until early 2003. The restatement resulted in net
sales for the quarter ended December 31, 2002 being decreased by $1,008,000 and
net sales for the quarter ended March 31, 2003 being increased by the same
amount. The restatement also resulted in distributor commissions for the quarter
ended December 31, 2002 being decreased by $459,000 and distributor commissions
for the quarter ended March 31, 2003 being increased by the same amount.
Also in connection with its review, the Company determined that its
accounts receivable as of March 31 and June 30, 2003 did not reconcile in total
to supporting details for such transactions. The restatement resulted in net
sales being decreased by $140,000 and $260,000 as of March 31 and June 30, 2003,
respectively.
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The Company had not recorded a reserve for distributor returns and
refunds as of September 30, 2003 and for prior periods. Based upon analysis of
the Company's historical returns and refund trends by country, it was determined
that the reserves for returns and refunds for prior periods were required and
should be recorded. The restatement resulted in net sales for the year ended
December 31, 2002 being decreased by approximately $350,000, with corresponding
adjustments to cost of sales for the estimated cost of products returned.
In 2001, the Company sold all of the outstanding common stock in Kaire
Nutraceuticals, Inc. ("Kaire"), a Delaware corporation and wholly-owned
subsidiary of the Company, to an unrelated third party. The gain on the sale of
Kaire was approximately $3.1 million, a portion of which was previously
deferred. The Company subsequently recognized into income approximately $1.9
million from the transaction over the period from the fourth quarter of 2001
through the second quarter of 2003. Based upon a review of the transaction, the
Company now believes the gain on sale of Kaire should have been recognized only
in 2001 and 2002 and not in 2003. For the year ended December 31, 2002, the
Company is now recognizing $2,400,000 of gain on the sale of Kaire as
Discontinued Operations and is reducing its Other Income by $800,000.
The Company disclosed in its Annual Report on Form 10-KSB for the year
ended December 31, 2002 that it had a net operating loss carry forward at
December 31, 2002 of approximately $6,000,000, subject to certain limitations.
Consequently, the Company made no provision for income taxes for any period in
2002 or 2001. Upon further review, it has been determined that the available net
operating loss was not expected to be sufficient to offset all of the domestic
and foreign taxable income in 2002 or 2001 and that an estimated tax provision
in the amount of $300,000 was necessary for the year ended December 31, 2002.
The Company has determined that the stock options (the "Options")
granted in January 2001 and October 2002 to senior executive officers of the
Company should be accounted for as variable stock options due to the provision
in the stock option plan that allowed the holder to exercise the stock option in
an immaculate cashless fashion. The cashless exercise feature allows option
holders to use the "in the money" value of the options (or the spread between
the exercise price and the fair market price of the underlying shares as of the
exercise date) as payment for all, or a portion, of the exercise price of an
option. The Options were amended in November 2002 to require the option holder
to obtain Company approval before the Option holder could use the cashless
exercise feature. Subsequent to the modification, fixed option accounting will
be applied to the options. Under variable accounting, changes in the intrinsic
value of the stock option result in recording a charge or credit to stock based
compensation expense. For the year ended December 31, 2002, the restatement
resulted in $1,434,000 being charged to stock option based compensation expense.
4
The following table presents amounts from operations as previously
reported and as restated (in thousands, except for per share data):
Year Ended December
---------------------------
December 31, 2002
---------------------------
As
Previously As
Reported Restated
------------ ------------
Net sales $ 39,662 $ 36,968
Cost of sales 7,391 6,985
------------ ------------
Gross profit 32,271 29,983
Operating expenses 28,770 29,745
------------ ------------
Income from operations 3,501 238
Other income (expense) 601 33
------------ ------------
Income from continuing operations before taxes
and minority interest 4,102 271
Income tax expense - (300)
Minority interest, net of taxes - (232)
------------ ------------
Income (loss) before discontinued operations 4,102 (261)
------------ ------------
Gain from discontinued operations, net of taxes - 2,400
------------ ------------
Net income 4,102 2,139
Preferred stock dividends 70 70
------------ ------------
Net income available to common stockholders $ 4,032 $ 2,069
============ ============
Basic income per common share:
Continuing operations $ 1.29 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.29 $ 0.66
============ ============
Diluted income per common share:
Continuing operations $ 1.24 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.24 $ 0.66
============ ============
Weighted average shares outstanding:
Basic 3,118 3,118
Diluted 3,247 3,118
The adjustments in net sales, cost of sales, commission expense, stock
based compensation expense, other income and income taxes resulted in a net
decrease in income before discontinued operations of approximately $4,363,000
from the amounts previously reported for the year ended December 31, 2002. Net
income available to stockholders decreased by approximately $1,963,000 from the
amounts previously reported. Restated basic and diluted income per share from
continuing operations decreased by $1.40 and $1.35, respectively, from the
amounts previously reported for the year ended December 31, 2002. Net income for
basic and diluted income per share decreased by $0.63 and $0.58, respectively,
from the amounts previously reported for the year ended December 31, 2002. The
cumulative effect of the restatements for 2001 and 2002 resulted in a net
increase in accumulated deficit of approximately $3,520,000 as of December 31,
2002.
Our Industry
We are engaged in the network marketing business, which is also referred
to as multi-level marketing. This type of organizational structure and approach
to marketing and sales has
5
proven to be extremely successful for several other multi-level marketing
companies such as Amway Corp., Mary Kay, Inc., Nu Skin Enterprises and
Herbalife. Generally, network marketing is based upon an organizational
structure where independent distributors of a company's products are compensated
for sales made directly to consumers. But, even more significantly, distributors
are compensated for sales generated by distributors recruited by that
distributor and all subsequent distributors recruited by their "down line"
network of distributors. This can be very lucrative for individual distributors
who develop extensive networks of distributors that sell company products as
well as recruit additional distributors.
According to information contained on the Direct Selling Association's
website, network marketing is one of the fastest growing segments for the
distribution of products on a worldwide basis. The Direct Selling Association
reports that over 47 million individuals are now involved in direct selling
worldwide (of which network marketing is a major segment), and that those
involved in direct selling generate $85 billion in annual sales around the
world. In the United States, the direct selling channel has generated sales of
approximately $28.7 billion of goods and services in 2002, making the United
States the largest direct selling market in the world.
We are presently marketing and selling lifestyle enhancement products
through our Lexxus subsidiaries, nutraceutical products through our wholly owned
eKaire subsidiary and pet nutraceuticals through our wholly owned ILMP
subsidiary. It is important to note that once a sizeable network of distributors
is established, alternative products and services can be offered to those
distributors for sale to consumers and additional distributors. The successful
introduction of new products can dramatically increase sales and profits for
both distributors and the multi-level marketing organization.
Our Products
Lexxus
We offer several Lexxus branded lifestyle enhancement products:
. Skindulgence(TM) is a skin care system marketed as a "30-Minute
Non-Surgical FaceLift" designed to create a more youthful appearance by helping
to tone and firm facial muscles, by helping to diminish fine lines and wrinkles
and by helping to improve skin tone and color. The facelift masque is coupled
with a cleanser and moisturizer. It is currently Lexxus' fastest growing product
accounting for approximately 49% of Lexxus' revenues in 2003.
. Alura(TM) is an intimacy creme designed to increase the sexual
satisfaction of women and accounted for approximately 34% of Lexxus' revenues in
2003.
. LexLips(TM) is a lip enhancing gloss for women, designed to create
the effect of fuller lips and to help reduce fine lines and wrinkles around the
mouth.
. La Vie(TM) is a dietary supplement described as a non-alcoholic red
wine. It is marketed as an energizing supplement containing aloe.
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. 180 DEG. Life System Carb-Blocker(TM) is marketed as a weight
management product based upon over 30 years of research.
. Lexxus Premium Noni(TM) is a 100% organic dietary supplement drink,
developed to help support the natural, optimum cell functions of the body.
Alura(TM) and Skindulgence(TM) are trademarks of Lexxus.
eKaire
We offer eKaire branded products, which are organized into five broad
categories: reviving products; energizing products; enhancing products;
optimizing products and renewing products.
Reviving Products
The eKaire reviving product line consists primarily of nutritional
supplements based on antioxidants including Maritime Prime with Pycnogenol(R)
and EnzoKaire Complete.
. Maritime Prime with Pycnogenol(R) is a dietary supplement that
contains Pycnogenol(R) which is designed to help maintain healthy
circulation by strengthening capillary walls by protecting against
free radical damage caused by stress, pollution and chemical
additives, and by improving skin and collagen texture, elasticity
and smoothness. Pycnogenol(R) is a patented extract from the bark of
the Maritime Prime trees grown in southwestern France.
. EnzoKaire Complete is a dietary supplement containing Enzogenol(TM),
which is a natural antioxidant, intended to provide protection for
cells against the effects of free radicals. It also increases energy
and endurance, and slows the aging process. Enzogenol(TM) is derived
from the bark of the New Zealand pine tree, Pinus radiata.
Most of the products in this product line are based on proprietary
formulations in several combinations containing natural products including
Pycnogenol (R) and Enzogenol(TM).
Energizing Products
The Kaire energizing product line consists primarily of natural
stimulants designed to enhance and increase vitality and endurance both mentally
and physically. Products in this category include Ginkgo Shield and Momentum.
. Ginkgo Shield is intended to assist in mental alertness and to
enhance the functioning of the circulatory system.
. Momentum is intended to help increase and balance energy levels.
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Enhancing Products
The Kaire enhancing product line is designed to support an individual's
overall health and includes such products as Immunol, Colloidal SilverKaire,
Synerzyme, Osteo Formula, and Pro GSH 90 Plus.
. Immunol is a shark liver oil based capsule, which is intended to aid
the human immune system.
. Colloidal Silverkaire is a solution of silver particles
electro-magnetically suspended in deionized water that is intended
to provide dietary support for the immune system.
. Synerzyme is a combination of naturally occurring enzymes and trace
minerals that is intended to enhance the efficacy of enzymes that
assist the body with the breakdown and assimilation of various foods
and fats.
. Osteo Formula is a dietary supplement that contains calcium, which
is intended to aid in bone strength and overall skeletal system
health.
. Pro GSH 90 Plus, a Whey Protein product, is a pharmaceutical-grade
milk serum protein isolate designed to enhance the immune system.
Optimizing Products
The Kaire optimizing product line provides many of the basic vitamins
and nutrients, which are missing in the typical adult diet, through products
such as MSM Complex, Bio10 and Celltonic Plus(TM).
. MSM Complex is intended to support an increased production of
collagen and elastin fibers and increases cell permeability.
. Bio10 is a live source of all 12 lactobacillus bacteria, which is
supposed to help improve digestion, and the process and absorption
of nutrients.
. Celltonic Plus(TM) is an organic mineral solution containing over 72
minerals and trace elements within an electrolyte drink designed to
strengthen cells and aid in the natural healing process.
Renewing Products
The Kaire renewing product line consists of moisturizing products
designed to soothe and refresh the skin. These products include Aloe Gel and
DermaKaire with Pycnogenol(R).
. Aloe Gel is a topical creme that soothes and refreshes the skin.
. DermaKaire with Pycnogenol is a moisturizing, whole-leaf Aloe
product combined with a powerful antioxidant intended to maintain
healthy-looking skin.
Pycnogenol (R) and Enzogenol(TM) are trademarks of suppliers of eKaire.
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I Luv My Pet
We formed ILMP in August 2003, which currently operates only in the
United States and Canada. ILMP offers quality of life products for pets.
Billions of dollars are spent each year in the U.S. alone on pets and pet
supplies, indicating the buyers' love for animals and the appreciation for their
companionship and love. ILMP currently offers dog and cat nutritional
supplements, and is researching additional cutting-edge products to expand the
product offerings. In 2004, the Company intends to focus on developing the ILMP
product line and network of distributors.
Sourcing of Products
We purchase finished goods from selected manufacturers and sell them
directly to our distributors for their resale or personal consumption. All of
our products are produced or provided by unaffiliated third-party suppliers
located in the United States. We are heavily dependent upon two primary
suppliers, one of which supplies our Skindulgence(TM) product line and the other
of which supplies our Alura(TM) product line. We believe that, in the event we
were unable to source products from these suppliers or the other important
suppliers of our other products, we could replace these products or substitute
similar ingredients in order to meet the product needs of our distributors.
For other products, we place orders for finished goods and manufacturing
services to meet the demand of the market. These orders are based on price
quotations and other terms obtained from selected manufacturers.
Research and Development
We believe that our ability to introduce new products increases our
distributors' visibility and competitiveness within the marketplace. The
executive management of NHTC and Lexxus devote a significant portion of their
time in new product review and evaluation. In addition, we rely upon independent
research consultants and our vendor's research and development staff for product
research, development and formulation. We have incurred minimal research and
development costs in the years ended December 31, 2003 and 2002.
Marketing and Distribution
Lexxus, eKaire and ILMP are set up as direct selling companies using a
network of distributors to sell products. Our distributors are independent
contractors who purchase products directly from the respective subsidiary via
the Internet for resale to retail consumers or for personal consumption.
Distributors may elect to work on a full-time or a part-time basis. The growth
of a distributor's business depends largely upon their ability to recruit a
down-line and the popularity of our products in the marketplace.
Currently, we have distributors located in all fifty states, as well as
the District of Columbia, Puerto Rico, Canada, Australia, New Zealand, Taiwan,
Hong Kong, Singapore, Philippines, South Korea, Brazil, India and sixteen
countries in eastern Europe, including Russia,
9
in order to maximize our direct selling efforts. As of December 31, 2003, we
have a physical presence in six of the top 20 direct selling markets in the
world. We intend to pursue additional foreign markets in 2004.
To become a Lexxus distributor, a person must accept an agreement
(posted on our Lexxus International website) to comply with our policies and
procedures and to pay a nominal $100 annual enrollment fee. To be considered
"active", the distributor must order a minimum of $100 of products each year.
Lexxus currently has approximately 80,000 active distributors.
To become an eKaire distributor, a person must sign an agreement (posted
on our eKaire website) to comply with our policies and procedures. To be
considered "active", the distributor must order a minimum of $50 of products
each year. eKaire currently has approximately 4,400 active distributors and
customers.
To become an ILMP distributor, a person must accept an agreement (posted
on our ILMP website) to comply with our policies and procedures and to pay a
nominal $49.50 annual enrollment fee. To be considered "active", the distributor
must order a minimum of $49.50 of products each year.
We pay commissions to qualified distributors based on sales volumes for
each commission period. We believe, based upon our knowledge of our competitor's
compensation plans, that we offer one of the highest commission payouts in the
direct selling industry. We also believe that the uniqueness and efficacy of our
products, combined with a high commission rate, creates a highly desirable
business opportunity and work environment for our distributors. See
"Compensation Plans".
Distributors generally pay for products by credit card in connection
with orders placed through their own Internet page at www.mylexxus.com,
www.mykaire.com or www.iluvmypet.com prior to shipment. Accordingly, we carry
minimal accounts receivable and credit losses are historically nominal.
We regularly sponsor promotional meetings and participate in
motivational training events in key cities around the world. These events are
designed to inform prospective and existing distributors about both existing and
new product lines as well as selling techniques. Distributors typically share
their direct selling experiences, their individual selling styles and their
recruiting methods at these promotional or training events. Prospective
distributors are educated about the structure, dynamics and benefits of the
network marketing industry. We are continually developing or updating our
marketing strategies and programs to motivate our distributors. These programs
are designed to increase distributors' monthly product sales and the recruiting
of new distributors in their down-lines.
Sponsorship
We rely on our distributors to recruit and sponsor new distributors and
to purchase our products. While we provide product samples, brochures and other
sales materials, distributors are
10
primarily responsible for recruiting and educating their new distributors with
respect to products, the compensation plan and how to build a successful
distributorship network.
The sponsoring of new distributors creates multiple levels in a network
marketing structure. The persons that a distributor sponsors within the network
are referred to as "downline" or "sponsored" distributors. If downline
distributors also sponsor new distributors, they create additional levels within
the structure, but their downline distributors remain in the same downline
network as their original sponsoring distributor.
Sponsoring activities are not required of distributors and we do not pay
any commissions for sponsoring new distributors. However, because of the
financial incentives provided to those who succeed in building a distributor
network that consumes and resells products, we believe that many of our
distributors attempt, with varying degrees of effort and success, to sponsor
additional distributors. Because they are seeking new opportunities for income,
people are often attracted to become distributors after using our products and
becoming regular customers or after attending introductory seminars. Once a
person becomes a distributor, he or she is able to purchase products directly
from us at wholesale prices via the Internet. The distributor is also entitled
to sponsor other distributors in order to build a network of distributors and
product users.
Compensation Plans
We believe that one of our key competitive advantages within the direct
selling industry is our distributor compensation plan. Under our compensation
plan, distributors are paid consolidated weekly commissions in the distributor's
home country, in their local currency, for their own product sales and for
product sales in that distributor's downline distributor network across all
geographic markets. This "seamless" compensation plan enables a distributor
located in one country to sponsor other distributors located in other countries
where we do business.
Based upon management's knowledge of our competitors' distributor
compensation plans, we believe that our compensation plan is among the most
financially rewarding plans offered to distributors by any network marketing
company. Currently, there are two fundamental ways in which our distributors can
earn commissions:
. Through retail markups on sales of products purchased by
distributors at wholesale prices; and
. Through a series of commissions paid on product sales.
Each of our products carries a specified number of sales volume points.
Commissions are based on total personal and group sales volume points per sales
period. Sales volume points are essentially based upon a percentage of a
product's wholesale cost. As the distributor's business expands from
successfully sponsoring other distributors who in turn expand their own
businesses by sponsoring other distributors, the distributor receives yet higher
commissions. In determining commissions, the number of levels of downline
distributors included within the distributor's commissionable group increases as
the number of distributorships directly below the distributor increases.
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Distributor Support
We are committed to providing a high level of support services tailored
to the needs of our distributors in each marketplace we are serving. We attempt
to meet the needs and build the loyalty of distributors by providing
personalized distributor services and by maintaining a generous product return
policy. See "Product Warranties and Returns". Because the majority of our
distributors are working on a part-time basis and have only a limited number of
hours each week to concentrate on their business, we believe that maximizing a
distributor's efforts by providing effective distributor support has been, and
will continue to be, important to our success.
Through training meetings, annual conventions, web-based messages,
distributor focus groups, regular telephone conference calls and other personal
contacts with distributors, we seek to understand and satisfy the needs of our
distributors. Via our websites, we provide product fulfillment and tracking
services that result in user-friendly and timely product distribution. Most of
our offices maintain meeting rooms, which our distributors may utilize for
training and sponsoring activities. Because of our efficient distribution
system, we do not believe that most of our distributors maintain a significant
inventory of our products.
To help maintain communication with our distributors, we offer the
following support programs:
Touchtalk and Fax on Demand
Touchtalk is an automated telephone system that distributors can call 24
hours a day, 7 days a week, to receive reports on the sales activity of their
organization and listen to selected messages on special offers, marketing
program updates and product information. Certain information is also available
via facsimile transmission to the distributor.
Teleconferences
Lexxus, eKaire and ILMP hold teleconferences with company management and
associate field leadership on various subjects such as technical product
discussions, distributor organization building and management techniques.
Internet
We maintain websites at www.naturalhealthtrendscorp.com, www.ekaire.com,
www.kaire.com, www.lexxusinternational.com, www.mylexxus.com, www.mykaire.com
and www.iluvmypet.com. On each website, the user can read company news, learn
more about various products, sign up to be a distributor, place orders, and
track the fulfillment and delivery of their order.
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Product Literature
We offer a variety of literature to distributors, including product
catalogs, informational brochures, pamphlets and posters for individual
products.
Toll Free Access
eKaire offers a toll free number, to place orders and to sponsor new
distributors, but Lexxus offers these services only through its websites. Both
eKaire and Lexxus offer "live" consumer support where a customer service
representative can address general questions or concerns. ILMP currently offers
customer support only via e-mail.
Broadcast Fax/Broadcast E-mail
Announcements about Lexxus, eKaire and ILMP are sent via facsimile
and/or e-mail to all active distributors.
Technology and Internet Initiatives
We believe that the internet has become increasingly important to our
business as more consumers communicate online and purchase products over the
Internet as opposed to traditional retail and direct sales channels. As a
result, we have committed significant resources to our e-commerce capabilities
and the abilities of our distributors to take advantage of the Internet.
Substantially all of our sales during 2003 occurred via the Internet. eKaire has
a personalized website for its distributors to purchase products via the
Internet at www.mykaire.com. Lexxus offers a global web page that allows a
distributor to have a personalized website at www.mylexxus.com through which he
or she can sell products in 30 global markets. In addition, ILMP has a
personalized website for its distributors to purchase products via the Internet
at www.iluvmypet.com.
Rules Affecting Distributors
We monitor regulations in each country in which we do business as well
as the activity of distributors to ensure that our distributors comply with
local laws. Our distributor policies and procedures establish the rules that
distributors must follow in each country. We also monitor distributor activity
in an attempt to provide our distributors with a "level playing field" so that
one distributor may not be disadvantaged by the activities of another. We
require our distributors to present products and business opportunities in an
ethical and professional manner. Distributors further agree that their
presentations to customers must be consistent with, and limited to, the product
claims and representations made in our literature. Even though sponsoring
activities can be conducted in many countries, our distributors may not conduct
marketing activities outside of those countries in which we currently conduct
business.
We require that we produce or pre-approve all sales aids used by
distributors such as videotapes, audiotapes, brochures and promotional clothing.
Further, distributors may not use any form of media advertising to promote
products unless it is pre-approved by the Company. Products may be promoted only
by personal contact or by literature produced or approved by us.
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Distributors are not entitled to use our trademarks or other intellectual
property without our prior consent.
Our compliance department systematically reviews reports of alleged
distributor misbehavior. If we determine that a distributor has violated our
distributor policies or procedures, we may terminate the distributor's rights
completely. Alternatively, we may impose sanctions such as warnings, probation,
withdrawal or denial of an award, suspension of privileges of the
distributorship, fines, withholding commissions until specified conditions are
satisfied or other appropriate injunctive relief. Our distributors are
independent contractors who may resign/terminate their distributorship at any
time without notice.
Competition
We compete with a significant number of other retailers that are engaged
in similar lines of business, including sellers of health-related products and
other direct sellers. Many of the competitors have greater name recognition and
financial resources than us as well as many more distributors. The two most well
known and established of the direct sellers are Mary Kay, Inc. and Amway Corp.,
each with over three million distributors worldwide. Other non-direct selling
retailers with which we compete include retail pharmacies and health stores,
such as General Nutrition Centers, and internet based companies, such as
VitaminShoppe.com and drugstore.com. The market for nutritional supplements is
rapidly growing and is highly competitive. The direct selling channel tends to
sell products at a higher price compared to traditional retailers, which poses a
degree of competitive risk. There is no assurance that we will continue to
compete effectively against retail stores, internet based retailers or other
direct sellers.
Seasonality
We believe that the recruitment of distributors and the general sales
volume fluctuates on a pattern opposite of traditional retail sales. When retail
stores have negligible or no sales growth, multi-level marketing sales tend to
increase. Since most of our distributors operate as a home-based business,
distributors tend to take "typical" vacations such as during summer and winter
holidays, thus, decreasing our sales volume during such vacation periods.
Intellectual Property
In November 2001, the inventor of our Alura(TM) product, from whom we
have a license to distribute Alura(TM), was awarded a patent for the formulation
of that product.
Most of the eKaire, Lexxus and ILMP products are packaged under a
"private label" arrangement. We have applied for trademark registration for
names, logos and various product names in several countries into which eKaire
and Lexxus are doing business or considering expanding into. We currently have
approximately three trademark registrations in the United States and three
trademark applications pending with the United States Patent and Trademark
Office. Our registered trademarks expire or become renewable from 2007 to 2008
and we rely on common law trademark rights to protect our unregistered
trademarks. These common law
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trademark rights do not provide us with the same level of protection as afforded
by a United States federal registration trademark. Common law trademark rights
are limited to the geographic area in which the trademark is actually utilized,
while a United States federal registration of a trademark enables the registrant
to discontinue the unauthorized use of the trademark by a third party anywhere
in the United States even if the registrant has never used the trademark in the
geographic area where the trademark is being used, provided, however, that the
unauthorized third party user has not, prior to the registration date, perfected
its common law rights in the trademark within that geographic area.
Government Regulation
Direct Selling Activities
Direct selling activities are regulated by various federal, state and
local governmental agencies in the United States and foreign countries. These
laws and regulations are generally intended to prevent fraudulent or deceptive
schemes often referred to as "pyramid" schemes, that compensate participants for
recruiting additional participants irrespective of product sales, use high
pressure recruiting methods and/or do not involve legitimate products. The laws
and regulations in our current markets often:
. impose cancellation/product return, inventory buy backs and cooling
off rights for consumers and distributors;
. require us or our distributors to register with governmental
agencies;
. impose reporting requirements; and
. impose upon us requirements, such as requiring distributors to
maintain levels of retail sales to qualify to receive commissions,
to ensure that distributors are being compensated for sales of
products and not for recruiting new distributors.
The laws and regulations governing direct selling are modified from time
to time to address concern of regulators. For example, in South Korea new
regulations were adopted that, among other things, restrict multi-level
marketing companies from imposing certain personal sales quota to obtain or
maintain distributorship or favorable compensation rates, modify product return
requirements so that product must be returned within a shorter period of time,
and require the companies to show sufficient insurance or guarantee to reimburse
customers and/or distributors for cancelled or unfilled orders. We have had to
make some modifications to our compensation plan and policies in order to be in
compliance with some of these rules.
Based on research conducted in opening our existing markets, the nature
and scope of inquiries from government regulatory authorities, and our history
of operations in such markets to date, we believe that our methods of
distribution are in compliance in all material respects with the laws and
regulations relating to direct selling activities of the countries in which we
currently operate. Even though we believe that laws governing direct selling are
generally becoming more permissive, many countries currently have laws in place
that would prohibit us
15
from conducting business in such markets. There can be no assurance that we will
be allowed to continue to conduct business in each of our existing markets that
we currently service or any new market we may enter in the future.
Regulation of Our Products
Our products and related promotional and marketing activities are
subject to extensive governmental regulation by numerous domestic and foreign
governmental agencies and authorities, including the FDA, the FTC, the Consumer
Product Safety Commission, the United States Department of Agriculture, State
Attorneys General and other state regulatory agencies, and similar government
agencies in each country in which we operate. For example, in Taiwan, all
"medicated" cosmetic and pharmaceutical products require registration. These
regulations can limit our ability to import products into new markets and can
delay introductions of new products into existing markets as we comply with the
registration and approval process for our products.
Some of our products are strictly regulated in some of the markets in
which we operate. These markets have varied regulations that apply to and
distinguish nutritional health supplements from "drugs" or "pharmaceutical
products." For example, the FDA of the United States under the Federal Food,
Drug and Cosmetic Act regulates our products. The Federal Food, Drug and
Cosmetic Act has been amended several times with respect to nutritional
supplements, most recently by the Nutrition Labeling and Education Act and the
Dietary Supplement Health and Education Act. The Dietary Supplement Health and
Education Act establishes rules for determining whether a product is a dietary
supplement. Under this statute, dietary supplements are regulated more like
foods than drugs, are not subject to the food additive provisions of the law,
and are generally not required to obtain regulatory approval prior to being
introduced to the market. None of this limits, however, the FDA's power to
remove an unsafe substance from the market. In the event a product, or an
ingredient in a product, is classified as a drug or pharmaceutical product in
any market, we will generally not be able to distribute that product in that
market through our distribution channel because of strict restrictions
applicable to drug and pharmaceutical products.
Most of our existing major markets also regulate product claims and
advertising regarding the types of claims and representations that can be made
regarding the efficacy of products, particularly dietary supplements.
Accordingly, these regulations can limit our ability and that of our
distributors to inform consumers of the full benefits of our products. For
example, in the United States, we are unable to make any claim that any of our
nutritional supplements will diagnose, cure, mitigate, treat or prevent disease.
The Dietary Supplement Health and Education Act, however, permits only
substantiated, truthful and non-misleading statements of nutritional support to
be made in labeling, such as statements describing general well-being resulting
from consumption of a dietary ingredient or the role of a nutrient or dietary
ingredient in affecting or maintaining a structure or a function of the body. In
addition, all product claims must be substantiated.
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Other Regulatory Issues
As a company incorporated in the United States and operating through
subsidiaries in foreign jurisdictions, we are subject to foreign exchange
control and transfer pricing laws that regulate the flow of funds between our
subsidiaries and us for product purchases, management services and contractual
obligations such as the payment of distributor commissions.
Product Warranties and Returns
Lexxus
The Lexxus refund policies and procedures closely follow industry and
country standards which vary greatly by country. For example, in the United
States, the Direct Marketing Association recommends that network marketers
permit returns during the twelve-month period following the sale while in Hong
Kong the return policy is as short as 14 days following the sale. We have
conformed our return policies to comply with local laws or the recommendation of
the local direct marketing association. In most cases, distributors may return
unopened product that is in resalable condition for a partial refund. Lexxus
must be notified of the return in writing and such written requests will be
considered a termination notice of the distributorship.
eKaire
eKaire product warranties and refund policies are similar to those of
other companies in the industry. If a distributor is not satisfied with the
product then he/she can return the product to eKaire for a full refund within
ninety (90) days of the first time the product was purchased. A distributor may
return or exchange products that are unopened and in resalable condition thirty
(30) days after the date of purchase.
ILMP
If a distributor is not satisfied with the product then he/she can
return the product to ILMP within thirty (30) days of the date of the first
purchase of a product for a full refund (less shipping and handling). A
distributor may return or exchange products that are unopened and in resalable
condition thirty (30) days after the date of subsequent purchases.
Management Information Systems
We utilize third parties to process all distributor orders and to
calculate distributor commission payments. Both Lexxus and ILMP use Marketvision
Communications Corp. to maintain their web-based system to process orders, to
communicate volume and commissions to its distributors.
The eKaire commission system provides each associate with a detailed
monthly accounting of all sales and recruiting activity. These statements
eliminate the need for substantial record keeping on behalf of the distributor.
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Insurance
NHTC currently carries general liability insurance in the amount of
$1,000,000 per occurrence and $2,000,000 in the aggregate as well as
international and other insurance coverages. However, we do not carry product
liability insurance, but believe that we are covered by the insurance maintained
by our principal suppliers. There can be no assurance, however, that product
liability insurance will be available, and if available, that it will be
sufficient to cover potential claims or that an adequate level of coverage will
be available in the future at a reasonable cost, if at all. A successful product
liability claim could have a material adverse affect on our business, financial
condition and results of operations.
Employees
The combined total of employees for our company, including the employees
of our foreign subsidiaries is 148 at December 31, 2003, including 36
management, 7 administrative assistants, 16 warehouse employees, and 89 "general
operations" employees, which includes employees in customer service and
administrative roles. 142 employees are full-time and 6 are considered
part-time. None of the employees are represented by a union, and we believe that
our employee relations are good.
Corporate History
In January 2002, we incorporated MyLexxus Europe AG, a corporation
organized under the laws of Switzerland and our majority-owned subsidiary
("MyLexxus Europe"). This company managed the sales of product into sixteen
eastern European countries, including Russia. In November 2003, the operations
of MyLexxus Europe AG were discontinued and new business activities were
commenced in a new company, KGC Networks Pte. Ltd. ("KGC"), a corporation
organized under the laws of Singapore. Effective as of November 17, 2003, we own
51% of the outstanding capital stock of KGC. The operations of KGC have been
included in the consolidated statement of operations since inception.
In March 2002, we incorporated Lexxus International Co., Ltd., a
corporation organized under the laws of Hong Kong and our wholly-owned
subsidiary ("Lexxus Hong Kong") which does business in Hong Kong. The operations
of Lexxus Hong Kong have been included in the consolidated statement of
operations since inception.
In April 2002, we incorporated MyLexxus Personal Care International
(India) Pvt. Ltd., a corporation organized under the laws of India and our
majority-owned subsidiary ("MyLexxus India") which does business in India. The
operations of MyLexxus India have been included in the consolidated statement of
operations since inception.
In June 2002, we incorporated Lexxus Marketing Pte. Ltd., a corporation
organized under the laws of Singapore and our majority-owned subsidiary ("Lexxus
Singapore"), which does business in Singapore. The operations of Lexxus
Singapore have been included in the consolidated statement of operations since
inception.
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In November 2002, we incorporated Lexxus International Network
Marketing, Inc., a corporation organized under the laws of the Philippines and
our majority-owned subsidiary ("Lexxus Philippines"), which does business in the
Philippines. The operations of Lexxus Philippines have been included in the
consolidated statement of operations since inception.
In June 2003, we incorporated Lexxus Korea Co., Ltd. (South Korea), a
corporation organized under the laws of South Korea and our wholly-owned
subsidiary ("Lexxus Korea"), which does business in South Korea. The operations
of Lexxus Korea have been included in the consolidated statement of operations
since inception.
In August 2003, we incorporated I Luv My Pet, Inc. ("ILMP") as a
wholly-owned subsidiary. ILMP is in the business of selling pet nutraceuticals.
The operations of ILMP have been included in the consolidated statement of
operations since inception.
Risk Factors
In addition to other information in this Annual Report, the following important
factors should be carefully considered in evaluating the Company and its
business because such factors currently have a significant impact on the
Company's business, prospects, financial condition and results of operations.
Risks Related to Our Business:
Our Failure To Maintain and Expand Our Distributor Relationships Could Adversely
Affect Our Business. We distribute our products through independent
distributors, and we depend upon them directly for all of our sales.
Accordingly, our success depends in significant part upon our ability to
attract, retain and motivate a large base of distributors. Our multi-level
marketing organization is headed by a relatively small number of key "master"
distributors responsible for a significant percentage of total sales, including,
in some cases, sales in several different countries. The loss of a significant
number of distributors, including any "master" distributors, could materially
and adversely affect sales of our products and could impair our ability to
attract new distributors. Moreover, the replacement of distributors could be
difficult because, in our efforts to attract and retain distributors, we compete
with other network marketing organizations, including those in the personal care
and cosmetic product industries. Our distributors may terminate their services
with us at any time and, in fact, like many network-marketing organizations, we
have a high rate of attrition.
If The Number Or Productivity Of Independent Distributors Does Not Increase, Our
Revenue Will Not Increase. To increase revenue, we must increase the number
and/or the productivity of our distributors. We can provide no assurances that
distributor numbers will increase or remain constant or that their productivity
will increase. We experienced a 113% and 33% increase in active distributors
during 2003 and 2002, respectively. The number of active distributors may not
increase and could decline in the future. Distributors may terminate their
services at any time, and, like most direct selling companies, we experience a
high turnover among distributors from year to year. We cannot accurately predict
any fluctuation in the number and productivity of distributors because we
primarily rely upon existing distributors to sponsor
19
and train new distributors and to motivate new and existing distributors.
Operating results could be adversely affected if our existing and new business
opportunities and products do not generate sufficient economic incentive or
interest to retain existing distributors and to attract new distributors.
As We Continue To Expand Into Foreign Markets Our Business Becomes Increasingly
Subject To Political And Economic Risks. Changes In These Markets Could
Adversely Affect Our Business. We commenced operations in Canada, Australia, New
Zealand and Taiwan in 2001, Europe and Russia, Hong Kong, India, Singapore and
the Philippines in 2002 and South Korea in 2003. In 2004, we anticipate
commencing operations in Mexico. We believe that our ability to achieve future
growth is dependent in part on our ability to continue our international
expansion efforts. However, there can be no assurance that we will be able to
grow in our existing international markets, enter new international markets on a
timely basis, or that new markets will be profitable. We must overcome
significant regulatory and legal barriers before we can begin marketing in any
foreign market. Also, before marketing commences it is difficult to assess the
extent to which our products and sales techniques will be accepted or successful
in any given country. In addition to significant regulatory barriers, we may
also encounter problems conducting operations in new markets with different
cultures and legal systems from those encountered elsewhere. We may be required
to reformulate certain of our products before commencing sales in a given
country. Once we have entered a market, we must adhere to the regulatory and
legal requirements of that market. No assurance can be given that we will be
able to successfully reformulate our products in any of our current or potential
international markets to meet local regulatory requirements or attract local
customers. The failure to do so would have a material adverse effect on our
business, financial condition, and results of operations. There can be no
assurance that we will be able to obtain and retain necessary permits and
approvals or that we will have sufficient capital to finance our expansion
efforts in a timely manner. In many market areas, other network marketing
companies already have significant market penetration, the effect of which could
be to desensitize the local distributor population to a new opportunity, or to
make it more difficult for us to recruit qualified distributors. There can be no
assurance that, even if we are able to commence operations in foreign countries,
there will be a sufficiently large population of persons inclined to participate
in a network marketing system, such as ours. We believe our future success will
depend in part on our ability to seamlessly integrate our distributor
compensation plan across all markets in which our products are sold. There can
be no assurance that we will be able to further develop and maintain a seamless
compensation program.
An Increase In The Amount Of Compensation Paid To Distributors Would Reduce
Profitability. A significant expense is the payment of compensation to our
distributors. We compensate our distributors by paying commissions, bonuses, and
certain awards and prizes. Management closely monitors the amount of
compensation to distributors paid as a percentage of net sales and may need to
adjust our compensation plan to prevent distributor compensation from having a
significant adverse effect on earnings. There can be no assurance that these
changes or future changes to our compensation plan or product pricing will be
successful in maintaining the level of distributor compensation expense as a
percentage of net sales. Furthermore, these changes may make it difficult to
recruit and retain qualified and motivated distributors. An
20
increase in compensation payments to distributors as a percentage of net sales
would reduce our profitability.
Internal Controls and Accounting Methods May Require Further Modification. The
Company has recently modified certain of its accounting policies and made other
adjustments to the accounting for past transactions, which resulted in the
restatement of the Company's financial statements for each quarter in 2001,
2002, and 2003 as well as for the years ended December 31, 2001 and 2002. See
the discussion of the Restatement of Previously Issued Financial Statements on
page 3. In connection with the restatement of its financial statements and the
audit of the Company's financial statements for the year ended December 31,
2003, the Company has been informed by its independent auditors that many of the
restatement items are the result of material weaknesses in the Company's
internal controls and procedures. The Company believes that it has implemented
new controls and procedures and plans to implement additional controls and
procedures sufficient to accurately report our financial performance on a timely
basis in the foreseeable future. If we are unable to implement these additional
controls and procedures, we may not be able to accurately report our financial
performance on a timely basis and our business and stock price would be
adversely affected. In addition, we may be unable to achieve Section 404
certification as mandated by the Sarbanes-Oxley Act.
We Rely On And Are Subject To Risks Associated With Our Reliance Upon
Information Technology Systems. Our success is dependent on the accuracy,
reliability, and proper use of sophisticated and dependable information
processing systems and management information technology. Our information
technology systems are designed and selected in order to facilitate order entry
and customer billing, maintain distributor records, accurately track purchases
and compensation payments, manage accounting and finance operations, generate
reports, and provide customer service and technical support. Any interruption in
these systems could have a material adverse effect on our business, financial
condition, and results of operations.
Taxation And Transfer Pricing Considerations Affect Our Foreign Operations. Our
principal domicile is the United States. Under tax treaties, we are eligible to
receive foreign tax credits in the United States for taxes actually paid abroad.
As our operations expand outside the United States, taxes paid to foreign taxing
authorities may exceed amounts of the credits available to us, resulting in the
payment of a higher overall effective tax rate on our worldwide operations. We
have adopted transfer pricing agreements with our subsidiaries to regulate
intercompany transfers, which agreements are subject to transfer pricing laws
that regulate the flow of funds between the subsidiaries and the parent
corporation for product purchases, management services, and contractual
obligations, such as the payment of distributor compensation. If the United
States Internal Revenue Service or the taxing authorities of any other
jurisdiction were to successfully challenge these agreements or require changes
in our transfer pricing practices, we could be required to pay higher taxes and
our earnings would be adversely affected. We believe that we operate in
compliance with all applicable transfer pricing 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 will not be modified, which, as a
result, may require changes in our operating procedures.
Our Lexxus Subsidiaries Have a Limited Operating History Which May Not be
Indicative of Future Performance. Although our Lexxus subsidiaries accounted for
approximately 96% of
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our total revenues during fiscal 2003, it has only been operating since January
2001, and therefore, is in the early stage of its development. Our business and
prospects must be considered in light of the risk, expense and difficulties
frequently encountered by companies in an early stage of development,
particularly companies in new and rapidly evolving international markets. If we
are unable to effectively allocate our resources and help grow our Lexxus
subsidiary, our stock price may be adversely affected and we may be unable to
execute our strategy of expanding our network of distributors. Our business
depends upon the performance of our Lexxus subsidiaries and, due to its
relatively short operating history, past performance may not be indicative of
future results.
Regulatory Matters Governing Our Industry Could Have A Significant Negative
Effect On Our Business. In both our United States and foreign markets, we are
affected by extensive laws, governmental regulations, administrative
determinations, court decisions and similar constraints. Such laws, regulations
and other constraints may exist at the federal, state or local levels in the
United States and at all levels of government in foreign jurisdictions.
Product Regulations.
The formulation, manufacturing, packaging, labeling, distribution, importation,
sale and storage of certain of our products are subject to extensive regulation
by various federal agencies, including the Food and Drug Administration ("FDA"),
the Federal Trade Commission (the "FTC"), the Consumer Product Safety Commission
and the United States Department of Agriculture and by various agencies of the
states, localities and foreign countries in which our products are manufactured,
distributed and sold. Failure by our distributors or us to comply with those
regulations could lead to the imposition of significant penalties or claims and
could materially and adversely affect our business. In addition, the adoption of
new regulations or changes in the interpretations of existing regulations may
result in significant compliance costs or discontinuation of product sales and
may adversely affect the marketing of our products, resulting in significant
loss of sales revenues.
Product Claims, Advertising And Distributor Activities.
Our failure to comply with FTC or state regulations, or with regulations in
foreign markets that cover our product claims and advertising, including direct
claims and advertising by us, as well as claims and advertising by distributors
for which we may be held responsible, may result in enforcement actions and
imposition of penalties or otherwise materially and adversely affect the
distribution and sale of our products. Distributor activities in our existing
markets that violate applicable governmental laws or regulations could result in
governmental or private actions against us in markets where we operate. Given
the size of our distributor force, we cannot assure that our distributors will
comply with applicable legal requirements.
Network Marketing System.
Our network marketing system is subject to a number of federal and state
regulations administered by the FTC and various state agencies as well as
regulations in foreign markets administered by foreign agencies. Regulations
applicable to network marketing organizations generally are directed at ensuring
that product sales ultimately are made to consumers and that advancement within
the organizations is based on sales of the organizations' products rather than
investments in the organizations or other non-retail sales related criteria. We
are subject to the
22
risk that, in one or more markets, our marketing system could be found not to be
in compliance with applicable regulations. The failure of our network marketing
system to comply with such regulations could have a material adverse effect on
our business in a particular market or in general.
We are also subject to the risk of private party challenges to the legality of
our network marketing system. The regulatory requirements concerning
network-marketing systems do not include "bright line" rules and are inherently
fact-based. An adverse judicial determination with respect to our network
marketing system, or in proceedings not involving us directly but which
challenge the legality of other multi-level marketing systems, could have a
material adverse effect on our business.
Transfer Pricing And Similar Regulations.
In many countries, including the United States, we are subject to transfer
pricing and other tax regulations designed to ensure that appropriate levels of
income are reported as earned by our United States or local entities and are
taxed accordingly. In addition, our operations are subject to regulations
designed to ensure that appropriate levels of customs duties are assessed on the
importation of our products.
Taxation Relating To Distributors.
Our distributors are subject to taxation, and in some instances legislation or
governmental agencies impose an obligation on us to collect the taxes, such as
value added taxes, and to maintain appropriate records. In addition, we are
subject to the risk in some jurisdictions of being responsible for social
security and similar taxes with respect to our distributors.
Other Regulations.
We are also subject to a variety of other regulations in various foreign
markets, including regulations pertaining to employment and severance pay
requirements, import/export regulations and antitrust issues. Our failure to
comply, or assertions that we fail to comply, with these regulations could have
a material adverse effect on our business in a particular market or in general.
To the extent we decide to commence or expand operations in additional
countries, government regulations in those countries may prevent or delay entry
into or expansion of operations in those markets. In addition, our ability to
sustain satisfactory levels of sales in our markets is dependent in significant
part on our ability to introduce additional products into the markets. However,
government regulations in both our domestic and international markets can delay
or prevent the introduction, or require the reformulation or withdrawal, of some
of our products.
Currency Exchange Rate Fluctuations Could Lower Our Revenue And Net Income. In
2003, we recognized approximately 83% of our revenue in non-United States
markets. We purchase all inventory in the United States in United States
dollars. In preparing our consolidated financial statements, we translate
revenue and expenses in foreign countries from their local currencies into
United States dollars using the average exchange rates for the period. The
effect of the translation of the Company's foreign operations are included in
accumulated other comprehensive income within stockholder's equity and such do
not impact the statement of
23
operations. Given our inability to predict the degree of exchange rate
fluctuations, we cannot estimate the effect these fluctuations may have upon
future reported results, product pricing or our overall financial condition.
Further, to date we have not attempted to reduce our exposure to short-term
exchange rate fluctuations by using foreign currency exchange contracts.
If We Are Unable To Expand Operations In Any Of The New Markets We Have
Currently Targeted, We May Have Difficulty Achieving Our Long-Term Objectives. A
significant percentage of our revenue growth over the past three years has been
attributable to our expansion into new markets. For example, the revenue growth
we experienced in 2002 and 2003 was due in part to our successful expansion of
operations into Hong Kong, Russia and South Korea. Moreover, our growth over the
next several years depends on our ability to successfully introduce our products
and our distribution system into new markets. We could face regulatory
difficulties in accessing these new markets. If we are unable to successfully
expand our operations into these new markets, our opportunities to grow our
business may be limited, and as a result, we may not be able to achieve our
long-term objectives.
Adverse Publicity Concerning Our Business, Marketing Plan Or Products Could Harm
Our Business And Reputation. The size of our distribution force and the results
of our operations can be particularly impacted by adverse publicity regarding
us, the legality of our distributor network, our products or the actions of our
distributors. Specifically, we are susceptible to adverse publicity concerning:
. The legality of network marketing;
. The safety of the ingredients found in our products or our
competitor's products;
. Regulatory investigations of us, our competitors and our respective
products;
. The actions of our current or former distributors; and
. Public perceptions of direct selling businesses in general.
In addition, in the past certain network marketing companies have experienced
negative publicity in connection with regulatory investigations and inquiries
that has harmed the network marketing industry in general. We, or one or more of
our network-marketing competitors, may receive negative publicity in the future
and it may harm our business and reputation.
Although Our Distributors Are Independent Contractors, Improper Distributor
Actions That Violate Laws Or Regulations Could Harm Our Business. Distributor
activities that violate governmental laws or regulations could result in
governmental actions against us in markets where we operate. Our distributors
are not employees and act independently of us. Some of our distributors may be
doing business in countries without proper registration or authority to do so.
We implement strict policies and procedures to ensure our distributors comply
with applicable legal requirements. However, given the size and diversity of our
distributor force, we experience problems with distributors from time to time.
Distributors often desire to enter a market before we have received approval to
do business in order to gain an advantage in the marketplace. Improper
distributor activity in new geographic markets could result in adverse publicity
and can be particularly harmful to our ability to ultimately enter these
markets.
24
Failure Of New Products To Gain Distributor And Market Acceptance Could Harm Our
Business. An important component of our business is our ability to develop new
products that create enthusiasm among our distributor force. If we fail to
introduce new products on a timely basis, our distributor productivity could be
harmed. In addition, if any new products fail to gain market acceptance, are
restricted by regulatory requirements, or have quality problems, this would harm
our results of operations. Factors that could affect our ability to continue to
introduce new products include, among others, limited capital resources,
government regulations, proprietary protections of competitors that may limit
our ability to offer comparable products and any failure to anticipate changes
in consumer tastes and buying preferences.
The Loss Of Key High-Level Distributors Could Negatively Impact Our Distributor
Growth And Our Revenue. For Lexxus and eKaire, we have approximately 84,400
total active distributors and 3,100 total senior level distributors. These
senior level distributors, together with their extensive networks of downline
distributors, account for substantially all of our revenue. As a result, the
loss of a senior level distributor or a group of leading distributors in the
distributor's network of downline distributors whether by their own choice or
through disciplinary actions by us for violations of our policies and procedures
could negatively impact our distributor growth and our revenue.
Increases In Duties On Our Imported Products In Our Non-United States Markets
Could Reduce Our Revenue And Harm Our Competitive Position. Historically, we
have imported most of our products into the countries in which they are
ultimately sold. These countries impose various legal restrictions on imports
and typically impose duties on our products. In any given country, regulators
may increase duties on imports and, as a result, reduce our profitability and
harm our competitive position relative to locally produced goods. In some
countries government regulations may prevent importation of our products
altogether or require us to locally manufacture or source a significant portion
of our products.
System Failures Could Harm Our Business. Because of our diverse geographic
operations and our seamless distributor compensation plan, our business is
highly dependent on efficiently functioning information technology systems
provided by Marketvision Communications Corp. The Marketvision systems and
operations are vulnerable to damage or interruption from fires, earthquakes,
telecommunications failures, computer viruses and worms, software defects and
other events. They are also subject to break-ins, sabotage, acts of vandalism
and similar misconduct. Despite precautions implemented by the staff of
Marketvision, problems could result in interruptions in services and materially
and adversely affect our business, financial condition and results of
operations.
Because Of Our Dependence Upon Consumer Perceptions, Adverse Publicity
Associated With Harmful Effects Resulting From The Consumption Of Our Products,
Or Any Similar Products Distributed By Other Companies, Could Have A Material
Adverse Effect On Us. Because we are highly dependent upon consumers' perception
of the safety and quality of our products as well as similar products
distributed by other companies, we could be adversely affected if any of our
products or any similar products distributed by other companies prove to be, or
are asserted to be, harmful to consumers. Also, because of our dependence upon
consumer perceptions, any adverse publicity associated with illness or other
adverse effects resulting from
25
consumers' use or misuse of our products or any similar products distributed by
other companies could have a material adverse impact on us. Adverse publicity
could also negatively affect our ability to attract, motivate and retain
distributors.
We Do Not Have Product Liability Insurance And Product Liability Claims Could
Hurt Our Business. Currently, we do not have product liability insurance,
although the insurance carried by our suppliers may cover certain product
liability claims against us. Nevertheless, we do not conduct or sponsor clinical
studies of our products. As a marketer of nutraceuticals, cosmetic lotions and
other products that are ingested by consumers or applied to their bodies, we may
become subjected to various product liability claims, including that: (i) our
products contain contaminants; (ii) our products include inadequate instructions
as to their uses; or (iii) our products include inadequate warnings concerning
side effects and interactions with other substances. Especially since we do not
have direct product liability insurance, it is possible that product liability
claims and the resulting adverse publicity could negatively affect our business.
If our suppliers' product liability insurance fails to cover product liability
claims, or such claims exceed the amount of coverage provided by such policies,
we could be required to pay substantial monetary damages which could materially
harm our business, financial condition and results of operations. As a result,
we may become required to pay higher premiums and accept higher deductibles in
order to secure adequate insurance coverage in the future.
We Do Not Manufacture Our Own Products So We Must Rely On Independent Third
Parties For The Manufacture And Supply Of Our Products. All of our products are
manufactured by outside third parties. There is no assurance that these outside
manufacturers will continue to reliably supply products to us at the level of
quality we require. In the event any of our third-party manufacturers were to
become unable or unwilling to continue to provide the products in required
volumes and quality levels, we would be required to identify and obtain
acceptable replacement manufacturing sources. There is no assurance that we will
be able to obtain alternative manufacturing sources on a timely basis. An
extended interruption in the supply of our products could result in a
substantial loss of sales. In addition, any actual or perceived degradation of
product quality as a result of our reliance on third party manufacturers may
have an adverse effect on sales or result in increased product returns and
buybacks.
A Large Portion Of Our Sales Is Concentrated In A Small Number Of Countries. Our
earnings in future periods may be susceptible to various risks because of the
concentration of our sales in a small number of countries. Of the thirty
countries in which we operated as of December 31, 2003, the United States,
Canada, Hong Kong, Russia, South Korea and Taiwan, accounted for approximately
96% of our total sales for the year ended December 31, 2003. As a result, our
future performance is dependent upon government regulation, economic conditions
and consumer demand for our products in these six countries.
Two Of Our Products Constitute A Significant Portion Of Our Sales. Our
Skindulgence(TM) and Alura(TM) products constitute a significant portion of our
retail sales, accounting for approximately 49% and 34%, respectively, of our
total sales in fiscal 2003. If demand for either of these products decreases
significantly, government regulation restricts the sale of these products, we
are unable to adequately source or deliver these products, or we cease offering
26
either of these products for any reason without a suitable replacement, our
business, financial condition and results of operations could be materially and
adversely effected.
Our Ability To Grow In The Future Will Be More Dependent On Increased
Penetration Of Existing Markets Than New Market Openings, Relative To Past
Years; As A Result, Our Business Will Be Adversely Affected If We Are Unable To
Successfully Increase Existing Market Penetration. During the past two years
Lexxus has expanded principally by entering into new markets and introducing new
products. Because we have already succeeded in entering into many of the most
attractive markets for our products and distribution system, an increasingly
important part of our strategy for continued growth is to increase the number
and range of our products available in our existing markets. In addition, our
future growth will depend upon improved training and other activities that
enhance distributor retention in our existing markets. We cannot assure that our
efforts to increase our market penetration in our existing markets will be
successful.
We May Not Properly Manage Our Growth. Our success has been, and will continue
to be, significantly dependent on our ability to manage rapid growth through
expansions and enhancements of our worldwide personnel and management, order
processing and fulfillment, inventory and shipping systems and other aspects of
operations. As we continue to expand our operations, the ability to manage this
growth will represent an increasing challenge and our failure to properly manage
this growth may materially and adversely affect our results of operation.
The High Level Of Competition In Our Industry Could Adversely Affect Our
Business. The business of marketing nutracuetical and lifestyle enhancement
products is highly competitive. This market segment includes numerous
manufacturers, distributors, marketers, and retailers that actively compete for
the business of consumers both in the United States and abroad. The market is
highly sensitive to the introduction of new products, which may rapidly capture
a significant share of the market. Although we are the exclusive distributor of
the Alura(TM) product in the network marketing segment, we cannot be sure that
another company will not replicate, or market similar products. Sales of similar
products by competitors may materially and adversely affect our business,
financial condition and results of operations.
We are subject to significant competition for the recruitment of distributors
from other network marketing organizations, including those that market similar
products as well as other types of products. Most of our competitors are
substantially larger than we are, offer a wider array of products, have far
greater financial resources and many more active distributors than we have. Our
ability to remain competitive depends, in significant part, on our success in
recruiting and retaining distributors through an attractive compensation plan
and other incentives. We believe that our compensation and incentive programs
provide our distributors with significant earning potential. However, we cannot
be sure that our programs for recruitment and retention of distributors will be
successful.
Terrorist Attacks Or Acts Of War May Seriously Harm Our Business. Terrorist
attacks or acts of war may cause damage or disruption to our company, our
employees, our facilities and our customers, which could impact our revenues,
expenses and financial condition. The terrorist
27
attacks that took place in the United States on September 11, 2001 were
unprecedented events that have created many economic and political
uncertainties, some of which may materially and adversely affect our business,
results of operations, and financial condition. The potential for future
terrorist attacks, the national and international responses to terrorist
attacks, and other acts of war or hostility have created many economic and
political uncertainties, which could materially and adversely affect our
business, results of operations, and financial condition in ways that we
currently cannot predict.
A General Economic Downturn May Reduce Our Revenues. Worldwide economic
conditions may adversely affect demand for our products. Consumer purchases of
our products may decline during recessionary periods and also may decline at
other times when disposable income is lower.
Loss Of Key Personnel Could Adversely Affect Our Business. Our future success
depends to a significant degree on the skills, experience and efforts of Mark D.
Woodburn, our President and Chief Financial Officer, and Terry LaCore, the Chief
Executive Officer of Lexxus. The loss of the services of either Mr. Woodburn or
Mr. LaCore could have a material adverse effect on our business, results of
operations and financial condition. We also depend on the ability of our
executive officers and other members of senior management to work effectively as
a team. The loss of one or more of our executive officers and other members of
senior management could have a material adverse effect on our business, results
of operations and financial condition.
We May Be Unable To Protect Our Proprietary Technology Rights. Our success
depends to a significant degree upon the protection of the Marketvision licensed
software and other proprietary technology rights. We rely on trade secret,
copyright and trademark laws and confidentiality agreements with employees and
third parties, all of which offer only limited protection. Moreover, the laws of
other countries in which we market our products may afford little or no
effective protection of our proprietary technology. The reverse engineering
unauthorized copying or other misappropriation of our proprietary technology
could enable third parties to benefit from our technology without paying us for
it. This could have a material adverse effect on our business, operating results
and financial condition. If we resort to legal proceedings to enforce our
intellectual property rights, the proceedings could be burdensome and expensive
and could involve a high degree of risk.
Our Use Of The "Alura" or "Lexxus" Trademarks May Infringe The Trademark Rights
Of Other Companies. Our use of "Alura" or "Lexxus" as well as the use of other
names, may result in costly litigation, divert management's attention and
resources, cause product shipment delays or require us to pay damages and/or to
enter into royalty or license agreements to continue to use a product name. We
may be required to stop using the name "Alura" or "Lexxus". Any of these events
could have a material adverse effect on our business, operating results and
financial condition.
Risks Related To Our Common Stock:
Disappointing Quarterly Revenue Or Operating Results Could Cause The Price Of
Our Common Stock To Fall. Our quarterly revenue and operating results are
difficult to predict and
28
may fluctuate significantly from quarter to quarter. If our quarterly revenue or
operating results fall below the expectations of investors or securities
analysts, the price of our common stock could fall substantially.
Our Common Stock Is Particularly Subject To Volatility Because Of The Industry
That We Are In. The stock market in general has experienced extreme price and
volume fluctuations. In addition, the market prices of securities of network
marketing companies, have been extremely volatile, and have experienced
fluctuations that have often been unrelated or disproportionate to the operating
performance of such companies. These broad market fluctuations could adversely
affect the market price of our common stock.
Future Sales By the Company or Existing Security Holders Could Depress The
Market Price Of Our Common Stock. If the Company or our existing stockholders
sell a large number of shares of our common stock, the market price of the
common stock could decline significantly. Further, even the perception in the
public market that the Company or our existing stockholders might sell shares of
common stock could depress the market price of the common stock.
There Are Risks Associated With Our Stock Trading On The NASD OTC Bulletin Board
Rather Than A National Exchange. There are significant consequences associated
with our stock trading on the NASD OTC Bulletin Board rather than a national
exchange such as NASDAQ. The effects of not being able to list our securities on
a national exchange include:
. Limited release of the market prices of our securities;
. Limited news coverage of us;
. Limited interest by investors in our securities;
. Volatility of our stock price due to low trading volume;
. Increased difficulty in selling our securities in certain states due
to "blue sky" restrictions; and
. Limited ability to issue additional securities or to secure
additional financing.
There is No Assurance That An Active Public Trading Market Will Continue. There
was an extremely limited public trading market for our common stock. Commencing
in the fourth quarter of 2003, a more active trading market for our shares
developed and the price of our shares of common stock increased considerably.
There can be no assurances that an active public trading market for our common
stock will be sustained. If for any reason an active public trading market does
not continue, purchasers of the shares of our common stock may have difficulty
in selling their securities should they desire to do so and the price of our
common stock may decline.
ITEM 2. PROPERTIES.
NHTC and Lexxus lease an aggregate of approximately 16,000 square feet
of office and warehouse space in Dallas, Texas. The original lease term is 38
months, expiring in September 2004, and the current rent is approximately
$153,000 per year. Additional warehousing for Lexxus is located in Hollister,
Missouri where Lexxus utilizes approximately 1,500 square feet
29
of warehouse space. The lease term is on a month-to-month basis at a rent of
$18,000 per year. The Canadian office and warehouse of Lexxus and eKaire leases
office space in Langley, British Columbia, totaling approximately 5,000 square
feet. The lease term is 36 months, expiring on January 2007 and the current rent
is approximately $22,000 per year.
Kaire Australia, Kaire New Zealand, Lexxus Australia and Lexxus New
Zealand lease office space and warehouse facilities of approximately 2,500
square feet in Queensland, Australia. The lease term is 60 months, expiring in
January 2007, and the current rent is approximately $32,000 per year.
In February 2002, Lexxus Hong Kong entered into a 42-month agreement for
approximately 5,400 square feet of office space at a current rate of
approximately $183,000 per year.
In March 2002, Lexxus Taiwan entered into a 24-month agreement for
approximately 10,000 square feet of office space located in Kaohsiung, Taiwan at
a current rate of approximately $56,000 per year. This lease was extended
effective March 1, 2004 for an additional six months. In May 2002, Lexxus Taiwan
entered into a 36-month agreement for approximately 4,500 square feet of office
spare located in Taipei, Taiwan at a current rate of approximately $86,000 per
year.
In August 2002, Lexxus India entered into a 60-month agreement for 2,665
square feet of office space located in Hyderabad, India at a current rate of
approximately $13,000 per year.
In September 2002, Lexxus Singapore entered into a 36-month agreement
for 4,155 square feet of office space at a current rate of approximately
$155,000 per year.
In January 2003, Lexxus Philippines entered into a 24-month agreement
for approximately 6,400 square feet of office space located in Manila at a
current rate of approximately $49,000 per year.
In April 2003, Lexxus South Korea entered into a 12-month agreement for
approximately 4,100 square feet of office space located in Seoul at a current
rate of approximately $266,000 per year.
We believe that such properties are suitable and adequate for our
current operating needs.
30
ITEM 3. LEGAL PROCEEDINGS.
On April 10, 2003, Bobby R. Porter and wife, Betty R. Porter, filed suit
against Lexxus International, Inc. and Alex Arnold (an employee of Lexxus
International, Inc.) in the 170th District Court of McLennan County, Texas
asserting misrepresentations made by the former owners of NuEworld.com Commerce,
Inc. ("NuEworld") pertaining to a stock investment made by the plaintiffs in
June 2000. The plaintiffs are seeking the sum of $40,000, court costs and other
relief. The Company acquired certain assets of NuEworld in January 2003. The
Company filed a motion to transfer venue in April 2003 and intends to vigorously
defend itself in this case.
In February 2004, the Company received notice from a plaintiff in an
action in Florida state court styled Haimes v. Natural Health Trends Corp. that
plaintiff was seeking to recover attorney's fees from the Company in the amount
of approximately $85,000 in connection with a judgment that the plaintiff
previously had taken against the Company and the Company had paid in full. While
the Company disputes such charges, they have entered into preliminary settlement
negotiations with the plaintiff.
From time to time, NHTC is involved in legal proceedings incidental to
the course of its business. NHTC believes that pending actions, both
individually and in the aggregate, will not have a material adverse effect on
the financial condition, results of operations, cash flows or prospects.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the last quarter of 2003, NHTC did not submit any matter to the
vote of the shareholders.
31
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
NHTC's Common Stock is currently quoted on the NASD Over the Counter
Bulletin Board ("OTCBB") under the symbol "NHLC". The following table sets forth
the range of high and low closing bid prices on a quarterly basis as reported by
the OTCBB for the fiscal years 2002 and 2003.
2002
Quarter High Bid($) Low Bid($)
----------------- --------------- -------------
First Quarter 4.00 2.00
Second Quarter 2.00 1.00
Third Quarter 3.00 1.00
Fourth Quarter 3.00 1.00
2003
Quarter High Bid($) Low Bid($)
----------------- --------------- -------------
First Quarter * 2.00 1.00
Second Quarter 6.30 1.60
Third Quarter 11.40 5.63
Fourth Quarter 11.10 4.80
The OTCBB quotations reflect inter-dealer prices, without retail
mark-ups, markdowns or commissions, and may not represent actual
transactions. On March 31, 2004, the closing price of our shares of
Common Stock as reported on the OTCBB was $18.27.
* In March 2003, we effected a 1-for-100 reverse stock split
with respect to the outstanding shares of our Common Stock.
32
Holders
As of February 19, 2004, NHTC had approximately 400 holders of record of
our Common Stock and approximately 3,400 beneficial owners of Common Stock.
Dividends
We have not paid any cash dividends on our Common Stock to date and do
not anticipate declaring or paying any cash dividends in the foreseeable future.
In addition, future-financing arrangements, if any, may preclude or otherwise
restrict the payment of dividends.
Securities authorized for issuance under equity compensation plans.
The following table summarizes the Company's Equity Compensation Plans
as of December 31, 2003:
Equity Compensation Plan Information
(b)
Weighted- (c)
(a) average exercise Number of securities
Number of securities price of remaining available for
to be issued upon outstanding future issuance under equity
exercise of options, compensation plans
outstanding options, warrants and (excluding securities
Plan category warrants and rights rights reflected in column (a))
----------------------------------------------------------------------------------------------------
Equity compensation
plans or arrangements
approved by security
holders 1,225,000(1) -- 1,225,000(1)
----------------------------------------------------------------------------------------------------
Equity compensation
plans or arrangements
not approved by security
holders 1,334,919(2) $ 1.21 --
----------------------------------------------------------------------------------------------------
Total 2,559,919 -- 1,225,000
----------------------------------------------------------------------------------------------------
(1) Includes 1,225,000 shares of our Common Stock reserved under our 2002 Stock
Option Plan, as amended, for future issuance which was approved by our
stockholders in May 2003 and 310,000 of which have been granted as of March
31, 2004.
(2) Includes (i) options exercisable for 570,000 shares of Common Stock issued
to the LaCore and Woodburn Partnership, (ii) options exercisable for 570,000
shares of Common Stock issued to Mr. LaCore, (iii) options exercisable for
30,000 shares of Common Stock issued to Benchmark Consulting Group (which
was subsequently assigned to the LaCore and Woodburn Partnership), (iv)
options exercisable for 30,000 shares of Common Stock issued to Mr. LaCore,
(v) options exercisable for 120,000 shares of Common Stock issued to certain
members of the Company's board of directors, (vi) options exercisable for
13,419 shares of Common Stock issued to two unrelated parties, and (vii)
options exercisable for 1,500 shares of Common Stock to an employee.
33
Recent Sales of Unregistered Securities
During the year ended December 31, 2003, the Company issued the
following unregistered securities:
In January 2003, the Company issued pursuant to Section 4(2) of the
Securities Act of 1933, as amended, 18,500 shares of Common Stock to a law firm
for legal services previously performed of approximately $34,000.
In January 2003, the Company issued pursuant to Section 4(2) of the
Securities Act of 1933, as amended, 10,000 shares of Common Stock to a
consulting firm for consulting services of approximately $19,000.
In March 2003, the Company issued pursuant to Section 4(2) of the
Securities Act of 1933, as amended, 360,000 shares of our Common Stock valued at
approximately $433,000 to NuEworld.com Commerce, Inc. pursuant to a database
purchase agreement. In the purchase, the shares were discounted approximately
35% from their market value of $1.85 per share due to certain trading
restrictions.
34
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion is intended to assist in the understanding of
NHTC's consolidated financial position and its results of operations for each of
the two years ended December 31, 2003 and 2002. This discussion should be read
in conjunction with Item 7. - Financial Statements, beginning on page F-1 of
this report and with other financial information included elsewhere in this
report. Unless stated otherwise, all financial information presented below,
throughout this report, and in the consolidated financial statements and related
notes includes NHTC and all of its subsidiaries on a consolidated basis.
Company Overview
NHTC is an international network marketing organization. NHTC controls
subsidiaries that distribute products through three separate direct selling
networks that promote health, wellness and vitality. Lexxus International, Inc.,
a majority-owned subsidiary and other Lexxus subsidiaries (collectively,
"Lexxus") sell certain cosmetic products as well as "quality of life" products,
which constitute approximately ninety-six percent (96%) of consolidated revenues
in 2003. eKaire.com, Inc., ("eKaire"), a wholly-owned subsidiary, distributes
nutritional supplements aimed at general health and wellness. I Luv My Pet,
Inc., ("ILMP"), a wholly-owned subsidiary, distributes nutritional supplements
for dogs and cats.
NHTC operates its Lexxus, eKaire and ILMP direct selling operations as a
single segment and primarily sells its products through a network of
approximately 85,000 active distributors. NHTC aggregates the Lexxus and eKaire
operating segments because it believes it operates as a single reportable
segment selling its products in similar distribution channels in each of its
operations. Operations of ILMP are not material for the year ended December 31,
2003 since it commenced in the fourth quarter of 2003.
As of March 29, 2004, NHTC purchased the common stock owned by the
minority shareholders of Lexxus International, Inc. (representing the 49%
interest in Lexxus not owned by the Company) in exchange for 100,000 shares of
restricted NHTC common stock. During 2004, the Company intends to continue to
pursue acquiring the minority ownership of most of its majority owned
subsidiaries. Effective on March 31, 2004, the Company acquired Marketvision
Communications Corp. ("Marketvision"). Marketvision is the exclusive developer
and service provider of the direct selling software used by the Company since
mid-2001.
NHTC's management reviews its financial information in each country
primarily by total net sales. Each of NHTC's operations sells primarily the same
products and possesses similar economic characteristics, such as similar gross
margins. For the year ended December 31, 2003, NHTC's foreign operations
accounted for approximately 83% of its consolidated net sales, whereas in the
same period in 2002, its foreign operations accounted for approximately 64% of
its consolidated net sales.
Net Sales. NHTC derives its revenue from sales of its products, sales of
its starter and renewal administrative enrollment packs, and from shipping fees.
Substantially all of its product sales are to independent distributors at
published wholesale prices. NHTC believes the vast
35
majority of its product sales are for personal consumption; however, NHTC cannot
distinguish its personal consumption sales from its other sales because it has
no involvement in its products after delivery other than usual and customary
product returns.
The number of active distributors for NHTC's products has increased from
approximately 30,000 to approximately 85,000 since 2001. NHTC attributes the
increase in the number of active distributors and the resulting improvement over
the past three years in its net sales to the following:
. relatively high commissions paid under the distributor compensation
plan. Management believes the NHTC compensation plan is among the
most financially rewarding plans offered by any network marketing
company;
. expansion into international markets including eastern Europe and
Russia, Hong Kong, India, Singapore, the Philippines, and South
Korea in 2002 and 2003; and
. introduction of certain new products, including the 180DEG. Life
System Carb-Blocker(TM) and Lexxus Premium Noni(TM).
NHTC believes its future success on increasing its net sales is
dependent on the following factors:
. continuing its product development strategy, which includes
continuing to enhance its existing proprietary products and
introducing new products, such as the recent launch of its 180DEG.
Life System Carb-Blocker(TM);
. continuing its planned international expansion; and
. continuing to attract and retain distributors who routinely purchase
its products by introducing new incentives and refining existing
commissions and incentives.
Cost of sales consists of products purchased from third-party
manufacturers, costs of promotional materials sold to NHTC's distributors,
freight, provisions for slow moving or obsolete inventories and the cost of
NHTC's third party service provider. NHTC's inventory turnover ratio improved
from 2.2 in 2002 to 3.7 in 2003.
NHTC's sales mix can be influenced by the following:
. changes in commission and incentive programs;
. changes in its sales prices;
. changes in consumer demand;
. changes in competitors' products;
. changes in economic conditions;
36
. changes in regulations;
. introduction of new products; and
. discontinuation of existing products.
Distributor commissions are dependent on the sales mix and typically
range between 43% to 46% of net sales. Commissions are paid to NHTC's
independent distributors in accordance with its global compensation plan based
on commissionable net sales, which consist of finished products. NHTC's
commission and incentive program calculates commissions and incentives based on
the following criteria:
. a distributor's placement and position within NHTC's overall global
commission plan;
. the volume of a distributor's direct and indirect commissionable
sales; and
. a distributor's achievement of certain sales levels.
Foreign exchange. NHTC is exposed to certain market risks, including
changes in currency exchange rates as measured against the United States dollar.
The value of the United States dollar may affect NHTC's financial results.
Changes in exchange rates could positively or negatively affect its financial
results, as expressed in United States dollars. The effect of the translation of
the Company's foreign operations are included in accumulated other comprehensive
income within stockholder's equity and such do not impact the statement of
operations. For the years ended December 31, 2003 and 2002, changes in currency
exchange rates did not have a material adverse impact on the Company.
Effect of inflation. NHTC believes inflation has not had a material
impact on its operations or profitability.
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 Management's Discussion and Analysis of Financial
Condition and Results of Operations," NHTC has identified certain policies that
are important to the portrayal of its consolidated financial condition and
consolidated results of operations. These policies require the application of
significant judgment by NHTC's management. NHTC periodically analyzes the need
for certain estimates, including the need for such items as reserves for
inventory valuation, impairment of long-lived assets, revenue recognition, sales
returns, and contingencies. NHTC bases any estimates needed on its historical
experience, industry standards, and various other assumptions that may be
reasonable under the circumstances. NHTC cautions its readers that actual
results could differ from its estimates under different assumptions or
conditions. If circumstances change relating to the various assumptions or
conditions used in such estimates NHTC could experience an adverse effect on its
consolidated financial condition, changes in financial condition, and results of
operations. NHTC's critical accounting policies at December 31, 2003 include the
following:
37
Inventory Valuation
NHTC's inventory carrying value is reviewed and compared to the net
realizable value of its inventory and any inventory value in excess of net
realizable value is written down. In addition, NHTC reviews its inventory for
obsolescence and any inventory identified as obsolete is reserved or written
off. NHTC's determination of obsolescence is based on assumptions about the
demand for its products, product expiration dates, estimated future sales, and
management's future plans.
Asset Impairment
NHTC reviews the book value of its property and equipment and other
long-term assets whenever an event or change in circumstances indicates that the
net book value of an asset or group of assets may be unrecoverable. NHTC's
impairment review includes a comparison of future projected cash flows
(undiscounted and without interest charges) generated by the asset or group of
assets with its associated carrying value. NHTC believes its expected future
cash flows approximate or exceed its net book value. However, if circumstances
change and the net book value of the asset or group of assets exceeds expected
cash flows, NHTC would have to recognize an impairment loss to the extent the
net book value of an asset exceeds its fair value. At December 31, 2003, the net
book value of NHTC's property and equipment and long-term assets was
approximately $883,000 and $509,000, respectively.
Allowance for Sales Returns
The Company maintains an allowance for sales returns and refunds based
on the return practices and policies by country and our historical experience.
The allowance for sales returns may need to be adjusted if actual sales returns
differ from estimates.
Tax Valuation Allowance
NHTC 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,
2003, the Company had net deferred assets of approximately $2.5 million. The
Company has established a valuation allowance for the full amount of such net
deferred tax assets at December 31, 2003, as management of the Company has not
been able to determine that it is more likely than not that the deferred tax
assets will be realized. However, should the Company's trend of taxable income
continue, it may be necessary, as early as fiscal 2004, to release a portion or
all of the valuation allowance.
Revenue Recognition and Deferred Costs
Product sales are recognized when shipped. NHTC defers revenue received
from the sale of its starter and renewal administrative packs due to the
twelve-month term of the membership. Such fees actually received are recognized
as revenue on a straight-line basis over the twelve-month term of the
membership. In addition, NHTC defers and recognizes to cost of sales on a
straight line basis the actual cost paid to a third party associated with the
administrative enrollment fees received from distributors. Although NHTC has no
immediate plans to significantly change the terms or conditions of the starter
or renewal memberships, any changes in the future could result in additional
revenue deferrals or could cause NHTC to recognize its deferred revenue over a
longer period of time.
38
Restatement of Previously Issued Financial Statements
During the quarters ended September 30 and December 31, 2003, the
Company re-evaluated its financial statements for the years ended December 31,
2002 and 2001, the quarterly periods included in such years and the quarterly
periods ended March 31, June 30 and September 30, 2003. As a result of such
review, the Company determined that it inadvertently applied the incorrect
accounting treatment with respect to the following items:
(i) revenue recognition with respect to administrative enrollment fees;
(ii) revenue cut-off between 2002 and 2003;
(iii) accounts receivable reconciliation to supporting documents;
(iv) reserves established for product returns and refunds;
(v) the gain recorded in connection with the sale of a subsidiary in 2001;
(vi) income tax provisions; and
(vii) stock option based compensation.
Consequently, the Company is amending and restating its financial
statements for each quarter in 2001, 2002 and 2003 as well as for the years
ended December 31, 2001 and 2002.
In connection with the review of the Company's financial statements, the
Company has revised its accounting treatment for administrative enrollment and
membership fees received from distributors in accordance with the principles
contained in Staff Accounting Bulletin No. 104, "Revenue Recognition", ("SAB
104") and related guidance. The Company determined that under SAB 104, such fees
actually received and recorded as current sales in prior quarters should have
been deferred and recognized as revenue on a straight-line basis over the
twelve-month term of the membership. The restatement resulted in net sales for
the year ended December 31, 2002 being decreased by approximately $1,336,000.
The restatement in net sales resulted in a corresponding adjustment to cost of
sales for direct costs paid to a third party associated with the administrative
enrollment fees received from distributors. Compared to amounts previously
reported, the restatement decreased cost of sales by approximately $336,000 for
the year ended December 31, 2002.
The Company also reviewed its revenue cut-off as of the beginning of
2003. It was noted that approximately $1,008,000 of sales originally recorded in
2002 were not actually shipped until early 2003. The restatement resulted in net
sales for the quarter ended December 31, 2002 being decreased by $1,008,000 and
net sales for the quarter ended March 31, 2003 being increased by the same
amount. The restatement also resulted in distributor commissions for the quarter
ended December 31, 2002 being decreased by $459,000 and distributor commissions
for the quarter ended March 31, 2003 being increased by the same amount.
Also in connection with its review, the Company determined that its
accounts receivable as of March 31 and June 30, 2003 did not reconcile in total
to supporting details for such transactions. The restatement resulted in net
sales being decreased by $140,000 and $260,000 as of March 31 and June 30, 2003,
respectively.
The Company had not recorded a reserve for distributor returns and
refunds as of September 30, 2003 and for prior periods. Based upon analysis of
the Company's historical returns and refund trends by country, it was determined
that the reserves for returns and refunds for prior periods were required and
should be recorded. The restatement resulted in net sales for
39
the year ended December 31, 2002 being decreased by approximately $350,000, with
corresponding adjustments to cost of sales for the estimated cost of products
returned.
In 2001, the Company sold all of the outstanding common stock in Kaire
Nutraceuticals, Inc. ("Kaire"), a Delaware corporation and wholly-owned
subsidiary of the Company, to an unrelated third party. The gain on the sale of
Kaire was approximately $3.1 million, a portion of which was previously
deferred. The Company subsequently recognized into income approximately $1.9
million from the transaction over the period from the fourth quarter of 2001
through the second quarter of 2003. Based upon a review of the transaction, the
Company now believes the gain on sale of Kaire should have been recognized only
in 2001 and 2002 and not in 2003. For the year ended December 31, 2002, the
Company is now recognizing $2,400,000 of gain on the sale of Kaire as
Discontinued Operations and is reducing its Other Income by $800,000.
The Company disclosed in its Annual Report on Form 10-KSB for the year
ended December 31, 2002 that it had a net operating loss carry forward at
December 31, 2002 of approximately $6,000,000, subject to certain limitations.
Consequently, the Company made no provision for income taxes for any period in
2002 or 2001. Upon further review, it has been determined that the available net
operating loss was not expected to be sufficient to offset all of the domestic
and foreign taxable income in 2002 or 2001 and that an estimated tax provision
in the amount of $300,000 was necessary for the year ended December 31, 2002.
The Company has determined that the stock options (the "Options")
granted in January 2001 and October 2002 to senior executive officers of the
Company should be accounted for as variable stock options due to the provision
in the stock option plan that allowed the holder to exercise the stock option in
an immaculate cashless fashion. The cashless exercise feature allows option
holders to use the "in the money" value of the options (or the spread between
the exercise price and the fair market price of the underlying shares as of the
exercise date) as payment for all, or a portion, of the exercise price of an
option. The Options were amended in November 2002 to require the option holder
to obtain Company approval before the Option holder could use the cashless
exercise feature. Subsequent to the modification, fixed option accounting will
be applied to the options. Under variable accounting, changes in the intrinsic
value of the stock option result in recording a charge or credit to stock based
compensation expense. For the year ended December 31, 2002, the restatement
resulted in $1,434,000 being charged to stock option based compensation expense.
40
The following table presents amounts from operations as previously
reported and as restated (in thousands, except for per share data):
Year Ended December
---------------------------
December 31, 2002
---------------------------
As
Previously As
Reported Restated
------------ ------------
Net sales $ 39,662 $ 36,968
Cost of sales 7,391 6,985
------------ ------------
Gross profit 32,271 29,983
Operating expenses 28,770 29,745
------------ ------------
Income from operations 3,501 238
Other income (expense) 601 33
------------ ------------
Income from continuing operations before taxes and
minority interest 4,102 271
Income tax expense - (300)
Minority interest, net of taxes - (232)
------------ ------------
Income (loss) before discontinued operations 4,102 (261)
------------ ------------
Gain from discontinued operations, net of taxes - 2,400
------------ ------------
Net income 4,102 2,139
Preferred stock dividends 70 70
------------ ------------
Net income available to common stockholders $ 4,032 $ 2,069
============ ============
Basic income per common share:
Continuing operations $ 1.29 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.29 $ 0.66
============ ============
Diluted income per common share:
Continuing operations $ 1.24 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.24 $ 0.66
============ ============
Weighted average shares outstanding:
Basic 3,118 3,118
Diluted 3,247 3,118
The adjustments in net sales, cost of sales, commission expense, stock
based compensation expense, other income and income taxes resulted in a net
decrease in income before discontinued operations of approximately $4,363,000
from the amounts previously reported for the year ended December 31, 2002. Net
income available to stockholders decreased by approximately $1,963,000 from the
amounts previously reported. Restated basic and diluted income per share from
continuing operations decreased by $1.40 and $1.35, respectively, from the
amounts previously reported for the year ended December 31, 2002. Net income for
basic and diluted income per share decreased by $0.63 and $0.58, respectively,
from the amounts previously reported for the year ended December 31, 2002. The
cumulative effect of the restatements for 2001 and 2002 resulted in a net
increase in accumulated deficit of approximately $3,520,000 as of December 31,
2002.
41
Results of Operations
Year Ended December 31, 2003 Compared to the Year Ended December 31, 2002
The following table summarizes NHTC's consolidated operating results as a
percentage of net sales for each of the years indicated:
Years Ended December 31,
---------------------------
2002
2003 As Restated
------------ ------------
Net sales 100.0% 100.0%
Cost of sales 19.9% 18.9%
------------ ------------
Gross profit 80.1% 81.1%
Operating expenses:
Distributor commissions 43.1% 45.5%
Selling, general and administrative expenses 26.6% 31.1%
Stock option based compensation - 3.9%
------------ ------------
Total operating expenses 69.7% 80.5%
------------ ------------
Income from operations 10.4% .6%
Other income (expense) - .1%
------------ ------------
Income from continuing operations before taxes and
minority interest expense 10.4% .7%
Income tax expense and minority interest (1.8%) (1.4%)
------------ ------------
Income (loss) before discontinued operations 8.6% (.7%)
------------ ------------
Gain from discontinued operations, net of taxes - 6.5%
------------ ------------
Net income 8.6% 5.8%
------------ ------------
Net Sales
Net sales were approximately $62,886,000 for the year ended December
31, 2003 compared to $36,968,000 for the year ended December 31, 2002. This
increase of approximately $25,918,000 or 70% was primarily attributable to the
increased number of active Lexxus distributors (approximately $21.9 million or
85% of the increase), Lexxus's expansion into new markets, including South Korea
in the second quarter of 2003 (approximately $2.7 million or 10% of the
increase) and sales of new products (approximately $1.3 million or 5% of the
increase). As of December 31, 2003, the Company had deferred revenue of
approximately $6.6 million of which $4.0 million pertained to goods shipped in
the first quarter of 2004 and recognized as revenue at that time.
Cost of Sales
Cost of sales was approximately $12,525,000 or 20% of net sales for the
year ended December 31, 2003 compared with approximately $6,985,000 or 19% of
net sales for the year ended December 31, 2002. This increase of approximately
$5,540,000 or 79% was primarily attributable to the Lexxus product mix and sales
volume compared to the 2002 sales of eKaire products and a smaller Lexxus
product mix in fewer countries. The increase in the cost of sales as a
percentage of revenues is primarily attributable to the change of product mix
sold in 2003 as well as higher transportation costs.
42
Gross Profit
Gross profit was approximately $50,361,000 or 80% of net sales for the
year ended December 31, 2003 compared with approximately $29,983,000 or 81% of
net sales for the year ended December 31, 2002. This increase of approximately
$20,378,000 or 68% was attributable to the increase in gross sales of Lexxus
products and the increase of cost of sales as a percentage of sales due to the
change of product mix sold in 2003 and higher transportation costs.
Commissions
Distributor commissions were approximately $27,096,000 or 43% of net
sales for the year ended December 31, 2003 compared with approximately
$16,834,000 or 46% of net sales for the year ended December 31, 2002. This
increase of approximately $10,262,000 or 61% was directly related to the
increase in gross sales and the terms of the compensation plans. The decrease in
commissions as a percentage of revenue is due to the normal fluctuations that
occur in the compensation plan and also due to the amount of revenue allocated
to the compensation plan.
Selling, General and Administrative Expenses
Selling, general and administrative costs were approximately
$16,741,000 or 27% of net sales for the year ended December 31, 2003 compared
with approximately $11,477,000 or 31% of net sales for the year ended December
31, 2002. This increase of approximately $5,264,000 or 46% was attributable to
approximately $1,343,000 of additional administrative expenses associated with
the new office in Seoul, South Korea and the balance of the increase resulted
from sales and marketing conventions, promotions and trainings. Selling, general
and administrative expenses decreased as a percentage of net sales from 31% in
2002 to 27% in 2003 due to operating efficiencies and economies of scale gained
with higher volumes of net sales.
Stock Option Based Compensation
Stock option based compensation expense was zero for the year ended
December 31, 2003 compared to approximately $1,434,000 million for the year
ended December 31, 2002. The stock option based compensation recorded in 2002
was in connection with the issuance of certain stock options granted in January
2001 and October 2002 to senior executive officers of the Company which
triggered variable accounting because the options contained a "cashless"
exercise feature. A cashless exercise feature allows option holders to use the
"in the money" value of the options (or the spread between the exercise price
and the fair market price of the underlying shares as of the exercise date) as
payment for all, or a portion, of the exercise price of an option. The options
were amended in November 2002 to require the option holder to obtain Company
approval before the option holder could use the cashless exercise feature. Under
variable accounting, changes in the market value of a company's shares will
generally result in recording a charge or credit to stock based compensation
expense.
Other Income (Expense)
Other expense was approximately $1,000 for the year ended December 31,
2003 compared with income of approximately $33,000 for the year ended December
31, 2002. This decrease of approximately $34,000 was due to recognized loss on
foreign exchange offset by an increase in other income.
43
Income Taxes
Income taxes were approximately $860,000 or 13% of income from
continuing operations before taxes for the year ended December 31, 2003 compared
with $300,000 for the year ended December 31, 2002. The decrease in effective
tax rate was attributable to use of net operating loss in the U.S. and lower
effective tax rates on foreign earnings in 2003. The Company's effective tax
rate differs materially from the U.S. Federal statutory rate for the reasons
identified in Note 7 of Notes to Consolidated Financial Statements contained
elsewhere herein.
Minority Interest, Net of Taxes
Minority interest expense was approximately $284,000 for the year ended
December 31, 2003 compared with approximately $232,000 for the year ended
December 31, 2002. This increase was primarily attributable to the minority
interest in KGC since inception in November 2003.
Income before Discontinued Operations
Income before discontinued operations was approximately $5,379,000 or
8.6% of net sales for the year ended December 31, 2003 compared to a loss of
approximately $261,000 for the year ended December 31, 2002. Compared to 2002,
this increase in 2003 is due to significantly larger net sales and smaller
commissions, selling, general and administrative and stock option based
compensation expenses as a percentage of net sales offset by a slight increase
in cost of sales as a percentage of net sales.
Discontinued Operations
Discontinued operations of approximately $2,400,000 for the year ended
December 31, 2002 was attributable to the recognition of the deferred gain on
the sale of Kaire Nutraceuticals, Inc. ("Kaire") recorded at December 31, 2002.
See Note 2 of Notes to Consolidated Financial Statements contained elsewhere
herein.
Net Income
Net income was approximately $5,379,000 or 8.6% of net sales for the
year ended December 31, 2003 compared to approximately $2,139,000 or 5.8% of net
sales for the year ended December 31, 2002. The Company recorded a gain from
discontinued operations of $2,400,000 in 2002.
Liquidity and Capital Resources
NHTC has historically funded the working capital and capital
expenditure requirements primarily from cash provided through sales of products,
through borrowings from institutions and individuals and issuance of preferred
stock.
In March 2000, NHTC sold 1,000 shares of Series J Preferred Stock, par
value $1,000 per share, (the "Series J Preferred Stock") realizing net proceeds
of $936,000. Series J Preferred Stock paid a dividend at the rate of 10% per
annum. Series J Preferred Stock and the accrued dividends thereon were
convertible into shares of Common Stock at a conversion price equal to the lower
of the closing bid price on the conversion date or 70% of the average closing
bid price of the Common Stock for the lowest three trading days during the
twenty day period immediately preceding the date on which NHTC receives notice
of conversion from a holder thereof. During 2001, $206,194 face amount of Series
J Preferred Stock was converted into 122,604 shares of Common Stock. During
2002, $777,476 face amount of Series J Preferred Stock was converted into
1,025,397 shares of Common Stock. During 2003, $16,330 face
44
amount of Series J Preferred Stock was converted into 28,468 shares of Common
Stock. As of December 31, 2003, there were no shares of Series J Preferred Stock
outstanding.
In October 2000, NHTC issued 50 shares of Series H Preferred Stock for
$50,000 realizing net proceeds of $43,500. The Series H Preferred Stock paid
dividends of 10% per annum and were convertible into shares of Common Stock at
the lower of the closing bid price on the conversion date or 75% of the market
value of the Common Stock on the conversion date. In April 2002, these 50 shares
of Series H Preferred Stock and $5,666 of accrued dividends were converted into
37,739 shares of Common Stock.
In April 2001, NHTC borrowed $100,000 from Augusta Street LLC. This
indebtedness was evidenced by NHTC's issuance of a convertible promissory note.
The note bore interest at 10% per annum and was payable on demand. The note was
convertible into shares of Common Stock at a discount equal to 75% of the
average closing bid price of the Common Stock on the five days preceding notice
of conversion. The note was converted into an aggregate of 78,343 shares of
Common Stock in September 2002.
In April 2001, NHTC issued 50 shares of Series H Preferred Stock for
$50,000 realizing net proceeds of $43,500. The Series H Preferred Stock pays
dividends of 10% per annum and was convertible into shares of Common Stock at
the lower of the closing bid price on the conversion date or 75% of the market
value of the Common Stock on the conversion date. In November 2002, these 50
shares of Series H Preferred Stock and $6,389 of accrued dividends were
converted into 40,422 shares of Common Stock.
In May 2001, NHTC issued 50 shares of Series H Preferred Stock for
$50,000 realizing net proceeds of $43,500. The Series H Preferred Stock pays
dividends of 10% per annum and is convertible into shares of Common Stock at the
lower of the closing bid price on the conversion date or 75% of the market value
of the Common Stock on the conversion date. In September 2002, 25 shares of
Series H Preferred Stock were converted into 23,087 shares of Common Stock. In
November 2002, 25 shares of Series H Preferred Stock and $5,440 of accrued
dividends were converted into 36,248 shares of Common Stock.
In December 2001, NHTC borrowed $138,000 from Augusta Street LLC. This
indebtedness was evidenced by NHTC's issuance of a convertible promissory note.
The note bore interest at 4.75% per annum and was payable on demand. The note
was convertible into shares of Common Stock at a discount equal to 75% of the
average closing bid price of the Common Stock on the five days preceding notice
of conversion. The note was converted into an aggregate of 106,562 shares of
Common Stock in September 2002.
During 2002, $1,200,960 face amount of Series F Preferred Stock was
converted into 610,995 shares of Common Stock.
In March 2002, NHTC borrowed $25,000 from Infusion Capital Investment
Corporation. This indebtedness was evidenced by NHTC's issuance of a convertible
promissory note. The note bore interest at 4.75% per annum and was payable on
demand. The note was convertible into shares of Common Stock at a discount equal
to 75% of the average closing bid price of the
45
Common Stock on the five days preceding notice of conversion. The note was
converted into an aggregate of 33,333 shares of Common Stock in October 2002.
In November 2002, NHTC paid $100,000 and issued a promissory note of
$120,000 to redeem 180 shares of Series F Preferred Stock. The note was fully
satisfied through cash payments by December 31, 2003.
At December 31, 2003, the ratio of current assets to current liabilities
was 1.24 to 1.0 and NHTC had working capital of approximately $3,839,000.
Cash provided by operations for the period ended December 31, 2003 was
approximately $9,528,000. Cash used by investing activities during the period
was approximately $1,783,000, which primarily relates to the capital
expenditures relating to the expansion of several international offices and to
the increase of restricted cash related to the credit card reserve. Cash used by
financing activities during the period was approximately $339,000 primarily
utilized for the repayment of notes payable and long-term debt. Total cash
increased by approximately $7,269,000 during the period.
NHTC has generated positive cash flows from its operations over the past
three years and believes that its existing liquidity and cash flows from
operations, including cash and cash equivalents totaling approximately $11.1
million should be adequate to fund normal business operations expected in the
future.
NHTC intends to continue to open additional operations in new foreign
markets in coming years. In 2004, NHTC plans to expand into Mexico. The
estimated cost to expand into a new country is approximately $2-3 million in the
aggregate, of which approximately $500,000 will relate to capital asset
purchases that will be depreciated over the life of the assets or lease term.
On March 31, 2004, the Company entered into a merger agreement with
Marketvision Communications Corp. ("Marketvision"), pursuant to which the
Company acquired all of the outstanding capital stock of Marketvision in
exchange for the issuance of 690,000 shares of NHTC restricted common stock,
promissory notes in the aggregate principle amount of approximately $3.2 million
and a cash payment of $1,336,875 for a total purchase price of approximately
$16.5 million. Marketvision is the exclusive developer and service provider of
the direct selling software used by the Company since mid-2001. Based upon the
number of new distributors enrolled, Marketvision charged the Company
approximately $1.9 million and $1.5 million for services provided during the
years ended December 31, 2003 and 2002, respectively. As of December 31, 2003,
NHTC owes Marketvision approximately $1.1 million, which is included in accounts
payable. Terry LaCore, a director of the Company and the Chief Executive Officer
of Lexxus was a principal stockholder of Marketvision.
NHTC is considering various alternatives pertaining to raising
additional capital to fund the repayment of the promissory notes issued in
connection with the Marketvision transaction, its expansion into new markets
and/or to make other acquisitions to further expand its business. If NHTC's
existing capital resources or cash flows become insufficient to meet its current
business
46
plans and projections, and if NHTC would be required to raise additional funds,
there is no assurance that funds could be raised on favorable terms, if at all.
Off-Balance Sheet Arrangements
NHTC does not utilize off-balance sheet financing arrangements other
than in the normal course of business. NHTC finances the use of certain
facilities, office and computer equipment, and automobiles under various
operating lease agreements. As of December 31, 2003, the total future minimum
lease payments under various operating leases totaled approximately $1.2 million
and are due in payments through 2007.
Recently Issued Accounting Standards
FASB Interpretation No. 45. In November 2002, the FASB issued FASB
Interpretation No. 45, "Guarantor's accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45).
FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a
liability for the fair value of an obligation assumed under a guarantee. FIN 45
also requires additional disclosures by a guarantor in its interim and annual
financial statements about the obligations associated with guarantees issued.
The recognition provisions of FIN 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN 45 did not have a material effect on the Company's
financial position, results of operations, or cash flows.
FASB Interpretation No. 46 and 46R. In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities."
Interpretation 46 changes the criteria by which one company includes another
entity in its consolidated financial statements. Previously, the criteria were
based on control through voting interest. Interpretation 46 requires a variable
interest entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities or
entitled to receive a majority of the entity's residual returns or both. A
company that consolidates a variable interest entity is called the primary
beneficiary of that entity. The consolidation requirements of Interpretation 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after December 31 2003. In December 2003, FASB
issued a revision to FASB Interpretation No. 46 to clarify some of the
provisions and to exempt certain entities from its requirements. Under the new
guidance, special effective date provisions apply to enterprises that have fully
or partially applied Interpretation 46 prior to issuance of the revised
interpretation. Otherwise, application of Interpretation 46R is required in
financial statements of public entities that have interests in structures that
are commonly referred to as special-purpose entities ("SPE's") for periods
ending after December 15, 2003. Application by public entities, other than small
business issuers, for all other types of variable interest entities other than
SPE's is required in financial statements for periods ending after March 15,
2004. NHTC does not have interest in structures commonly referred to as SPE's,
therefore the adoption of Interpretation 46R is not expected to have a material
impact on NHTC's consolidated financial position, results of operations or cash
flows.
SFAS 149. In April 2003, FASB issued Statements of Financial Accounting
Standards No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging
47
Activities." SFAS 149 amends SFAS 133 "Accounting for Derivatives Instruments
and Hedging Activities" and the related implementation guidance and is effective
for contracts entered into or modified after June 30, 2003, except for hedging
relationships designated after June 30, 2003. SFAS 149 clarifies the definition
of a derivative and amends the financial accounting and reporting required for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. In addition, SFAS 149 improves the
financial reporting requirements by requiring a more consistent reporting of
contracts as either derivatives or hybrid instruments. The adoption of this
standard did not have a significant impact on the Company's financial condition,
results of operations, or cash flows.
48
ITEM 7. FINANCIAL STATEMENTS.
NHTC's consolidated financial statements, including the notes thereto,
together with the report of independent certified public accountants thereon,
are presented following Item 14 beginning at page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On December 22, 2003, the Company filed a Form 8-K disclosing that the
Audit Committee and Board of Directors of the Company had approved the dismissal
of Sherb & Co., LLP ("Sherb") as the Company's independent auditors of the
Company's financial statements for the year ended December 31, 2003. The Company
disclosed that the reports of Sherb on the Company's financial statements within
the two most recent fiscal years or any subsequent interim periods contained no
adverse opinion or disclaimer of opinion and were not qualified or modified as
to uncertainty, audit scope or accounting principles; with the exception that
Sherb's independent auditors report for the year ended December 31, 2001 raised
substantial doubt about the Company's ability to continue as a going concern due
to historic losses and the need for additional funding. The Form 8-K further
disclosed that for the two most recent fiscal years and any subsequent interim
period preceding Sherb's dismissal, there were neither disagreements with Sherb
nor any reportable events.
The Form 8-K filed on December 17, 2003 also disclosed that the
Company's Audit Committee and Board of Directors had approved the engagement of
BDO Seidman, LLP ("BDO") as it new independent auditors as of December 31, 2003.
ITEM 8A. CONTROLS AND PROCEDURES.
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms and that such
information is accumulated and communicated to our management, including our
President and Chief Financial Officer, as appropriate, to allow for timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
During the quarters ended September 30 and December 31, 2003, the
Company re-evaluated its financial statements for the years ended December 31,
2002 and 2001, the quarterly periods included in such years and the quarterly
periods ended March 31, June 30 and September 30, 2003. As a result of such
review, the Company determined that it inadvertently applied the incorrect
accounting treatment with respect to the following items:
49
(i) revenue recognition with respect to administrative enrollment fees;
(ii) revenue cut-off between 2002 and 2003;
(iii) accounts receivable reconciliation to supporting documents;
(iv) reserves established for product returns and refunds;
(v) the gain recorded in connection with the sale of a subsidiary in 2001;
(vi) income tax provisions; and
(vii) stock option based compensation.
Consequently, the Company is amending and restating its financial
statements for each quarter in 2001, 2002 and 2003 as well as for the years
ended December 31, 2001 and 2002 with respect to each of the foregoing items
(collectively, the "Restatement Items").
An evaluation of the Company's disclosure controls and procedures (as
defined in Section 13(a)-14(c) of the Exchange Act) as of December 31, 2003 was
carried out under the supervision and with the participation of the Company's
President and Chief Financial Officer and other members of the Company's senior
management. The Company's President and Chief Financial Officer concluded that
the Company's disclosure controls and procedures as currently in effect are
effective in ensuring that the information required to be disclosed by the
Company in the reports it files or submits under the Exchange Act is (i)
accumulated and communicated to the Company's management (including the
President and Chief Financial Officer) in a timely manner, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms. During the quarter ended
December 31, 2003 and March 31, 2004, the Company substantially altered and
improved its internal controls over financial reporting with respect to (i) each
of the Restatement Items, and (ii) monthly financial reports provided to the
Company by its subsidiaries. The Company plans to implement additional controls
and procedures sufficient to accurately report their financial performance on a
timely basis. There have been no other changes in the Company's internal control
over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that
occurred during the quarter ended December 31, 2003, that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
The Company intends to continually review and evaluate the design and
effectiveness of its disclosure controls and procedures and to improve its
controls and procedures over time and to correct any deficiencies that it may
discover in the future. The goal is to ensure that senior management has timely
access to all material financial and non-financial information concerning the
Company's business. While the Company believes the present design of its
disclosure controls and procedures is effective to achieve its goal, future
events affecting its business may cause the Company to modify its disclosure
controls and procedures.
50
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS.
Incorporated herein by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 10. EXECUTIVE COMPENSATION.
Incorporated herein by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Incorporated herein by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated herein by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A under the Securities Exchange
Act of 1934.
51
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Index to Exhibits
NUMBER DESCRIPTION OF EXHIBIT
2.1 Acquisition Agreement between NHTC and Lexxus International (2)
2.2 Acquisition Agreement among NHTC, NHTC Acquisition Corp.
and Kaire International, Inc. (the "Acquisition Agreement"). (3)
2.3 Stock Purchase Agreement among Zeos International, Ltd. and
NHTC (Sale of Kaire Nutraceuticals, Inc.) (2)
3.1 Amended and Restated Certificate of Incorporation of the Company. (4)
3.2 Amended and Restated By-Laws of NHTC. (4)
4.1 Specimen Certificate of NHTC's Common Stock. (4)
4.2 Form of Class A Warrant. (4)
4.3 Form of Class B Warrant. (4)
4.4 Form of Warrant Agreement between NHTC and Continental Stock Transfer &
Trust Company for Class A and B Warrants. (4)
4.5 1994 Stock Option Plan. (4)
4.6 1997 Stock Option Plan. (11)
4.7 1998 Stock Option Plan. (11)
4.8 Articles of Amendment of Articles of Incorporation of the Company. (6)
4.9 Articles of Amendment of Articles of Incorporation- Series C Preferred
Stock. (7)
4.10 Articles of Amendment of Articles of Incorporation- Series E Preferred
Stock. (3)
4.11 Articles of Amendment of Articles of Incorporation- Series F Preferred
Stock. (3)
4.12 Articles of Amendment of Articles of Incorporation- Series G Preferred
Stock. (3)
4.13 Articles of Amendment of Articles of Incorporation- Series H Preferred
Stock. (3)
4.14 Form of Warrant in connection with the Acquisition Agreement. (3)
4.15 Articles of Amendment of Articles of Incorporation - Series J Preferred
Stock (13)
4.16 Stock Option Agreement between NHTC and Terry LaCore. (2)
4.17 Stock Option Agreement between NHTC and Benchmark Consulting Group. (2)
4.18 Convertible Promissory Note issued by NHTC to Augusta Street LLC in the
amount of $100,000. (2)
4.19 Convertible Promissory Note issued by NHTC to Augusta Street LLC in the
amount of $138,000. (2)
4.20 Consulting Agreement between NHTC and Summit Trading Limited. (2)
4.21 Lease for Registrant's Irving, Texas facility. (2)
4.22 Distributorship Agreement between Lexxus International, Inc. and 40 J's
L.L.C. (2)
4.23 Stock Option Grant between NHTC and Naline Thompson. (2)
21 Subsidiaries of the Registrant (see Note 1 to Notes to Consolidated
Financial Statements contained herein)
31 Certification Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
(1) Filed upon the initial filing of this Registration Statement.
52
(2) Previously filed with NHTC's Form 10-KSB for the year ended
December 31, 2001.
(3) Previously filed with NHTC's Proxy Statement on Schedule 14A, dated
January 25, 1999.
(4) Previously filed with Registration Statement No. 33-91184.
(5) Previously filed with NHTC's Form 8-K dated August 7, 1997.
(6) Previously filed with NHTC's Form 10-QSB dated June 30, 1997.
(7) Previously filed with the Company's Form 10-QSB dated September 30, 1998.
(8) Previously filed with the Company's Form 10-KSB for the year ended
December 31, 1996.
(9) Previously filed with NHTC's Form 10-KSB for the year ended
December 31, 1998.
(11) Previously filed with NHTC's Registration Statement, File No. 333-80465.
(13) Previously filed with NHTC's Form 8-K dated March 17, 2000.
(b) Reports on Form 8-K
On December 22, 2003, the Company filed Form 8-K disclosing the change
effective as of December 17, 2003 in certifying accountants from
Sherb & Co., LLP to BDO Seidman, LLP.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Incorporated herein by reference to the Company's proxy statement to be
filed pursuant to Regulation 14A under the Securities and Exchange Act of 1934.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, we have duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Dated: Dallas, Texas
April 13, 2004
NATURAL HEALTH TRENDS CORP.
By: /s/ Mark D. Woodburn
--------------------------------
Mark D. Woodburn
President and Chief Financial Officer
(Principal Financial and Accounting
Officer)
Pursuant to the requirements of Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Mark D. Woodburn President, Chief Financial April 13, 2004
--------------------------- Officer and Director
Mark D. Woodburn
/s/ Terry LaCore Director April 13, 2004
---------------------------
Terry LaCore
/s/ Sir Brian Wolfson Director April 13, 2004
---------------------------
Sir Brian Wolfson
/s/ Randall A. Mason Director April 13, 2004
---------------------------
Randall A. Mason
54
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
The following consolidated financial statements of Natural Health Trends Corp.
are included in response to Item 7:
PAGE
Independent Auditors' Report for the Year ended December 31, 2003........ F-2
Independent Auditors' Report for the Year ended December 31, 2002........ F-3
Consolidated Balance Sheet............................................... F-4
Consolidated Statements of Operations.................................... F-5
Consolidated Statements of Stockholders' Equity.......................... F-6
Consolidated Statements of Comprehensive Income.......................... F-7
Consolidated Statements of Cash Flows.................................... F-8
Notes to Consolidated Financial Statements............................... F-9
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors
Natural Health Trends Corp. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Natural Health
Trends Corp. and Subsidiaries ("the Company") as of December 31, 2003, and the
related consolidated statements of operations, stockholders' equity,
comprehensive income and cash flows for the year ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present,
in all material respects, the consolidated financial position of Natural Health
Trends Corp. and Subsidiaries as of December 31, 2003, and the consolidated
results of its operations and its cash flows for the year ended December 31,
2003, in conformity with accounting principles generally accepted in the United
States of America.
/s/ BDO Seidman, LLP
----------------------------------
BDO Seidman, LLP
Dallas, Texas
March 26, 2004 (except for note 11
which is dated as of March 31, 2004)
F-2
INDEPENDENT AUDITORS' REPORT
Board of Directors
Natural Health Trends Corp. and Subsidiaries
New York, New York
We have audited the accompanying consolidated balance sheet of Natural Health
Trends Corp. and Subsidiaries ("NHTC") as of December 31, 2002, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year ended December 31, 2002. These consolidated financial statements are
the responsibility of NHTC's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present,
in all material respects, the consolidated financial position of Natural Health
Trends Corp. and Subsidiaries as of December 31, 2002, and the consolidated
results of its operations and its cash flows for the year ended December 31,
2002, in conformity with accounting principles generally accepted in the United
States of America.
The consolidated financial statements for the year ended December 31, 2002 have
been restated (see Note 2).
/s/ Sherb & Co., LLP
Sherb & Co., LLP
Certified Public Accountants
New York, New York
March 7, 2003 (except for note 2
which is dated as of March 24, 2004)
F-3
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31,
2003
------------------
ASSETS
Current assets:
Cash and cash equivalents $ 11,133,075
Restricted cash 1,363,188
Accounts receivable 238,487
Inventories 3,580,303
Prepaid expenses and other current assets 3,363,941
------------------
Total current assets 19,678,994
Property and equipment, net 882,648
Goodwill 207,765
Database, net 509,391
Deposits and other assets 778,607
------------------
Total asset $ 22,057,405
==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,820,339
Accrued expenses 831,454
Accrued distributor commissions 2,285,182
Income taxes payable 1,442,655
Notes payable 287,703
Current portion of long-term debt 26,400
Deferred revenue 6,633,586
Other current liabilities 512,838
------------------
Total current liabilities 15,840,157
Long term debt 30,665
------------------
Total liabilities 15,870,822
Minority interest 710,957
Commitments and contingencies
Stockholders' equity
Preferred stock ($1,000 par value; authorized 1,500,000 shares) -
Common stock ($0.001 par value; authorized 500,000,000 shares;
issued and outstanding 4,656,409 shares) 4,656
Additional paid in capital 34,006,862
Accumulated deficit (28,389,232)
Accumulated other comprehensive loss (146,660)
------------------
Total stockholders' equity 5,475,626
------------------
Total liabilities and stockholders' equity $ 22,057,405
==================
See accompanying Notes to Consolidated Financial Statements.
F-4
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
------------------------------------
2002
2003 As Restated
---------------- ----------------
Net sales $ 62,885,830 $ 36,968,048
Cost of sales 12,524,826 6,985,139
---------------- ----------------
Gross profit 50,361,004 29,982,909
Operating expenses:
Distributor commissions 27,095,921 16,834,000
Selling, general and administrative expenses 16,741,213 11,477,024
Stock option based compensation - 1,434,000
---------------- ----------------
Total operating expenses 43,837,134 29,745,024
---------------- ----------------
Income from operations 6,523,870 237,885
Other income (expense):
Gain (loss) on foreign exchange (77,280) 20,557
Other income 139,156 73,132
Interest expense, net (62,996) (60,850)
---------------- ----------------
Total other income (expense) (1,120) 32,839
---------------- ----------------
Income from continuing operations before taxes and
minority interest 6,522,750 270,724
Income tax provision (860,000) (300,000)
Minority interest, net of taxes (284,210) (231,991)
---------------- ----------------
Income (loss) before discontinued operations 5,378,540 (261,267)
Gain from discontinued operations, net of taxes - 2,400,000
---------------- ----------------
Net income 5,378,540 2,138,733
Preferred stock dividends 810 70,111
---------------- ----------------
Net income available to common stockholders $ 5,377,730 $ 2,068,622
================ ================
Basic income per common share:
Continuing operations $ 1.17 $ (0.11)
Discontinued operations - 0.77
---------------- ----------------
Net income $ 1.17 $ 0.66
================ ================
Diluted income per common share:
Continuing operations $ 0.95 $ (0.11)
Discontinuing operations - 0.77
---------------- ----------------
Net income $ 0.95 $ 0.66
================ ================
Weighted average shares outstanding:
Basic 4,609,296 3,118,196
Diluted 5,688,099 3,118,196
See accompanying Notes to Consolidated Financial Statements.
F-5
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-------------------------------------------------------
Common Stock Preferred Stock
------------------------------------------------------- Paid in
Shares Amount Shares Amount Capital
-----------------------------------------------------------------------
BALANCE -December 31, 2001 (restated) 2,209,379 $ 2,209 2,324 $ 2,324,298 $ 29,557,552
-----------------------------------------------------------------------
Conversion of Convertible Series F Preferred Stock 610,995 611 (1,201) (1,200,960) 1,200,349
Conversion of Convertible Series H Preferred Stock 137,497 137 (150) (150,000) 149,863
Conversion of Convertible Series J Preferred Stock 1,025,397 1,026 (777) (777,476) 776,450
Conversion of Notes Payable to Common Stock 236,663 237 - - 279,885
Conversion of Series F Preferred Stock to note
payable (180) (179,532)
Shares issued for services 19,510 20 - - 36,304
Preferred Stock dividends - - - - 70,111
Stock option based compensation - - - - 1,434,000
Foreign currency translation
Deferred Compensation
Net Income
-----------------------------------------------------------------------
BALANCE -December 31, 2002 (restated) 4,239,441 $ 4,240 16 $ 16,330 $ 33,504,514
-----------------------------------------------------------------------
Conversion of Convertible Series J Preferred Stock 28,468 28 (16) (16,330) 16,302
Shares issued in acquisition 360,000 360 - - 432,540
Shares issued for services 28,500 28 - - 52,696
Preferred Stock dividends - - - - 810
Foreign currency translation
Deferred Compensation
Net Income
-----------------------------------------------------------------------
BALANCE -December 31, 2003 4,656,409 $ 4,656 - $ - $ 34,006,862
=======================================================================
Accumulated
Other
Accumulated Comprehensive Deferred
Deficit Loss Compensation Total
----------------------------------------------------------------
BALANCE -December 31, 2001 (restated) $ (35,835,584) $ (2,241) $ (416,250) $ (4,370,016)
----------------------------------------------------------------
Conversion of Convertible Series F Preferred Stock -
Conversion of Convertible Series H Preferred Stock -
Conversion of Convertible Series J Preferred Stock -
Conversion of Notes Payable to Common Stock 280,122
Conversion of Series F Preferred Stock to note
payable (179,532)
Shares issued for services 36,324
Preferred Stock dividends (70,111) -
Stock option based compensation - 1,434,000
Foreign currency translation (7,325) (7,325)
Deferred Compensation 270,000 270,000
Net Income 2,138,733 2,138,733
----------------------------------------------------------------
BALANCE -December 31, 2002 (restated) $ (33,766,962) $ (9,566) $ (146,250) $ (397,694)
----------------------------------------------------------------
Conversion of Convertible Series J Preferred Stock -
Shares issued in acquisition 432,900
Shares issued for services 52,724
Preferred Stock dividends (810) -
Foreign currency translation (137,094) (137,094)
Deferred Compensation 146,250 146,250
Net Income 5,378,540 5,378,540
----------------------------------------------------------------
BALANCE -December 31, 2003 $ (28,389,232) $ (146,660) $ - $ 5,475,626
================================================================
See accompanying Notes to Consolidated Financial Statements.
F-6
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31,
----------------------------
2002
2003 As Restated
------------ ------------
Net income $ 5,378,540 $ 2,138,733
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (137,094) (7,325)
------------ ------------
Comprehensive income $ 5,241,446 $ 2,131,408
============ ============
See accompanying Notes to Consolidated Financial Statements.
F-7
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
----------------------------
2002
2003 As Restated
------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,378,540 $ 2,138,733
Less gain from discontinued operations - (2,400,000)
------------ ------------
Income from continuing operations 5,378,540 (261,267)
------------ ------------
Adjustments to reconcile income from continuing operations to net cash
provided by operating activities:
Depreciation and amortization 531,944 199,698
Minority interest in subsidiaries 284,210 231,991
Stock option based compensation - 1,434,000
Common stock issued for services 52,724 36,324
Change in deferred compensation 146,250 270,000
Changes in operating assets and liabilities:
Accounts receivable 281,265 (399,935)
Inventories (426,679) (2,066,363)
Prepaid expenses and other current assets (1,745,291) (496,922)
Deposits and other assets (435,918) (465,625)
Accounts payable 570,922 1,613,742
Accrued expenses (644,185) 642,182
Accrued commissions 1,607,773 557,557
Deferred revenue 3,134,194 2,344,299
Income taxes payable 932,655 300,000
Other current liabilities (140,205) 545,820
------------ ------------
Total adjustments 4,149,659 4,746,768
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 9,528,199 4,485,501
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (556,987) (706,364)
Database purchase (190,844) -
Increase in restricted cash (1,035,303) (227,076)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (1,783,134) (933,440)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Minority interest contribution - 194,756
Proceeds of notes payable and long-term debt - 25,000
Repayments of notes payable and long-term debt (338,842) (224,861)
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (338,842) (5,105)
------------ ------------
EFFECT OF TRANSLATION ADJUSTMENTS ON CASH AND CASH EQUIVALENTS (137,094) (7,325)
NET INCREASE IN CASH AND CASH EQUIVALENTS 7,269,129 3,539,631
CASH, BEGINNING OF PERIOD 3,863,946 324,315
------------ ------------
CASH, END OF PERIOD $ 11,133,075 $ 3,863,946
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid $ 42,444 $ 90,033
Interest paid $ 49,951 $ 19,933
DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
(1) Conversion of preferred stock to common stock $ 16,330 $ 2,128,436
(2) Conversion of debentures, notes payable and related accrued interest
to Common Stock - 280,122
(3) Preferred Stock dividends 810 70,111
(4) Common Stock issued for acquisition 432,900 -
(5) Preferred Stock redeemed for notes payable - 179,532
(6) Common stock issued for services 52,724 36,324
See accompanying Notes to Consolidated Financial Statements.
F-8
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
1. BASIS OF PRESENTATION
Natural Health Trends Corp. ("NHTC" or "the Company") is a Florida corporation
incorporated in 1988. NHTC is an international direct selling company, which
operates through subsidiaries that distribute products to promote health,
wellness and vitality. Lexxus International, Inc., a majority owned subsidiary
and other Lexxus subsidiaries (collectively "Lexxus"), sell certain cosmetic
products as well as "quality of life" products. eKaire.com, Inc. ("eKaire"), a
wholly owned subsidiary, distributes nutritional supplements aimed at general
health and wellness. Other active wholly or majority owned subsidiaries of NHTC
and their countries of incorporation include:
. Lexxus International (SW Pacific) Pty. Ltd. (Australia)
. Kaire Nutraceuticals Australia Pty. Ltd. (Australia)
. Lexxus International (NZ) Ltd. (New Zealand)
. Kaire Nutraceuticals New Zealand Ltd. (New Zealand)
. Lexxus International. Co., Ltd. (Taiwan)
. MyLexxus Europe AG (Switzerland)
. KGC Networks Pte. Ltd. (Singapore)
. Lexxus International Co., Ltd. (Hong Kong)
. MyLexxus Personal Care International (India) Pvt. Ltd. (India)
. Lexxus International Marketing, Pte. Ltd. (Singapore)
. Lexxus International Network Marketing, Inc. (the Philippines)
. Lexxus Korea Co., Ltd. (South Korea)
. I Luv My Pet, Inc. (U.S.)
NHTC's common stock, par value, $.001 per share (the "Common Stock") is listed
on the Over the Counter Bulletin Board (the "OTCBB"). In March 2003, NHTC
effected a 1-for-100 reverse stock split with respect to its outstanding shares
of Common Stock. In addition, the trading symbol for the shares of its Common
Stock changed from "NHTC" to "NHLC". All share references will give effect to
the reverse stock split.
2. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
During the quarters ended September 30 and December 31, 2003, the Company
re-evaluated its financial statements for the years ended December 31, 2002 and
2001, the quarterly periods included in such years and the quarterly periods
ended March 31, June 30 and September 30, 2003. As a result of such review, the
Company determined that it inadvertently applied the incorrect accounting
treatment with respect to the following items:
(i) revenue recognition with respect to administrative enrollment fees;
F-9
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
(ii) revenue cut-off between 2002 and 2003;
(iii) accounts receivable reconciliation to supporting documents;
(iv) reserves established for product returns and refunds;
(v) the gain recorded in connection with the sale of a subsidiary in
2001;
(vi) income tax provisions; and
(vii) stock option based compensation.
Consequently, the Company is amending and restating its financial statements for
each quarter in 2001, 2002 and 2003 as well as for the years ended December 31,
2001 and 2002.
In connection with the review of the Company's financial statements, the Company
has revised its accounting treatment for administrative enrollment and
membership fees received from distributors in accordance with the principles
contained in Staff Accounting Bulletin No. 104, "Revenue Recognition", ("SAB
104") and related guidance. The Company determined that under SAB 104, such fees
actually received and recorded as current sales in prior quarters should have
been deferred and recognized as revenue on a straight-line basis over the
twelve-month term of the membership. The restatement resulted in net sales for
the year ended December 31, 2002 being decreased by approximately $1,336,000.
The restatement in net sales resulted in a corresponding adjustment to cost of
sales for direct costs paid to a third party associated with the administrative
enrollment fees received from distributors. Compared to amounts previously
reported, the restatement decreased cost of sales by approximately $336,000 for
the year ended December 31, 2002.
The Company also reviewed its revenue cut-off as of the beginning of 2003. It
was noted that approximately $1,008,000 of sales originally recorded in 2002
were not actually shipped until early 2003. The restatement resulted in net
sales for the quarter ended December 31, 2002 being decreased by $1,008,000 and
net sales for the quarter ended March 31, 2003 being increased by the same
amount. The restatement also resulted in distributor commissions for the quarter
ended December 31, 2002 being decreased by $459,000 and distributor commissions
for the quarter ended March 31, 2003 being increased by the same amount.
Also in connection with its review, the Company determined that its accounts
receivable as of March 31 and June 30, 2003 did not reconcile in total to
supporting details for such transactions. The restatement resulted in net sales
being decreased by $140,000 and $260,000 as of March 31 and June 30, 2003,
respectively.
The Company had not recorded a reserve for distributor returns and refunds as of
September 30, 2003 and for prior periods. Based upon analysis of the Company's
historical returns and refund trends by country, it was determined that the
reserves for returns and refunds for prior periods were required and should be
recorded. The restatement resulted in net sales for the year ended December 31,
2002 being decreased by approximately $350,000, with corresponding adjustments
to cost of sales for the estimated cost of products returned.
In 2001, the Company sold all of the outstanding common stock in Kaire
Nutraceuticals, Inc. ("Kaire"), a Delaware corporation and wholly-owned
subsidiary of the Company, to an unrelated third party. The gain on the sale of
Kaire was approximately $3.1 million, a portion of which was previously
deferred. The Company subsequently recognized into income approximately $1.9
F-10
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
million from the transaction over the period from the fourth quarter of 2001
through the second quarter of 2003. Based upon a review of the transaction, the
Company now believes the gain on sale of Kaire should have been recognized only
in 2001 and 2002 and not in 2003. For the year ended December 31, 2002, the
Company is now recognizing $2,400,000 of gain on the sale of Kaire as
Discontinued Operations and is reducing its Other Income by $800,000.
The Company disclosed in its Annual Report on Form 10-KSB for the year ended
December 31, 2002 that it had a net operating loss carry forward at December 31,
2002 of approximately $6,000,000, subject to certain limitations. Consequently,
the Company made no provision for income taxes for any period in 2002 or 2001.
Upon further review, it has been determined that the available net operating
loss was not expected to be sufficient to offset all of the domestic and foreign
taxable income in 2002 or 2001 and that an estimated tax provision in the amount
of $300,000 was necessary for the year ended December 31, 2002.
The Company has determined that the stock options (the "Options") granted in
January 2001 and October 2002 to senior executive officers of the Company should
be accounted for as variable stock options due to the provision in the stock
option plan that allowed the holder to exercise the stock option in an
immaculate cashless fashion. The cashless exercise feature allows option holders
to use the "in the money" value of the options (or the spread between the
exercise price and the fair market price of the underlying shares as of the
exercise date) as payment for all, or a portion, of the exercise price of an
option. The Options were amended in November 2002 to require the option holder
to obtain Company approval before the Option holder could use the cashless
exercise feature. Subsequent to the modification, fixed option accounting will
be applied to the options. Under variable accounting, changes in the intrinsic
value of the stock option result in recording a charge or credit to stock based
compensation expense. For the year ended December 31, 2002, the restatement
resulted in $1,434,000 being charged to stock option based compensation expense.
F-11
The following table presents amounts from operations as previously reported and
as restated (in thousands, except for per share data):
Year Ended December
---------------------------
December 31, 2002
---------------------------
As
Previously As
Reported Restated
------------ ------------
Net sales $ 39,662 $ 36,968
Cost of sales 7,391 6,985
------------ ------------
Gross profit 32,271 29,983
Operating expenses 28,770 29,745
------------ ------------
Income from operations 3,501 238
Other income (expense) 601 33
------------ ------------
Income from continuing operations before taxes and minority
interest 4,102 271
Income tax expense - (300)
Minority interest, net of taxes - (232)
------------ ------------
Income (loss) before discontinued operations 4,102 (261)
------------ ------------
Gain from discontinued operations, net of taxes - 2,400
------------ ------------
Net income 4,102 2,139
Preferred stock dividends 70 70
------------ ------------
Net income available to common stockholders $ 4,032 $ 2,069
============ ============
Basic income per common share:
Continuing operations $ 1.29 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.29 $ 0.66
============ ============
Diluted income per common share:
Continuing operations $ 1.24 $ (0.11)
Discontinued operations - 0.77
------------ ------------
Net income $ 1.24 $ 0.66
============ ============
Weighted average shares outstanding:
Basic 3,118 3,118
Diluted 3,247 3,118
F-12
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
The adjustments in net sales, cost of sales, commission expense, stock based
compensation expense, other income and income taxes resulted in a net decrease
in income before discontinued operations of approximately $4,363,000 from the
amounts previously reported for the year ended December 31, 2002. Net income
available to stockholders decreased by approximately $1,963,000 from the amounts
previously reported. Restated basic and diluted income per share from continuing
operations decreased by $1.40 and $1.35, respectively, from the amounts
previously reported for the year ended December 31, 2002. Net income for basic
and diluted income per share decreased by $0.63 and $0.58, respectively, from
the amounts previously reported for the year ended December 31, 2002. The
cumulative effect of the restatements for 2001 and 2002 resulted in a net
increase in accumulated deficit of approximately $3,520,000 as of December 31,
2002.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
NHTC and all of its wholly and majority-owned subsidiaries, after the
elimination of intercompany balances and transactions.
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.
Actual results may differ from these estimates.
F-13
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
Foreign Currency Translation
The assets and liabilities in foreign currencies are translated into U.S.
dollars at the rates in effect at the balance sheet date. The income and
expenses in foreign currencies are translated into U.S. dollars at the
average rates for the year then ended. The related translation adjustments
are reflected as a cumulative translation adjustment in consolidated
stockholders' equity. Foreign currency gains and losses resulting from
transactions are included in results of operations in the period in which
the transaction occurred.
Reclassifications
Certain 2002 amounts in the consolidated statements of operations have been
reclassified to conform with the current year presentation.
Cash and Cash Equivalents
Cash and cash equivalents consist of money market accounts and commercial
paper with an initial term of fewer than three months. For purposes of the
statement of cash flows, NHTC considers highly liquid debt instruments with
original maturities of three months or less to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk are primarily cash equivalents, short-term
investments and receivables.
NHTC maintains its cash in several bank accounts. Accounts in the United
States are insured by the Federal Deposit Insurance Corporation ("FDIC") up
to $100,000. Some of NHTC's cash balances exceed the insured limits.
Virtually all of Lexxus and eKaire product sales are generated through the
Internet and utilize credit cards for payment. Credit is extended until
credit card purchases have cleared the bank, which is on average 5 to 7
days. Credit losses, if any, have been provided for in the financial
statements and are based on management's estimates. NHTC does not believe
that it is subject to any unusual or significant credit risk in the normal
course of business.
Accounts Receivable
Accounts receivable are due to the lag time between the credit card
purchase and the funding of the credit card balances through the credit
card processing company.
Inventories
Inventories consisting primarily of nutritional supplements and "quality of
life" products are stated at the lower of cost or market. Cost is
determined using the first-in, first-out ("FIFO") method. The Company
provides an adequate allowance for any slow-moving or obsolete inventories.
Restricted Cash
NHTC is required to maintain two restricted cash accounts: a reserve with
the credit card processing company and a reserve with a Canadian bank as
security for a bank drafting
F-14
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
process utilized by eKaire in the ordinary course of business. The primary
purpose of the reserve with the credit card company is to provide for
potential uncollectible amounts and chargebacks by either Lexxus or eKaire
credit card customers. The credit card processing company may periodically
increase the restricted cash requirement. The amount on deposit is
calculated at an average of 2% of net sales over a rolling six month time
period.
Property and Equipment
Property and equipment are carried at cost. Depreciation of property and
equipment is computed for financial reporting purposes using the
straight-line method over the estimated useful lives of the various assets.
Impairment of Long-Lived Assets
Property and equipment and definite-lived intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. If the sum of the expected
undiscounted cash flows is less than the carrying value of the related
asset or group of assets, a loss is recognized for the difference between
the fair value and carrying value of the asset or group of assets. Such
analyses necessarily involve significant judgment. NHTC believes that no
such impairment exists at December 31, 2003.
Goodwill
Goodwill consists of the excess of cost over the fair value of identifiable
net assets of businesses acquired. As of January 1, 2002, the Company
adopted Financial Accounting Standards Board Statement No. 142, "Goodwill
and Other Intangible Assets" (FAS 142) and as such no longer amortizes
goodwill, but rather tests it annually for impairment. There was no
impairment of goodwill at December 31, 2003. Under FAS 142, the Company
discontinued amortization of its goodwill beginning January 1, 2002, which
resulted in reduced expense of approximately $5,000 (net of related tax
effects) in fiscal 2002.
Fair Value of Financial Instruments
The carrying amounts reported in the balance sheet for cash, receivables,
accounts payable, accrued expenses and notes payable approximate fair value
based on the short-term maturity of these instruments.
Revenue Recognition
The Company's revenues are primarily derived from sales of products, sales
of starter and renewal administrative enrollment packs and shipping fees.
Product sales and direct expenses are recognized when the products are
shipped. The Company defers revenue from the sale of its starter and
renewal packs related to its administrative enrollment fee. The Company
amortizes its deferred revenue and its associated direct costs over twelve
months, the term of the membership. As of December 31, 2003, the Company
had deferred revenue of approximately $6.6 million of which $4.0 million
pertained to goods shipped in the first quarter of 2004 and recognized as
revenue at that time. Deferred revenues also included refundable
distributor fees of $2.6 million.
The Company also estimates and records a sales return allowance for
possible sales refunds based on its historical experience on a country by
country basis.
F-15
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
Shipping and Handling Cost
The Company records freight and shipping revenue collected from
distributors as revenue. The Company records shipping and handling costs
associated with customer shipments as cost of sales.
Commissions expense
Distributors are paid commissions based on their direct and indirect
commissionable net sales and downline growth. Commissions are earned over
52 business periods and are paid two weeks in arrears. Commissions are
accrued when earned.
Advertising Costs
Advertising and promotional expenses are included in selling, general and
administrative expenses and are charged to operations when incurred.
Advertising costs for 2003 and 2002 were not material.
Income Taxes
Pursuant to Statement of Financial Accounting Standards No. 109 ("SFAS
109") "Accounting for Income Taxes", NHTC accounts for income taxes under
the asset and liability method. Under the asset and liability method,
deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. This method also requires the recognition of future
tax benefits such as net operating loss carryforwards, to the extent that
realization of such benefits is more likely than not.
Earnings Per Share
Statement of Financial Accounting Standards No. 128, ("SFAS 128") "Earnings
Per Share", requires a presentation of "Basic" and (where applicable)
"Diluted" earnings per share. Generally, basic earnings per share is
computed on only the weighted average number of common shares actually
outstanding during the period, and the diluted computation considers
potential shares issuable upon exercise or conversion of other outstanding
instruments where dilution would result.
Accounting for Stock-Based Compensation
Currently, NHTC follows Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and its related
interpretations for stock options granted to employees and members of its
board of directors. Under the recognition and measurement principles of APB
25, NHTC is not required to recognize any compensation expense unless the
market price of the stock exceeds the exercise price on the date of grant,
the terms of the grant are subsequently modified or in the case of variable
options. The Financial Accounting Standards Board has recently issued a
proposal to change the recognition and measurement principles for
equity-based compensation granted to employees and board members. Under the
proposed rules, NHTC would be required to recognize compensation expense
related to stock options granted to employees and board members effective
for the year beginning after December 15, 2004. The compensation
F-16
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
expense would be calculated based on the expected number of options
expected to vest and would be recognized over the stock options' vesting
period. If this proposal is passed, NHTC would be required to recognize
compensation expense related to stock options granted to its employees or
board members, which could have a material effect on its consolidated
financial condition and results of operations.
For disclosure purposes in according with Statement of Financial Accounting
Standards 123 ("SFAS 123"), the fair value of options is estimated on the
date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for stock options granted
during the years ended December 31, 2003 and 2002, respectively: annual
dividends of $0 for both years; expected volatility of 100% and 200% for
2003 and 2002, respectively; risk free interest rate of 4.25% and 7.00% for
2003 and 2002, respectively; and expected life of 3 years for 2003 and
2002, respectively. The weighted average fair value of stock options
granted in 2002 was $0.81. If NHTC had recognized compensation cost of
stock options in accordance with SFAS 123, NHTC's proforma income and net
income per share would have been as follows:
Years Ended December 31,
------------------------------
2002
2003 As Restated
------------- -------------
Net income available to common shareholders $ 5,377,730 $ 2,068,622
Add: Stock-based employee compensation expense included in reported net
income, net of tax effect - 1,434,000
Deduct: Total stock-based employee compensation expense determined under
fair value based method, net of tax effect (38,000) (955,567)
------------- -------------
Pro forma net income available to common stockholders $ 5,339,730 $ 2,547,055
------------- -------------
Basic income per share:
As reported $ 1.17 $ 0.66
Pro forma $ 1.16 $ 0.82
Diluted income per share:
As reported $ 0.95 $ 0.66
Pro forma $ 0.94 $ 0.82
Recently Issued Accounting Standards
FASB Interpretation No. 45. In November 2002, the FASB issued FASB
Interpretation No. 45, "Guarantor's accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others"
(FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor
must recognize a liability for the fair value of an obligation assumed
under a guarantee. FIN 45 also requires additional disclosures by a
guarantor in its interim and annual financial statements about the
obligations associated with guarantees issued. The recognition provisions
of FIN 45 are effective for any guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
adoption of FIN 45 did not have a material effect on the Company's
financial position, results of operations, or cash flows.
F-17
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
FASB Interpretation No. 46 and 46R. In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities."
Interpretation 46 changes the criteria by which one company includes
another entity in its consolidated financial statements. Previously, the
criteria were based on control through voting interest. Interpretation 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. A company that consolidates a variable
interest entity is called the primary beneficiary of that entity. The
consolidation requirements of Interpretation 46 apply immediately to
variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after December 31 2003. In December 2003, FASB
issued a revision to FASB Interpretation No. 46 to clarify some of the
provisions and to exempt certain entities from its requirements. Under the
new guidance, special effective date provisions apply to enterprises that
have fully or partially applied Interpretation 46 prior to issuance of the
revised interpretation. Otherwise, application of Interpretation 46R is
required in financial statements of public entities that have interests in
structures that are commonly referred to as special-purpose entities
("SPE's") for periods ending after December 15, 2003. Application by public
entities, other than business issuers, for all other types of variable
interest entities other than SPE's is required in financial statements for
periods ending after March 15, 2004. NHTC does not have interest in
structures commonly referred to as SPE's, therefore the adoption of
Interpretation 46R is not expected to have a material impact on NHTC's
consolidated financial position, results of operations or cash flows.
SFAS 149. In April 2003, FASB issued Statements of Financial Accounting
Standards No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS 149 amends SFAS 133 "Accounting
for Derivatives Instruments and Hedging Activities" and the related
implementation guidance and is effective for contracts entered into or
modified after June 30, 2003, except for hedging relationships designated
after June 30, 2003. SFAS 149 clarifies the definition of a derivative and
amends the financial accounting and reporting required for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. In addition, SFAS 149 improves the
financial reporting requirements by requiring a more consistent reporting
of contracts as either derivatives or hybrid instruments. The adoption of
this standard did not have a significant impact on the Company's financial
condition, results of operations, or cash flows.
4. PROPERTY AND EQUIPMENT, NET
Property and equipment consisted of the following at December 31, 2003:
F-18
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
Estimated Useful
Type of Property or Equipment Lives Amount
-------------------------------------------------------------------------------------
Equipment, furniture and fixtures 5 to 7 $ 609,476
Computers and peripherals 3 284,237
Software 3 to 5 169,278
Leasehold improvements 3 to 5 280,594
-------------
$ 1,343,585
Less accumulated depreciation 460,937
-------------
Property and equipment, net $ 882,648
=============
5. NOTES PAYABLE and LONG-TERM DEBT
Notes payable consisted of the following at December 31, 2003:
Description: Amount:
--------------------------------------------------------------------------------------------------
Note payable due to a vendor; interest at 8% per annum, due upon demand $ 145,496
Notes payable due to vendors; non interest bearing, due upon demand 40,000
Notes payable due to a distributor; interest at 1% per annum, due upon demand 102,207
----------
Total Notes Payable $ 287,703
==========
Long-term debt at December 31, 2003 consisted of the noncurrent maturities of
$30,665 and current maturities of $26,400 that are due to a governmental agency.
The debt bears interest at 7% per annum, includes monthly principle and interest
payments of $2,200 and will be paid in full in 2006.
6. STOCKHOLDERS' EQUITY
Preferred Stock
NHTC is authorized to issue a maximum of 1,500,000 shares of $1,000 par
value preferred stock, in one or more series and containing such rights,
privileges and limitations, including voting rights, dividend rates, conversion
privileges, redemption rights and terms, redemption prices and liquidation
preferences, as NHTC's board of directors may, from time to time, determine.
Series F Preferred Stock:
In February 1999, NHTC issued 2,800 shares of Series F Preferred Stock with
a stated value of $1,000 per share realizing a net value of $2,800,000. This
issuance was in accordance with the asset purchase agreement of Kaire
International, Inc. The preferred stock paid dividends at 6% per annum and was
payable upon conversion into either cash or NHTC Common Stock. The preferred
stock and the accrued dividends thereon were convertible into shares of the
Company's Common Stock at a conversion price equal to 95% of the average closing
bid price of the Common Stock for the three trading days immediately preceding
the date on which the Company received notice of conversion from a holder. The
Company was permitted at any time, on five days prior written notice, to redeem
the outstanding preferred stock at a redemption price equal to the stated value
and the accrued dividends thereon.
F-19
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
During the year ended December 31, 2002, the Company converted the final
remaining 1,201 shares of the Series F Preferred Stock into 610,995 shares of
Common Stock. As of December 31, 2003, no shares of the Series F Preferred Stock
are outstanding.
Series H Preferred Stock:
In October 2000, NHTC sold 50 shares of Series H Preferred Stock with a
stated value of $1,000 per share realizing net proceeds of $43,500. The
preferred stock paid dividends at the rate of 8% per annum. The preferred stock
and the accrued dividends thereon were convertible into shares of NHTC's Common
Stock at a conversion price equal to the lower of the closing bid price on the
date of issuance or 75% of the average closing bid price of the Common Stock for
the three trading days immediately preceding the date on which NHTC received
notice of conversion from a holder. In April 2002, these 50 shares of Series H
Preferred Stock and $5,666 of accrued dividends were converted into 37,739
shares of Common Stock.
In April 2001, NHTC issued 50 shares of Series H Preferred Stock for
$50,000 realizing net proceeds of $43,500. The Series H Preferred Stock paid
dividends at the rate of 10% per annum. The preferred stock and the accrued
dividends thereon were convertible into shares of NHTC Common Stock at a
conversion price equal to the lower of the closing bid price on the date of
conversion or 75% of the market value of the Common Stock on the conversion
date. In November 2002, these 50 shares of Series H Preferred Stock and $6,389
of accrued dividends were converted into 40,422 shares of Common Stock.
In May 2001, NHTC issued 50 shares of Series H Preferred Stock for $50,000
realizing net proceeds of $43,500. The Series H Preferred Stock paid dividends
at the rate of 10% per annum. The preferred stock and the accrued dividends
thereon were convertible into shares of NHTC Common Stock at a conversion price
equal to the lower of the closing bid price on the date of conversion or 75% of
the market value of the Common Stock on the conversion date. In September 2002,
25 shares of Series H Preferred Stock were converted into 23,087 shares of
Common Stock. In November 2002, the remaining 25 shares of Series H Preferred
Stock and $5,440 of accrued dividends were converted into 36,249 shares of
Common Stock.
As of December 31, 2002, there were no shares of Series H Preferred Stock
outstanding.
Series J Preferred Stock:
In March 2000, NHTC sold 1,000 shares of Series J Preferred Stock with a
stated value of $1,000 per share realizing net proceeds of $936,000. The
preferred stock paid a dividend at the rate of 10% per annum, payable in cash or
stock at NHTC's option. The preferred stock and the accrued dividends thereon
were convertible into shares of the Company's Common Stock at a conversion price
equal to the lower of the closing bid price on the date of issuance or 70% of
the average closing bid price of the Common Stock for the lowest three trading
days during the twenty day period immediately preceding the date on which NHTC
received notice of conversion from a holder.
Pursuant to the terms of the Series J Preferred, if NHTC did not have an
effective registration statement 120 days subsequent to the issuance of the
Series J Preferred Stock, a 2% penalty on the face amount of $1,000,000 accrued
for every 30 days without an effective
F-20
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
registration statement. In the year ended December 31, 2002, NHTC recorded an
additional $4,626 in accrued dividends for the period such stock was
outstanding. During the year ended December 31, 2002, NHTC converted 777 shares
of Series J Preferred Stock into 1,025,397 shares of NHTC Common Stock. During
the year ended December 31, 2003, NHTC converted the final outstanding 16 shares
of Series J Preferred Stock into 28,468 shares of NHTC Common Stock.
As of December 31, 2003, there were no shares of Series J Preferred Stock
outstanding.
Convertible Debentures
During 2002, NHTC converted approximately $263,000 of its promissory notes,
plus accrued interest of $16,455 into 236,663 shares of NHTC Common Stock.
Common Stock for Services and Acquisitions
In April 2002, the Company issued 17,500 shares of Common Stock for certain
legal services. In December 2002, the Company issued 2,010 shares of Common
Stock to an individual as an incentive for loaning funds.
On January 31, 2003, the Company entered into a Database Purchase Agreement
with NuEworld.com Commerce, Inc. ("NuEworld") and Lighthouse Marketing
Corporation, a wholly owned subsidiary ("Lighthouse") of NHTC, pursuant to which
Lighthouse purchased a database of distributors from NuEworld in exchange for
the issuance of 360,000 shares of restricted NHTC Common Stock. The shares were
discounted approximately 35% from the market value of $1.85 per share due to
certain trading restrictions. The total purchase price, including acquisition
related costs, was approximately $624,000 based upon the value of the NHTC
restricted Common Stock issued. NuEworld was in the business of marketing and
selling a variety of products and services through its own direct-selling
distribution network. The database cost is being amortized over an estimated
life of five years. Accumulated amortization as of December 31, 2003 was
approximately $115,000.
In January 2003, the Company issued 18,500 shares of NHTC Common Stock to a
law firm for legal services valued at approximately $34,000 based upon the
closing price of the Common Stock. Also in January 2003, the Company issued
10,000 shares of Common Stock to a consulting firm for consulting services
valued at approximately $19,000 based upon the closing price of the Common
Stock.
7. INCOME TAXES
The Company's provision for income taxes consisted of the following:
Years ended December 31,
------------------------------
2003 2002
-------------- --------------
As Restated
--------------
Current tax expense:
Federal $ 256,000 $ 58,000
State 40,000 8,000
Foreign 564,000 234,000
-------------- --------------
$ 860,000 $ 300,000
============== ==============
F-21
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
The Company accounts for income taxes under the provisions of SFAS 109.
SFAS 109 requires the recognition of deferred tax assets and liabilities for
both the expected impact of differences between the financial statement and tax
basis of assets and liabilities, and for the expected future tax benefit to be
derived from tax loss and tax credit carryforwards. SFAS 109 additionally
requires the establishment of a valuation allowance to reflect the likelihood of
realization of deferred tax assets. During 2003, the Company utilized a portion
of its deferred tax assets. At December 31, 2003, the Company had net deferred
assets remaining of approximately $2.5 million which included deferred tax
assets of approximately $2.8 million comprised primarily of net operating loss
carry forwards and alternative minimum tax credits and deferred liabilities of
approximately $300,000 comprised primarily of the difference between the
financial statement and tax basis of fixed assets and the database purchase
cost. The Company has established a valuation allowance for the full amount of
such net deferred tax assets at December 31, 2003, as management of the Company
has not been able to determine that it is more likely than not that the deferred
tax assets will be realized. However, should the Company's trend of taxable
income continue, it may be necessary, as early as fiscal 2004, to release a
portion or all of the valuation allowance.
The Company has a net operating loss carry forward at December 31, 2003 of
approximately $7.6 million, a portion of which begins to expire in 2011. A
portion of the net operating loss carry forward may be subject to an annual
limitation as defined by Section 382 of the Internal Revenue Code. The Company
has not provided for U.S. Federal and foreign withholding taxes on the foreign
subsidiaries undistributed earnings as of December 31, 2003. Such earnings are
intended to be reinvested indefinitely.
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before income taxes as follows:
For the year ended
December 31,
------------------------------
2003 2002
------------- -------------
As Restated
-------------
Income tax computed at the US Federal statutory
rate $ 2,218,000 $ 92,000
Effect of permanent differences 37,000 6,000
Increase (decrease) in valuation allowance (1,389,000) 291,000
Foreign taxes different than Federal rate (32,000) (94,000)
State income taxes, net of Federal benefit 26,000 5,000
------------- -------------
Provision for income taxes $ 860,000 $ 300,000
============= =============
F-22
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
8. COMMITMENTS AND CONTINGENCIES
Office Leases
NHTC and Lexxus lease an aggregate of approximately 16,000 square feet of
office and warehouse space in Dallas, Texas. The original lease term is 38
months, expiring in September 2004, and the current rent is approximately
$153,000 per year. Additional warehousing for Lexxus is located in Hollister,
Missouri where Lexxus utilizes approximately 1,500 square feet of warehouse
space. The lease term is on a month-to-month basis at a rent of $18,000 per
year. The Canadian office and warehouse of Lexxus and eKaire leases office space
in Langley, British Columbia, totaling approximately 5,000 square feet. The
lease term is 36 months, expiring on January 2007 and the current rent is
approximately $22,000 per year.
Kaire Australia, Kaire New Zealand, Lexxus Australia and Lexxus New Zealand
lease office space and warehouse facilities of approximately 2,500 square feet
in Queensland, Australia. The lease term is 60 months, expiring in January 2007,
and the current rent is approximately $32,000 per year.
In February 2002, Lexxus Hong Kong entered into a 42-month agreement for
approximately 5,400 square feet of office space at a current rate of
approximately $183,000 per year.
In March 2002, Lexxus Taiwan entered into a 24-month agreement for
approximately 10,000 square feet of office space located in Kaohsiung, Taiwan at
a current rate of approximately $56,000 per year. This lease was extended
effective March 1, 2004 for an additional six months. In May 2002, Lexxus Taiwan
entered into a 36-month agreement for approximately 4,500 square feet of office
spare located in Taipei, Taiwan at a current rate of approximately $86,000 per
year.
In August 2002, Lexxus India entered into a 60-month agreement for 2,665
square feet of office space located in Hyderabad, India at a current rate of
approximately $13,000 per year.
In September 2002, Lexxus Singapore entered into a 36-month agreement for
4,155 square feet of office space at a current rate of approximately $155,000
per year.
In January 2003, Lexxus Philippines entered into a 24-month agreement for
approximately 6,400 square feet of office space located in Manila at a current
rate of approximately $49,000 per year.
In April 2003, Lexxus South Korea entered into a 12-month agreement for
approximately 4,100 square feet of office space located in Seoul at a current
rate of approximately $266,000 per year.
F-23
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
Total rental expense was approximately $1,137,000 and $518,000 for the
years ended December 31, 2003 and 2002, respectively. The table below shows the
future minimum lease payments due under non-cancelable operating leases at
December 31, 2003.
Year Amount
---------------------------------------------
2004 $ 794,000
2005 311,000
2006 67,000
2007 9,000
2008 and thereafter -0-
-----------
Total $ 1,181,000
===========
Litigation
On April 10, 2003, Bobby R. Porter and wife, Betty R. Porter, filed suit
against Lexxus International, Inc. and Alex Arnold (an employee of Lexxus
International, Inc.) in the 170th District Court of McLennan County, Texas
asserting misrepresentations made by the former owners of NuEworld.com Commerce,
Inc. ("NuEworld") pertaining to a stock investment made by the plaintiffs in
June 2000. The plaintiffs are seeking the sum of $40,000, court costs and other
relief. The Company acquired certain assets of NuEworld in January 2003. The
Company filed a motion to transfer venue in April 2003 and intends to vigorously
defend itself in this case.
In February 2004, the Company received notice from a plaintiff in an action
in Florida State Court styled Haimes v. Natural Health Trends Corp. that
plaintiff was seeking to recover attorney's fees from the Company in the amount
of approximately $85,000 in connection with a judgment that the plaintiff
previously had taken against the Company and the Company had paid in full. While
the Company disputes such charges, they have entered into preliminary settlement
negotiations with the plaintiff.
From time to time, NHTC is involved in legal proceedings incidental to the
course of its business. NHTC believes that pending actions, both individually
and in the aggregate, will not have a material adverse effect on its financial
condition, results of operations or cash flows.
Major Suppliers
All of the Company's products are manufactured by outside companies. The
Company does not maintain long-term purchase commitments with any manufacturer.
Two manufacturers represent approximately 83% of the total product sales for the
year ended December 31, 2003. Although there are a limited number of
manufacturers for these products, management of the Company believes that other
suppliers could provide similar components on comparable terms.
9. STOCK OPTION AND WARRANT PLANS
The following table summarizes the changes in stock options and
warrants outstanding and the related exercise price for shares of the Company's
Common Stock.
Weighted Weighted
Average Average
Exercise Price Exercise Price
Shares Options Exercisable Shares Warrants Exercisable
---------- -------------- ----------- --------- -------------- ------------
Outstanding at
December 31, 2001 61,500 $ 1.10 61,000 1,419 $ 141.00 1,419
Granted 1,260,000 1.05 1,179,996 2,000 5.00 2,000
Cancelled - - - - - -
Outstanding at
December 31, 2002 1,321,500 $ 1.05 1,241,496 3,419 $ 61.44 3,419
Granted 10,000 1.80 10,000 - - -
Cancelled - - - -
---------- ---------- ---------- ------------
Outstanding at
December 31, 2003 1,331,500 $ 1.06 1,291,504 3,419 $ 61.44 3,419
========== ========== ========== ============
F-24
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
The following table summarizes information about exercisable stock options
and warrants at December 31, 2003:
Remaining
Range of Contractual Average Average
Exercise Number Life in Exercise Number Exercise
Price Outstanding Years Price Exercisable Price
------------------------------------------------------------------------------
Options $1.00 - 1.80 1,331,500 1.75 - 9.83 $ 1.32 1,291,504 $ 1.04
------------------------------------------------------------------------------
Warrants $5.00-141.00 3,419 1.25 - 2.10 $ 73.00 3,419 $ 73.00
------------------------------------------------------------------------------
10. SEGMENT INFORMATION AND FOREIGN OPERATIONS
The Company conducts its business within one industry segment. No single
distributor has accounted for more than 10% of total sales for either 2003 or
2002.
Long-lived assets include property and equipment, net and other noncurrent
assets. The Company's net sales by country to unaffiliated customers in 2003 and
2002 and long-lived assets by country as of December 31, 2003 and 2002 are
approximately as follows:
Long-lived Long-lived
assets at assets at
Net sales Net sales December 31, December 31,
for 2003 for 2002 2003 2002
---------------- ----------------- ---------------- ----------------
As restated As restated
----------------- ----------------
U.S. and Canada $ 10,668,000 $ 13,452,000 $ 1,203,000 $ 481,000
Taiwan 3,097,000 5,579,000 271,000 341,000
Hong Kong 30,763,000 6,067,000 217,000 181,000
Russia 13,467,000 8,999,000 - 42,000
Korea 2,492,000 - 389,000 -
Other 2,399,000 2,871,000 298,000 249,000
--------------- ---------------- ---------------- ----------------
Consolidated $ 62,886,000 $ 36,968,000 $ 2,378,000 $ 1,294,000
=============== ================ ================ ================
F-25
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
11. SUBSEQUENT EVENTS AND RELATED PARTY TRANSACTION
As of March 29, 2004, the Company purchased 4,900 shares of common stock
owned by the minority shareholders of Lexxus International, Inc., a Delaware
corporation ("Lexxus"), (representing the 49% interest in Lexxus not owned by
the Company) in exchange for 100,000 shares of restricted NHTC common stock. The
total purchase price, including acquisition related costs, was approximately
$1.7 million based upon the closing price of NHTC common stock.
Effective on March 31, 2004, the Company entered into a merger agreement
with Marketvision Communications Corp. ("Marketvision"), pursuant to which the
Company acquired all of the outstanding capital stock of Marketvision in
exchange for the issuance of 690,000 shares of NHTC restricted common stock (the
"Issued Shares"), promissory notes in the aggregate principle amount of
approximately $3.2 million and a cash payment of $1,336,875 for a total purchase
price of approximately $16.5 million. Marketvision is the exclusive developer
and service provider of the direct selling software used by the Company since
mid-2001. Based upon the number of new distributors enrolled, Marketvision
charged the Company approximately $1.9 million and $1.5 million for services
provided during the years ended December 31, 2003 and 2002, respectively. As of
December 31, 2003, NHTC owes Marketvision approximately $1.1 million, which is
included in accounts payable.
Management believes that this transaction is in the best interests of the
Company because (i) the success of the Company's business is dependent upon
Marketvision's direct selling software and (ii) the Company projects enrolling a
significant number of new distributors in the future, which would be very
expensive under the former compensation agreement between the Company and
Marketvision. Since the former owners of Marketvision include Terry LaCore, a
member of the Company's Board of Directors and the Chief Executive Officer of
Lexxus International, Inc., a wholly owned subsidiary of NHTC, the Board of
Directors hired the independent appraisal firm of Bernstein, Conklin & Balcombe
to assess the fairness of the transaction with Marketvision from a financial
point of view. In March 2004, Bernstein, Conklin & Balcombe delivered its
opinion to the Company's Board of Directors that the Marketvision transaction is
fair to the Company from a financial point of view.
In addition, the Company entered into a Shareholder's Agreement with the
former shareholders of Marketvision. Such agreement contained customary terms
and conditions, including restrictions on transfers of the NHTC shares, rights
of first refusal and indemnification. Further, the Shareholder's Agreement
contains a one time put right for the benefit of the former shareholders of
Marketvision (other than Mr. LaCore) that requires NHTC, during the six month
period commencing eighteen months following the earlier of (i) the first
anniversary of the closing date, or (ii) the date on which the Issued Shares are
registered with the Securities and Exchange Commission (the "SEC") for resale to
the public, to repurchase all or part of the NHTC shares still owned by the such
stockholders for $4.00 per share less any amount previously received by such
stockholders from the sale of their shares of NHTC stock. The agreement also
provided the former stockholders of Marketvision with piggyback registration
rights in the event we file a registration statement with the SEC, other than on
Forms S-4 or S-8, stock option grants for the former stockholders (other than
Mr. LaCore) as well as three-year
F-26
NATURAL HEALTH TRENDS CORP. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 and 2002
employment agreements for the former stockholders, other than Mr. LaCore. In the
event that the Company defaults on its payment obligations under the notes or
the employment agreements, an entity owned by the former shareholders of
Marketvision (other than Mr. LaCove) has certain rights to use, develop, modify,
market, distribute and sublicense the Marketvision software to third parties.
F-27