10-K 1 nhtc_10k-123110.htm FORM 10-K nhtc_10k-123110.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010
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:  0-26272
 
NATURAL HEALTH TRENDS CORP.
(Exact name of registrant as specified in its charter)
 
 Delaware       59-2705336
 (State or other jurisdiction of      (I.R.S. Employer
 incorporation or organization)      Identification No.)
 
2603 Oak Lawn Avenue
5th Floor
Dallas, Texas  75219
(Address of principal executive offices, including zip code)
 
Registrant’s telephone number, including area code:  (972) 241-4080
 
Securities registered pursuant to Section 12(b) of the Act:
None
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of each class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not 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-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨ Accelerated filer ¨  
       
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)  Small reporting company þ  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the closing price of such common equity on June 30, 2011: $3,565,128

At November 7, 2011, the number of shares outstanding of the registrant’s common stock was 11,326,323 shares.

DOCUMENTS INCORPORATED BY REFERENCE
None.
 


 
 

 

NATURAL HEALTH TRENDS CORP.
Annual Report on Form 10-K
December 31, 2010
 
TABLE OF CONTENTS
 
   
Page
PART I
   
Item 1.
Business
1
Item 1A.
Risk Factors
10
Item 1B.
Unresolved Staff Comments
21
Item 2.
Properties
21
Item 3.
Legal Proceedings
21
Item 4.
(Removed and Reserved)
22
     
PART II
   
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
23
Item 6.
Selected Financial Data
24
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
37
Item 8.
Financial Statements and Supplementary Data
38
Item 9.
Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
66
Item 9A.
Controls and Procedures
66
Item 9B.
Other Information
67
     
PART III
   
Item 10.
Directors, Executive Officers and Corporate Governance
67
Item 11.
Executive Compensation
69
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
75
Item 13.
Certain Relationships and Related Transactions, and Director Independence
76
Item 14.
Principal Accounting Fees and Services
76
     
PART IV
   
Item 15.
Exhibits and Financial Statement Schedules
77
     
Signatures
 
78

 
 

 

EXPLANATORY NOTE

This is the first periodic report of Natural Health Trends Corp. covering periods ended after September 30, 2009.  Readers should be aware that several aspects of this Annual Report on Form 10-K differ from other annual reports.  First, this report is for each of the fiscal years ended December 31, 2009 and 2010, in lieu of filing separate reports for each of those years.  Second, we are including in this report expanded financial and other disclosures in lieu of filing separate Quarterly Reports on Form 10-Q for each of the quarters ended March 31, 2010 through September 30, 2010.  We do not intend to file separate Quarterly Reports on Form 10-Q for any of the quarters ended March 31, 2010 through September 30, 2010.  We believe that the filing of this expanded annual report enables us to provide information to investors in a more efficient manner than separately filing each of the quarterly reports described above.  In addition, we intend to file, as soon as practicable, our Quarterly Reports on Form 10-Q for each of the quarters ended March 31, 2011 through September 30, 2011.  The Company intends to file timely all reports required under the Exchange Act in the future.

Unless otherwise noted, the terms “we,” “our,” “us,” and “Company,” refer to Natural Health Trends Corp. and its subsidiaries.  References to “dollars” and “$” are to United States dollars.

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, in particular “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Item 1. Business,” include “forward-looking statements” within the meaning of section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  When used in this report, the words or phrases “will likely result,” “expect,” “intend,” “will continue,” “anticipate,” “estimate,” “project,” “believe” and similar expressions are intended to identify “forward-looking statements” within the meaning of the Exchange Act.  These statements represent our expectations or beliefs concerning, among other things, future revenue, earnings, growth strategies, new products and initiatives, future operations and operating results, and future business and market opportunities.

Forward-looking statements in this report speak only as of the date hereof, and forward looking statements in documents incorporated by reference speak only as of the date of those documents.  We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.  We caution and advise readers that these statements are based on certain assumptions that may not be realized and involve risks and uncertainties that could cause actual results to differ materially from the expectations and beliefs contained herein.

For a summary of certain risks related to our business, see “Item 1A. Risk Factors” in this report.  Additional factors that could cause actual results to differ materially from our forward-looking statements are set forth in this report, including under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in our financial statements and the related notes.

 
 

 

Part I
Item 1.                 BUSINESS

Overview of Business

Natural Health Trends Corp. is an international direct-selling and e-commerce company headquartered in Dallas, Texas. Subsidiaries controlled by the Company sell personal care, wellness, and “quality of life” products under the “NHT Global” brand.  In most markets, we sell our products to an independent distributor network that either uses the products themselves or resells them to consumers.

Our majority-owned subsidiaries have an active physical presence in the following markets:  North America; Greater China, which consists of Hong Kong, Taiwan and China; Russia; South Korea; Japan; and Europe, which consists of Italy and Slovenia.

We seek to be a leader in the direct selling industry serving the health and wellness marketplace by selling our products into many markets, primarily through our direct selling marketing operations.  Our objectives are to enrich the lives of the users of our products and enable our distributors to benefit financially from the sale of our products.
 
We were originally incorporated as a Florida corporation in 1988.  We merged into one of our subsidiaries and re-incorporated in Delaware effective June 29, 2005.

Our common stock is quoted under the symbol “NHTC” on the Pink Sheets, a centralized electronic quotation service run by Pink OTC Markets Inc. for over-the-counter securities.

Available Information

We maintain executive offices at 2603 Oak Lawn Avenue, 5th Floor, Dallas, Texas 75219 and our telephone number is (972) 241-4080.  We maintain a corporate website located at www.naturalhealthtrendscorp.com.  Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on our website as soon as reasonably practicable after we file electronically such material with, or furnish it to, the United States Securities and Exchange Commission, or SEC.  Our Code of Ethics for Senior Financial Officers can also be found on our website.  The information provided on our website should not be considered part of this report. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1–800–SEC–0330.  The SEC maintains an internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Our Principal Products

We offer a line of “NHT Global” branded products in three distinct categories including wellness, skincare and lifestyle.  These three product categories, along with the business opportunity we offer in most of our markets, provide our members a platform to further their goal of achieving and maintaining healthy, quality lifestyles complete with product supplementation and the opportunity for financial rewards.

NHT Global Essentials, the wellness and nutritional supplementation product line includes:
 
 
·
Premium Noni Juice™ is a reconstituted morinda citrifolia fruit juice, made from organic noni puree. Noni is a fruit native in the Samoan Islands of the South Pacific.  Marketed as a refreshing and energizing beverage, its natural flavor has been enhanced with white grape concentrate, concord grape concentrate, pineapple juice puree and other natural flavors.

 
·
Triotein™ is a lactose-free whey protein powder that provides amino acid substrates needed to stimulate the body’s production of an anti-oxidant, intracellular glutathione peroxidase, in an effort to optimize the body’s ability to increase immunity.

 
·
Cluster X2™  is a product created for increased and more efficient cell hydration, improved cellular function and communication and release of cellular toxins.
 
 
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·
Trifusion Max™  is a beverage with a unique blend of exotic fruits and berries rich in antioxidants, lycopene, and more.  Its main ingredients are Acai berry, Goji berry, the Mangosteen fruit, and the Gac fruit; each containing phytonutrients.  Phytonutrients are compounds having antioxidative properties found naturally in plant-based foods such as fruit and vegetables.  The newly formulated Trifusion Max now contains calcium as well for improved health benefits.

 
·
Glucosamine 2200™ is a great source of daily glucosamine to assist with joint and cartilage health and reduce inflammation and swelling in the joints, the primary cause of pain. The consumption of Glucosamine 2200 can directly stimulate cartilage cells to produce more collagen and proteoglycan of the articular cartilage and help prevent loss of synovial fluid to support normal functionality of the joints.

 
·
FibeRich® is a dietary supplement high in dietary fiber to assist with proper digestive health and more. Every teaspoon of FibeRich contains more than 6 grams of dietary fiber helping to ease bowel movements and remove toxic substances from our bodies. FibeRich also contains 8 billion compound high-density probiotics including L. rhamnosus, L. acidophilus, B. longum and B. bifidum. These probiotics protect the digestive tract and can help the body to absorb vitamins, minerals and nutrients. 

 
·
Energin™ is a dietary supplement to help increase metabolism and energy and improve brain function.  The key ingredient in Energin is Korean Ginseng, which helps to promote a healthy physical, as well as active mental lifestyle. Studies show that Korean ginseng helps stimulate the formation of blood vessels and improves blood circulation in the brain, thereby improving memory and cognitive abilities.

 
·
Essential Probiotics™ helps maintain the ecological balance of intestinal micro flora, helps peristalsis in the intestinal tract and supports overall intestinal health. Essential Probiotics is a great-tasting powder which dissolves easily and is conveniently packaged in a foil stick pack for portability. One pouch taken daily following a meal is all that is required to restore a healthy balance to the intestinal tract.

 
·
ReStor is a patent-pending liquid dietary supplement targeted to help the body replace a critical enzyme called Ca2+ATPase, which naturally declines as we age. This enzyme is important for optimal cellular function and has been known to assist with improved sleep function and efficiency, reduced joint and muscular pain and soreness, improved bladder function and, increased muscle endurance and strength.

NHT Global Beauty, the skincare product line includes:

 
·
Skindulgence™ 30-Minute Non-Surgical Facelift System is a skin care system that includes a daily cleanser and moisturizer, as well as a specialty mask to lift and reduce the appearance of fine lines and wrinkles in just 30 minutes and after just one use.  The 30-Minute Non-Surgical Facelift is designed to help tone and firm facial muscles as it dries and tightens on the skin.

 
·
Time Restore™ series is comprised of the Time Restore Essence and Time Restore Eye Cream and is specifically targeted toward anti-aging benefits and long-term wrinkle reduction. Skindulgence Time Restore products combine the Skindulgence herbal aromatherapy technology and dermatology technology such as Adenosine, Argireline, Matrixyle3000, Polylift and Regu-Age to create and sustain healthier, more beautiful, younger looking skin.

 
·
BioCell™ is a patented skincare treatment product providing the ultimate in hydration and skin brightening.  The patented bio-cellulose mask material helps BioCell’s essence gel penetrate deep into the skin, locking in moisture and resulting in a more even skin tone, skin clarity and providing the nutrition a user’s skin needs to maintain a youthful glow.

 
·
24K Renaissance Skin Rejuvenation Serum™ facilitates moisture absorption and storage to bring your skin healthy hydration. Formulated with real 24K gold flakes, NHT Global has found that ingredients EGF and TRF combined with Hyaluronate form an all-natural bionic protective layer to a user’s skin’s surface increasing water retention and ultimately diminishing the appearance of fine lines and wrinkles and helping restore elasticity.

NHT Global Lifestyle, the lifestyle enhancing product line includes:

 
·
Alura™ by NHT Global is an intimacy enhancing cream for women.

 
·
Valura™ is topical male intimacy enhancing gel to improve and stimulate male sexual performance and desire.
 
 
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·
La Vie™ is an energy-boosting dietary supplement with a proprietary herbal blend and natural flavors formulated to increase energy and vitality and assist with mental clarity and focus.

 
·
Twin Slim™ is an easy to use weight management program targeted to reduce unwanted pounds and help increase metabolism, burn fat and curb appetite. Complete with a weight management guide encouraging proper diet and nutrition along with regular exercise, Twin Slim offers a jump start slimming solution many need to achieve their desired weight loss goals.  The proprietary Twin Slim products, GC Slim and Magic Drop, target subcutaneous fat reduction and increase energy throughout the day.

In addition, some of our subsidiaries offer products specific to their local markets.

NHT Global continuously sources unique, proprietary and immediate impact products to offer to our members and customers. Product development is an ongoing process at NHT Global that is fueled by marketplace trends and new scientific findings and research.

Working closely with raw material manufacturers and leading domestic and international contract manufacturers, NHT Global’s mission is to co-develop and bring to market the highest quality products. Our manufacturers are primarily located in the United States and some in Asia.  Our raw materials (including botanical ingredients) are sourced from reputable suppliers around the world. In addition, raw material Certificates of Analysis are reviewed in our effort to assure that the appropriate testing has been performed and are within ingredient specification requirements.

Operations of the Business

Operating Strategy

Our objective is to help our members succeed in achieving their life objectives; be it personal health, beauty, happiness or financial security.  The Company consists of professionals who focus on assisting our members in attaining their goals.

We believe that, since early 2010, we have completely changed our corporate identity and are building a competitive business model applicable to the markets we operate in based on six key competencies:

 
·
Our field leaders are experienced and culturally coherent.  They work effectively with the Company’s management, implementing our strategies and providing continuous feedback to improve the Company’s services.  Most of them have been with the Company for seven years or more and are fiercely loyal to the Company.
 
·
The Company has implemented a commission structure that makes it as easy as possible to join the Company’s business, while giving existing members a chance to start making money as quickly as possible in a number of different ways.
 
·
We have developed and rolled out a comprehensive training system that provides a complete career path appropriate for our members.  Our training material covers the needs of all of our members, be they prospects, new recruits, product evangelists, sales leaders or dream builders.
 
·
The continuously improving mentality and methodology we have instilled in our field leaders and personnel have not only distinguished us as an organization, but have also given us a constant flow of information as to how we can do better to service our members.
 
·
We have developed a year-round, multi-faceted promotional plan that targets different segments of our membership and has proven most effective in the last couple of years.
 
·
Last, but perhaps most importantly, a discipline and capability has been established to continue launching high-quality consumer products that are designed to facilitate the accomplishment of our corporate objective.

Sourcing of Products

Our corporate staff works with research and development personnel of our manufacturers and other prospective vendors to create product concepts and develop the product ideas into actual products.  Each of our three current major product lines - Skindulgence™, Alura™ and Premium Noni Juice™ - were originally conceived by our manufacturing vendors.  We then enter into supply agreements with the vendors pursuant to which we obtain rights to sell the products under private labels (or trademarks) that are owned by us.  Because our current main products all came to us originally as proposals from our vendors, we have incurred minimal “out-of-pocket” research and development costs through December 31, 2010.  In addition, some of our local markets introduce their own products from time to time and these products are sometimes adopted by our other markets.
 
 
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We or certain of our subsidiaries generally purchase finished goods from manufacturers and sell them to our distributors for their resale or personal consumption.  Alix Technologies (for Skindulgence™ and LaVie™), 40Js LLC (for Alura™) and Two Harbors Trading Company (for Premium Noni Juice™) are our three most significant vendors, accounting for a majority of our product purchases.  We believe that in the event we are unable to source products from our current or alternate suppliers, our revenue, income and cash flow could be adversely and materially impacted.  We have a contract with Two Harbors Trading Company that has annual renewal rights and a contract with 40Js LLC through December 2014.  We do not currently have a long term contract with Alix Technologies.

Marketing and Distribution

We distribute our products internationally primarily through a network marketing system, which is a form of person-to-person direct selling.  Under this system, distributors purchase products at wholesale prices for resale to consumers and for personal consumption.  The concept of network marketing is based on the strength of personal recommendations that frequently come from friends, neighbors, relatives, and close acquaintances.  We believe that network marketing is an effective way to distribute our products because it allows person-to-person product education and testimonials as well as higher levels of customer service, all of which are not as readily available through other distribution channels.  In some markets, like China, we distribute our products directly to consumers using an e-commerce platform.

Our distributors are independent full-time or part-time contractors who purchase products directly from our subsidiaries via the internet for resale to retail consumers (other than in China, parts of Europe, and certain other markets) or for their own personal consumption.  Purchasers of our products in China, Europe and certain other markets may purchase only for their own personal consumption and not for resale.  The growth of a distributor’s business depends largely upon their ability to recruit a down-line network of distributors and the popularity of our products in the marketplace.

The following table sets forth the number of active distributors by market for the time periods indicated.  We consider a distributor “active” if they have placed at least one product order with us during the preceding year.

   
December 31,
   
2008
   
2009
   
2010
                 
North America
    1,310       700       550
Hong Kong
    20,810       12,090       9,770
Taiwan
    3,450       2,030       1,630
South Korea
    3,480       1,860       950
Japan
    1,200       690       440
Russia
    920       2,480       2,520
Europe
    1,250       590       490
Other
    270            
Total
    32,690       20,440       16,350

To become a NHT Global distributor, a prospective distributor must agree to the terms and conditions of our distributor agreement posted on our website.  NHT Global distributors generally pay an annual enrollment fee.  The distributor agreement sets forth our policies and procedures, and we may elect to terminate a distributor for non-compliance.

We pay commissions to eligible NHT Global distributors based on sales by such distributors’ down-line distributors during a given commission period.  To be eligible to receive commissions, distributors in some countries may be required to make nominal monthly or other periodic purchases of products.  We believe that the uniqueness and desirability of our NHT Global products, combined with a high commission rate, creates a highly desirable business opportunity and work environment for our NHT Global distributors.  See “Working with Distributors.

Distributors generally place orders through the internet and pay by credit card prior to shipment.  Accordingly, we carry minimal accounts receivable and credit losses are historically minimal.
 
We sponsor promotional meetings and motivational training events in key cities in our markets for current and potential NHT Global distributors.  These events are designed to inform prospective and existing distributors about both existing and new product lines as well as selling techniques.  Distributors typically share their direct selling experiences, their individual selling styles and their recruiting methods at these promotional or training events.  Prospective distributors are educated about the structure, dynamics and benefits of the direct selling industry.  We are continually developing or updating our marketing strategies and programs to motivate our distributors.  These programs are designed to increase distributors' monthly product sales and the recruiting of new distributors in their down-lines.
 
 
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Management Information Systems

The NHT Global business uses a proprietary web-based system to process orders and to communicate business volume activity and commissions to distributors.  Other than this proprietary system, we have not fully automated and integrated other critical business processes such as inventory management.  We automated a substantial amount of our financial reporting processes with the implementation of Oracle’s E-Business Suite in the fourth quarter of 2005.  We expect to implement further functionality provided we have adequate operating cash flows to reinvest.

Employees

At December 31, 2009, we employed 119 total employees worldwide, of which 22 were located in the United States, 63 in Hong Kong and China, 21 in Taiwan, 3 in Europe, 7 in South Korea, and 3 in Japan.

At December 31, 2010, we employed 103 total employees worldwide, of which 22 were located in the United States, 52 in Hong Kong and China, 18 in Taiwan, 3 in Europe, 6 in South Korea, and 2 in Japan.

Seasonality

From quarter to quarter, we are somewhat impacted by seasonal factors and trends such as major cultural events and vacation patterns.  For example, most Asian markets celebrate their respective local New Year in the first quarter, which generally has a significant negative impact on that quarter.  We believe that direct selling is also generally negatively impacted during the third quarter, when many individuals, including our distributors, traditionally take time off for vacations.  In addition, the national holidays in Hong Kong, China and Taiwan in early October tend to have a significant adverse effect on sales in those markets.
     
Our spending is materially affected by the major events planned for at different times of the year.  A major promotional event could significantly increase the reported expenses during the quarter in which the event actually takes place, while the revenue that might be generated by the event may not occur in the same reporting period.

Intellectual Property

Most of our products are packaged under a "private label" arrangement.  We have obtained or applied for trademark registration for certain names, logos and various product names in several countries in which we are doing business or considering expanding into.  We also rely on common law trademark rights to protect our unregistered trademarks.  These common law trademark rights do not provide us with the same level of protection as afforded by a United States federal registration trademark.  Common law trademark rights are limited to the geographic area in which the trademark is actually utilized, while a United States federal registration of a trademark enables the registrant to discontinue the unauthorized use of the trademark by a third party anywhere in the United States even if the registrant has never used the trademark in the geographic area where the trademark is being used; provided, however, that the unauthorized third party user has not, prior to the registration date, perfected its common law rights in the trademark within that geographic area.

In 2005, we implemented a foreign holding and operating company structure for our non-United States businesses, which involved the division of our United States and non-United States operations.  As part of implementing this structure, we and some of our United States subsidiaries granted an exclusive license to some of our non-United States subsidiaries to use outside of the United States all of their intangible property, including trademarks, trade secrets and other proprietary information.

Working with Distributors

Sponsorship

Sponsoring new distributors creates multiple levels in the direct selling structure of NHT Global.  The persons that a distributor sponsors within the network are referred to as "sponsored" distributors.  Persons newly recruited are assigned by sponsoring distributors into network positions that can be “under” other distributors, thus they can be called “down-line” distributors.  If down-line distributors also sponsor new distributors, they create additional levels within the structure, but their down-line distributors remain in the same down-line network as their original sponsoring distributor.
 
 
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We rely on our distributors to recruit and sponsor new distributors.  Our top up-line distributors tend to focus on building their network of “down-line” distributors and assisting them with the sale of our products.  While we provide product samples, brochures and other sales materials, distributors are primarily responsible for recruiting and educating their new distributors with respect to products, the compensation plan and how to build a successful distributorship network.

Distributors are not required to sponsor other distributors as their down-line, and we do not pay any commissions for sponsoring new distributors.  However, because of the financial incentives provided to those who succeed in building a distributor network that consumes and resells products, we believe that many of our distributors attempt, with varying degrees of effort and success, to sponsor additional distributors.  Because they are seeking new opportunities for income, people are often attracted to become distributors after using our products or after attending introductory seminars.  Once a person becomes a distributor, he or she is able to purchase products directly from us at wholesale prices via the internet.  The distributor is also entitled to sponsor other distributors in order to build a network of distributors and product users.

Compensation Plans

NHT Global employs what is commonly referred to as a binary compensation plan.  We believe that one of our key competitive advantages within the direct selling industry is our compensation plan for distributors.  Under the NHT Global compensation plan, distributors are paid weekly commissions, generally in their home country currency, for product sold by their down-line distributor network across all geographic markets, except China, where in the second quarter of 2007 we launched an e-commerce retail platform and do not pay any commissions.  Distributors are not paid commissions on purchases or sales of our products made directly by them.  This “seamless” compensation plan enables a distributor located in one country to sponsor other distributors located in other countries where we are authorized to conduct our business.  Currently, there are basically two ways in which NHT Global distributors can earn income:

 
·
Through retail markups on sales of products purchased by distributors at wholesale prices (in some markets, sales are for personal consumption only and income may not be earned through retail mark-ups on sales in that market); and
 
 
·
Through commissions paid on product purchases made by their down-line distributors.

Each of our products is designated a specified number of sales volume points, also called bonus volume or “BV.”  Commissions are based on total personal and group sales volume points per sales period.  Sales volume points are essentially a percentage of a product’s wholesale price.  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 higher commissions from purchases made by an expanding down-line network.  To be eligible to receive commissions, a distributor may be required to make nominal monthly or other periodic purchases of our products.  Certain of our subsidiaries do not require these nominal purchases for a distributor to be eligible to receive commissions.  In determining commissions, the number of levels of down-line distributors included within the distributor's commissionable group increases as the number of distributorships directly below the distributor increases.  Under our current compensation plan, certain of our commission payout may be limited to a hard cap in terms of a specific percentage of the total product sales.  In some markets, commissions may be further limited.

In some markets, we also pay certain bonuses on purchase by several generations of personally sponsored distributors, as well as bonuses on commissions earned by several generations of personally sponsored distributors.  Distributors can also earn income, trips and other prizes in specific time-limited promotions and contests we hold from time to time.

From time to time we make modifications and enhancements to our compensation plan to help motivate distributors, which can have an impact on distributor commissions.   From time to time we also enter into agreements for business or market development, which may result in additional compensation to specific distributors.

Distributor Support

We are committed to providing a high level of support services tailored to the needs of our distributors in each marketplace we are serving.  We attempt to meet the needs and build the loyalty of distributors by providing personalized distributor services and by maintaining a generous product return policy (see “Product Warranties and Returns”).  We believe that maximizing a distributor’s efforts by providing effective distributor support has been, and could continue to be, important to our success.

Through training meetings, annual conventions, web-based messages, distributor focus groups, regular telephone conference calls and other personal contacts with distributors, we seek to understand and satisfy the needs of our distributors.  Via our websites, we provide product fulfillment and tracking services that result in user-friendly and timely product distribution.
 
 
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To help maintain communication with our distributors, we offer the following support programs:

 
·
Teleconferences – we hold teleconferences with company management and associate field leadership on various subjects such as technical product discussions, distributor organization building and management techniques.

 
·
Internet – we maintain a website at www.nhtglobal.com.  On this website, the user can read company news, learn more about various products, sign up to be a distributor, place orders, and track the fulfillment and delivery of their order.

 
·
Product Literature – we offer a variety of literature to distributors, including product catalogs, informational brochures, pamphlets and posters for individual products.

 
·
Broadcast E-mail – we send announcements via e-mail to all active distributors.

Technology and Internet Initiatives

We believe that the internet has become increasingly important to our business as more consumers communicate online and purchase products over the internet as opposed to traditional retail and direct sales channels.  As a result, we have committed significant resources to our e-commerce capabilities and the abilities of our distributors to take advantage of the internet.  Substantially all of our sales have occurred via the internet.  NHT Global offers a global web page that allows a distributor to have a personalized website through which he or she can sell products in all of the countries in which we do business.  Links to these websites can be found at our main website for distributors at www.nhtglobal.com.  The information provided on these websites should not be considered part of this report.

Rules Affecting Distributors

Our distributor policies and procedures establish the rules that distributors must follow in each market.  We also monitor distributor activity in an attempt to provide our distributors with a “level playing field” so that one distributor may not be disadvantaged by the activities of another.  We require our distributors to present products and business opportunities in an ethical and professional manner.  Distributors further agree that their presentations to customers must be consistent with, and limited to, the product claims and representations made in our literature.

We require that we produce or pre-approve all sales aids used by distributors such as videotapes, audiotapes, brochures and promotional clothing.  Further, distributors may not use any form of media advertising to promote products unless it is pre-approved by us.  Products may be promoted only by personal contact or by literature produced or approved by us.  Distributors are not entitled to use our trademarks or other intellectual property without our prior consent.

Our compliance department reviews reports of alleged distributor misbehavior.  If we determine that a distributor has violated our distributor policies or procedures, we may terminate the 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, not employees, and may act independently of us. Further, our distributors may resign or terminate their distributorship at any time without notice. See “Item 1A. Risk Factors.”

Government Regulations
 
Direct Selling Activities
 
Direct selling, or multi-level marketing, activities are regulated by various federal, state and local governmental agencies in the United States and foreign countries.  These laws and regulations are generally intended to prevent fraudulent or deceptive schemes, often referred to as “pyramid” schemes, which compensate participants for recruiting additional participants irrespective of product sales, use high-pressure recruiting methods and/or do not involve legitimate products.  The laws and regulations in our current markets often:
 
 
·
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.
 
 
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The laws and regulations governing direct selling are modified from time to time, and, like other direct selling companies, we are subject from time to time to government investigations in our various markets related to our direct selling activities.  This can require us to make changes to our business model and aspects of our global compensation plan in the markets impacted by such changes and investigations.

Based on advice of our engaged outside professionals in existing markets, the nature and scope of inquiries from government regulatory authorities and our history of operations in those markets to date, we believe our method of distribution complies in all material respects with the laws and regulations related to direct selling of the countries in which we currently operate.

As a result of restrictions in China on direct selling activities, we are not conducting direct selling in China.  Consumers and members purchase the Company’s products via our Hong Kong-based web site or our e-commerce platform in China.  The regulatory environment in China is complex.  Because we operate a direct selling model outside of China, our operations in China have attracted constant and significant regulatory and media scrutiny.  At the end of 2005, China adopted new direct selling and anti-pyramiding regulations that are restrictive and contain various limitations, including a restriction on the ability to pay multi-level compensation to independent distributors.  Regulations are subject to discretionary interpretation by municipal and provincial level regulators.  Interpretations of what constitutes permissible activities by regulators can vary from province to province and can change from time to time because of the lack of clearly defined rules regarding direct selling activities.

Because of the Chinese government’s significant concerns about direct selling activities, it scrutinizes very closely activities of direct selling companies.  The scrutiny has increased following adoption of the new direct selling and anti-pyramiding regulations and our business continues to be subject to reviews and investigations by municipal and provincial level regulators.  At times, investigations and related actions by government regulators have caused an obstruction to our members’ activities in certain locations, and have resulted in a few cases of enforcement actions.  In each of these cases, we helped our members with their defense in the legality of their conduct.  So far, no material changes to our business model have been required.  We expect to receive continued guidance and direction as we work with regulators to address our business model and any changes that need to be made to comply with the new direct selling regulations.
       
In accordance with the direct selling regulations, our Chinese subsidiary applied for a direct selling license first in 2005, provided a revised version in June 2006, and then updated again our application in November 2007.  After the approval from the municipal and the provincial authorities, the application did not progress further with the central government.  Eventually, the information contained in our most recent application became stale and we withdrew the license application in February 2009 with the intention of filing an updated application in the future.  As the Company continues to experience changes in the management, location and nature of its business in China, the Company plans to re-apply but has not yet filed an updated application.

Regulation of Our Products

Our products and related promotional and marketing activities are subject to extensive governmental regulation by numerous governmental agencies and authorities in the United States, including the FDA, the FTC, the Consumer Product Safety Commission, the United States Department of Agriculture, State Attorneys General and other state regulatory agencies.  In our foreign markets, the products are generally regulated by similar government agencies, such as the Ministry of Health, Labour and Welfare in Japan and the Department of Health in Taiwan.

Our personal care products are subject to various laws and regulations that regulate cosmetic products and set forth regulations for determining whether a product can be marketed as a “cosmetic” or requires further approval as an over-the-counter drug.  In the United States, regulation of cosmetics is under the jurisdiction of the FDA.  The Food, Drug and Cosmetic Act defines cosmetics by their intended use, as “articles intended to be rubbed, poured, sprinkled, or sprayed on, introduced into, or otherwise applied to the human body . . . for cleansing, beautifying, promoting attractiveness, or altering the appearance.”  Among the products included in this definition are skin moisturizers, eye and facial makeup preparations, perfumes, lipsticks, fingernail polishes, shampoos, permanent waves, hair colors, toothpastes and deodorants, as well as any material intended for use as a component of a cosmetic product.  Conversely, a product will not be considered a cosmetic, but may be considered a drug if it is intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or is intended to affect the structure or any function of the body.  A product’s intended use can be inferred from marketing or product claims.  The other markets in which we operate have similar regulations.  In Japan, the Ministry of Health, Labour and Welfare regulates the sale and distribution of cosmetics and requires us to have an import business license and to register each personal care product imported into Japan.  In Taiwan, all “medicated” cosmetic products require registration.  In China, personal care products are placed into one of two categories, “general” and “drug.”  Products in both categories require submission of formulas and other information with the health authorities, and drug products require human clinical studies.  The product registration process in China for these products can take from nine to more than 18 months or longer.  Such regulations in any given market can limit our ability to import products and can delay product launches as we go through the registration and approval process for those products.  The sale of cosmetic products is regulated in the European Union under the European Union Cosmetics Directive, which requires a uniform application for foreign companies making personal care product sales.
 
 
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The markets in which we operate all have varied regulations that distinguish foods and nutritional health supplements from “drugs” or “pharmaceutical products.”  Because of the varied regulations, some products or ingredients that are recognized as a “food” in certain markets may be treated as a “pharmaceutical” in other markets.  That sometimes requires us to either modify a product or refrain from selling the product in that market.  As a result, we must often modify the ingredients and/or the levels of ingredients in our products for certain markets.  In some circumstances, the regulations in foreign markets may require us to obtain regulatory approval prior to introduction of a new product or limit our uses of certain ingredients altogether.  Because of negative publicity associated with some supplements, there has been an increased movement in the United States and other markets to expand the regulation of dietary supplements, which could impose additional restrictions or requirements in the future.  In general, the regulatory environment is becoming more complex with increasingly strict regulations each year.

Effective June 2008, the FDA established regulations to require current good manufacturing practices (cGMP) for dietary supplements.  The regulations ensure that dietary supplements are produced in a quality manner, do not contain contaminants or impurities, and are accurately labeled. The regulations include requirements for establishing quality control procedures for us and our vendors and suppliers, designing and constructing manufacturing plants, and testing ingredients and finished products.  The regulations also include requirements for record keeping and handling consumer product complaints.  If dietary supplements contain contaminants or do not contain the type or quantity of dietary ingredient they are represented to contain, the FDA would consider those products to be adulterated or misbranded.  

Our business is subject to additional FDA regulations, such as those implementing an adverse event reporting system (“AER’s”) effective December 2007, which requires us to document and track adverse events and report serious adverse events, which are events involving hospitalization or death, associated with consumers’ use of our products.  

Most of our major markets also regulate advertising and product claims regarding the efficacy of products. This is particularly true with respect to our dietary supplements because we typically market them as foods or health foods.  For example, in the United States, we are unable to claim that any of our nutritional supplements will diagnose, cure, mitigate, treat or prevent disease.  In the United States, the Dietary Supplement Health and Education Act, however, permits substantiated, truthful and non-misleading statements of nutritional support to be made in labeling, such as statements describing general well-being resulting from consumption of a dietary ingredient or the role of a nutrient or dietary ingredient in affecting or maintaining a structure or a function of the body. Most of the other markets in which we operate have not adopted similar legislation and we may be subject to more restrictive limitations on the claims we can make about our products in these markets.

Other Regulatory Issues

As a United States entity operating through subsidiaries in foreign jurisdictions, we are subject to foreign exchange control, transfer pricing and custom laws that regulate the flow of funds between our subsidiaries and us for product purchases, management services and contractual obligations, such as the payment of distributor commissions. As is the case with most companies that operate in our product categories, we might receive inquiries from time to time from government regulatory authorities regarding the nature of our business and other issues, such as compliance with local direct selling, transfer pricing, customs, taxation, foreign exchange control, securities and other laws.

Product Warranties and Returns

NHT Global refund policies and procedures closely follow industry and country-specific standards, which vary greatly by country.  For example, in the United States, the Direct Selling Association recommends that direct sellers permit returns during the twelve-month period following the sale, while in Hong Kong the standard return policy is 14 days following the sale.  Our return policies have conformed to local laws or the recommendation of the local direct selling association.  In most cases, distributors who timely return unopened product that is in resalable condition may receive a refund.  The amount of the refund may be dependent on the country in which the sale occurred, the timeliness of the return, and any applicable re-stocking fee.  NHT Global must be notified of the return in writing and such written requests would be considered a termination notice of the distributorship.  From time to time, we may alter our return policy in response to special circumstances.
 
 
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Our Industry

We are engaged in the direct selling industry, selling lifestyle enhancement products, cosmetics, personal care and dietary supplements.   More specifically, we are engaged in what is called network marketing or multi-level marketing.  This type of organizational structure and approach to marketing and sales include companies selling lifestyle enhancement products, cosmetics and dietary supplements, or selling other types of consumer products, such as Tupperware Corporation and Amway Corp.  Generally, direct selling is based upon an organizational structure in which independent distributors of a company’s products are compensated for sales made directly to consumers.

NHT Global distributors are compensated for sales generated by distributors they have recruited and all subsequent distributors recruited by their "down-line" network of distributors.  The experience of the direct selling industry has been that once a sizeable network of distributors is established, new and alternative products and services can be offered to those distributors for sale to consumers and additional distributors.  The successful introduction of new products can dramatically increase sales and profits for both distributors and the direct selling marketing organization.

Competition

We compete with a significant number of other retailers that are engaged in similar lines of business, including sellers of health-related products and other network marketing companies such as Nu Skin Enterprises, Inc., USANA Health Sciences, Inc., Mannatech, Inc., Reliv’ International, Inc, and Herbalife, Ltd.  Many of our competitors have greater name recognition and financial resources than we do and also have many more distributors.  A number of our former employees and distributors now work for competitors, and sometimes try to use relationships and knowledge obtained with us to compete with us.

Our ability to compete with other network marketing companies depends, in significant part, on our success in attracting and retaining distributors.  There can be no assurance that our programs for attracting and retaining distributors will be successful.  The pool of individuals interested in network marketing is limited in each market and is reduced to the extent other network marketing companies successfully attract these individuals into their businesses.  Although we believe that we offer an attractive opportunity for our distributors, there can be no assurance that other network marketing companies will not be able to recruit our existing distributors or deplete the pool of potential distributors in a given market.

The direct selling channel tends to sell products at a higher price compared to traditional retailers, which poses a degree of competitive risk.  There is no assurance that we would continue to compete effectively against retail stores, internet-based retailers or other direct sellers.

Item 1A.                 RISK FACTORS

We are exposed to a variety of risks that are present in our business and industry.  The following are some of the more significant factors that could affect our business, results of operations and financial condition.

Difficult economic conditions could harm our business.

Global economic conditions continue to be challenging, and it is not possible for us to predict the extent and timing of any improvement in global economic conditions.  The economic downturn could adversely impact our business in the future by causing a decline in demand for our products, particularly if the economic conditions are prolonged or worsen.  In addition, such economic conditions may adversely impact access to capital for us and our suppliers, may decrease our distributors' ability to obtain or maintain credit cards or otherwise afford to purchase our products, and may otherwise adversely impact our operations and overall financial condition.

We may experience substantial negative cash flows, which may have a significant adverse effect on our business and could threaten our solvency.

We experienced substantial negative cash flows during the years ended December 31, 2008, 2009 and 2010, primarily due to declines in our revenues without proportional decreases in expenditures.  If we again experience negative cash flows, our decreasing cash balance could impair our ability to support our operations and, eventually, threaten our solvency, which would have a material adverse effect on our business, results of operations and financial condition, as well as our stock price.  Negative cash flows and the related adverse market perception associated therewith may have negatively affected, and may in the future negatively affect, our ability to attract new distributors and/or sell our products.  There can be no assurance that we will be successful in maintaining an adequate level of cash resources and we could be forced to act more aggressively in the area of expense reduction in order to conserve cash resources as we look for alternative solutions.
 
 
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If we experience negative cash flows, we may need to seek additional debt or equity financing, which may not be available on acceptable terms or at all.  If available, it could have a highly dilutive effect on the holdings of existing stockholders.

Unless we are able to stabilize or grow revenues, control expenses and achieve positive cash flows, our ability to support our obligations could be impaired and our liquidity could be adversely affected and our solvency and our ability to repay our debts when they come due could be threatened.  We may need to seek additional debt or equity financing on acceptable terms in order to improve our liquidity.  However, we may not be able to obtain additional debt or equity financing on satisfactory terms, or at all, and any new financing could have a dilutive effect to our existing stockholders.

The anti-dilution provisions of warrants to purchase 1,645,547 shares of our common stock would, if triggered, cause substantial dilution and may, therefore, make it particularly difficult to obtain new equity financing.  The warrants were originally issued under a Securities Purchase Agreement dated October 19, 2007.  The warrants have an exercise price of $3.52 per share, subject to certain anti-dilution provisions that reduce the exercise price and increase the number of shares underlying the warrants if the Company issues its common stock or equivalent securities at below the exercise price for the warrants (with certain transactions exempted).  Warrants to purchase 149,595 shares of our common stock expire on April 21, 2013, and the remaining warrants for the purchase of 1,495,952 shares of our common stock expire on April 21, 2016.

We could be adversely affected by additional management changes or an inability to attract and retain key management, directors and consultants.

Our future success depends to a significant degree on the skills, experience and efforts of our top management and directors.  A series of changes in top management since November 2005 may have had, and may in the future have, a material adverse effect on our business, results of operations and financial condition.  We also depend on the ability of our executive officers and other members of senior management to work effectively as a team.  The loss of one or more of our executive officers, members of our senior management or directors could have a material adverse effect on our business, results of operations and financial condition.  Moreover, as our business evolves, we may require additional or different management members, directors or consultants, and there can be no assurance that we will be able to locate, attract and retain them if and when they are needed.

Because our Hong Kong operations account for a majority of our overall business, and most of our Hong Kong business is derived from the sale of products to members in China, any material adverse change in our business relating to either Hong Kong or China would likely have a material adverse impact on our overall business.

In 2008, 2009 and 2010 approximately 66%, 64% and 59% of our revenue, respectively, was generated in Hong Kong.  Most of our Hong Kong revenues are derived from the sale of products that are delivered to members in China.    This geographic concentration in our business means that events or conditions that could negatively impact this geographic region or our operations in this region would have a greater adverse impact upon our overall business and financial results than would be the case with a company having greater geographic diversification.

In contrast to our operations in other parts of the world, we have not implemented a direct sales model in China. The Chinese government permits direct selling only by organizations that have a license that we do not have, and has also adopted anti-multilevel marketing legislation.   We operate an e-commerce direct selling model in Hong Kong and recognize the revenue derived from sales to both Hong Kong and Chinese members as being generated in Hong Kong.   Products purchased by members in China are delivered by us to one or more third parties that act as the importers of record under agreements to pay applicable duties.   In addition, through a Chinese entity we sell products in China using an e-commerce retail model.  The Chinese entity operates separately from the Hong Kong entity, although a Chinese member may elect to participate separately in both.

We believe that the laws and regulations in China regarding direct selling and multi-level marketing are not specifically applicable to our Hong Kong based e-commerce activity, and that our Chinese entity is operating in compliance with applicable Chinese laws.   However, there can be no assurance that the Chinese authorities will agree with our interpretations of applicable laws and regulations or that China will not adopt new laws or regulations.   Should the Chinese government determine that our e-commerce activity violates China’s direct selling or anti-multilevel marketing legislation, or should new laws or regulations be adopted, there could be a material adverse effect on our business, financial condition and results of operations.

Because of the Chinese government’s significant concerns about direct selling activities, it scrutinizes very closely activities of direct selling companies. At times, investigations and related actions by government regulators have resulted in a few cases where we have paid substantial fines.  In each of these cases, we have been allowed to recommence operations after the government’s investigation, and no material changes to our business model were required in connection with these fines and impediments. 
 
 
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Although we attempt to work closely with both national and local Chinese governmental agencies in conducting our business, our efforts to comply with national and local laws may be harmed by a rapidly evolving regulatory climate, concerns about activities resembling violations of direct selling or anti-multi-level marketing legislation, subjective interpretations of laws and regulations, and activities by individual distributors that may violate laws notwithstanding our strict policies prohibiting such activities. Any determination that our operations or activities, or the activities of our individual distributors or employee sales representatives, or importers of record are not in compliance with applicable laws and regulations could result in the imposition of substantial fines, extended interruptions of business, restrictions on our future ability to obtain business licenses or expand into new locations, changes to our business model, the termination of required licenses to conduct business, or other actions, any of which could materially harm our business, financial condition and results of operations.

Various other factors could harm our business in Hong Kong and China, such as worsening economic conditions in Hong Kong or China, adverse local publicity or other events that may be out of our control.  For example, we were advised to voluntarily suspend marketing activities in China during the third quarter of 2007 when the Chinese government was expected to impose a more intense enforcement program against illegal chain sales activities.  We did not want to run the risk of being inadvertently entangled in the government enforcement actions and voluntarily withdrew all marketing activities from China during that period.  It may be necessary or advisable to repeat this or similar actions from time to time in the future, and such periods of reduced activity could have a material adverse effect on our business.

As a network marketing company, we rely on an independent sales force and we do not have direct control over the marketing of our products.

We rely on non-employee, independent distributors to market and sell our products.  We have a large number of distributors and a relatively small corporate staff to implement our marketing programs and to provide motivational support and training to our distributors.  Distributors may voluntarily terminate their agreements with us at any time, and there is typically significant turnover in our distributor ranks.

Our failure to maintain and expand our distributor relationships could adversely affect our business.

We distribute our products through independent distributors, and we depend upon them directly for all of our sales in most of our markets.  Accordingly, our success depends in significant part upon our ability to attract, retain and motivate a large base of distributors.  Our direct selling organization is headed by a relatively small number of key distributors.  The loss of a significant number of distributors, including any key distributors, could materially and adversely affect sales of our products and could impair our ability to attract new distributors.  Moreover, the replacement of distributors could be difficult because, in our efforts to attract and retain distributors, we compete with other direct selling organizations, including but not limited to those in the personal care, cosmetic product and nutritional supplement industries.  Our distributors may terminate their services with us at any time and, in fact, like most direct selling organizations we have a high rate of attrition.

We experienced a 43%, 37% and 20% decrease in active distributors during 2008, 2009 and 2010, respectively.  The number of active distributors or their productivity may not increase and could further decline in the future.  Distributors may terminate their services at any time, and, like most direct selling companies, we experience a high turnover in our distributor ranks.  We cannot accurately predict any fluctuation in the number and productivity of distributors because we primarily rely upon existing distributors to sponsor and train new distributors and to motivate new and existing distributors. Operating results could be adversely affected if our existing and new business opportunities and products do not generate sufficient economic incentive or interest to retain existing distributors and to attract new distributors.

The number and productivity of our distributors could be harmed by several factors, including:

 
·
adverse publicity or negative perceptions regarding us, our products, our distribution channel, our method of distribution or our competitors;
 
·
lack of interest in, or the technical failure of, existing or new products;
 
·
lack of interest in our existing compensation plan for distributors or in enhancements or other changes to that compensation plan;
 
·
our actions to enforce our policies and procedures;
 
·
regulatory actions or charges or private actions against us or others in our industry;
 
·
general economic and business conditions;
 
·
changes in management or the loss of one or more key distributor leaders;
 
·
entry of new competitors, or new products or compensation plan enhancements by existing competitors, in our markets; and
 
·
potential saturation or maturity levels in a given country or market which could negatively impact our ability to attract and retain distributors in such market.

 
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The high level of competition in our industry could adversely affect our business.

The business of marketing personal care, cosmetic, nutritional supplements, and lifestyle enhancement products is highly competitive.  This market segment includes numerous manufacturers, distributors, marketers, and retailers that actively compete for the business of consumers both in the United States and abroad.  The market is highly sensitive to the introduction of new products, which may rapidly capture a significant share of the market.  Sales of similar products by competitors may materially and adversely affect our business, financial condition and results of operations.

We are subject to significant competition for the recruitment of distributors from other direct selling organizations, including those that market similar products.  Many of our competitors are substantially larger than we are, offer a wider array of products, have far greater financial resources and many more active distributors than we have.  Our ability to remain competitive depends, in significant part, on our success in recruiting and retaining distributors through an attractive compensation plan and other incentives.  We believe that our compensation and incentive programs provide our distributors with significant earning potential.  However, we cannot be sure that our programs for recruitment and retention of distributors would be successful.

Some of our competitors have employed or otherwise contracted for the services of our former officers, employees, consultants, and distributors, who may try to use information and contacts obtained while under contract with us for competitive advantage.  While we seek to protect our information through contractual and other means, there can be no assurance that we will timely learn of such activity, have the resources to attempt to stop it, or have adequate remedies available to us.

An increase in the amount of compensation paid to distributors would reduce profitability.

A significant expense is the payment of compensation to our distributors, which represented approximately 39%, 38% and 37% of net sales during 2008, 2009 and 2010, respectively.  We compensate our distributors by paying commissions, bonuses, and certain awards and prizes.  Factors impacting the overall commission payout include the growth and depth of the distributor network, the distributor retention rate, the level of promotions, local promotional programs and business development agreements.  Any increase in compensation payments to distributors as a percentage of net sales will reduce our profitability.

Our compensation plan includes a cap on distributor compensation paid out as a percentage of product sales.  We have enforced that cap from December 2008, which diluted commissions payable to certain highly-paid distributors.   There can be no assurance that enforcement of this cap will ensure profitability (which depends on many other factors).  Moreover, enforcement of this cap could cause key distributors affected by the cap to leave and work elsewhere.

Failure of new products to gain distributor and market acceptance could harm our business.

An important component of our business is our ability to develop new products that create enthusiasm among our distributor force.  If we fail to introduce new products on a timely basis, our distributor productivity could be harmed.  In addition, if any new products fail to gain market acceptance, are restricted by regulatory requirements, or have quality problems, this would harm our results of operations.  Factors that could affect our ability to continue to introduce new products include, among others, limited capital and human resources, government regulations, proprietary protections of competitors that may limit our ability to offer comparable products and any failure to anticipate changes in consumer tastes and buying preferences.

Direct-selling laws and regulations may prohibit or severely restrict our direct sales efforts and cause our revenue and profitability to decline, and regulators could adopt new regulations that harm our business.

Our direct selling system is subject to extensive laws, governmental regulations, administrative determinations, court decisions and similar constraints.  These laws and regulations are generally intended to prevent fraudulent or deceptive schemes, often referred to as “pyramid” schemes, which compensate participants for recruiting additional participants irrespective of product sales, use high pressure recruiting methods and/or do not involve legitimate products.

Complying with these widely varying and sometimes inconsistent rules and regulations can be difficult and may require the devotion of significant resources on our part.  There can be no assurance that we or our distributors are in compliance with all of these regulations.  Our failure or our distributors’ failure to comply with these regulations or new regulations could lead to the imposition of significant penalties or claims and could negatively impact our business.  If we are unable to continue business in existing markets or commence operations in new markets because of these laws, our revenue and profitability may decline.
 
 
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We are also subject to the risk that new laws or regulations might be implemented or that current laws or regulations might change, which could require us to change or modify the way we conduct our business in certain markets.  This could be particularly detrimental to us if we had to change or modify the way we conduct business in markets that represent a significant percentage of our net sales.  For example, the FTC released a proposed New Business Opportunity Rule in April 2006.  As initially drafted, the proposed rule would have required pre-sale disclosures for all business opportunities, which may have included network marketing compensation plans such as ours.  However, in March 2008 the FTC issued a revised notice of proposed rulemaking, which indicates that the New Business Opportunity Rule as drafted will not apply to multi-level marketing companies.  The comment and rebuttal periods regarding the proposed rule have closed, but the FTC has not yet issued a final rule.  The New Business Opportunity Rule is currently only a proposed rule and may change before it is implemented, if it is implemented at all.

Challenges by third parties to the form of our business model could harm our business.

We are also subject to the risk of private party challenges to the legality of our direct selling system.  The regulatory requirements concerning direct selling systems do not include “bright line” rules and are inherently fact-based and subject to judicial interpretation. An adverse judicial determination against us with respect to our direct selling system, or in proceedings not involving us directly but which challenge the legality of other direct selling marketing systems, could have a material adverse effect on our business.  Moreover, there is a risk that such challenges and settlements involving other parties could provide incentives for similar actions by distributors against us and other direct selling companies.  Any challenges regarding us or others in our industry could harm our business if such challenges result in the imposition of any fines or damages on our business, create adverse publicity, increase scrutiny of our industry, detrimentally affect our efforts to recruit or motivate distributors and attract customers, or interpret laws in a manner inconsistent with our current business practices.

Our products and related activities are subject to extensive government regulation, which could delay, limit or prevent the sale of some of our products in some markets. 

The formulation, manufacturing, packaging, labeling, importation, advertising, distribution, sale and storage of certain of our products are subject to extensive regulation by various federal agencies, including the U.S. Food and Drug Administration (the “FDA”), the FTC, the Consumer Product Safety Commission and the United States Department of Agriculture and by various agencies of the states, localities and foreign countries in which our products are manufactured, distributed and sold.  For example, the FDA requires us and our suppliers to meet relevant current good manufacturing practice, or cGMP, regulations for the preparation, packing and storage of foods and OTC drugs.  We are also now required to report serious adverse events associated with consumer use of certain of our products.  Other laws and regulations govern or restrict the claims that may be made about our products and the information that must be included and excluded on labels.

In markets outside the United States, prior to commencing operations or marketing new products, we may be required to obtain approvals, licenses, or certifications from a ministry of health or a comparable agency.   Moreover, a foreign jurisdiction may pass laws that would prohibit the use of certain ingredients in their particular market.  Compliance with these regulations can create delays and added expense in introducing new products to certain markets.

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.  If we are not able to satisfy the various regulations, then we would have to cease sales of that product in that market.  In addition, the adoption of new regulations or changes in the interpretation of existing regulations may result in significant compliance costs or discontinuation of product sales and may adversely affect the marketing of our products, resulting in significant loss of sales revenues.

We cannot predict the nature of any future laws, regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations or administrative orders, when and if promulgated, could have on our business.  These potential effects could include, however, requirements for the reformulation of certain products to meet new standards, the recall or discontinuance of certain products, additional record keeping and reporting requirements, expanded documentation of the properties of certain products, expanded or different labeling, or additional scientific substantiation.  Any or all of these requirements could have a material adverse effect on our business, financial condition, or results of operations.
 
 
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New regulations governing the marketing and sale of nutritional supplements could harm our business.

There has been an increasing movement in the United States and other markets to increase the regulation of dietary supplements, which could impose additional restrictions or requirements in the future.  In the United States, for example, some legislators and industry critics continue to push for increased regulatory authority by the FDA over nutritional supplements.  Our business could be harmed if more restrictive legislation is successfully introduced and adopted in the future.  In particular, the adoption of legislation requiring FDA approval of supplements or ingredients could delay or inhibit our ability to introduce new supplements.  We face similar pressures in our other markets, including Europe, which is expected to adopt additional regulations setting new limits on acceptable maximum levels of vitamins and minerals.  In the United States, effective December 1, 2009, the FTC approved revisions to its Guides Concerning the Use of Endorsements and Testimonials in Advertising, or Guides, that require disclosure of material connections between an endorser and the company they are endorsing and do not allow marketing using atypical results.  The requirements and restrictions of the revised Guides may diminish the impact of our marketing efforts and negatively impact our sales results.  If we or our distributors fail to comply with these Guides, the FTC could bring an enforcement action against us and we could be fined and/or forced to alter our operations.  Our operations also could be harmed if new laws or regulations are enacted that restrict our ability to market or distribute nutritional supplements or impose additional burdens or requirements on nutritional supplement companies or require us to reformulate our products.

Regulations governing the production and marketing of our personal care products could harm our business.

Our personal care products are subject to various domestic and foreign laws and regulations that regulate cosmetic products and set forth regulations for determining whether a product can be marketed as a “cosmetic” or requires further approval as an over-the-counter drug.  A determination that our cosmetic products impact the structure or function of the human body, or improper marketing claims by our distributors may lead to a determination that such products require pre-market approval as a drug.  Such regulations in any given market can limit our ability to import products and can delay product launches as we go through the registration and approval process for those products.  Furthermore, if we fail to comply with these regulations, we could face enforcement action against us and we could be fined, forced to alter or stop selling our products and/or required to adjust our operations.  Our operations also could be harmed if new laws or regulations are enacted that restrict our ability to market or distribute our personal care products or impose additional burdens or requirements on the contents of our personal care products or require us to reformulate our products.
 
If we are found not to be in compliance with good manufacturing practices our operations could be harmed.

FDA regulations on Good Manufacturing Practices and Adverse Event Reporting requirements for the nutritional supplement industry have recently gone into effect and require good manufacturing processes for us and our vendors, including stringent vendor qualifications, ingredient identification, manufacturing controls and record keeping.   We are also now required to report serious adverse events associated with consumer use of our products.  Our operations could be harmed if regulatory authorities make determinations that we or our vendors are not in compliance with the new regulations.  A finding of noncompliance may result in administrative warnings, penalties or actions impacting our ability to continue selling certain of our products.  In addition, compliance with these regulations has increased and may further increase the cost of manufacturing certain of our products as we work with our vendors to assure they are qualified and in compliance.
 
Failure to comply with domestic and foreign laws and regulations governing product claims and advertising could harm our business

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 ensure that our distributors would comply with applicable legal requirements.

Although our distributors are independent contractors, improper distributor actions that violate laws or regulations could harm our business.

Our distributors are independent contractors and, accordingly, we are not in a position to directly provide the same direction, motivation and oversight as we would if distributors were our own employees.  As a result, there can be no assurance that our distributors will participate in our marketing strategies or plans, accept our introduction of new products, or comply with our distributor policies and procedures.  Extensive federal, state and local laws regulate our business, our products and our network marketing program.  Because we have expanded into foreign countries, our policies and procedures for our independent distributors differ due to the different legal requirements of each country in which we do business.  While we have implemented distributor policies and procedures designed to govern distributor conduct and to protect the goodwill associated with our trademarks and trade names, it can be difficult to enforce these policies and procedures because of the large number of distributors and their independent status.  Given the size and diversity of our distributor force, we experience problems with distributors from time to time, especially with respect to our distributors in foreign markets.  Distributors often desire to enter a market, before we have received approval to do business, to gain an advantage in the marketplace.  Improper distributor activity in new geographic markets could result in adverse publicity and can be particularly harmful to our ability to ultimately enter these markets.  Violations by our distributors of applicable law or of our policies and procedures in dealing with customers could reflect negatively on our products and operations, and harm our business reputation.  In addition, it is possible that a court could hold us civilly or criminally accountable based on vicarious liability because of the actions of our independent distributors.  If any of these events occur, the value of an investment in our common shares could be impaired.
 
 
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Adverse publicity associated with our products, ingredients or network marketing program, or those of similar companies, could harm our financial condition and operating results.

Adverse publicity concerning any actual or claimed failure by us or our distributors to comply with applicable laws and regulations regarding product claims and advertising, good manufacturing practices, the regulation of our network marketing program, the licensing of our products for sale in our target markets or other aspects of our business, whether or not resulting in enforcement actions or the imposition of penalties, could have an adverse effect on our goodwill and could negatively affect our ability to attract, motivate and retain distributors, which would negatively impact our ability to generate revenue.  We cannot ensure that all distributors will comply with applicable legal requirements relating to the advertising, labeling, licensing or distribution of our products.

In addition, our distributors’ and consumers’ perception of the safety and quality of our products and ingredients as well as similar products and ingredients distributed by other companies can be significantly influenced by national media attention, publicized scientific research or findings, widespread product liability claims and other publicity concerning our products or ingredients or similar products and ingredients distributed by other companies.  Adverse publicity, whether or not accurate or resulting from consumers’ use or misuse of our products, that associates consumption of our products or ingredients or any similar products or ingredients with illness or other adverse effects, questions the benefits of our or similar products or claims that any such products are ineffective, inappropriately labeled or have inaccurate instructions as to their use, could negatively impact our reputation or the market demand for our products.

We have a limited product line.

We offer a limited number of products under our NHT Global brand.  Our Premium Noni Juice™ , Skindulgence™ , Alura™ and La Vie™ products each account for a significant portion of our total sales and, together, account for a significant majority of our total sales.  If demand for any of these four products decreases significantly, government regulation restricts the sale of these products, we are unable to adequately source or deliver these products (we currently source two of these products from a single supplier and the other two products from two other suppliers), or we cease offering any of these products for any reason without a suitable replacement, our business, financial condition and results of operations could be materially and adversely affected.

We do not manufacture our own products so we must rely on independent third parties for the manufacturing and supply of our products.

All of our products are manufactured by independent third parties.  There is no assurance that our current manufacturers will continue to reliably supply products to us at the level of quality we require.  In particular, the ongoing economic crisis creates risk for us if any of these third parties suffer liquidity or operational problems.  If a key manufacturer becomes insolvent or is forced to lay off employees assisting with our projects, our results could suffer.  In the event any of our third-party manufacturers become unable or unwilling to continue to provide the products in required volumes and quality levels at acceptable prices, we will be required to identify and obtain acceptable replacement manufacturing sources or replacement products.  There is no assurance that we will be able to obtain alternative manufacturing sources or products or be able to do so on a timely basis.  An extended interruption in the supply of our products will result in a substantial loss of sales.  In addition, any actual or perceived degradation of product quality as a result of our reliance on third party manufacturers may have an adverse effect on sales or result in increased product returns and buybacks.

Growth may be impeded by the political and economic risks of entering and operating foreign markets.
 
Our ability to achieve future growth is dependent, in part, on our ability to continue our international expansion efforts.  However, there can be no assurance that we would be able to grow in our existing international markets, enter new international markets on a timely basis, or that new markets would be profitable.  We must overcome significant regulatory and legal barriers before we can begin marketing in any foreign market.
 
 
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Also, it is difficult to assess the extent to which our products and sales techniques would be accepted or successful in any given country.  In addition to significant regulatory barriers, we may also encounter problems conducting operations in new markets with different cultures and legal systems from those encountered elsewhere.  We may be required to reformulate certain of our products before commencing sales in a given country.  Once we have entered a market, we must adhere to the regulatory and legal requirements of that market.  No assurance can be given that we would be able to successfully reformulate our products in any of our current or potential international markets to meet local regulatory requirements or attract local customers.  The failure to do so could have a material adverse effect on our business, financial condition, and results of operations.  There can be no assurance that we would be able to obtain and retain necessary permits and approvals.

In many markets, other direct selling companies already have significant market penetration, the effect of which could be to desensitize the local distributor population to a new opportunity, or to make it more difficult for us to recruit qualified distributors. There can be no assurance that, even if we are able to commence operations in foreign countries, there would be a sufficiently large population of potential distributors inclined to participate in a direct selling system offered by us.  We believe our future success could depend in part on our ability to seamlessly integrate our business methods, including distributor compensation plan, across all markets in which our products are sold.  There can be no assurance that we would be able to further develop and maintain a seamless compensation program.

Currency exchange rate fluctuations could lower our revenue and net income.

In 2008, 2009 and 2010, approximately 93%, 95% and 95%, respectively, of our revenue was recorded by subsidiaries located outside of North America.  Revenue transactions and related commission payments, as well as other incurred expenses, are typically denominated in the local currency.  Accordingly, our international subsidiaries use the local currency as their functional currency.  The results of operations of our international subsidiaries are exposed to foreign currency exchange rate fluctuations during consolidation since we translate into U.S. dollars using the average exchanges rates for the period.  As exchange rates vary, revenue and other operating results may differ materially from our expectations.  Additionally, we may record significant gains or losses related to foreign-denominated cash and cash equivalents and the re-measurement of inter-company balances.

We believe that our foreign currency exchange rate exposure is somewhat limited since the Hong Kong dollar is pegged to the U.S. dollar.  We also purchase almost all inventories in U.S. dollars.  Our foreign currency exchange rate exposure, mainly to South Korean won, Taiwan dollar, Japanese yen, Chinese yuan, Russian ruble and European euro, represented approximately 32% and 36% of our revenue in 2009 and 2010, respectively.  Our foreign currency exchange rate exposure may increase in the near future as our Greater China, Russia and European subsidiaries expand operations and we develop new markets.  Additionally, our foreign currency exchange rate exposure would significantly increase if the Hong Kong dollar were no longer pegged to the U.S. dollar.

Given our inability to predict the degree of exchange rate fluctuations, we cannot estimate the effect these fluctuations may have upon future reported results, product pricing or our overall financial condition.  Further, to date we have not attempted to reduce our exposure to short-term exchange rate fluctuations by using foreign currency exchange contracts.

Transfer pricing, duties and other tax regulations affect our business.

In many countries, including the United States, we are subject to transfer pricing and other tax regulations designed to ensure that appropriate levels of income are reported as earned by our United States or local entities and are taxed accordingly.  In addition, our operations are subject to regulations designed to ensure that appropriate levels of customs duties are assessed on the importation of our products.

Our principal domicile is the United States.  Under tax treaties, we are eligible to receive foreign tax credits in the United States for taxes paid abroad.  Taxes paid to foreign taxing authorities may exceed the credits available to us, resulting in the payment of a higher overall effective tax rate on our worldwide operations.

We have adopted transfer pricing agreements with our subsidiaries to regulate inter-company transfers, which agreements are subject to transfer pricing laws that regulate the flow of funds between the subsidiaries and the parent corporation for product purchases, management services, and contractual obligations, such as the payment of distributor compensation.  In 2005, we implemented a foreign holding and operating company structure for our non-United States businesses, although we have since discontinued our operational use of this structure to reduce costs and because we determined that our United States operating losses will lower our overall effective tax rate.
 
 
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We believe that we operate in compliance with all applicable transfer pricing laws and we intend to continue to operate in compliance with such laws.  However, there can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws would not be modified, which, as a result, may require changes in our operating procedures.

Failure to properly pay business taxes or customs duties, including those in China, could have a material adverse effect.

In the course of doing business we may be subject to various taxes, such as sales and use, value-added, franchise, income, and import duties.  The failure to properly calculate, report and pay such taxes or duties when we are subject to them could have a material adverse effect on our financial condition and results of operations.  Moreover, any change in the law or regulations regarding such taxes or duties, or any interpretation thereof, could result in an increase in the cost of doing business.

We may be held responsible for certain taxes or assessments relating to the activities of our distributors, which could harm our financial condition and operating results.

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.

We may face litigation that could harm our business.

We have been parties to lawsuits and other proceedings in the past.  Prosecuting and defending against existing and potential litigation and other governmental proceedings may continue to require significant expense and attention of our management.  There can be no assurance that the significant money, time and effort spent will not adversely affect our business, financial condition and results of operations.

We may be unable to protect or use our intellectual property rights.

We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection of our confidential information and trademarks.  Moreover, the laws of some countries in which we market our products may afford little or no effective protection of our intellectual property rights.  The unauthorized copying, use or other misappropriation of our confidential information, trademarks and other intellectual property could enable third parties to benefit from such property without paying us for it.  This could have a material adverse effect on our business, operating results and financial condition.  If we resort to legal proceedings to enforce our intellectual property rights, the proceedings could be burdensome, expensive and result in inadequate remedies.  It is also possible that our use of our intellectual property rights could be found to infringe on prior rights of others and, in that event, we could be compelled to stop or modify the infringing use, which could be burdensome and expensive.

We do not have product liability insurance and product liability claims could hurt our business.

Currently, we do not have product liability insurance, although the insurance carried by our suppliers may cover certain product liability claims against us.  As a marketer of dietary supplements, cosmetics and other products that are ingested by consumers or applied to their bodies, we may become subjected to various product liability claims, including that:

 
·
our products contain contaminants or unsafe ingredients;
 
·
our products include inadequate instructions as to their uses; or
 
·
our products include inadequate warnings concerning side effects and interactions with other substances.

If our suppliers’ product liability insurance fails to cover product liability claims or other product liability claims, or any product liability claims exceeds the amount of coverage provided by such policies or if we are unsuccessful in any third party claim against the manufacturer or if we are unsuccessful in collecting any judgment that may be recovered by us against the manufacturer, we could be required to pay substantial monetary damages which could materially harm our business, financial condition and results of operations. As a result, we may become required to pay higher premiums and accept higher deductibles in order to secure adequate insurance coverage in the future.  Especially since we do not have direct product liability insurance, it is possible that product liability claims and the resulting adverse publicity could negatively affect our business.
 
 
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Our internal controls and accounting methods may require modification.

We continue to develop controls and procedures and plan to implement additional controls and procedures sufficient to accurately report our financial performance on a timely basis in the foreseeable future.  If we do not develop and implement effective controls and procedures, we may not be able to report our financial performance on a timely basis and our business and stock price would be adversely affected.

If we fail to achieve and maintain an effective system of internal controls in the future, we may not be able to accurately report our financial results or prevent fraud.  As a result, investors may lose confidence in our financial reporting.
 
The Sarbanes-Oxley Act of 2002 requires that we report annually on the effectiveness of our internal control over financial reporting.  Among other things, we must perform systems and processes evaluation and testing.  We must also conduct an assessment of our internal controls to allow management to report on our assessment of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act.  We are required to provide management’s assessment of internal controls in conjunction with the filing of this report.  As disclosed under Item 9A of this report, our management has not been able to document our internal controls sufficiently to conclude that our internal control over financial reporting was effective at December 31, 2009 and 2010, and therefore has concluded that such internal controls are not effective.  If and as we obtain that documentation, our future assessment, or the assessment by our independent registered public accounting firm, could reveal significant deficiencies or material weaknesses in our internal controls, which may need to be disclosed in future Annual Reports on Form 10-K.  We believe, at the current time, that we are taking appropriate steps to mitigate these risks.  However, disclosures of this type can cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock.  Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud.  Deficiencies in our internal controls over financial reporting may negatively impact our business and operations.

We rely on and are subject to risks associated with our reliance upon information technology systems.

Our success is dependent on the accuracy, reliability, and proper use of information processing systems and management information technology.  Our information technology systems are designed and selected to facilitate order entry and customer billing, maintain distributor records, accurately track purchases and distributor compensation payments, manage accounting operations, generate reports, and provide customer service and technical support.  Any interruption in these systems could have a material adverse effect on our business, financial condition, and results of operations.

Although we believe that the members of our software development team have the qualifications, know-how and experience to perform the necessary software development and other information technology services, there can be no assurance that there will not be delays or interruptions in these services.  An interruption or delay in availability of these services could, if it lasted long enough, prevent us from making sales, cause distributors to leave our business, or otherwise materially adversely affect our business.

System failures and attacks could harm our business.

Because of our diverse geographic operations and our internationally applicable distributor compensation plans, our business is highly dependent on efficiently functioning of our information technology systems and operations, which are vulnerable to damage or interruption from fires, earthquakes, telecommunications failures, computer viruses and worms, hacking, denial of service attacks, software defects and other events.  They are also subject to break-ins, sabotage, acts of vandalism and similar misconduct, as well as human error.  Despite precautions implemented by our information technology staff, problems could result in interruptions in services and materially and adversely affect our business, financial condition and results of operations.

Moreover, hackers could attack our system seeking to retrieve personal or confidential information of the company or of third parties, such as credit card information used to purchase our products on-line.  Although we take steps to prevent such loss of information, there can be no assurance that our system will not be successfully hacked.  Laws in the United States and other jurisdictions where we do business require prompt notice of any such loss of information.  Failure to comply with those reporting obligations could result in material penalties.  In addition, if our system were hacked, we could incur material costs in investigating the incidents and could be liable for damages.  Any such damages may or may not be covered by insurance.

Terrorist attacks, cyber attacks, acts of war, epidemics or other communicable diseases or any other natural disasters may seriously harm our business.

Terrorist attacks, cyber attacks, or acts of war or natural disasters may cause damage or disruption to us, our employees, our facilities and our customers, which could impact our revenues, expenses and financial condition.  The potential for future terrorist attacks, the national and international responses to terrorist attacks, and other acts of war or hostility, such as the Chinese objection to the Taiwan independence movement and its resultant tension in the Taiwan Strait, could materially and adversely affect our business, results of operations, and financial condition in ways that we currently cannot predict.  Additionally, natural disasters less severe than the Indian Ocean tsunami that occurred in December 2004 may adversely affect our business, financial condition and results of operations.
 
 
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Disappointing quarterly revenue or operating results could cause the price of our common stock to fall.
     
Our quarterly revenue and operating results are difficult to predict and may fluctuate significantly from quarter to quarter.  If our quarterly revenue or operating results fall below the expectations of investors or securities analysts, the price of our common stock could fall substantially.

Our common stock is particularly subject to volatility because of the industry in which we operate.

The market prices of securities of direct selling companies have been extremely volatile, and have experienced fluctuations that have often been unrelated or disproportionate to the operating performance of such companies.  These broad market fluctuations could adversely affect the market price of our common stock.

There is no assurance that an active public trading market will continue.

There can be no assurance that an active public trading market for our common stock will be sustained.  If for any reason an active public trading market does not continue, purchasers of the shares of our common stock may have difficulty in selling their securities should they desire to do so and the price of our common stock may decline.

The exercise of our warrants may result in substantial dilution and may depress the market price of our common stock.

As of November 7, 2011, we had outstanding 11,326,323 shares of common stock and also (i) options to purchase an aggregate of 22,500 shares of our common stock, all with an exercise price of $1.80, (ii) warrants outstanding from our May 2007 private placement exercisable for 2,059,307 shares of our common stock at an exercise price of $5.00 per share, (iii) 138,400 shares of Series A preferred stock, convertible into the same number of shares of common stock and (iv) warrants issued in our October 2007 private placement exercisable for 1,645,547 shares of common stock at an exercise price of $3.52 per share. If these convertible securities are exercised or converted, and the shares of common stock issued upon such exercise or conversion are sold, our common stockholders may experience substantial dilution and the market price of our shares of common stock could decline.  Further, the perception that such convertible securities might be exercised or converted could adversely affect the market price of our shares of common stock.  In addition, holders of our warrants and options are likely to exercise them when, in all likelihood, we could obtain additional capital on terms more favorable to us than those provided by the warrants and options.  The anti-dilution provisions of warrants to purchase 1,645,547 shares of our common stock would, if triggered, cause substantial dilution and may, therefore, make it particularly difficult to obtain new equity financing.

Future sales by us or our existing stockholders could depress the market price of our common stock.

If we or our existing stockholders sell a large number of shares of our common stock, the market price of our common stock could decline significantly.  Further, even the perception in the public market that we or our existing stockholders might sell shares of common stock could depress the market price of the common stock.

Penny stock regulations are applicable to investment in our shares of common stock

Broker-dealer practices in connection with transactions in "penny stocks" are regulated by certain penny stock rules adopted by the SEC.  Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges, provided that current prices and volume information with respect to transactions in such securities are provided by the exchange or system).  Penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market.  The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer's account.  In addition, penny stock rules generally require that prior to a transaction in a penny stock, the broker-dealer make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction.  These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for a stock that becomes subject to penny stock rules.  Many brokers will not deal with penny stocks, restricting the market for our shares of common stock.
 
 
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Item 1B.                 UNRESOLVED STAFF COMMENTS

Not applicable.

Item 2.                 PROPERTIES

We lease approximately 4,400 square feet in Dallas, Texas for our corporate headquarters.  Outside the United States, we lease office space in Hong Kong, China, Japan, Taiwan and South Korea.  In China, we also lease a building north of the city of Dalian with the intention of developing a multi-purposed facility serving the needs of consumers in northern China.  We contract with third parties for fulfillment and distribution operations in most of our international markets.  We believe that our existing properties are in good condition, suitable and adequate for the conduct of our business.

Item 3.                 LEGAL PROCEEDINGS

On June 26, 2008, the Company sued Terry LaCore and bHIP Global, Inc. in the 116th District Court, Dallas County, Texas, in Cause No. 08-06925 styled Natural Health Trends Corp. v. bHIP Global, Inc. and Terry LaCore.  The Company sought an unspecified amount in actual and punitive damages, as well as a temporary and permanent injunction and other equitable relief.  The Company claimed that Mr. LaCore deceived the Company, breached fiduciary duties, and breached various agreements regarding the use, disclosure and return of confidential information and other assets and the non-interference with the Company and its business and relationships.  The Company also claimed that Mr. LaCore and bHIP Global, Inc. were unlawfully taking, disparaging and/or interfering with the Company’s reputation, identity, confidential information, contracts and relationships, products, businesses and other assets.  The Company obtained temporary injunctive relief against Mr. LaCore and  bHIP Global, Inc. and its officers, agents, employees and attorneys.  On April 10, 2009, the Company added a former employee and director of its Hong Kong subsidiary, Jeff Provost, as a defendant in this lawsuit.  On July 2, 2009, Mr. Provost asserted counterclaims against the Company for certain bonuses and other compensation that Mr. Provost alleged were owed to him.  Mr. Provost sought in excess of $400,000 on his counterclaims.  On December 31, 2009, the Company signed a confidential Settlement Agreement with bHIP Global, Inc., Terry LaCore, Jeff Provost, and MarketVision Consulting Group, Inc.  The parties no longer desired to pursue their claims for business purposes and their differences have been resolved on a mutually acceptable basis.  As part of the Settlement Agreement, bHIP Global, Inc. purchased the Company’s rights to the name “BHIP.” On January 12, 2010, the court entered an order dismissing with prejudice all claims asserted by all parties in the bHIP lawsuit.

On July 16, 2008, Lisa Grossmann, a former distributor and consultant for the Company, sued the Company, and certain current officers and directors, in the Superior Court of California in Sacramento, California, in Case No. 34-2008-00016090 styled Lisa Grossmann, et al. v. Natural Health Trends Corp., et al.  Ms. Grossmann purported to sue individually and on behalf of California distributors, shareholders, and customers of the Company.  On behalf of California residents, Ms. Grossmann alleged that the defendants engaged in, or conspired to engage in, unfair competition and false advertising and seeks an unspecified amount of restitution and disgorgement, as well as an injunction.  Individually, Ms. Grossmann alleged that the Company breached a contract to pay distributor commissions to her, the Company breached an implied covenant of good faith and fair dealing, all defendants were unjustly enriched at her expense, the individual defendants breached fiduciary duties to her, all defendants were negligent in conducting the affairs of the Company, and all defendants committed fraud.  Ms. Grossman sought in excess of $500,000 in damages on her individual claims.  On June 8, 2009, the Superior Court granted the defendants’ motion to quash service of the lawsuit on them for lack of personal jurisdiction.  On June 16, 2009, Ms. Grossmann added one of the Company’s subsidiaries, NHT Global, Inc. (“NHTG”), as a defendant to her lawsuit.  On September 24, 2009, the Court denied NHTG’s motion to quash service of the lawsuit for lack of personal jurisdiction.  However, on December 23, 2009, the Court sustained a demurrer to Ms. Grossmann’s claim on behalf of California residents, without leave to amend, and ordered that all of the remaining claims be dismissed for inconvenient forum.  The Court entered judgment on those orders, which judgment was not appealed.

On or about January 4, 2010, Steve Francisco sued the Company’s subsidiary, NHT Global, Inc., in the Superior Court for Orange County, California, in Case No. 30-2010-00333395, styled Steve Francisco, Starsearch International, LLC, and Healthlik Resources, LLC v. NHT Global, Inc., eKaire.com, Inc. and Does 1 through 20.  Mr. Francisco sought damages for the alleged breach of a prior settlement agreement under which NHT Global had agreed to pay Mr. Francisco payments of not less than $10,000 and not more than $30,000 per month unless and until Mr. Francisco violated NHT Global’s policies and procedures.  On March 12, 2009, NHT Global had terminated payments to Mr. Francisco for violating the policies and procedures.  Mr. Francisco sought recovery of $100,000 in damages accrued through the date of filing of the lawsuit and an order requiring NHT Global to continue making the monthly payments required by the settlement agreement, as well as an accounting, attorneys’ fees and costs.  Mr. Francisco’s lawsuit also sought payment of certain promissory notes in the aggregate amount of $102,000 made by eKaire.com, Inc., a former subsidiary no longer affiliated with the Company, who separately answered the lawsuit.  Trial of this lawsuit was set for February 14, 2011.  On February 14, 2011, the parties announced to the court that they had reached an oral settlement agreement that was pending documentation.  On or about March 8, 2011, NHT Global, Inc. and the plaintiffs in this lawsuit signed a Confidential Settlement Agreement and Mutual Release, containing a mutually agreeable, confidential settlement of the case.
 
 
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On or about June 9, 2010, the Company vacated the premises it leased at 2050 Diplomat Drive, Dallas, Texas, so that it could be leased to a new tenant.  The landlord, CLP Properties Texas, LP (the “Landlord”), terminated the lease as of June 17, 2010 and entered into a lease with a new tenant.  On or about August 17, 2010, the Company received the Landlord’s written demand for payment of $413,000 for unpaid rent and other charges due under the lease through June 17, 2010.  On September 30, 2010, CLP Properties Texas, LP, sued the Company in the 116th Judicial District Court, Dallas County, Texas, in Cause No. 10-13043, styled CLP Properties Texas, LP v. Natural Health Trends Corp.  The lawsuit alleged breach of the lease and sought actual damages, interest, costs and attorneys’ fees.  The Company answered with a general denial, and gave notice to the Landlord that it intended to assert an affirmative defense of failure to mitigate damages.  On or about June 2, 2011, the parties signed a Settlement Agreement under which the Company agreed to pay the Landlord $50,000 by June 3, 2011 and an additional $75,000 by September 15, 2011.  These amounts were timely paid, and the lawsuit was dismissed with prejudice.

Currently, there is no pending litigation against us other than as disclosed in the paragraphs above.  From time to time, we may become a party to litigation and subject to claims incident to the ordinary course of our business.  Although the results of such litigation and claims in the ordinary course of business cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, results of operations or financial condition.  Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

Item 4.                 (REMOVED AND RESERVED)

 
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Part II

Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is currently quoted on the Pink Sheets, a centralized electronic quotation service run by Pink OTC Markets Inc. for over-the-counter securities under the trading symbol “NHTC.”  Prior to August 13, 2010, our common stock was quoted under the trading symbol “BHIP.”  Our common stock was traded on the Nasdaq Capital Market before November 11, 2009.  The following table sets forth the composite of the high and low bid quotations of our common stock as reported by the Pink Sheets and the high and low intra-day sales prices of our common stock as reported on the Nasdaq Capital Market.  The bid quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

   
2009
   
2010
 
   
High
   
Low
   
High
   
Low
 
                         
March 31
  $ 0.40     $ 0.21     $ 0.30     $ 0.13  
June 30
    0.82       0.34       0.35       0.21  
September 30
    1.06       0.45       0.30       0.17  
December 31
    0.79       0.14       0.17       0.05  

On November 7, 2011, the last reported bid quotation of our common stock on the Pink Sheets was $0.65 per share.

Holders of Record

At November 7, 2011, there were approximately 190 record holders of our common stock (although we believe that the number of beneficial owners of our common stock is substantially greater).

Dividends

We have never declared or paid any cash dividend on our common stock.  We currently intend to retain earnings, if any, to finance the growth and development of our business.  We do not expect to pay any dividends in the foreseeable future.  Payment of any future dividends on shares of our common stock will be at the discretion of our Board of Directors.  At December 31, 2010, we had accrued unpaid dividends of $140,000 with respect to the Series A preferred stock, but such dividends have not been declared and we are under no obligation to pay such accrued dividends except in certain extraordinary circumstances.
 
 
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Equity Compensation Plan Information

The following table sets forth information regarding all compensation plans under which Company equity securities are authorized for issuance as of December 31, 2009 and 2010:

Plan Category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
   
Weighted-average exercise price of outstanding options, warrants and rights
(b)
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
 
                   
As of December 31, 2010:
                 
Equity compensation plans approved by security holders
    22,500     $ 1.80       602,335  
Equity compensation plans not approved by security holders
                 
Total
    22,500     $ 1.80       602,335  
                         
As of December 31, 2009:
                       
Equity compensation plans approved by security holders
    27,500     $ 1.80       529,519  
Equity compensation plans not approved by security holders
                 
Total
    27,500     $ 1.80       529,519  

Recent Sales of Unregistered Securities

On June 18, 2009, we issued 60,000 shares of common stock to Phillip M. Kelly, as Chapter 7 Bankruptcy Trustee in the Matter of John Loghry and Robin Loghry pursuant to a Settlement Agreement and Mutual Release dated as of May 14, 2009, by and among Phillip M. Kelly, as Chapter 7 Bankruptcy Trustee in the Matter of John Loghry and Robin Loghry, on the one hand, and Natural Health Trends Corp., NHT Global, Inc., Steve Francisco, and Starsearch International, LLC.  The shares were issued as partial settlement and release of claims asserted against the Company in Civil Action No. 3:06-CV-0561-L, styled Phillip M. Kelly, as Chapter 7 Bankruptcy Trustee in the matter of John Loghry and Robyn Loghry, Plaintiff, vs. Lexxus International, Inc., Natural Health Trends Corp., Terry LaCore, Lisa Grossmann, Curtis Broome, and Mark Woodburn, Defendants, in the United States District Court for the Northern District of Texas.  The shares were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended.

Item 6.               SELECTED FINANCIAL DATA

Not applicable under smaller reporting company disclosure rules.
 
 
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Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview

We are an international direct-selling and e-commerce company.  Subsidiaries controlled by us sell personal care, wellness, and “quality of life” products under the “NHT Global” brand.  In most markets, we sell our products to an independent distributor network that either uses the products themselves or resells them to consumers.  Our majority-owned subsidiaries have an active physical presence in the following markets:  North America; Greater China, which consists of Hong Kong, Taiwan and China; Russia; South Korea; Japan; and Europe, which consists of Italy and Slovenia.

Our distributor network operates in a seamless manner from market to market, except for the Chinese market.  We believe that each of our operating segments should be aggregated into a single reportable segment as they have similar economic characteristics.  Additionally, we believe that each of the operating segments are similar in the nature of the products sold, the product acquisition process, the types of customers products are sold to, the methods used to distribute the products, and the nature of the regulatory environment.  Our e-commerce retail business in China does not require a direct selling license and allows for discounts on volume purchases.  There is no separate segment manager who is held accountable by our chief operating decision-makers, or anyone else, for operations, operating results and planning for the Chinese market on a stand-alone basis.  Accordingly, we consider ourselves to be in a single reporting segment and operating unit structure.

As of December 31, 2010, we were conducting business through approximately 16,000 active distributors.  We consider a distributor “active” if they have placed at least one product order with us during the preceding year.  Currently we do not intend to devote material resources to opening any additional foreign markets in the near future.  Our priority is to focus our resources in our most promising markets, namely Greater China and Russia.  Additionally, we have consolidated underperforming markets in Latin America and Southeast Asia to further improve operating results and free up additional internal resources for our most promising markets.

We generate about 95% of our net sales from subsidiaries located outside North America, with sales in Hong Kong representing almost 60% of net sales in the latest fiscal year.  Because of the size of our foreign operations, operating results can be impacted negatively or positively by factors such as foreign currency fluctuations, and economic, political and business conditions around the world.  In addition, our business is subject to various laws and regulations, in particular regulations related to direct selling activities that create certain risks for our business, including improper claims or activities by our distributors and potential inability to obtain necessary product registrations.

China has been and continues to be our most important business development project.  In June 2004, NHT Global obtained a general business license in China.  Direct selling is prohibited in China without a direct selling license that we do not have.  In December 2005, we submitted a preliminary application for a direct selling license.  In June 2006, we submitted a revised application package in accordance with new requirements issued by the Chinese government.  In June 2007, we launched a new e-commerce retail platform in China that does not require a direct selling license and is separate from our current worldwide platform.  We believe this model, which offers discounts based on volume purchases, will encourage repeat purchases of our products for personal consumption in the Chinese market.  The platform is designed to be in compliance with our understanding of current laws and regulations in China.  In November 2007, we filed a new, revised direct selling application incorporating a name change, our new e-commerce model and other developments.  These direct selling applications were not approved or rejected by the pertinent authorities, but did not appear to materially progress.  By now, the information contained in the most recent application is stale.  The Company applied to temporarily withdraw the license application in February 2009 to furnish new information and intends to amend its application with the goal to re-apply in the future.   We are unable to predict whether we will be successful in obtaining a direct selling license to operate in China, and if we are successful, when we will be permitted to enhance our e-commerce retail platform with direct selling operations.

Most of the Company’s Hong Kong revenue is derived from the sale of products that are delivered to members in China.  After consulting with outside professionals, the Company believes that its Hong Kong e-commerce business does not violate any applicable laws in China even though it is used for the internet purchase of our products by buyers in China.  But the government in China could, in the future, officially interpret its laws and regulations – or adopt new laws and regulations – to prohibit some or all of our e-commerce activities with China and, if our members engage in illegal activities in China, those actions could be attributable to us.  In addition, other Chinese laws regarding how and when members may assemble and the activities that they may conduct, or the conditions under which the activities may be conducted, in China are subject to interpretations and enforcement attitudes that sometimes vary from province to province, among different levels of government, and from time to time.  Members sometimes violate one or more of the laws regulating these activities, notwithstanding training that the Company attempts to provide.  Enforcement measures regarding these violations, which can include arrests, raise the uncertainty and perceived risk associated with conducting this business, especially among those who are aware of the enforcement actions but not the specific activities leading to the enforcement. The Company believes that this has led some existing members in China – who are signed up as distributors in Hong Kong - to leave the business or curtail their selling activities and has led potential members to choose not to participate.  Among other things, the Company is combating this with more training and public relations efforts that are designed, among other things, to distinguish the Company from businesses that make no attempt to comply with the law.  This environment creates uncertainty about the future of doing this type of business in China generally and under our business model, specifically.  See “Item 1A.  Risk Factors—Because our Hong Kong operations account for a majority of our overall business….”
 
 
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Income Statement Presentation

We derive revenue from sales of products, enrollment packages, and shipping charges.  Substantially all of our product sales are to independent distributors at published wholesale prices.  Product sales are recorded when the products are shipped and title passes to independent distributors, which generally is upon our delivery to the carrier that completes delivery to the distributors.  We estimate and accrue a reserve for product returns based on our return policies and historical experience.  Enrollment package revenue, including any nonrefundable set-up fees, is deferred and recognized over the term of the arrangement, generally twelve months.  

Cost of sales consist primarily of products purchased from third-party manufacturers, freight cost for shipping products to distributors, import duties, costs of promotional materials sold to the Company’s distributors at or near cost, and provisions for slow moving or obsolete inventories.  Cost of sales also includes purchasing costs, receiving costs, inspection costs and warehousing costs.

Distributor commissions are typically our most significant expense and are classified as an operating expense.  Under our compensation plan, distributors are paid weekly commissions, generally in their home country currency, for product sold by their down-line distributor network across all geographic markets, except China, where we launched an e-commerce retail platform and do not pay any commissions.  Distributors are not paid commissions on purchases or sales of our products made directly by them.  This "seamless" compensation plan enables a distributor located in one country to sponsor other distributors located in other countries where we are authorized to conduct our business.  Currently, there are basically two ways in which our distributors can earn income:

 
·
Through retail markups on sales of products purchased by distributors at wholesale prices (in some markets, sales are for personal consumption only and income may not be earned through retail mark-ups on sales in that market); and
 
·
Through commissions paid on product purchases made by their down-line distributors.

Each of our products is designated a specified number of sales volume points, also called bonus volume or “BV.”  Commissions are based on total personal and group sales volume points per sales period.  Sales volume points are essentially a percentage of a 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 higher commissions from purchases made by an expanding down-line network.  To be eligible to receive commissions, a distributor may be required to make nominal monthly or other periodic purchases of our products.  Certain of our subsidiaries do not require these nominal purchases for a distributor to be eligible to receive commissions.  In determining commissions, the number of levels of down-line distributors included within the distributor's commissionable group increases as the number of distributorships directly below the distributor increases.  Under our current compensation plan, certain of our commission payouts may be limited to a hard cap in terms of a specific percentage of total product sales.  In some markets, commissions may be further limited.  In some markets, we also pay certain bonuses on purchases by several generations of personally sponsored distributors, as well as bonuses on commissions earned by several generations of personally sponsored distributors.  Distributors can also earn income, trips and other prizes in specific time-limited promotions and contests we hold from time to time.  Distributor commissions are dependent on the sales mix and, for fiscal 2008, 2009 and 2010, represented 39%, 38%, and 37% of net sales, respectively.  From time to time we make modifications and enhancements to our compensation plan to help motivate distributors, which can have an impact on distributor commissions.  From time to time we also enter into agreements for business or market development, which may result in additional compensation to specific distributors.

Selling, general and administrative expenses consist of administrative compensation and benefits (including stock-based compensation), travel, credit card fees and assessments, professional fees, certain occupancy costs, and other corporate administrative expenses.  In addition, this category includes selling, marketing, and promotion expenses including costs of distributor conventions which are designed to increase both product awareness and distributor recruitment.  Because our various distributor conventions are not always held at the same time each year, interim period comparisons will be impacted accordingly.

The functional currency of our international subsidiaries is generally their local currency.  Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period.  Equity accounts are translated at historical rates.  The resulting translation adjustments are recorded directly into a separate component of stockholders’ equity and represents the only component of accumulated other comprehensive income.
 
 
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Sales to customers outside the United States are transacted in the respective local currencies and are translated into U.S. dollars using average rates of exchange for each monthly accounting period to which they relate.  Most of our product purchases from third-party manufacturers are transacted in U.S. dollars.  Consequently, our sales and net earnings are affected by changes in currency exchange rates, with sales and earnings generally increasing with a weakening U.S. dollar and decreasing with a strengthening U.S. dollar. 
 
Results of Operations
 
Annual Financial Information
 
The following table sets forth our operating results as a percentage of net sales for the periods indicated.
 
   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
                   
Net sales
    100.0 %     100.0 %     100.0 %
Cost of sales
    27.7       31.0       29.6  
Gross profit
    72.3       69.0       70.4  
Operating expenses:
                       
Distributor commissions
    38.5       37.7       36.8  
Selling, general and administrative expenses
    37.5       45.2       41.6  
Depreciation and amortization
    3.2       4.3       5.1  
Total operating expenses
    79.2       87.2       83.5  
Loss from operations
    (6.9 )     (18.2 )     (13.1 )
Other income (expense), net
    (0.5 )     (2.8 )     2.5  
Loss before income taxes
    (7.4 )     (21.0 )     (10.6 )
Income tax provision (benefit)
    1.0       (0.2 )     (0.1 )
Net loss
    (8.4 )%     (20.8 )%     (10.5 )%

Net Sales

The following table sets forth revenue by market for the periods indicated (in thousands):

   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
                                     
North America
  $ 3,247       7.1 %   $ 1,477       4.8 %   $ 1,214       5.2 %
Hong Kong
    30,272       66.1       19,574       63.7       13,930       59.1  
China
    1,328       2.9       1,644       5.3       1,202       5.1  
Taiwan
    4,444       9.7       2,259       7.3       1,870       7.9  
South Korea
    3,805       8.3       1,652       5.4       828       3.5  
Japan
    1,244       2.7       675       2.2       428       1.8  
Russia
                1,602       5.2       3,541       15.0  
Europe
    1,223       2.7       1,859       6.1       563       2.4  
Other1
    243       0.5                          
Total
  $ 45,806       100.0 %   $ 30,742       100.0 %   $ 23,576       100.0 %

 
 
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Net sales were $30.7 million for the year ended December 31, 2009 compared to $45.8 million for the year ended December 31, 2008, a decrease of $15.1 million or 33%.  Hong Kong sales decreased $10.7 million, or 35%, over the comparable period a year ago.  Net sales for North America, South Korea, Taiwan and Japan were down $1.8 million, $2.2 million, $2.2 million and $569,000, respectively.  North America sales were impacted by the launch of retail product selling in Italy during June 2008.  Prior to the launch, sales into the European market were fulfilled by our North America subsidiaries.  European sales during the year ended December 31, 2009 totaled $1.9 million and included sales related to our Russian market through August 2009, at which time the Russian market officially launched.  Russian sales during the four months ended December 31, 2009 totaled $1.6 million.  Additionally, net sales in China from our e-commerce retail platform increased $316,000 over the comparable period a year ago.

The decrease in net sales in Hong Kong, Taiwan and South Korea was primarily due to the Company’s effort to reduce loss-making recruitment programs.  The Company lowered the cost of new member acquisition and began focusing more on improving the productivity of its existing members.  Also, certain of the Company’s Hong Kong member’s groups re-organized their leadership during the first half of 2009.  In working with the changing leadership of the groups, the Company deferred and scaled back certain marketing activities.  Net sales in Hong Kong were also down in 2009 due in part to delays in shipping orders during the 4th quarter of 2009 that resulted from operational issues with our third party logistics partners, who were replaced during 2010.  As of December 31, 2009, the operating subsidiaries of the Company had 20,000 active distributors, compared to 33,000 active distributors at December 31, 2008.  Hong Kong experienced a decrease of 9,000 active distributors, or 42%, from December 31, 2008 to December 31, 2009.

Net sales were $23.6 million for the year ended December 31, 2010 compared to $30.7 million for the year ended December 31, 2009, a decrease of $7.1 million or 23%.  Hong Kong sales decreased $5.6 million, or 29%, over the comparable period a year ago.  Net sales for North America, South Korea, Taiwan, and Japan were down $263,000, $824,000, $389,000 and $247,000, respectively.  Net sales for Europe decreased by $1.3 million, while Russian net sales increased $1.9 million.  The European market was directly impacted by the launch of the Russian market in August 2009.  Prior to the launch, sales into the Russian market were included as part of the European market.  Additionally, net sales in China from our e-commerce retail platform decreased $442,000 over the comparable period a year ago.

During 2010, the Company continued its plan to focus on incentives that improve productivity and reduce loss-making recruitment programs.  Although the number of active distributors continued to decline from the prior year, the rate of the decline lessened.  In any event, the decrease in net sales was primarily due to the Company’s lower product sales as a result of fewer active distributors and lower membership fee revenue due to promotions in 2010 which offered free or discounted enrollment fees.  As of December 31, 2010, the operating subsidiaries of the Company had 16,000 active distributors, compared to 20,000 active distributors at December 31, 2009.  Hong Kong experienced a decrease of 2,000 active distributors, or 19%, from December 31, 2009 to December 31, 2010.

As of December 31, 2010, the Company had deferred revenue of approximately $1.0 million, of which $776,000 pertained to product sales and $253,000 pertained to unamortized enrollment package revenue.

Gross Profit

Gross profit was $21.2 million, or 69.0% of net sales, for the twelve months ended December 31, 2009 compared with $33.1 million, or 72.3% of net sales, for the twelve months ended December 31, 2008.  This decrease in gross profit of $11.9 million was due to decreased product sales.  The erosion in gross profit as a percentage of net sales was mainly due to non-variable Chinese importation costs and the decline in enrollment package revenue.

Gross profit was $16.6 million, or 70.4% of net sales, for the twelve months ended December 31, 2010 compared with $21.2 million, or 69.0% of net sales, for the twelve months ended December 31, 2009.  This decrease of $4.6 million was due to decreased product sales as well.  However, the gross profit percentage slightly increased due to elimination of the non-variable Chinese importation cost at the end of 2009 upon transition to a new service provider.

Distributor Commissions

Distributor commissions were $11.6 million, or 37.7% of net sales, for the year ended December 31, 2009 compared with $17.7 million, or 38.5% of net sales, for the year ended December 31, 2008.  Distributor commissions decreased by $6.1 million, or 34%, mainly due to the decrease in product sales along with less supplemental commissions paid in Taiwan, Europe, South Korea and North America offset by a slight increase in supplemental commissions paid in Hong Kong.

Distributor commissions were $8.7 million, or 36.8% of net sales, for the year ended December 31, 2010 compared with $11.6 million, or 37.7% of net sales, for the year ended December 31, 2009.  Distributor commissions decreased by $2.9 million, or 25%, mainly due to the decrease in product sales along with less supplemental commissions paid in Hong Kong, South Korea, North America and Russia.
 
 
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We expected certain changes to our commission plan in March 2008 to result in a commission payout percentage that would settle around 40% of product sales.  We made further enhancements to the commission plan in the latter half of 2010 in all of our most significant markets.  The enhancements should not have a significant impact on the overall payout rate.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $13.9 million, or 45.2% of net sales, for the year ended December 31, 2009 compared with $17.2 million, or 37.5% of net sales, for the year ended December 31, 2008.  Selling, general and administrative expenses decreased by $3.3 million, or 19%, in the twelve months ended December 31, 2009 mainly due to the following:

 
·
lower legal and accounting fees ($732,000), employee-related expense and severance costs ($454,000), facility-related costs ($120,000) and insurance costs ($89,000) in North America;
 
·
lower credit card charges and assessments ($266,000), public relations expense ($211,000), professional fees ($160,000), facility-related expenses ($216,000) and event and other distributor-related costs ($168,000) offset by an increase in employee-related expense and severance costs ($185,000) in Hong Kong and China;
 
·
lower professional fees ($255,000), employee-related costs ($48,000) and event costs ($20,000) in Europe;
 
·
lower operating costs due to office closures in Mexico ($408,000) and Southeast Asia ($81,000);
 
·
lower employee-related costs ($398,000), facility related expenses ($199,000) and credit card changes and assessments ($76,000) in South Korea;
 
·
lower overall expenses in Japan ($110,000) and Taiwan ($117,000); partially offset by
 
·
higher stock-based compensation expense ($61,000) of which $26,000 is due to accelerated vesting on certain shares of restricted stock as stipulated in the Going Forward Agreement entered into with the former President of the Company’s subsidiary, MarketVision Communications Corp., and due to the issuance of 60,000 shares of common stock as part of the settlement of the John Loghry legal matter;
 
·
higher overall expenses in Russia ($327,000) due to the launch of the Russian market in 2009; and
 
·
higher other professional fees ($362,000) in North America and a legal expense credit in the second quarter of 2008 for reimbursement from our D&O insurance carrier ($100,000).

Selling, general and administrative expenses were $9.8 million, or 41.6% of net sales, for the year ended December 31, 2010 compared with $13.9 million, or 45.2% of net sales, for the year ended December 31, 2009.  Selling, general and administrative expenses decreased by $4.1 million, or 29%, in the twelve months ended December 31, 2010 mainly due to the following:

 
·
lower legal and accounting fees ($135,000), other professional fees ($842,000), facility-related costs ($125,000), employee-related expense and severance costs ($531,000), litigation settlement costs ($109,000) and insurance costs ($136,000) in North America;
 
·
lower credit card charges and assessments ($150,000), facility-related expenses ($276,000) and event and other distributor-related costs ($253,000), employee-related expense and severance costs ($402,000) and other miscellaneous business expenses ($82,000) in Hong Kong and China;
 
·
lower employee-related costs ($223,000) and facility-related expenses ($48,000) offset by an increase in professional fees ($39,000) in South Korea;
 
·
lower overall expenses in Japan ($45,000), Europe ($185,000) and Taiwan (216,000); and
 
·
lower stock-based compensation expense ($318,000); partially offset by
 
·
an increase in credit card charges and assessments ($109,000), professional fees ($70,000) and employee-related expense, event and other distributor-related costs and facility-related costs ($80,000) in Russia.

Other Income (Expense), Net

 Other expense was $226,000 and $875,000 for the years ended December 31, 2008 and 2009, respectively, compared with income of $583,000 for the year ended December 31, 2010.  The increase in other expense from 2008 to 2009 was primarily due to the loss on redemption of the convertible debentures that was recorded upon redemption in August 2009.  Additionally, we de-recognized $2.2 million and $221,000 of unclaimed, aged commission checks in certain of our international markets, primarily Hong Kong, during 2008 and 2009, respectively, as it was determined that it is probable that these commission payments will not be claimed.  Such significant de-recognition is not expected to occur in the future.  We recorded additional income of $2.3 million during the fourth quarter of 2009 upon termination of our relationship with our Hong Kong logistics partners.  Certain amounts invoiced, but unpaid, for services, product and accrued interest were cancelled and offset against inventories and property and equipment retained by the logistics partners.  The only significant component of other income during 2010 was an unrealized gain on foreign exchange amounting to $524,000.
 
 
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Income Taxes

The provision for income taxes was $456,000 for the year ended December 31, 2008 due primarily to a $351,000 deferred tax liability recorded in Hong Kong upon de-recognition of unclaimed, aged commission checks.  A portion of the deferred tax liability reversed in each of 2009 and 2010, which resulted in an overall income tax benefit in each year.  The Company has not recognized a tax benefit for U.S. tax purposes due to uncertainty that the benefit will be realized.
 
 
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Quarterly Financial Information

The following tables set forth our operating results as a percentage of net sales for each of the last twelve fiscal quarters, as derived from our unaudited quarterly statements of operations.  The unaudited quarterly statements of operations are consistent with the consolidated financial statements herein and include normally recurring adjustments that management considers to be necessary for a fair presentation of the data.  Quarterly results are not necessarily indicative of future results of operations.  This information should be read in conjunction with the audited consolidated financial statements and notes thereto that are included elsewhere in this report.

   
2008
   
2009
   
2010
 
   
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
   
First
   
Second
   
Third
   
Fourth
 
                                                                         
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
    27.1       28.0       27.7       28.0       28.3       29.6       32.9       35.1       29.4       28.3       30.0       30.6  
Gross profit
    72.9       72.0       72.3       72.0       71.7       70.4       67.1       64.9       70.6       71.7       70.0       69.4  
Operating expenses:
                                                                                               
Distributor commissions
    35.1       37.3       41.5       40.5       38.3       39.2       35.0       37.3       36.1       33.4       39.9       38.1  
Selling, general and administrative expenses
    40.3       34.7       39.6       35.6       38.2       43.8       56.1       47.7       42.9       45.8       42.0       35.8  
Depreciation and amortization
    3.6       3.0       3.1       3.3       3.4       4.0       5.7       4.9       5.0       6.8       4.8       3.9  
Total operating expenses
    79.0       75.0       84.2       79.4       79.9       87.0       96.8       89.9       84.0       86.0       86.7       77.8  
Loss from operations
    (6.1 )     (3.0 )     (11.9 )     (7.4 )     (8.2 )     (16.6 )     (29.7 )     (25.0 )     (13.4 )     (14.3 )     (16.7 )     (8.4 )
Other income (expense), net
    0.2       (5.4 )     (8.8 )     12.5       (8.5 )     (12.0 )     (19.8 )     31.5       0.1       5.3       3.1       1.6  
Income (loss) before income taxes
    (5.9 )     (8.4 )     (20.7 )     5.1       (16.7 )     (28.6 )     (49.5 )     6.5       (13.3 )     (9.0 )     (13.6 )     (6.8 )
Income tax provision (benefit)
    0.3       0.3       0.3       3.0       1.2       (0.9 )     0.5       (2.1 )     0.2       (0.5 )     0.5       (0.6 )
Net income (loss)
    (6.2 )%     (8.7 )%     (21.0 )%     2.1 %     (17.9 )%     (27.7 )%     (50.0 )%     8.6 %     (13.5 )%     (8.5 )%     (14.1 )%     (6.2 )%

We may experience variations in the results of operations from quarter to quarter as a result of factors that include the following:
 
 
·
the recruiting and retention of distributors;
 
·
the opening of new markets;
 
·
the timing of Company-sponsored events, incentives and promotions;
 
·
new product introductions;
 
·
the timing of holidays, which may reduce the amount of time that our distributors spend selling products or recruiting new distributors;
 
·
the negative impact of changes in or interpretations of regulations that may limit or restrict the sale of certain products in some countries;
 
·
the adverse effect of a failure by us or distributors (or allegations of such failure) to comply with applicable governmental regulations; and   
 
·
the availability of finished goods for local distribution.
 
As a result of these and other factors, quarterly revenues, expenses, and results of operations could vary significantly in the future, and period-to-period comparisons should not be relied upon as indications of future performance.  There can be no assurance that we will be able to increase revenues in future periods or be able to sustain the level of revenue on a quarterly or annual basis that we have sustained in the past. 
 
 
31

 

Net Sales

The following table sets forth revenue by quarter for the periods indicated (in thousands):

         
Change – 2008 vs. 2009
   
Change – 2009 vs. 2010
 
   
2008
   
2009
   
2010
   
Dollar
   
Percentage
   
Dollar
   
Percentage
 
                                           
March 31
  $ 11,395     $ 9,869     $ 6,233     $ (1,526 )     (13.4 )%   $ (3,636 )     (36.8 )%
June 30
    12,323       8,472       5,935       (3,851 )     (31.3 )     (2,537 )     (29.9 )
September 30
    11,016       5,698       5,216       (5,318 )     (48.3 )     (482 )     (8.5 )
December 31
    11,072       6,703       6,192       (4,369 )     (39.5 )     (511 )     (7.6 )
Total
  $ 45,806     $ 30,742     $ 23,576     $ (15,064 )     (32.9 )   $ (7,166 )     (23.3 )

The reduction in net sales for each quarter 2009 as compared to 2008 was due to our Hong Kong market as sales decreased 35% year over year.  The decrease was primarily due to the Company’s effort to reduce loss-making recruitment programs.  The Company lowered the cost of new member acquisition and began focusing more on improving the productivity of its existing members.  Also, certain of the Company’s Hong Kong member’s groups re-organized their leadership during the first half of 2009.  In working with the changing leadership of the groups, the Company deferred and scaled back certain marketing activities.  Net sales in Hong Kong during the fourth quarter of 2009 were also down due in part to delays in shipping orders that resulted from operational issues with our third party logistics partners, who were replaced during 2010.  The shipping delays in Hong Kong were resolved in the first quarter of 2010 and resulted in additional income being recognized.  Disregarding the shipping delay, product orders were relatively consistent from quarter to quarter during 2010.

The decline in the percentage change in net sales during the latter half of 2010 as compared to 2009 was due to increased sales in the Russian market surrounding its one-year anniversary event and partly due to the Hong Kong shipping delay as we were unable to recognize the sales during the fourth quarter of 2009.

Gross Profit

Gross profit began to dip around to slightly below 70% during the third quarter of 2009 when the Russian market officially launched.  In July 2009, the Company activated an engagement with a service provider in Russia to provide storage, distribution and order processing services.  Non product-related sales contributed to a slight rebound in gross profit during the first two quarters of 2010.  Additionally, on or about June 9, 2010, the Company vacated the premises it leased at 2050 Diplomat Drive, Dallas, Texas, so that it could be leased to a new tenant.  At that time, a new distribution arrangement commenced which resulted in additional costs savings and improvement in gross profit.  We expect that the lost margin due to the service provider engagement in Russia will gradually return as Russian sales increase.

Distributor Commissions

Distributor commissions as a percentage of net sales began declining during the third quarter of 2009 due to fewer commissions earned in the recently opened Russian market as compared to our more mature markets.  We made further enhancements to the commission plan in the latter half of 2010 to add several new layers of bonuses.  These enhancements occurred gradually in all of our most significant markets.  We expect that our commission payout percentage going forward will remain at roughly 40% of commissionable sales.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include a combination of both fixed and variable expenses.  Our fixed costs included in selling, general and administrative expenses declined almost every quarter since the beginning of 2008.  As discussed within “Liquidity and Capital Resources,” this was due to cost reduction initiatives which resulted in, among other things, lower corporate legal and accounting costs; lower rent expense, public relations expense, and professional fees in Hong Kong and China; office closures in Mexico and Southeast Asia and downsizing in South Korea; and staff reduction at our corporate headquarters.  As a result of these cost cutting efforts, our selling, general and administrative expenses declined from $4.6 million during the first quarter of 2008 to about $2.2 million quarterly during the second half of 2010.  We do not expect our fixed costs to decline significantly, if at all, from that incurred during the latter part of 2010.
 
 
32

 

Other Income (Expense), Net

Other expense was incurred each quarter in 2008 and the first three quarters of 2009 due to interest expense on convertible debentures issued in October 2007, including amortization of debt issuance cost and accretion of debt discount, and the loss on redemption of the convertible debentures that was recorded upon redemption in August 2009.  During the fourth quarter of 2008 and the third quarter of 2009, we de-recognized $2.2 million and $221,000 of unclaimed, aged commission checks in certain of our international markets, primarily Hong Kong, respectively, as it was determined that it is probable that these commission payments will not be claimed.  Such significant de-recognition is not expected to occur in the future.  Additionally, we recorded income of $2.3 million during the fourth quarter of 2009 upon termination of our relationship with our Hong Kong logistics partners.  Certain amounts invoiced, but unpaid, for services, product and accrued interest were cancelled and offset against inventories and property and equipment retained by the logistics partners.  The only significant component of other income during 2010 was an unrealized gain on foreign exchange amounting to $524,000, of which half was recognized during the second quarter.

Income Taxes

The provision for income taxes included $351,000 deferred tax expense during the fourth quarter of 2008 upon de-recognition of unclaimed, aged commission checks in Hong Kong.  A portion of the deferred tax liability reversed in each of 2009 and 2010, which resulted in an overall income tax benefit in each year.
 
 
33

 

Liquidity and Capital Resources
 
In 2007 through 2010, the Company supplemented its working capital and capital expenditure needs with capital raised from several private placements.

On May 4, 2007, the Company consummated a private equity placement generating gross proceeds of approximately $3.0 million.  The May 2007 financing consisted of the sale of 1,759,307 shares of the Company’s Series A convertible preferred stock and the sale of warrants evidencing the right to purchase 1,759,307 shares of the Company’s common stock.  As partial consideration for placement agency services, the Company issued warrants evidencing the right to purchase an additional 300,000 shares of the Company’s common stock to the placement agent that assisted in the financing.  The warrants are exercisable at any time during the period beginning November 4, 2007 (six months after their issuance) and ending May 4, 2013 (six years after their issuance).  The exercise price of the warrants was $3.80 per share until May 3, 2010, $4.35 per share until November 3, 2011, and is currently $5.00 per share until May 4, 2013, when the warrants expire.

On October 19, 2007, the Company raised gross proceeds of $3.7 million in a private placement of variable rate convertible debentures (the “Debentures”) having an aggregate face amount of $4,250,000, seven-year warrants to purchase 1,495,952 shares of the Company’s common stock, and one-year warrants to purchase 1,495,952 shares of the Company’s common stock.  One-half of the original principal amount of the Debentures was payable in 12 equal monthly installments beginning on November 1, 2008, and the balance was payable on October 19, 2009, unless extended by the holders to October 19, 2012.  The warrants are exercisable beginning six months and one day after their respective issuance and have an exercise price of $3.52 per share.  The placement agent and its assigns also received five-year warrants to purchase 149,595 shares of the Company’s common stock at an exercise price of $3.52 per share.  Such one-year warrants expired unexercised on April 21, 2009.

At December 31, 2010, the Company’s cash and cash equivalents totaled $648,000.  Total cash and cash equivalents decreased by approximately $1.9 million and $904,000 during the years 2009 and 2010, respectively.
 
At December 31, 2010, the ratio of current assets to current liabilities was 0.31 to 1.00 and the Company had a working capital deficit of approximately $5.6 million.  Current liabilities included deferred revenue of $1.0 million that consisted of amortized enrollment package revenues and unshipped orders.  The ratio of current assets to current liabilities excluding deferred revenue would be 0.36 to 1.00.  Working capital as of December 31, 2010 decreased $1.1 million compared to that as of December 31, 2009 mainly due to the operating loss incurred during 2010.  This loss was funded by our existing cash and an increase in trade payables.  This increase in working capital deficit was offset by our transition of third party logistics partners in Hong Kong during early 2010, which ultimately reduced the amount of unshipped product that was reflected in current liabilities at the end of 2009.  The working capital deficit increased by $489,000 between December 31, 2008 and December 31, 2009, due to the incurrence of an operating loss during 2009.

Cash used in operations during the year 2010 was $292,000 compared with $2.7 million and $1.6 million during the years 2008 and 2009, respectively.  The decline in cash usage during 2010 was due to our limited availability of cash and the funding of operations with trade payables.  During 2009, cash was utilized to fund the losses.  In 2008, cash was mainly utilized due to decreases in current liabilities, specifically accounts payable, accrued distributor commissions and other expenses, partly offset by a $1.3 million reduction in existing inventories.  The aggregate impact on cash resulting from the decrease in current liabilities totaled $3.8 million.  This was due to the Company’s efforts to reduce operating expenses during the latter half of fiscal 2007 and lower distributor commission payout.  The reduction in inventories was primarily the result of the Company’s intentional efforts to slow down inventory purchasing and monetize existing inventories.

No significant cash flows from investing activities occurred during 2010.  Cash provided by investing activities during 2009 was $3.4 million, due mainly to the removal of restrictions in April 2009 on cash held in China as part of a statutory requirement when a direct selling license was pending.  This cash was utilized to redeem the Debentures in August 2009.  Cash provided by investing activities during 2008 was $198,000, primarily due to a decrease in restricted cash maintained as a reserve with a certain credit card processing company in South Korea to provide for potential uncollectible amounts and chargebacks, partially offset by an increase in capital expenditures during the second quarter of 2008 in Hong Kong for new office space and in China for additional retail space, and during the third quarter of 2008 in China for additional warehouse space.
 
No significant cash flows from financing activities occurred during 2010.  Cash used in financing activities during 2009 was $3.8 million due to the monthly installment payments on the Debentures that began on November 1, 2008 and the redemption that occurred in August 2009 (as more fully described below).  Cash used in financing activities during 2008 was $396,000.  This was also primarily due to the monthly installments on the Debentures that began on November 1, 2008.  Additionally, a short-term loan for $145,000 was entered into during 2008 by our South Korean subsidiary and repaid in July 2008.
 
 
34

 

The Company has taken numerous actions to ensure that it will continue as a going concern.  It planned and executed many cost reduction and margin improvement initiatives since the end of the third quarter of 2007, such as (1) reducing headcount, which includes the termination of multiple management-level positions in Greater China, South Korea and North America; (2) down-sizing offices in Greater China and South Korea; (3) closing offices in Latin America and Southeast Asia; (4) renegotiating vendor contracts in Greater China; (5) increasing product pricing in Greater China, Europe and the U.S.; (6) changing commission plans worldwide; (7) streamlining logistics processes in Greater China; (8) introducing better margin pre-assortments; and (9) working actively with our service providers in Greater China to ensure continued services and reduce service charges; and (10) reducing Company-wide discretionary expenses.  Also, we believe that we have taken a number of effective steps toward stabilizing the Company’s revenues on a sequential basis, especially in the Hong Kong market.  As a result, the Company believes that its current cash breakeven level has been significantly reduced and is attainable as seen in the Form 10-Q for the nine months ended September 31, 2011.

The Company believes that its existing internal liquidity, supported by cash on hand, anticipated improvement in cash flows from operations with more stabilized revenue and much lower fixed costs since October 2007 should be adequate to fund normal business operations and address its financial commitments for at least the next 12 months, assuming no significant unforeseen expense or further revenue decline.  If the Company’s foregoing beliefs or assumptions prove to be incorrect, however, the Company’s business, results of operations and financial condition could be materially adversely affected.  See “Item 1A.  Risk Factors.”

On August 10, 2009, the Company redeemed each of its Debentures issued on October 19, 2007 in the aggregate original principal amount of $4,250,000.  Pursuant to an agreement reached with all of the debenture holders, the Company redeemed the Debentures by paying the debenture holders $2.4 million (96% of the then remaining outstanding principal amount plus unpaid interest accrued through August 10, 2009). The holders of the debentures accepted this payment as full and final payment of all amounts owed, and all claims arising, under the Debentures and waived any right or claim to the payment of the Optional Redemption Amount set out in the Debentures.  Pursuant to their terms, the Debentures were to have matured on October 19, 2009, and the Company had the option of redeeming them earlier for an Optional Redemption Price equal to 115% of the outstanding principal amount.

The Company does not have any significant unused sources of liquid assets.  Potentially the Company might receive additional external funding if currently outstanding warrants are exercised.  Furthermore, if necessary, the Company may attempt to generate more funding from the capital markets, but currently does not believe that will be necessary.

We do not intend to devote material resources to opening any additional foreign markets in the near future.  Our priority is to focus our resources in our most promising markets, namely Greater China and Russia.
 
The Company has entered into non-cancelable operating lease agreements for locations within the United States and for its international subsidiaries, with expirations through July 2013.
 
The Company has entered into an agreement with one of its suppliers to purchase its product through December 2014.  To maintain this agreement, the Company is required to purchase a minimum of $200,000 and $220,000 of product in 2011 and 2012, respectively.  The minimum purchase requirement in the following two years is dependent on the volume in the preceding year plus an incremental amount not to exceed $40,000.
 
The Company has employment agreements with certain members of its management team that can be terminated by either the employee or the Company upon four weeks’ notice.  The employment agreements entered into with the management team contain provisions that guarantee the payments of specified amounts in the event of a change in control, as defined, or if the employee is terminated without cause, as defined, or terminates employment for good reason, as defined.  In addition, the Company has an employment agreement with another employee that can be terminated at will by either the employee or the Company, provided that the Company must pay a specified amount if it terminates the agreement without cause, as defined, or the employee terminates the agreement with good reason, as defined.  As of December 31, 2010, no outstanding obligations existed under any severance agreements.

Critical Accounting Policies and Estimates

The Company has identified certain policies and estimates that are important to the portrayal of its financial condition and results of operations.  Critical accounting policies and estimates are defined as both those that are material to the portrayal of our financial condition and results of operations and as those that require management’s most subjective judgments.  These policies and estimates require the application of significant judgment by the Company’s management.
 
 
35

 

The most significant accounting estimates inherent in the preparation of the Company’s financial statements include estimates associated with obsolete inventory and the fair value of acquired intangible assets, including goodwill, as well as those used in the determination of liabilities related to sales returns and income taxes.  Various assumptions and other factors prompt the determination of these significant estimates.  The process of determining significant estimates is fact specific and takes into account historical experience and current and expected economic conditions.  The actual results may differ materially and adversely from the Company’s estimates.  To the extent that there are material differences between the estimates and actual results, future results of operations will be affected.  The Company’s critical accounting policies at December 31, 2009 and 2010 include the following:

Inventory Valuation.  The Company reviews its inventory carrying value and compares it to the net realizable value of its inventory and any inventory value in excess of net realizable value is written down.  In addition, the Company reviews its inventory for obsolescence and any inventory identified as obsolete is reserved or written off.  The Company’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.  Also, if actual sales or management plans are less favorable than those originally projected by management, additional inventory reserves or write-downs may be required.  At December 31, 2008, 2009 and 2010, the Company’s inventory value was $2.1 million, $1.0 million and $751,000, respectively, net of reserves of $239,000, $273,000 and $59,000, respectively.  Inventory provision of $229,000 recognized during 2009 primarily related to the Company’s transition of logistics service providers in Hong Kong.  No significant provision was recorded during 2008 and 2010.
 
Valuation of Goodwill and Other Intangible Assets.  In accordance with accounting principles generally accepted in the United States of America, the value of indefinite-lived intangible assets and residual goodwill is not amortized, but is tested at least annually for impairment.  Our impairment testing for goodwill is performed separately from our impairment testing of indefinite-lived intangibles.  We test goodwill for impairment, at least annually, by reviewing the book value compared to the fair value at the reportable unit level.  We test individual indefinite-lived intangibles at least annually by reviewing the individual book values compared to the fair value.  At December 31, 2008, 2009 and 2010, goodwill of approximately $1.8 million was reflected on the Company’s balance sheet.  No impairment of goodwill or intangible assets was recognized during the periods presented.

Allowance for Sales Returns. An allowance for sales returns is provided during the period the product is shipped.  The allowance is based upon the return policy of each country, which varies from 14 days to one year, and their historical return rates, which range from approximately 1% to 5% of sales.  Sales returns were approximately 4%, 3% and 2% of sales for the years ended December 31, 2008, 2009 and 2010, respectively.  The allowance for sales returns was approximately $517,000, $268,000 and $380,000 at December 31, 2008, 2009 and 2010, respectively.  No material changes in estimates have been recognized during the periods presented.

Revenue Recognition. Product sales are recorded when the products are shipped and title passes to independent distributors.  Product sales to distributors are made pursuant to a distributor agreement that provides for transfer of both title and risk of loss upon our delivery to the carrier that completes delivery to the distributors, which is commonly referred to as “F.O.B. Shipping Point.”  The Company primarily receives payment by credit card at the time distributors place orders.  The Company’s sales arrangements do not contain right of inspection or customer acceptance provisions other than general rights of return.  Amounts received for unshipped product are recorded as deferred revenue.  Such amounts totaled $1.9 million, $2.0 million and $776,000 at December 31, 2008, 2009 and 2010, respectively.  Shipping charges billed to distributors are included in net sales.  Costs associated with shipments are included in cost of sales.

Enrollment package revenue, including any nonrefundable set-up fees, is deferred and recognized over the term of the arrangement, generally twelve months.  Enrollment packages provide distributors access to both a personalized marketing website and a business management system.  No upfront costs are deferred as the amount is nominal.  At December 31, 2008, 2009 and 2010, enrollment package revenue totaling $964,000, $553,000 and $253,000 was deferred, respectively.  Although the Company has no immediate plans to significantly change the terms or conditions of enrollment packages, any changes in the future could result in additional revenue deferrals or could cause us to recognize the deferred revenue over a longer period of time.
 
Tax Valuation Allowance. The Company evaluates the probability of realizing the future benefits of any of its deferred tax assets and records a valuation allowance when it believes a portion or all of its deferred tax assets may not be realized.  The Company increased the valuation allowance to equal its net deferred tax assets during 2005 due to the uncertainty of future operating results.  The valuation allowance will be reduced at such time as management believes it is more likely than not that the deferred tax assets will be realized.  During 2008, 2009 and 2010, no such reduction in the valuation allowance occurred.  Any reductions in the valuation allowance will reduce future income tax provisions.
 
 
36

 

Provision for income taxes depends on the statutory tax rates in each of the jurisdictions in which we operate.  We believe that we operate in compliance with all applicable transfer pricing laws and we intend to continue to operate in compliance with such laws.  However, there can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws would not be modified, which, as a result, may require changes in our operating procedures.  If the United States Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully challenge these agreements, plans, or arrangements, or require changes in our transfer pricing practices, we could be required to pay higher taxes, interest and penalties, and our earnings would be adversely affected.
 
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable under smaller reporting company disclosure rules.

 
37

 
 
Item 8. 
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NATURAL HEALTH TRENDS CORP.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
 
Report of Lane Gorman Trubitt, PLLC, Independent Registered Public Accounting Firm 
 39
Consolidated Balance Sheets 
 40
Consolidated Statements of Operations 
 41
Consolidated Statements of Stockholders’ Equity and Comprehensive Loss   42
Consolidated Statements of Cash Flows
  43
Notes to Consolidated Financial Statements 
 44
 
 
 
38

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors and Stockholders
Natural Health Trends Corp.
Dallas, Texas

We have audited the accompanying consolidated balance sheets of Natural Health Trends Corp. (the “Company”) as of December 31, 2010, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended.  Natural Health Trends Corp.’s management is responsible for these financial statements.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Natural Health Trends Corp.  as of December 31, 2010, 2009 and 2008, and the results of its operations and its cash flows for each of the years then ended,  in conformity with accounting principles generally accepted in the United States of America.


/s/ Lane Gorman Trubitt, PLLC

Dallas, Texas
November 15, 2011
 
 
39

 
 
NATURAL HEALTH TRENDS CORP.

CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)

   
December 31,
 
   
2008
   
2009
   
2010
 
ASSETS
                 
Current assets:
                 
Cash and cash equivalents
  $ 3,491     $ 1,552     $ 648  
Restricted cash
    340       330       422  
Accounts receivable
    71       143       105  
Inventories, net
    2,141       1,006       751  
Other current assets
    735       1,196       639  
Total current assets
    6,778       4,227       2,565  
Property and equipment, net
    1,173       664       203  
Goodwill
    1,764       1,764       1,764  
Intangible assets, net
    1,800       1,000       200  
Restricted cash
    3,646       316       225  
Other assets
    1,464       889       406  
Total assets
  $ 16,625     $ 8,860     $ 5,363  
                         
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
                         
Current liabilities:
                       
Accounts payable
  $ 1,746     $ 2,478     $ 3,115  
Income taxes payable
    187       350       330  
Accrued distributor commissions
    554       513       723  
Other accrued expenses
    2,456       1,567       1,792  
Deferred revenue
    2,841       2,586       1,029  
Convertible debentures, net of discount of $2,320 at December 31, 2008
    1,534              
Deferred tax liability
    351       207       178  
Other current liabilities
    1,170       1,076       1,017  
Total current liabilities
    10,839       8,777       8,184  
Commitments and contingencies
                       
Stockholders’ equity (deficit):
                       
Natural Health Trends stockholders’ equity (deficit):
                       
Preferred stock, $0.001 par value; 5,000,000 shares authorized; 1,761,900 shares designated Series A convertible preferred stock, 138,400 shares issued and outstanding at December 31, 2008, 2009 and 2010, aggregate liquidation value of $296
        124           124           124  
Common stock, $0.001 par value; 50,000,000 shares authorized; 10,691,582, 10,809,751, and 10,725,899 shares issued and outstanding at December 31, 2008, 2009 and 2010, respectively
      11         11         11  
Additional paid-in capital
    79,711       80,239       80,414  
Accumulated deficit
    (74,853 )     (81,195 )     (83,643 )
Accumulated other comprehensive income:
                       
Foreign currency translation adjustments
    759       911       366  
Total Natural Health Trends stockholders’ equity (deficit)
    5,752       90       (2,728 )
Noncontrolling interest
    34       (7 )     (93 )
Total stockholders’ equity (deficit)
    5,786       83       (2,821 )
Total liabilities and stockholders’ equity
  $ 16,625     $ 8,860     $ 5,363  

See accompanying notes to consolidated financial statements.
 
 
40

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)

   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
                   
Net sales
  $ 45,806     $ 30,742     $ 23,576  
Cost of sales
    12,681       9,528       6,969  
Gross profit
    33,125       21,214       16,607  
Operating expenses:
                       
Distributor commissions
    17,650       11,598       8,671  
Selling, general and administrative expenses (including stock-based compensation expense of $554, $492, and $175 during 2008, 2009 and 2010, respectively)
    17,171       13,885       9,802  
Depreciation and amortization
    1,456       1,319       1,213  
Impairment of long-lived assets
    30              
Total operating expenses
    36,307       26,802       19,686  
Loss from operations
    (3,182 )     (5,588 )     (3,079 )
Other income (expense), net:
                       
Gain (loss) on foreign exchange
    (121 )     (130 )     524  
Interest income
    107       36       9  
Interest expense (including amortization of debt issuance costs and accretion of debt discount of $2,083 and $2,039 during 2008 and 2009, respectively)
    (2,424 )     (2,551 )     (18 )
Loss on redemption of convertible debentures
          (683 )      
De-recognition of commission liabilities (see Note 1)
    2,237       221        
Termination of logistics service arrangement (see Note 1)
          2,264        
Other
    (25 )     (32 )     68  
Total other income (expense), net
    (226 )     (875 )     583  
Loss before income taxes
    (3,408 )     (6,463 )     (2,496 )
Income tax provision (benefit)
    456       (78 )     (27 )
Net loss
    (3,864 )     (6,385 )     (2,469 )
Plus:  Net loss attributable to noncontrolling interest
          43       21  
Net loss attributable to Natural Health Trends
    (3,864 )     (6,342 )     (2,448 )
                         
Preferred stock dividends
    (17 )     (16 )     (16 )
Net loss attributable to common stockholders of Natural Health Trends
  $ (3,881 )   $ (6,358 )   $ (2,464 )
                         
Loss per share of Natural Health Trends – basic and diluted
  $ (0.40 )   $ (0.63 )   $ (0.23 )
                         
Weighted-average number of shares outstanding – basic and diluted
    9,677       10,144       10,507  

See accompanying notes to consolidated financial statements.
 
 
41

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
(In Thousands, Except Share Data)
 
   
Preferred Stock
   
Common Stock
    Additional Paid-In     Accumulated     Accumulated Other Comprehensive     Total     Noncontrolling        
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
 Income
   
NHT
   
Interest
   
Total
 
                                                             
BALANCE, December 31, 2007
    138,400     $ 124       10,327,405     $ 10     $ 79,158     $ (70,989 )   $ 1,259     $ 9,562     $ 33     $ 9,595  
Net loss
                                  (3,864 )           (3,864 )           (3,864 )
Foreign currency translation adjustments
                                        (500 )     (500 )     1       (499 )
Total comprehensive loss
                                                            (4,364 )     1       (4,363 )
Issuance of restricted stock, net
                364,177       1       (1 )                 ––              
Stock-based compensation
                            554                   554             554  
BALANCE, December 31, 2008
    138,400       124       10,691,582       11       79,711       (74,853 )     759       5,752       34       5,786  
Net loss
                                  (6,342 )           (6,342 )     (43 )     (6,385 )
Foreign currency translation adjustments
                                        152       152       2       154  
Total comprehensive loss
                                                            (6,190 )     (41 )     (6,231 )
Issuance of common stock
                60,000             36                   36             36  
Issuance of restricted stock, net
                58,169                                            
Stock-based compensation
                            492                   492             492  
BALANCE, December 31, 2009
    138,400       124       10,809,751       11       80,239       (81,195 )     911       90       (7 )     83  
Net loss
                                  (2,448 )           (2,448 )     (21 )     (2,469 )
Foreign currency translation adjustments
                                        (545 )     (545 )     (65 )     (610 )
Total comprehensive loss
                                                            (2,993 )     (86 )     (3,079 )
Cancellation of restricted stock, net
                (83,852 )                                          
Stock-based compensation
                            175                   175             175  
BALANCE, December 31, 2010
    138,400     $ 124       10,725,899     $ 11     $ 80,414     $ (83,643 )   $ 366     $ (2,728 )   $ (93 )   $ (2,821 )

See accompanying notes to consolidated financial statements.
 
 
42

 

NATURAL HEALTH TRENDS CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

   
Year Ended December 31,
 
   
2008
   
2009
   
2010
 
                   
CASH FLOWS FROM OPERATING ACTIVITIES:
                 
Net loss
  $ (3,864 )   $ (6,385 )   $ (2,469 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Depreciation and amortization of property and equipment
    656       519       413  
Amortization of intangibles
    800       800       800  
Amortization of debt issuance costs
    356       502        
Accretion of debt discount
    1,727       1,537        
Loss on redemption of convertible debentures
          683        
Stock-based compensation
    554       528       175  
Impairment of long-lived assets
    30              
Loss on disposal of property and equipment
                58  
Deferred income taxes
    526       (144 )     (28 )
Changes in assets and liabilities:
                       
Accounts receivable
    293       (66 )     38  
Inventories, net
    1,328       1,138       270  
Other current assets
    581       (461 )     568  
Other assets
    313       121       500  
Accounts payable
    (424 )     731       640  
Income taxes payable
    (185 )     155       (40 )
Accrued distributor commissions
    (1,407 )     (50 )     206  
Other accrued expenses
    (1,174 )     (896 )     209  
Deferred revenue
    (636 )     (256 )     (1,553 )
Other current liabilities
    (2,204 )     (100 )     (79 )
Net cash used in operating activities
    (2,730 )     (1,644 )     (292 )
                         
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Purchases of property and equipment, net
    (299 )     (5 )     (2 )
Decrease (increase) in restricted cash
    497       3,363       (1 )
Net cash provided by (used in) investing activities