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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ________.
Commission File Number: 0-25238
NATURAL HEALTH TRENDS CORP.
Incorporated in Florida I.R.S. Employer Identification No.
59-2705336
12901 Hutton Drive
Dallas, Texas 75234
(972) 241-4080
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of August 2, 2004, the number of shares outstanding of the registrant's class
of common stock, par value $0.001 per share, was 5,449,869.
NATURAL HEALTH TRENDS CORP.
Quarterly Report on Form 10-Q
June 30, 2004
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 1
Consolidated Statements of Operations 2
Consolidated Statements of Comprehensive Income 3
Consolidated Statements of Cash Flows 4
Notes to the Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities; Use of Proceeds and Issuer
Purchases of Equity Securities 23
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2004 2003
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 7,837,497 $ 11,133,075
Restricted cash 2,279,255 1,363,188
Accounts receivable 547,753 238,487
Inventories, net 11,973,034 3,580,303
Prepaid expenses and other 4,520,726 3,363,941
------------ ------------
Total current assets 27,158,265 19,678,994
Property and equipment, net 724,130 882,648
Software 5,400,000 --
Goodwill 14,026,923 207,765
Database, net 553,521 509,391
Deferred tax asset 1,309,340 --
Deposits and other assets 842,276 778,607
------------ ------------
Total assets $ 50,014,455 $ 22,057,405
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,650,840 $ 3,820,339
Accrued expenses 2,676,227 831,454
Accrued distributor commissions 3,768,020 2,285,182
Income taxes payable 1,258,236 1,442,655
Deferred tax liability 256,343 --
Notes payable 232,113 287,703
Current portion of long-term debt 2,495,781 26,400
Deferred revenue 16,401,247 6,633,586
Other current liabilities 238,963 512,838
------------ ------------
Total current liabilities 31,977,770 15,840,157
Long term debt 326,237 30,665
------------ ------------
Total liabilities 32,304,007 15,870,822
Minority interest 523,387 710,957
Mezzanine common stock 960,000 --
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 5,449,869 and 4,656,409 shares as of June 30, 2004 and
December 31, 2003, respectively) 5,450 4,656
Additional paid in capital 48,802,323 34,006,862
Accumulated deficit (32,025,704) (28,389,232)
Accumulated other comprehensive loss (555,008) (146,660)
------------ ------------
Total stockholders' equity 16,227,061 5,475,626
------------ ------------
Total liabilities and stockholders' equity $ 50,014,455 $ 22,057,405
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
1
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net Sales $ 17,686,659 $ 11,984,085 $ 56,121,868 $ 23,224,402
Cost of sales 3,287,860 1,681,983 11,215,988 3,778,690
------------ ------------ ------------ ------------
Gross profit 14,398,799 10,302,102 44,905,880 19,445,712
Operating expenses:
Distributor commissions 12,578,193 4,928,928 32,782,848 9,510,046
Selling, general and administrative expenses 9,769,336 4,026,873 16,242,500 6,849,829
------------ ------------ ------------ ------------
Total operating expenses 22,347,529 8,955,801 49,025,348 16,359,875
------------ ------------ ------------ ------------
(Loss) income from operations (7,948,730) 1,346,301 (4,119,468) 3,085,837
Other income (expense):
Loss on foreign exchange (6,582) (64,292) (15,450) (11,492)
Other income (expense), net (124,031) (75,318) 44,552 (10,804)
Interest expense, net (59,084) (11,776) (59,997) (20,176)
------------ ------------ ------------ ------------
Total other income (expense), net (189,697) (151,386) (30,895) (42,472)
------------ ------------ ------------ ------------
(Loss) income from operations before taxes and
minority interest (8,138,427) 1,194,915 (4,150,363) 3,043,365
Income tax benefit (provision) 1,544,678 (330,322) 747,065 (700,322)
Minority interest benefit (expense) (153,450) 82,417 (233,174) (23,231)
------------ ------------ ------------ ------------
Net (loss) income (6,747,199) 947,010 (3,636,472) 2,319,812
Preferred stock dividends -- 408 -- 810
------------ ------------ ------------ ------------
Net (loss) income available to common stockholders $ (6,747,199) $ 946,602 $ (3,636,472) $ 2,319,002
============ ============ ============ ============
Basic (loss) income per common share $ (1.24) $ 0.20 $ (0.72) $ 0.51
============ ============ ============ ============
Diluted (loss) income per common share $ (1.24) $ 0.17 $ (0.72) $ 0.43
============ ============ ============ ============
Weighted average shares outstanding:
Basic 5,446,713 4,627,941 5,059,130 4,569,988
============ ============ ============ ============
Diluted 5,446,713 5,628,487 5,059,130 5,421,302
============ ============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
2
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net (loss) income $ (6,747,199) $ 947,010 $ (3,636,472) $ 2,319,812
Other comprehensive income, net of tax:
Foreign currency translation adjustment (262,971) (9,403) (408,348) 15,437
------------ ------------ ------------ ------------
Comprehensive (loss) income $ (7,010,170) $ 937,607 $ (4,044,820) $ 2,335,249
============ ============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
3
NATURAL HEALTH TRENDS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
----------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (3,636,472) $ 2,319,812
Adjustments to reconcile net (loss) income to net cash (used in)
provided by operating activities:
Depreciation and amortization 503,030 444,866
Stock issued for services 25,031 50,265
Minority interest of subsidiary 233,174 23,231
Imputed compensation 66,000 --
Deferred income taxes (1,052,997) --
Changes in assets and liabilities, excluding acquisitions of businesses:
Accounts receivable (309,266) (662,321)
Inventories, net (8,392,731) (3,176)
Prepaid expenses (2,414,123) 281,387
Deposits and other assets (99,753) 26,726
Accounts payable 2,645,936 (1,085,428)
Accrued expenses 1,742,016 55,116
Accrued distributor commissions 1,482,838 --
Income tax payable (184,419) 700,322
Deferred revenue 9,767,661 (1,574,261)
Other current liabilities (273,875) 14,602
------------ ------------
Total Adjustments 3,738,522 (1,728,671)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 102,050 591,141
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquired (1,336,875) --
Capital expenditures (146,122) (561,289)
Database purchase 39,537 (226,845)
Increase in restricted cash (916,067) (628,041)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (2,359,527) (1,416,175)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of notes payable and long-term debt (494,039) (198,114)
Payment to minority investors (135,714) --
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (629,753) (198,114)
------------ ------------
EFFECT OF TRANSLATION ADJUSTMENTS ON CASH AND CASH EQUIVALENTS (408,348) 15,437
NET DECREASE IN CASH (3,295,578) (1,007,711)
CASH, BEGINNING OF PERIOD 11,133,075 3,863,946
------------ ------------
CASH, END OF PERIOD $ 7,837,497 $ 2,856,235
============ ============
SUPPLEMENTAL DISCLOSURE OF CASHFLOW INFORMATION: Six Months Ended
June 30,
----------------------------
2004 2003
------------ ------------
Interest paid $ 20,392 $ 13,089
Income taxes paid, net of refunds received $ 496,441 $ 102,655
DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Common stock issued for acquisitions $ 15,498,220 $ 432,900
The accompanying notes are an integral part of these
consolidated financial statements.
4
NATURAL HEALTH TRENDS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2004
(Unaudited)
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 wholly-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:
o Lexxus International (SW Pacific) Pty. Ltd. (Australia)
o Kaire Nutraceuticals Australia Pty. Ltd. (Australia)
o Lexxus International (NZ) Ltd. (New Zealand)
o Kaire Nutraceuticals New Zealand Ltd. (New Zealand)
o Lexxus International Co., Ltd. (Taiwan)
o MyLexxus Europe AG (Switzerland)
o KGC Networks Pte. Ltd. (Singapore)
o Lexxus International Co., Ltd. (Hong Kong)
o Lexxus International Marketing, Pte. Ltd. (Singapore)
o Lexxus International Network Marketing, Inc. (the Philippines)
o Lexxus Korea Co., Ltd. (South Korea)
o I Luv My Pet, Inc. (U.S.)
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. As a result, certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, consisting of normal recurring adjustments, considered necessary
for a fair statement of the Company's financial information as of June 30, 2004,
and for the six months and three months ended June 30, 2004 and 2003. The
results of operations of any interim period are not necessarily indicative of
the results of operations to be expected for the fiscal year. These consolidated
financial statements should be read in conjunction with the consolidated
financial statements and related notes included in our 2003 Annual Report on
Form 10-KSB.
NHTC's common stock, par value, $0.001 per share (the "Common Stock"),
is listed on the NASD 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. On May 27, 2004, the Company filed
a listing application with The NASDAQ Stock Market for quotation of its shares
of common stock. No assurance can be given that the Company will be approved by
NASDAQ, or if approved, when the Company's shares will be quoted thereon.
5
2. 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.
Reclassifications
Certain 2003 amounts in the consolidated statements of operations and
the consolidated statements of cash flows have been reclassified to
conform with the current year presentation.
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 June 30,
2004, the Company had deferred revenue of approximately $16,401,000, of
which approximately $7,004,000 pertained to goods ordered that will be
shipped in the third quarter of 2004 and will be recognized as revenue
at the time they are shipped. The Company extended its existing 14-day
return policy to 180 days for certain Hong Kong sales recorded in the
three months ended June 30, 2004. The Company is unable to estimate the
sales returns that will result from this change in policy and
accordingly has concluded to defer revenue recognition on sales orders
of approximately $5,404,000 as of June 30, 2004 until the 180-day return
period has expired in accordance with Statement of Financial Accounting
Standards No. 48 "Revenue Recognition when Right of Return Exists".
Deferred revenue will be written off for sales returns recorded during
the 180-day period pertaining to these sales orders. Deferred revenue
also included the unearned refundable annual distributor fees of
approximately $3,993,000.
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.
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 three weeks in arrears.
Commissions are accrued when earned.
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
6
board members effective for the year beginning after December 15, 2004.
The compensation 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 period, respectively: annual dividends of $0
for both years; expected volatility of 100% and 200% for 2004 and 2003,
respectively; risk free interest rate of 4.25% and 7.00% for 2004 and
2003, respectively; and expected life of 3 years for 2004 and 2003,
respectively. There were no stock options granted during the six months
ended June 30, 2004 or 2003. 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:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net (loss) income available to common stockholders $ (6,747,199) $ 946,602 $ (3,636,472) $ 2,319,002
Add: Stock-based employee compensation expense
included in reported net income, net of tax effect -- -- -- --
Deduct: Total stock-based employee compensation
expense determined under fair value based method, net
of tax effect (5,542) (9,500) (11,084) (19,000)
------------ ------------ ------------ ------------
Pro forma net income available to common stockholders $ (6,752,741) $ 937,102 $ (3,647,556) $ 2,300,002
============ ============ ============ ============
Basic (loss) income per share:
As reported $ (1.24) $ 0.20 $ (0.72) $ 0.51
============ ============ ============ ============
Pro forma $ (1.24) $ 0.20 $ (0.72) $ 0.50
============ ============ ============ ============
Diluted (loss) income per share:
As reported $ (1.24) $ 0.17 $ (0.72) $ 0.43
============ ============ ============ ============
Pro forma $ (1.24) $ 0.17 $ (0.72) $ 0.42
============ ============ ============ ============
Earnings Per Share
Basic earnings per share is computed based on the weighted average
number of common shares outstanding during the periods presented.
Diluted earnings per share data gives effect to all potentially dilutive
common shares that were outstanding during the periods presented.
7
Net income per share from operations for the three and six months ended
June 30, 2004 and 2003 are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Basic Calculation:
Net (loss) income available to common stockholders $ (6,747,199) $ 946,602 $ (3,636,472) $ 2,319,002
Weighted average number of shares outstanding 5,446,713 4,627,941 5,059,130 4,569,988
------------ ------------ ------------ ------------
Basic net (loss) income per share from operations $ (1.24) $ 0.20 $ (0.72) $ 0.51
============ ============ ============ ============
Diluted Calculation:
Net (loss) income available to common stockholders $ (6,747,199) $ 946,602 $ (3,636,472) $ 2,319,002
Weighted average number of shares outstanding 5,446,713 6,667,124 5,059,130 6,459,939
Net effect of dilutive stock options and warrants based
upon treasury stock method -- (1,038,637) -- (1,038,637)
------------ ------------ ------------ ------------
Weighted average number of shares outstanding assuming
full conversion of all potentially dilutive
securities 5,446,713 5,628,487 5,059,130 5,421,302
------------ ------------ ------------ ------------
Diluted net (loss) income per share from operations $ (1.24) $ 0.17 $ (0.72) $ 0.43
============ ============ ============ ============
Accounting for Software
As part of the Marketvision Communications Corp. acquisition (see
Business Combinations), the Company acquired approximately $5,600,000 of
computer software and programs. The valuation of the software was
determined by a third party appraisal firm. The software is classified
as a non-current asset in the balance sheet and is being amortized over
a seven-year period beginning April 1, 2004.
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
8
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.
SFAS 150. In May 2003, the FASB issued Statements of Financial
Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS
150"). SFAS 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. SFAS 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an
asset in some circumstances). SFAS 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS 150 has not had, and is not
expected to have, a significant impact on the Company's financial
condition, results of operations or cash flows.
3. BUSINESS COMBINATIONS
The Company entered into the following business combinations during the
six months ended June 30, 2004:
Purchase of the Minority Interest of Lexxus International, Inc.
On March 29, 2004, the Company purchased 4,900 shares of common stock
owned by the minority stockholders 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 of approximately
$15,000, was approximately $1,977,000 based upon the average closing price of
NHTC common stock of $23.08 discounted by 15% due to the restrictions contained
in the purchase agreement. The average closing price of $23.08 was calculated
based on the closing price of NHTC common stock a few days before and after the
acquisition was announced. The entire purchase price was allocated to goodwill.
9
Purchase of MarketVision Communications Corp.
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 $3,203,000, a cash payment of $1,336,875 in April 2004, less
pre-acquisition net payables due to MarketVision of approximately $609,000, for
a total purchase price of approximately $17,618,000, including acquisition costs
of approximately $150,000. The Issued Shares were valued at the average closing
price of NHTC common stock of $23.08 discounted by 15% due to certain
restrictions contained in the purchase agreement. The average closing price of
$23.08 was calculated based on the closing price of NHTC common stock a few days
before and after the acquisition was announced. MarketVision is the exclusive
developer and service provider of direct selling internet technology used by the
Company since 2001. MarketVision hosts and maintains the internet technology for
the Company and charges an annual fee for this service based upon the number of
enrolled distributors of the Company's products. MarketVision earned revenues
for this service of approximately $1,839,000 and $579,000 for the year ended
December 31, 2003 and three months ended March 31, 2004, respectively.
Management believes that this transaction was 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 stockholders of MarketVision. Such agreement contained customary terms
and conditions, including restrictions on transfers of the Issued Shares, rights
of first refusal and indemnification. Further, the Shareholder's Agreement
contains a one time put right related to 240,000 Issued Shares for the benefit
of the former stockholders 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
such 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
the Issued Shares. The Company has recorded this obligation of $960,000 as
mezzanine common stock in the balance sheet at June 30, 2004. The agreement also
provided the former stockholders of MarketVision with piggyback registration
rights in the event NHTC files 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 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 stockholders of MarketVision (other than Mr. LaCore) has
certain rights to use, develop, modify, market, distribute and sublicense the
MarketVision software to third parties.
Operations of MarketVision subsequent to March 31, 2004 have been
included in the Company's consolidated financial statements. The transaction was
accounted for using the purchase method of accounting and the purchase price was
allocated among the assets acquired based on their estimated fair market values.
The assets of MarketVision included certain computer equipment and developed
software.
10
The purchase price was calculated as follows:
690,000 shares of NHTC Common Stock valued at $23.08 per
share less 15% discount for restrictions associated with the stock
issued $ 13,536,420
Cash paid in April 2004 1,336,875
Promissory notes issued at closing 3,203,403
Preacquisition net payables due to MarketVision (609,190)
Acquisition costs 150,302
---------------
Total purchase price $ 17,617,810
===============
The purchase price was allocated among assets acquired based on their
estimated fair market values as follows:
Property and equipment 25,000
Amortizable intangible assets 5,600,000
Goodwill 11,992,810
Deferred taxes (1,904,000)
Deferred tax asset recognized for the Company's loss carry forward
based upon offset against MarketVision's deferred tax liabilities 1,904,000
---------------
Total purchase price allocation $ 17,617,810
===============
Amortizable intangibles acquired will be amortized over their estimated
life of seven years. The purchase price allocation is based on preliminary
estimates, including estimates of federal tax contingencies, which are subject
to change once additional information becomes available. Changes to these
estimates could result in changes to the purchase price allocation.
Purchase of the Minority Interest of Lexxus International Co., Ltd. (Taiwan)
On April 19, 2004, the Company purchased 510,000 shares of common stock
owned by the minority stockholders of Lexxus International Co., Ltd. (Taiwan), a
Taiwan limited liability corporation ("Lexxus Taiwan"), (representing the 30%
interest in Lexxus Taiwan not owned by the Company or Lexxus) in exchange for
approximately $136,000 in cash. The cash consideration given approximated the
book value of the shares acquired and no goodwill resulted from the transaction.
All Lexxus Taiwan minority shareholders were unrelated to the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management's Discussion and Analysis should be read in
conjunction with Management's Discussion and Analysis included in our Annual
Report on Form 10-KSB for the year ended December 31, 2003, filed with the
Securities and Exchange Commission ("SEC"), and our other filings, including
Current Reports on Form 8-K, filed with the SEC through the date of this Report.
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.
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. I Luv My Pet, Inc., ("ILMP"), a wholly-owned subsidiary,
distributes nutritional supplements for dogs and cats. NHTC operates its Lexxus,
11
eKaire and ILMP direct selling operations as a single segment and primarily
sells its products through a network of commissioned 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 six months ended June 30, 2004.
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 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.
Cost of sales. Cost of sales 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, prior to the
closing of the merger with Marketvision as of March 31, 2004, the cost of NHTC's
third party software service provider.
Distributor commissions. Distributor commissions are dependent on the
sales mix and, for 2004, typically range between 49% to 54% 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.
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 stockholders' equity and such do not impact the statement of
operations.
Effect of inflation. NHTC believes inflation has not had a material
impact on its operations or profitability.
Critical Accounting Policies and Estimates
For a complete review of NHTC's critical accounting policies and new
accounting pronouncements that may impact NHTC's operations, refer to the Annual
Report on Form 10-KSB for the year ended December 31, 2003. 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 June 30, 2004 include the following:
12
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.
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.
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.
Tax Valuation Allowances
The Company evaluates the probability of realizing the future benefits
of any of its deferred tax assets and records a valuation allowance when it
believes a portion or all of its deferred tax assets may not be realized. If the
Company is unable to realize the expected future benefits of its deferred tax
assets, it would be required to provide an additional valuation allowance.
13
Results of Operations
Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30,
2003
The following table summarizes NHTC's consolidated operating results as
a percentage of net sales for each of the years indicated:
Three Months Ended
June 30,
-------------------------
2004 2003
---------- ----------
Net sales 100.0% 100.0%
Cost of sales 18.6% 14.0%
---------- ----------
Gross profit 81.4% 86.0%
Operating expenses:
Distributor commissions 71.1% 41.1%
Selling, general and administrative expenses 55.2% 33.6%
---------- ----------
Total operating expenses 126.3% 74.7%
---------- ----------
(Loss) income from operations (44.9%) 11.3%
Other income (expense) (1.1%) (1.3%)
---------- ----------
(Loss) income from continuing operations before taxes and
minority interest expense (46.0%) 10.0%
Income tax benefit (expense) and minority interest 7.9% (2.1%)
---------- ----------
Net (loss) income (38.1%) 7.9%
========== ==========
Overview of the Results of Operations for the Three Months ended June 30, 2004
As previously disclosed, on April 12, 2004, an investigative television
program was aired nationwide in the People's Republic of China with respect to
the operation of the Company's Lexxus Hong Kong subsidiary and the Lexxus
representative office located in Beijing. After a thorough internal
investigation of the issues raised in the television program, the Company
concluded that additional training and development of certain Lexxus independent
distributors located in Hong Kong was warranted. Accordingly, the Company began
intensive training of its independent distributors with respect to (i)
applicable Chinese legal requirements, and (ii) the need for distributors to
accurately and fairly describe business opportunities available to potential
distributors. In May 2004, the Company elected to suspend shipment of product to
certain Hong Kong distributors until they had completed the required training.
This resulted in an unshipped sales backlog of orders to be shipped of
approximately $6.6 million as of June 30, 2004. Training of the distributors has
been substantially completed as of August 4, 2004.
Due to the adverse publicity caused by the airing of the television
program, gross sales (before returns and refunds) for the Lexxus Hong Kong
operations declined from an average of approximately $285,000 per day during the
quarter ended March 31, 2004 to an average of approximately $110,000 per day
during the thirty (30) day period from April 12, 2004 through May 12, 2004.
However, gross sales (before returns and refunds) have steadily increased since
that time and averaged approximately $169,000 per day during the quarter ended
June 30, 2004. It is difficult to predict when, if ever, sales from the Lexxus
Hong Kong operations will increase to levels comparable to that of the first
quarter.
14
In order to accommodate the concerns of many independent distributors,
Lexxus extended its existing 14-day return policy in Hong Kong to 180 days to
allow distributors and customers who purchased products during the two-week
period prior to, and the two-week period after, the airing of the television
program to return purchased merchandise for a full refund. The Company is unable
to estimate the sales returns that will result from this change in policy and
accordingly has concluded to defer revenue recognition on sales orders of
approximately $5,404,000 as of June 30, 2004 until the 180-day return period has
expired in accordance with Statement of Financial Accounting Standards No. 48
"Revenue Recognition when Right of Return Exists". Deferred revenue will be
written off for sales returns recorded during the 180-day period pertaining to
these sales orders. Further, the Company decided not to seek recovery for any
commissions already paid to its distributors related to product sales recorded
during this period that were subsequently returned. In addition, the Company
incurred significant additional costs during the second quarter to conduct the
training efforts and to further remediate the adverse publicity in the Hong Kong
region.
A summary of the net adverse impact to the Company's results of
operations for the three months ended June 30, 2004 due to the sales backlog and
the estimated additional costs and charges incurred for training and remediation
efforts are as follows:
Item Amount
- ------------------------------------------------------------------ -----------
Hong Kong Deferred Revenue: (Unaudited)
Orders entered but not shipped $ 6,598,000
Less: estimated cost of sales on orders not shipped (1,188,000)
Less: estimated commissions on orders not shipped (3,299,000)
-----------
2,111,000
Orders not allowed as revenue under SFAS No. 48 $ 5,404,000
Less: estimated cost of sales on SFAS No. 48 orders (973,000)
-----------
4,431,000
-----------
Hong Kong Training and Remediation Costs:
Incremental product returns under the special extended return
privilege $ 1,963,000
Less: estimated cost of sales on incremental product returns (353,000)
Additional fees paid for retention of distributors 360,000
Facilities and related costs to conduct distributor training 590,000
Advertising, legal and media related costs 80,000
-----------
$ 2,640,000
-----------
Total net adverse impact for the period $ 9,182,000
===========
Net Sales
Net sales were approximately $17,687,000 for the three months ended
June 30, 2004 compared to $11,984,000 for the three months ended June 30, 2003.
This net increase of approximately $5,703,000 or 48% was primarily attributable
to the increased number of active Lexxus distributors and re-orders
(approximately $12.4 million) and sales of new products (approximately $6.5
million) offset partially by sales deferred as of June 30, 2004 (approximately
$7.0 million in sales back log) and approximately $5.4 million with respect to
application of SFAS No. 48 and also offset by an additional sales return
allowance taken in the quarter of approximately $0.8 million.
15
Cost of Sales
Cost of sales was approximately $3,288,000 or 18.6% of net sales for
the three months ended June 30, 2004 compared with approximately $1,682,000 or
14% of net sales for the three months ended June 30, 2003. This increase of
approximately $1,606,000 or 95% was primarily attributable to increased net
sales and the Lexxus product mix sold in 2004 compared to 2003. Cost of sales as
a percentage of net sales increased which is primarily attributable to the
change of product mix sold in 2004 and greater air freight costs to ship product
from the US to Asia in 2004.
Gross Profit
Gross profit was approximately $14,399,000 or 81.4% of net sales for
the three months ended June 30, 2004 compared with approximately $10,302,000 or
86.0% of net sales for the three months ended June 30, 2003. This increase of
approximately $4,097,000 or 40% was attributable to the increase in gross sales
of Lexxus products partially offset by the cost of sales as a percentage of net
sales increased due to the change of product mix sold in 2004 and the greater
air freight costs to ship product from the US to Asia in 2004.
Distributor Commissions
Distributor commissions were approximately $12,578,000 or 71.1% of net
sales for the three months ended June 30, 2004 compared with approximately
$4,929,000 or 41.1% of net sales for the three months ended June 30, 2003. This
increase of approximately $7,649,000 or 155% was directly related to the
increase in net sales, the terms of the compensation plans and promotions held
during the second quarter of 2004. The increase in commission expense as a
percentage of net sales for the three months ended June 30, 2004 compared to the
three months ended June 30, 2003 was primarily due to sales promotions and the
commissions paid on returns and refunds pertaining to the Hong Kong region. In
accordance with SFAS No. 48, the Company deferred approximately $5,404,000 of
revenue in the period ended June 30, 2004 yet recognized the commissions,
therefore, higher commissions are applied to a lower revenue base. See "Overview
of the Results of Operations for the Three Months ended June 30, 2004" above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were approximately
$9,769,000 or 55.2% of net sales for the three months ended June 30, 2004
compared with approximately $4,027,000 or 33.6% of net sales for the three
months ended June 30, 2003. The increase in selling, general and administrative
costs as a percentage of net sales is primarily attributable to the additional
deferred revenue at June 30, 2004 resulting from orders entered but not shipped
of approximately $7,004,000 and Hong Kong orders of approximately $5,404,000 for
which sales returns cannot be estimated as of June 30, 2004. The increase in
selling, general and administrative expenses of approximately $5,742,000 or 143%
was attributable to the administrative expenses associated with the new office
in Seoul, South Korea, which was opened in the second quarter of 2003, and the
balance of the increase resulted from sales and marketing conventions,
promotions and trainings, especially in the Hong Kong and Korean operations.
Selling, general and administrative expenses increased as a percentage of net
sales to 55.2% in 2004 compared to 33.6% in 2003 primarily due to the additional
costs associated with the training and remediation efforts being conducted in
the Hong Kong region. See "Overview of the Results of Operations for the Three
Months ended June 30, 2004" above.
Other Expenses
Other expenses were approximately $190,000 for the three months ended
June 30, 2004 compared with expense of approximately $151,000 for the three
months ended June 30, 2003. This increase of approximately $39,000 was due to an
increase in other expenses and an increase in interest expense on notes payable
related to acquisition of Marketvision.
16
Income Taxes
Income tax benefit was approximately $1,545,000 or (19.0%) of income
before taxes and minority interest for the three months ended June 30, 2004
compared with income tax expense of $330,000 or 27.6% of income before taxes and
minority interest for the three months ended June 30, 2003. The decrease in
effective tax rate was attributable to use of net operating losses in the U.S.
and lower effective tax rates on foreign earnings in 2004.
Minority Interest, Net of Taxes
Minority interest expense was approximately $153,000 for the three
months ended June 30, 2004, as compared to minority interest income of
approximately $82,000 for the three months ended June 30, 2003. The increase in
the expense relates primarily to the profitable operations of our subsidiary,
KGC Networks Pte. Ltd.
Net (Loss) Income
Net loss was approximately $6,747,000 or (38.1%) of net sales for the
three months ended June 30, 2004 compared to net income of approximately
$947,000 or 7.9% of net sales for the three months ended June 30, 2003. Compared
to 2003, this decrease in net income in 2004 is primarily due to the decline in
net sales for the Hong Kong region due to adverse publicity, the Hong Kong
region sales backlog as of June 30, 2004, the deferral of Hong Kong revenue
related to SFAS No. 48 and the additional costs and charges incurred in the Hong
Kong region for training and remediation efforts during the three months ended
June 30, 2004. See "Overview of the Results of Operations for the Three Months
ended June 30, 2004" above.
Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003
The following table summarizes NHTC's consolidated operating results as
a percentage of net sales for each of the years indicated:
Six Months Ended
June 30,
-------------------------
2004 2003
---------- ----------
Net sales 100.0% 100.0%
Cost of sales 20.0% 16.3%
---------- ----------
Gross profit 80.0% 83.7%
Operating expenses:
Distributor commissions 58.4% 40.9%
Selling, general and administrative expenses 28.9% 29.5%
---------- ----------
Total operating expenses 87.3% 70.4%
---------- ----------
Income (loss) from operations (7.3%) 13.3%
Other income (expense) (0.1%) (0.2%)
---------- ----------
Income (loss) from continuing operations before taxes and
minority interest expense (7.4%) 13.1%
Income tax benefit (expense) and minority interest 0.9% (3.1%)
---------- ----------
Net income (loss) (6.5%) 10.0%
========== ==========
17
Overview of the Results of Operations for the Six Months ended June 30, 2004
The Company's results of operations for the six months ended June 30,
2004 were adversely impacted due to the decline during the three months ended
June 30, 2004 in net sales for the Hong Kong region attributable to adverse
publicity, the Hong Kong sales backlog as of June 30, 2004 and the additional
costs and charges incurred for training and remediation efforts in the Hong Kong
region. See "Overview of the Results of Operations for the Three Months ended
June 30, 2004".
Net Sales
Net sales were approximately $56,122,000 for the six months ended June
30, 2004 compared to $23,224,000 for the six months ended June 30, 2003. This
net increase of approximately $32,898,000 or 142% was primarily attributable to
the increased number of active Lexxus distributors (approximately $30.4
million), Lexxus's expansion into new markets, including South Korea in the
second quarter of 2003 (approximately $1.3 million), sales of new products
(approximately $11.2 million) and the shipment of Hong Kong orders in backlog as
of December 31, 2003 (approximately $4.0 million), offset partially by sales
deferred as of June 30, 2004 (approximately $7.0 million in sales back log) and
approximately $5.4 million with respect to application of SFAS No. 48 and also
offset by an additional sales return allowance taken in the first six months of
quarter of approximately $1.6 million for requests for returns taken but not yet
processed.
Cost of Sales
Cost of sales was approximately $11,216,000 or 20.0% of net sales for
the six months ended June 30, 2004 compared with approximately $3,779,000 or
16.3% of net sales for the six months ended June 30, 2003. This increase of
approximately $7,437,000 or 197% was primarily attributable to increased net
sales and the Lexxus product mix compared to eKaire product mix in 2004 compared
to 2003. Cost of sales as a percentage of net sales increased which is primarily
attributable to the change of product mix sold in 2004 and greater air freight
costs to ship product from the US to Asia in 2004.
Gross Profit
Gross profit was approximately $44,906,000 or 80.0% of net sales for
the six months ended June 30, 2004 compared with approximately $19,446,000 or
83.7% of net sales for the six months ended June 30, 2003. This increase of
approximately $25,460,000 or 131% was attributable to the increase in gross
sales of Lexxus products partially offset by the cost of sales as a percentage
of net sales increased due to the change of product mix sold in 2004 and the
greater air freight costs to ship product from the US to Asia in 2004.
Distributor Commissions
Distributor commissions were approximately $32,783,000 or 58.4% of net
sales for the six months ended June 30, 2004 compared with approximately
$9,510,000 or 40.9% of net sales for the six months ended June 30, 2003. This
increase of approximately $23,273,000 or 245% was directly related to the
increase in net sales, the terms of the compensation plans and promotions held
during the six months ended June 30, 2004. The increase in commission expense as
a percentage of net sales for the six months ended June 30, 2004 compared to the
six months ended June 30, 2003 was primarily due to sales promotions and the
commissions paid on returns and refunds pertaining to the Hong Kong region. In
accordance with SFAS No. 48, the Company deferred approximately $5,404,000 of
revenue in the period ended June 30, 2004 yet recognized the commissions,
therefore, higher commissions are applied to a lower revenue base. See "Overview
of the Results of Operations for the Three Months ended June 30, 2004" above.
18
Selling, General and Administrative Expenses
Selling, general and administrative costs were approximately
$16,243,000 or 28.9% of net sales for the six months ended June 30, 2004
compared with approximately $6,850,000 or 29.5% of net sales for the six months
ended June 30, 2003. This increase of approximately $9,393,000 or 137% was
attributable to the administrative expenses associated with the new office in
Seoul, South Korea, which was opened in the second quarter of 2003, and the
balance of the increase resulted from sales and marketing conventions,
promotions and trainings, especially in the Hong Kong and Korean operations. The
2004 selling, general and administrative costs as a percentage of net sales is
higher than usual which is primarily attributable to the additional deferred
revenue at June 30, 2004 resulting from orders entered but not shipped of
approximately $7,004,000 and Hong Kong orders of approximately $5,404,000 for
which sales returns cannot be estimated as of June 30, 2004. See "Overview of
the Results of Operations for the Three Months ended June 30, 2004" above.
Other Income (Expense)
Other expense was approximately $31,000 for the six months ended June
30, 2004 compared with expense of approximately $42,000 for the six months ended
June 30, 2003. This increase of approximately $11,000 was due to an increase in
other income partially offset by an increase in interest expense on notes
payable related to the acquisition of Marketvision.
Income Taxes
Income tax benefit was approximately $747,000 or (18.0%) of income
before taxes and minority interest for the six months ended June 30, 2004
compared with $700,000 or 23.0% of income before taxes and minority interest for
the six months ended June 30, 2003. The decrease in effective tax rate was
attributable to use of net operating losses in the U.S. and lower effective tax
rates on foreign earnings in 2004.
Minority Interest, Net of Taxes
Minority interest expense was approximately $233,000 for the six months
ended June 30, 2004, as compared to approximately $23,000 of expense for the six
months ended June 30, 2003. The increase in the expense relates primarily to the
profitable operations of our subsidiary, KGC Networks Pte. Ltd.
Net Income (Loss)
Net loss was approximately ($3,636,000) or (6.5%) of net sales for the
six months ended June 30, 2004 compared to net income of approximately
$2,320,000 or 10% of net sales for the six months ended June 30, 2003. Compared
to 2003, this decrease in net income in 2004 is primarily due to the decline in
net sales for the Hong Kong region due to adverse publicity, the Hong Kong
region sales backlog as of June 30, 2004, the deferral of Hong Kong revenue in
accordance with SFAS No. 48 and the additional costs and charges incurred in the
Hong Kong region for training and remediation efforts during the three months
ended June 30, 2004. See "Overview of the Results of Operations for the Three
Months ended June 30, 2004" above.
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.
At June 30, 2004, the ratio of current assets to current liabilities
was 0.85 to 1.00 and NHTC had working capital deficit of approximately
$4,820,000. Working capital as of June 30, 2004 declined from December 31, 2003
and March 31, 2004 levels primarily driven by increased deferred revenue and
increased accrued expenses, both due to the Hong Kong operations.
19
Cash provided by operations for the six months ended June 30, 2004 was
approximately $102,000. Cash used by investing activities during the period was
approximately $2,360,000, which primarily relates to the cash payment made to
Marketvision as part of the acquisition coupled with an increase of restricted
cash related to the credit card reserve and capital expenditures. Cash used in
financing activities during the period was approximately $630,000 utilized for
the repayment of notes payable and long-term debt and the payment to minority
investors in Taiwan. Total cash decreased by approximately $3,296,000 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 its cash and cash equivalents, 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 and possibly
other countries in 2005. The estimated cost to expand into a new country is
approximately $2 to $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.
Direct sales and foreign investment in the direct sales industry are
very tightly regulated in China. The Company has been unable to determine
whether any governmental investigations have been initiated or are under
consideration by the Chinese government as a result of the adverse publicity
received there. Nevertheless, in June 2004, Lexxus obtained a license to engage
in wholesale/retail business in China. The wholesale/retail license has a
duration of 30 years and requires a capital investment of $12 million, of which
$8 million must be funded in cash over a three-year period. Currently, a
wholesale/retail outlet is the only legal way to operate in China, as direct
selling is illegal. There is a proposal in China to allow direct selling within
the marketplace. The Company is currently unable to predict whether it will be
successful in obtaining a direct selling license to operate in China, and if it
is successful, when it will be permitted to commence direct selling operations
there. Further, even if the Company is successful in obtaining a direct selling
license to do business in China, it is uncertain as to whether the Company will
generate profits from such operations.
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, to continue its expansion into new
markets, to fund its operations in the event that sales in the Lexxus Hong Kong
subsidiary do not increase materially, to fund the capital investment required
by the wholesale/retail license obtained in China 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 plans
and projections, and if NHTC is required to raise additional funds, there is no
assurance that funds could be raised on favorable terms, if at all. Failure to
raise additional funds could materially and adversely affect the Company's
business, prospects and financial condition.
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.
Forward Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q
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 Quarterly 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 Quarterly Report,
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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. 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 Quarterly 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 Quarterly 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:
o our relationship with our distributors;
o our need to continually recruit new distributors;
o our internal controls and accounting methods may require further
modification;
o regulatory matters governing our products and network marketing
system;
o adverse publicity associated with our products or network marketing
organizations;
o product liability claims;
o our reliance on outside manufacturers;
o risks associated with operating internationally, including foreign
exchange risks;
o product concentration;
o dependence on increased penetration of existing markets;
o the competitive nature of our business; and
o 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
NHTC does not engage in trading market risk sensitive instruments and
does not purchase investments as hedges or for purposes "other than trading"
that are likely to expose it to certain types of market risk, including interest
rate, commodity price or equity price risk. NHTC has not issued any debt
instruments, entered into any forward or future contracts, purchased any options
or entered into any swaps.
Currency Risk and Exchange Rate Information
Some of NHTC's revenue and some of their expenses are recognized
outside of the United States, except for inventory purchases, which are
primarily transacted in U.S. dollars from vendors in the United States. The
local currency of each subsidiary's primary markets is considered the functional
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currency. Revenue and expenses are translated at the weighted average exchange
rates for the periods reported. Therefore, the reported revenue and earnings
will be positively impacted by a weakening of the U.S. dollar and will be
negatively impacted by a strengthening of the U.S. dollar. Given the uncertainty
of exchange rate fluctuations, we cannot estimate the effect of these
fluctuations on our future business, product pricing, results of operations or
financial condition.
Seasonality
In addition to general economic factors, NHTC is impacted by seasonal
factors and trends such as major cultural events and vacation patterns. For
example, most Asian markets celebrate their respective local New Year in the
first quarter, which generally has a negative impact on that quarter. We believe
that direct selling in the United States and Europe is also generally negatively
impacted during the month of August, which is in our third quarter, when many
individuals, including our distributors, traditionally take time off for
vacations.
Item 4. 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:
(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 amended and restated 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 June 30, 2004 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 six months
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ended June 30, 2004, the Company made changes to improve 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 hired a new Chief Financial Officer in August 2004 and is in the process
of hiring additional accounting staff to supplement existing personnel. In
addition, the Company has commenced its documentation required under the
Sarbanes-Oxley Act of 2002 and is developing additional policies and procedures
to further strengthen its international reporting, including the areas of
revenue recognition, sales and expense cut-off and sales returns. 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
June 30, 2004, 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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On or around March 31, 2004, Lexxus International, Inc. ("Lexxus")
received a letter from John Loghry, a former Lexxus distributor, alleging that
Lexxus had wrongfully terminated an alleged oral distributorship agreement with
Mr. Loghry and that the Company had breached an alleged oral agreement to issue
shares of the Company's common stock to Mr. Loghry. The letter demanded a
settlement payment of $35 million without any explanation as to the amount of
the claim. After Mr. Loghry threatened to commence suit against Lexxus and the
Company in Nebraska, on May 13, 2004, Lexxus and the Company filed an action for
declaratory relief against Mr. Loghry in the United States District Court for
the Northern District of Texas seeking, inter alia, a declaration that Mr.
Loghry was not wrongfully terminated and is not entitled to recover anything
from Lexxus or the Company. Mr. Loghry has filed counterclaims against the
Company and Lexxus asserting his previously articulated claims. Discovery
currently is commencing. The Company intends to vigorously defend itself in this
case.
From time to time, the Company is involved in legal proceedings
incidental to the course of its business. The Company believes that all pending
actions, individually and in the aggregate, will not have a material adverse
effect on the financial condition, results of operations, cash flows or business
prospects.
Item 2. Changes in Securities; Use of Proceeds and Issuer Purchases of Equity
Securities
On 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
$1,977,000 based upon the closing price of NHTC common stock. The Company issued
the shares of common stock pursuant to Section 4(2) of the Securities Act of
1933, as amended.
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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 $3,203,000,
a cash payment of $1,336,875 in April 2004, less pre-acquisition net payables
due to MarketVision of approximately $609,000, for a total purchase price of
approximately $17,618,000, including acquisition costs of approximately
$150,000. MarketVision is the exclusive developer and service provider of direct
selling internet technology used by the Company since 2001. The Company issued
the shares of common stock pursuant to Section 4(2) of the Securities Act of
1933, as amended.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
On May 27, 2004, the Company filed a listing application with The
NASDAQ Stock Market for quotation of its shares of common stock. No assurance
can be given that the Company will be approved by NASDAQ, or if approved, when
the Company's shares will be quoted thereon.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31a. Certification of President required by Section 302 of the
Sarbanes-Oxley Act of 2002.
31b. Certification of Chief Financial Officer required by Section 302
of the Sarbanes-Oxley Act of 2002.
32a. Certification of President required by Section 906 of the
Sarbanes-Oxley Act of 2002.
32b. Certification of Chief Financial Officer required by Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On April 15, 2004, the Company filed a Current Report on Form 8-K with
the SEC in connection with its announcement of the acquisition of
MarketVision. On July 1, 2004, the Company filed a Form 8-K/A with the
SEC to provide the unaudited proforma consolidated financial statements
of the Company and the historical audited financial statements of
MarketVision, which was acquired as of March 31, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NATURAL HEALTH TRENDS CORP.
By: /s/ MARK D. WOODBURN
-----------------------------
Mark D. Woodburn
President
By: /s/ CHRIS SHARNG
-----------------------------
Chris Sharng
Chief Financial Officer
Date: August 13, 2004
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