Item 1.
Business
Overview
RBC Life Sciences, Inc., a Nevada corporation formed in 1999 (along with its subsidiaries, sometimes hereinafter referred to collectively as “we”, “our”, the “Company” or “RBC”), is principally engaged in the marketing and distribution of nutritional supplements and personal care products (collectively “Nutritional Products”) through subsidiaries in the U.S. and Canada and, effective October 1, 2011, a branch office in Taiwan. This product line is marketed under the “RBC Life” brand name and may be broadly categorized as: (i) wellness products, (ii) fitness products and (iii) skin care products. The product line includes herbal formulas, vitamins, minerals, antioxidants and skin, hair and body care products.
In certain markets, primarily the U.S., Canada and Taiwan, we market Nutritional Products through a network of independent distributors that we refer to as “Associates.” We also market Nutritional Products in certain international markets through license arrangements. The licensees are third parties who are granted exclusive rights to distribute Nutritional Products in their respective territories and, for the most part, distribute these products through an independent network of Associates in the licensed territory.
Associates are independent contractors who purchase products for personal use, purchase products for resale to retail customers and sponsor other individuals as Associates. Associates can derive compensation both from the direct sales of products and from sales generated by sponsored Associates. The marketing effort of our Associates involves person-to-person communication of information related to our products and the system by which our products are sold. We believe this feature makes network marketing a more effective means of marketing our products than in-store retail sales where there is little or no direct explanation of product benefits. Network marketing provides financial opportunity to a broad cross-section of people, including those seeking to simply supplement other income, as well as those who desire a full-time home-based business.
In addition to Nutritional Products, we also market a line of wound care products (“Medical Products”) through a U.S. subsidiary under the MPM Medical brand name. Medical Products are primarily distributed in the U.S. to hospitals, nursing homes, clinics and pharmacies through traditional medical/surgical supply dealers and pharmaceutical distributors. These products are used to prevent and treat wounds, and manage pain associated with wounds, in the acute care, long-term care and oncology markets.
Our principal offices are located at 2301 Crown Court, Irving, Texas 75038. We can be reached by phone at 972-893-4000, by fax at 972-893-4111 and by email at webmaster@rbclifesciences.com. Our corporate information can be accessed at www.rbclifesciences.com or www.mpmmedicalinc.com.
Industry Overview
Nutritional Products. In the Nutritional Products business segment, we compete in two industries: nutrition and direct selling. The nutrition industry is highly fragmented and very competitive. Companies in this industry manufacture and distribute products generally intended to maintain and/or enhance the body's health and general well-being. Products manufactured and distributed include (i) nutritional supplements, (ii) natural and organic foods, (iii) functional foods and (iv) natural and organic personal care and household products. The majority of our net sales in this segment are sales of nutritional supplements.
According to the latest global market data published by the Nutrition Business Journal (“NBJ”), global nutrition industry sales increased 6% to $302 billion in 2010. Of that $302 billion, nutritional supplements contributed $85 billion, while natural and organic foods contributed $84 billion, functional foods $102 billion, and natural and organic personal care and household products $31 billion. In 2010, total sales of Nutritional Products in our two largest markets, the U.S. and Russia/Eastern Europe, grew 6% and 9%, respectively.
NBJ reported that in 2010 the overall U.S. nutrition market grew 6% to $117 billion, up from 4% growth in 2009. In 2009, growth in the U.S. nutrition market was negatively affected by the global economic downturn that began in 2008. NBJ estimated that the U.S nutrition market will grow between 6% and 8% each year through 2013.
We believe that there are a number of demographic, health care and lifestyle trends that continue to drive the growth of the nutrition industry, including:
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The aging population, particularly the baby-boomer generation, combined with the tendency on the part of consumers
to purchase more nutritional supplements as they age;
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The general public's heightened awareness and understanding of the connection between diet and health, and its interest in healthier lifestyles and more proactive approaches in managing health care needs;
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Rising health care costs that lead many consumers to take preventive measures, including alternative medicines and nutritional supplements; and
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The publication of research findings supporting the positive health effects of certain nutritional supplements.
Nutritional products are distributed through various market participants, which include the following:
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Mass market retailers, including mass merchandisers, drug stores, supermarkets, and discount stores;
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Natural health food retailers;
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Network marketing;
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Mail order;
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Health care professionals and practitioners; and
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The Internet.
Our primary distribution model is a network marketing system, which is a common form of direct selling. According to the latest data available from the World Federation of Direct Selling Associations (the "WFDSA"), the direct selling industry generated approximately $132 billion in worldwide retail sales in 2010, with approximately 88 million independent distributors. WFDSA statistics show that the U.S. continues to be the largest market for direct sales in the world. According to the Direct Selling Association (“DSA”), the U.S. member association of the WFDSA, the U.S. generated approximately $29 billion in annual retail sales in 2010 with approximately 16 million independent distributors. DSA statistics show that wellness products, which include nutritional supplements, accounted for 23%, and personal care products accounted for 19%, of the approximately $29 billion in annual retail sales generated in the U.S.
Medical Products. In the Medical Products business segment, we compete in the wound care industry. Industry participants in this multi-billion dollar market are companies of all sizes that manufacture and distribute a wide range of products related to the treatment and prevention of wounds. Products manufactured and distributed in this industry include:
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Wound management products such as adhesive bandages and gauze;
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Wound closure products such as staples, various clips and sutures;
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Advanced wound care products, which are represented by a variety of moist wound healing dressings such as alginate dressings, film dressings, foam dressings, hydrocolloid dressings and hydrogel dressings;
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Active wound healing products such as skin replacements, collagen dressings and growth factors;
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Debriding products including various cleansers; and
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Pressure relief devices such as beds, mattress overlays and other support devices.
Wounds requiring treatment can be either acute or chronic. Industry data indicates that acute wounds comprise a large majority of all wounds. These are wounds that follow the normal process of healing and generally include burns, traumatic wounds and surgical incisions. Chronic wounds are wounds that do not heal within a normally expected time frame under standard care and generally include venous, arterial, pressure and diabetic ulcers. The increasing prevalence of chronic wounds is driven by the large and growing elderly, diabetic and obese populations as these groups are more likely to suffer from conditions that compromise circulation, which is a primary cause of chronic wounds.
Our Medical Products generally fall into the advanced wound care and debriding product categories. These products are primarily used in the prevention and treatment of chronic wounds.
Competitive Strengths
Product Portfolio. We have developed a line of high-quality health products based on the demands of the industries in which we operate. Our product lines feature proprietary products, newly developed products and products that have been available for many years. We regularly review and if necessary improve our product formulations based on new scientific data, market demands and regulatory changes to ensure our product portfolio remains current and attractive to our customers, and satisfies regulatory requirements.
In-house Manufacturing. We manufacture certain proprietary raw materials for our exclusive use, including the key raw material used in certain of our top-selling products, Microhydrin® and Microhydrin Plus®, which are Nutritional Products. Together, these products accounted for 10% of consolidated net sales and 14% of Nutritional Products sales in 2011. We believe that our ability to manufacture these proprietary raw materials is a competitive advantage for us because it allows us to
better protect our proprietary technology and know-how, and better manage the quality of and costs associated with the production of our key raw materials.
Science-based Product Development. We emphasize science-based product development in the fields of nutrition and wound care. We have developed substantially all of our products utilizing scientific data as the basis of product formulation, including published research, in-house and third-party research and sponsored research. We maintain an on-going research and development effort that includes in-house personnel as well as third-party advisers including medical professionals.
Operating Flexibility. Other than the production of certain proprietary raw materials, we contract the production of all our products to third-party contract manufacturers. This arrangement allows us to minimize capital expenditures, benefit from specialized expertise provided by the contract manufacturer and maintain operating overhead in line with sales. We have found the marketplace for quality contract manufacturers to be competitive and attractive. We have established an internal quality system, including the use of in-house quality control laboratories and personnel, to monitor the performance of our third-party manufacturers to ensure they maintain a high quality of service.
Experienced Management Team. Our management team includes individuals with expertise in various managerial disciplines including nutrition, wound care, international business development, marketing, sales, operations, quality assurance, finance and information technology.
Business Strategy
We seek to grow our business by pursuing the following strategies:
Exploit New Product Opportunities; Develop New and Improved Products. In May 2011, we launched a new dietary supplement product, Stem-KineTM. Stem-Kine has been shown in published human clinical studies to nutritionally enable bone marrow and other stem cell-producing tissues, which form the natural repair and renewal system of the body, to increase their production of stem cells. We market this product under a license agreement that provides RBC exclusive marketing rights in 42 countries, including all countries where our products are currently sold by us or our licensees, except that the licensor has retained the right to sell Stem-Kine to licensed health care practitioners in the U.S. We believe this product possesses unique features and benefits that provide a key opportunity for sales growth in the Nutritional Products segment.
As a distributor of health products, we believe that it is vital to continually evaluate ways to improve existing products and to develop new and innovative products. We expect to use our existing resources and, to the extent we deem prudent, invest additional resources, to identify opportunities for new and improved products. As was the case with Stem-Kine, our product development activities will continue to center around the development and introduction of science-based products in response to newly released clinical and other scientific data, new technology and customer preferences.
Attract and Retain Network Marketing Associates. We believe that the network marketing model is the most effective way to sell our Nutritional Products. Our objective is to increase sales in this channel by increasing the attraction, recruitment, retention and productivity of our Associates. We seek to accomplish these objectives by (i) providing training and support to new and existing Associates through various means, including the sponsorship of meetings and events and providing sales tools and resources at low or no cost, (ii) introducing new and/or improved products and (iii) providing financial incentives through the Associate compensation plan. In 2011, we sponsored our first annual leadership event, which was only open to our top-performing Associates. In addition, we introduced enhancements to our Associate compensation plan that provide more balance between compensation earned by attracting new Associates and compensation earned by retaining existing Associates. In 2012, we plan to introduce a new Associate training program, which is designed to increase the leadership and training skills of field Associates who are actively working to grow their distributorships.
Expand Network Marketing into New Markets. We believe that significant growth opportunities for our Nutritional Products exist in new international markets. Before initiating sales in a new market, we consider a number of factors including anticipated demand for our products, market size, receptiveness to network marketing, and the market entry process, which includes consideration of possible regulatory restrictions on our products or our network marketing system. To the extent possible, we expect to seamlessly integrate our Associate compensation plan in each new market to allow Associates to receive commissions for global-not merely local-product sales. We believe the seamless integration of the Associate compensation plan significantly enhances our ability to expand internationally. To test the market internationally for our products and network marketing program, during 2010, we began selling selected Nutritional Products in certain countries in Southeast Asia, primarily Taiwan, under a not-for-resale (“NFR”) program. The NFR program allows consumers in NFR markets to sign up as customers, purchase products, refer others to our network marketing program and receive commissions. Based on the favorable response to this program, we opened an office and distribution facility in Taiwan on October 1, 2011. We believe that providing local marketing and sales
support, customer service and product order fulfillment provides a better platform to generate additional sales growth in the Taiwan market. Subject to achieving positive results in Taiwan, we will consider opening additional offices in Southeast Asia as expansion opportunities develop.
Expand Medical Products in Existing and New Markets. We believe there is significant opportunity to increase net sales of our Medical Products in the U.S. and international markets. We have developed and continue to develop new market opportunities in the U.S. based on our expertise in the wound care market. To this end, we expect to (i) increase our sales force in 2012 by adding four employed field sales representatives, (ii) introduce new products, (iii) provide training and other support to our field sales force and the sales force of key distributors and (iv) increase the body of clinical data supporting the safety and efficacy of our products. In addition, we continue to work with third parties to facilitate the expansion of Medical Products distribution into international markets, primarily focusing on Canada and Central America. In December 2010, we engaged a manufacturer representative based in Puerto Rico who began to support distribution of Medical Products in Puerto Rico during 2011.
Leverage and Expand our Relationship with CCI. Our largest customer is Coral Club International, Inc. (“CCI”), which is a licensee that distributes Nutritional Products in a territory comprised mainly of Russia and Eastern Europe. Net sales to CCI accounted for approximately 45% of consolidated net sales in 2011. Our objective is to support growth in this territory by supplying CCI with new products and providing operational and regulatory support. We will continue to implement initiatives to accomplish these objectives and seek other ways to facilitate growth in this territory.
Products
The Nutritional Products segment, which accounted for 76%, 77% and 75% of consolidated net sales in 2011, 2010 and 2009, respectively, markets nutritional supplements and personal care products under the RBC Life brand name. The Medical Products segment markets wound care products under the MPM Medical brand name. For additional information related to these industry segments, please see Note M to our consolidated financial statements beginning on page of this report.
Nutritional Products. We currently market a line of over 75 nutritional supplements and personal care products, including herbs, vitamins and minerals, as well as natural skin, hair and body care products. These products may be broadly categorized as: (i) wellness products, (ii) fitness products and (iii) skin care products. Featured products include:
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Stem-Kine - dietary supplement shown in published human clinical studies to nutritionally enable bone marrow and other stem cell-producing tissues, which form the natural repair and renewal system of the body, to increase their production of stem cells;
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Microhydrin and Microhydrin Plus - powerful, broad-spectrum antioxidants;
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NeuroBright® - introduced in August 2009, this product supports healthy brain function and enhances energy and acuity;
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Organic spirulina - sold in powder, tablet, capsule and, in combination with other ingredients, bar forms, a nutritious algae that provides a complete range of vital nutrients and a higher percentage of easily digested protein than meat;
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OliViva® - made from freshly harvested olive leaves, an antioxidant beverage that supports the immune system, increases energy and supports the cardiovascular system;
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ColoVada Plus® - an effective fourteen-day colon cleansing program that has been widely used for more than 20 years;
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HydraCel® - a product that improves the quality of drinking water by reducing surface tension for increased hydration and making water more alkaline;
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24 Seven® - a daily multivitamin/mineral supplement;
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Immune 360® - a product to nourish and support the function of the immune system;
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Digestion Formula - a combination of digestive enzymes to supplement the decline of enzymes that naturally occurs with aging; and
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C7® - a science-based skin care product collection that incorporates ingredients with unique benefits.
Our top-selling products are antioxidant products marketed under the trade names Microhydrin and Microhydrin Plus, which collectively accounted for approximately 10% and 14% of consolidated net sales in 2011 and 2010, respectively. No other product accounted for more than 10% of our sales. Stem-Kine, which was launched in May 2011, has also become a top-selling product accounting for 5% of consolidated net sales in 2011. With the exception of Stem-Kine, our finished products are produced according to our specifications and/or formula; Stem-Kine is produced in accordance with the formula owned by its developer. In all cases, however, our finished products are produced by manufacturers and suppliers that we do not control. We maintain quality control of our products through the quality systems we have established, which include the use of in-house laboratories as well as the manufacturing and laboratory facilities of our third-party suppliers. Our manufacturing and distribution practices
are in compliance with current good manufacturing practice regulations as established by the FDA.
Substantially all of our product line has been developed utilizing scientific data as the basis of product formulation. Scientific data includes published research, in-house and third-party research and sponsored research. Most of our product formulations feature one or more of the following key ingredients:
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Silica mineral hydride, a nutritional antioxidant manufactured by us using our proprietary formula and process and used as an ingredient in the formulation of nutritional supplement and personal care products;
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Organic spirulina sourced from the highest quality producers, sold as a stand-alone product and combined as an ingredient in many other nutritional supplement formulations; and
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Organic aloe vera specially processed to retain the benefits found in a fresh aloe vera leaf and sold as a beverage and as a topical gel and used as an ingredient in many of our skin care products.
We established a manufacturing facility in June 2002 to produce certain key raw materials that were formerly sourced from a third-party supplier. Through the establishment of this facility, we developed our own proprietary manufacturing processes, improved the quality of key raw materials used in our product line and expanded the range of raw materials available to us. We provide raw materials manufactured by us to third-party manufacturers for their use in producing our finished products. Our proprietary raw materials represent key ingredients used in certain top-selling products including Microhydrin, Microhydrin Plus, NeuroBright and HydraCel.
Medical Products. As is the case with our Nutritional Products, substantially all of our Medical Products were developed utilizing scientific data as the basis of product formulation. Our Medical Products are produced according to our specifications and/or formulas by manufacturers and suppliers that we do not control. We maintain quality control of our products through the quality systems we have established, which include the use of in-house laboratories as well as the manufacturing and laboratory facilities of our third-party suppliers.
We currently market a line of approximately 28 wound care products. Certain wound care products, which account for approximately 87% of Medical Products sales, are for the treatment and healing of wounds such as pressure ulcers, leg ulcers, cuts, burns and abrasions. These products include cleansers, dressings, hydrogels, calcium alginates, moisture barriers, antimicrobials and a unique hydrogel wound dressing with Lidocaine. Our other wound care products, which represent approximately 13% of Medical Products sales, are designed to reduce destruction to skin and tissue caused by radiation, and to reduce pain and itching in the skin and the internal mucosa caused by radiation reactions or reactions to certain cancer medications.
Manufacturing and Product Sourcing
We manufacture certain proprietary raw materials used in the production of many of our Nutritional Products. Included in the raw materials we produce is silica mineral hydride, the key ingredient used in production of certain of our top-selling products including Microhydrin and Microhydrin Plus. These raw materials are manufactured according to proprietary formulations and processes developed by us for our exclusive use. Our manufacturing operations are conducted at our headquarters located in Irving, Texas.
We source Stem-Kine from its developer, which produces Stem-Kine in accordance with its own formula and specifications. We purchase and market Stem-Kine under the terms of a 20-year license agreement dated December 29, 2010, and our rights under this license agreement are subject to satisfaction of certain annual minimum purchase requirements set forth in the agreement. We believe that the developer is a high-quality manufacturer and is capable of meeting our current and projected demand during the term of the agreement.
With respect to our other finished products, we contract with third-party manufacturers and suppliers, such as Progressive Laboratories, Inc., Brady Precision Converting, LLC, Merical Vita-Pak, Inc. and Pacific Nutritional, Inc., to produce the products according to our specifications and/or formulas. This strategy provides operating flexibility with minimum investment and helps us to control operating costs. We believe that our manufacturers and suppliers are high-quality and are capable of meeting our current and projected demand over the next several years. We do not have long-term contracts with any of these manufacturers or suppliers. Most of our products can be manufactured by a number of contract manufacturers at competitive prices.
Sales by Geographic Area
For information related to sales by geographic region for the years ended December 31, 2011, 2010 and 2009, please see Note M to our consolidated financial statements beginning on page of this report.
Independent Distributor Network
Overview. We distribute Nutritional Products in certain markets, primarily the U.S., Canada and Taiwan, through a network of independent distributors that we refer to as “Associates.” In using this distribution model, we sell substantially all of our Nutritional Products in these markets through individuals who are not our employees. Our Associates generally purchase products from us for resale to consumers or 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 associates. We believe that network marketing is an effective method of distribution because it allows person-to-person interaction about our products and business, which is not readily available through other distribution channels.
Our sales in these markets are dependent upon the number and productivity of our Associates. Growth in sales is dependent upon the sponsorship of new Associates and retention of existing Associates. We had approximately 14,900 and 10,700 active Associates at December 31, 2011 and 2010, respectively. We consider an Associate active if he/she has placed an order within the previous 12 months.
In March 2010, we began selling certain Nutritional Products in Taiwan under our NFR program. We later expanded distribution under the NFR program to include Brunei, Singapore and Hong Kong. The NFR program allows consumers in NFR markets to sign up as customers, purchase products, refer others to our network marketing program and receive commissions. The principle difference between an NFR program customer and a North American Associate is that Associates in North America may resell the products that they purchase from us whereas NFR program customers cannot. However, an NFR program customer can sponsor a new NFR program customer, who is then able to purchase products directly from us. Because of the similarities between NFR program customers and North American Associates, we consider an NFR program customer to be equivalent to an Associate.
Based on the favorable response to the NFR program in Taiwan, we opened an office and distribution facility in Taiwan on October 1, 2011. We believe that providing local marketing and sales support, customer service and product order fulfillment provides a better platform to generate additional sales growth in the Taiwan market. Subject to achieving positive results in Taiwan, we will consider opening additional offices in Southeast Asia as expansion opportunities develop.
We do not have any significant accounts receivable from our Associates because they are required to pay for purchases prior to shipment. Associates pay for products primarily by credit card, although orders can also be paid with cash, direct account withdrawal, money orders or checks. We are not dependent upon the sales of any individual Associate, the loss of whom would have a material adverse effect on our business.
Associates. A person who wishes to become an Associate must complete an application under the sponsorship of an existing Associate. Upon the Company's acceptance of the application, the new Associate then becomes part of the sponsoring Associate's organization. New Associates sign a written contract and agree to adhere to policies and procedures that govern the activities of Associates. Associates are independent contractors and not our employees. An Associate has the right to purchase products at wholesale, sponsor new Associates and earn compensation in accordance with the Associate compensation plan. While some Associates sell products and recruit new Associates on a full-time basis, most engage in these activities on a part-time basis or only purchase our products for personal consumption.
Sponsoring. We develop and sell sales materials and tools for use by our Associates, who have the primary responsibility for recruiting and educating new Associates with respect to our products, the Associate compensation plan and how to build a successful distributorship. Because new Associates are linked to their sponsor, sponsorship of new Associates creates multiple levels in the network marketing structure. Persons that an Associate sponsors are referred to as “downline” or sponsored Associates.
Sponsoring activities are not required of Associates and we do not pay any commissions for the act of sponsoring new Associates, although commissions are paid based on the product sales of downline associates. Because of the financial incentives provided to those who succeed in building an Associate network that purchases and resells products, we believe that many of our Associates attempt, with varying degrees of effort and success, to sponsor new Associates.
Compensation. Our Associate compensation plan provides several opportunities for Associates to earn compensation. We believe our compensation plan provides financial rewards comparable to those offered by other compensation plans in the industry. There are generally two ways in which our Associates earn compensation:
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Through retail markups on sales of products purchased at wholesale; and
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Through a series of commissions on product sales generated by the Associate and his or her downline Associates.
Commissions are based on the total monthly sales by the Associate and his or her downline organization. As an Associate's
business expands from successfully sponsoring new Associates into the business, who in turn expand their own businesses, an Associate can earn higher commissions. Most commissions are paid to Associates monthly.
Support. Associates are encouraged to assume responsibility for training and motivating other Associates within their respective downline organizations and to conduct meetings for potential new Associates. Associates can purchase sales and training materials from us, and they generally assume the costs of advertising and marketing our products to their customers, as well as the direct cost of sponsoring and training new Associates.
In addition to the development of sales and training materials for use by our Associates, we also periodically sponsor and conduct local, regional and international Associate events and training seminars. Attendance at these sessions is voluntary, although our experience indicates that the most effective and successful Associates are those that participate in training activities. These live events are supplemented by regular e-mail communications and corporate conference calls.
We also use the Internet to support our Associates and enhance communication with them. Through our multimedia website, Associates can obtain information about us and our products. They can also obtain other current information such as new product announcements, descriptions of product specials and sales promotions and other marketing and training materials. In addition, Associates have the ability to sponsor new Associates and to place orders through our website. To help our Associates effectively manage their businesses, we allow them to obtain a wide-range of information related to their downline organization directly from our database, which can be accessed through our website.
Compliance. On occasion, Associates fail to adhere to our Associate policies and procedures. We systematically review reports of alleged Associate misconduct. Infractions of the policies and procedures are reviewed by a compliance committee that determines what disciplinary action may be warranted in each case. If we determine that an Associate has violated any of our Associate policies and procedures, we may take a number of disciplinary actions. For example, we may terminate the Associate's purchase and distribution rights completely or impose sanctions, such as warnings or probation. We may also withdraw or deny awards, suspend privileges, withhold commissions until specific conditions are satisfied or take other appropriate actions at our discretion.
Returns. Our product return policy allows retail customers to return the unused portion of any product to the Associate who sold them the product for a full cash refund. We reimburse the Associate with a replacement product or a credit on account upon receipt of proper documentation and the return of the remaining product.
Nutritional Products returned by Associates that are unused and resalable are refunded up to one year from the date of purchase at 100% of the sales price less a 10% restocking fee and commissions paid. Returned product that was damaged during shipment to the customer is 100% refundable. Return of product that was not damaged at the time of receipt by the Associate may result in cancellation of the Associate’s distributorship according to the terms of the Associate agreement. For the years 2011, 2010 and 2009, returns were less than 1% of Nutritional Products sales.
Licensees
We have entered into exclusive license arrangements for distribution of our Nutritional Products in certain international markets. Under these arrangements, the licensees purchase products from us for distribution in their territories, and, in most cases, pay us a monthly royalty based on sales of our products in their territories. Most of our sales under these arrangements are to CCI, which has exclusive distribution rights in a territory comprised mainly of Russia and Eastern Europe. Sales to CCI were 45%, 55% and 50% of consolidated net sales in 2011, 2010 and 2009, respectively. Under arrangements with other licensees, our products are also distributed in other international markets including Western Europe, United Arab Emirates and Indonesia.
Pursuant to these arrangements, the licensees, who are unaffiliated third parties, are granted exclusive rights to sell our products in their respective territories, which is generally accomplished through network marketing. The independent distributor networks of licensees using the network marketing distribution model have similar characteristics to our Associate network, and the distributors are compensated through a similar compensation plan as that used by us for our Associates. All of the license agreements with our licensees require the licensees to purchase minimum annual amounts from us in order to retain their exclusive rights.
Medical Products Distribution
Sales force. At December 31, 2011, the MPM Medical sales force consisted of eight full-time sales representatives and approximately five manufacturer representatives assigned to specific geographic territories within the U.S. This compares to a sales force at December 31, 2010 that consisted of six full-time sales representatives and approximately 14 manufacturer
representatives.
Distribution. We distribute our wound care products primarily in the U.S. to hospitals, nursing homes, clinics, pharmacies and home health care agencies through a traditional, nationwide network of medical/surgical supply dealers and pharmaceutical distributors. Our sales force calls on the customers that use our wound care products, as well as the dealers and distributors through whom our customers purchase these products.
Many potential customers for wound products have become members of group purchasing organizations (“GPOs”) in an effort to reduce costs. GPOs negotiate pricing arrangements with health care product manufacturers and distributors and offer the negotiated prices to affiliated hospitals and other members. We generally do not solicit GPOs because, in most cases, we do not offer a product range that is broad enough to effectively compete in the wound care product category. However, we have been successful in obtaining three-year contracts with three GPOs, one of which became effective in February 2012 while the other two became effective in 2010. These contracts provide MPM sales representatives the opportunity to present our wound care products to and solicit sales from members of these GPOs. With respect to potential customers that are members of GPOs with which we do not have a contract, because our product line includes certain specialty products that are not generally offered through GPOs, our sales force is able, with varying degrees of success, to solicit sales of our products that these potential customers cannot purchase through their GPO. In addition, our sales force calls on other potential customers such as specialty distributors, which include distributors that supply products and services reimbursed under Part B of Medicare and health care providers that service specialty markets such as the oncology market and the home health care market. Other than the GPO contracts described above, we do not have long-term supply contracts with any of our customers, dealers or distributors.
Since 2004, a medical/surgical dealer has significantly expanded its business and, as a result, increased its purchases of our wound care products. This dealer distributes our Medical Products and provides services mainly to nursing homes, which obtain reimbursement for the price of products from Medicare. This dealer accounted for 59%, 61% and 62% of Medical Products net sales in 2011, 2010 and 2009, respectively.
On February 27, 2012, we were notified that this dealer filed a voluntary petition for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Central District of California in Santa Ana, California on February 24, 2012. According to its bankruptcy petition, this dealer filed its petition as the most effective means of stabilizing its finances as it resolves a recent reimbursement guidelines dispute with Medicare, which the dealer believes is improperly withholding payments. The reimbursement dispute does not involve products we supply to this dealer. The petition states that this dealer relies on Medicare payments for more than 90% of its revenue and that Medicare has currently suspended all of its payments to the dealer. In a press release issued by the dealer at the time of the filing, the dealer stated that the Chapter 11 filing will allow it to continue operating without interruption while it resolves its payment dispute with Medicare as expeditiously as possible. As of the date of the bankruptcy filing, we had approximately $436,000 in accounts receivable that are owed by this dealer, and we have continued to fill this dealers's post-petition orders. The accounts receivable balance as of March 23, 2012 was $684,000. While we believe the amounts due to us from this dealer will be collected in full, we will continue to monitor these proceedings as they progress in order to appropriately assess and enforce our rights in this matter.
Third-Party Reimbursement. Most of our Medical Products are purchased by health care providers for use on patients in their care. In most cases, these health care providers obtain reimbursement for the cost of our products from various third-party payers, including Medicare, Medicaid, private insurance plans and managed care organizations. In response to national attention focused on health care, significant health care reform initiatives have been adopted and others have been proposed that may affect the availability and amount of third party reimbursements. Also, in an effort to control rising health care costs, there have been, and may continue to be, proposals by legislators, regulators and third-party payers to curb these costs. We believe that presently available third-party reimbursement is adequate to support the market for our products; however, continued demand for our Medical Products is partially dependent upon the extent of available reimbursement for these products.
Returns. Generally, unused Medical Products may be returned up to six months from the date of purchase for a refund equal to 100% of the sales price less a 25% restocking fee. Returned product that was damaged during shipment to the customer is 100% refundable. For the years 2011, 2010 and 2009, returns were less than 1% of Medical Products sales.
Trademarks, Patents or Other Intellectual Property
We have trademark registrations in the U.S. and certain foreign jurisdictions of the Company name, RBC Life Sciences®; our Nutritional Product brand name, RBC Life®; our logo and certain key product names including Microhydrin, Colo Vada Plus, C7, Immune 360 and OliViva. We also have trademark registrations in the U.S. of certain other key product and product ingredient names such as NeuroBright, Microhydrin Plus, HydraCel, Regenecare®, Oramagic®, RediaPlex® and Normlshield®. In addition, we have trademark applications pending in the U.S. and certain foreign jurisdictions for other key trade dress used by us. As long
as we continue to renew our trademarks when necessary, the trademark protection provided by them is perpetual. We also rely on common law trademark rights to protect our unregistered trademarks. Common law trademark rights do not provide the same level of protection as afforded by a U.S. federal registration of a trademark. Also, common law trademark rights are limited to the geographic area in which the trademark is actually used. These trademarks are useful in achieving brand recognition within our industries.
During 2002, we developed proprietary formulations and manufacturing processes to produce certain raw materials, which are principal ingredients in our leading products. We have not filed for patent protection related to our proprietary formulations or manufacturing processes. Therefore, there can be no assurance that another company will not replicate one or more of our products.
The developer of Stem-Kine has filed a patent application in the U.S. that covers compositions of matter, uses and formulations associated with Stem-Kine. There can be no assurance that this patent will be issued, that it will exclude competitors or provide us with competitive advantages or that others have not or will not develop similar products.
Seasonality
Our business is not subject to significant seasonal fluctuations. However, as a practical matter, CCI, whose principal office is located in Moscow, generally limits its shipping orders during the winter months due to unfavorable weather conditions.
Inventory Requirements, Backlogs
Distributors of our Nutritional Products, except for licensees, and distributors of our Medical Products generally do not maintain large inventories of our products. They depend on us to maintain our inventory at a level that will allow us to fill their orders or the orders of their customers, as the case may be, as they are placed. We generally ship orders within 24 to 72 hours after we receive them so there is no significant backlog of orders related to these distribution channels.
We do not maintain inventory in anticipation of product orders from our licensees. Under the terms of our license agreements, the licensee is generally required to make a cash deposit equal to 50% of the purchase order amount at the time the purchase order is placed, and must allow two to three months for delivery. In addition, under our agreement with CCI, we store products for CCI in our warehouse and then ship them at a later date to locations designated by CCI in accordance with its business needs. As part of this agreement, CCI accepts ownership of and pays for the products as they are segregated in our warehouse for CCI’s account. However, we do not recognize sales until the products are shipped. Therefore, we define backlog as purchase orders received by us that are accompanied by the requisite deposit, plus the purchase price of CCI products that are stored in our warehouse pending shipment. Backlog fluctuates depending on licensee ordering patterns and the timing of CCI’s shipping requests. Backlog was approximately $6,125,000 and $6,548,000 at December 31, 2011 and 2010, respectively. We expect substantially all of the backlog at December 31, 2011 to be filled during 2012.
Industry/Competitors
We market our Nutritional Products in a highly competitive industry both domestically and internationally. We compete against companies that sell heavily advertised products through retail stores as well as other network marketing companies. Many of our competitors are significantly larger than we are, have far greater financial resources and have broader name recognition.
In the distribution of Nutritional Products, we compete with retail outlets, such as health food stores, supermarkets and department stores, and other network marketing companies. We endeavor to compete successfully by offering a wide selection of products that incorporate proprietary technology, are science-based and have a reputation for high quality. We believe that our products possess features and provide benefits that are desired by consumers looking for natural health products. We place a high degree of emphasis on new product development to ensure our product line remains current with developing trends in our industry and new scientific evidence. We generally do not attempt to compete based on price, although price is a consideration. Prices are justified through product quality and benefits and, to the extent possible, the proprietary ingredients and unique formulations.
We also compete against other network marketing companies for the time, attention and commitment of new and current Associates. The pool of individuals interested in the business opportunities presented by network marketing tends to be limited in each market and is reduced to the extent other network marketing companies successfully recruit these individuals into their businesses. Our ability to remain competitive depends, in significant part, on our success in sponsoring and retaining Associates. We endeavor to compete successfully by offering unique and effective products at prices competitive with other network marketing companies, a rewarding Associate compensation plan and attractive Associate support programs.
Our Medical Products also face heavy competition. In the wound care product market, we compete against a number of companies, most of which are significantly larger, have far greater financial resources and have broader name recognition. As with our Nutritional Products, we place a high degree of emphasis on new product development to ensure our product line remains current with developing trends and new scientific evidence. We endeavor to compete by offering a range of high quality products, which are unique and effective, at competitive prices.
Research and Development
From time to time, we have contracted with scientists at universities, medical colleges and private research organizations to conduct pilot studies to evaluate the safety and functions of our products. Most of these studies have been conducted to evaluate the safety and functions of Microhydrin or Microhydrin-based formulations. We have also engaged several studies to evaluate the efficacy of certain of our wound care products distributed to the oncology market. Amounts expended by us to fund these studies have not been significant.
We enhance our product line through the development of new products and the improvement of existing products. New product ideas are derived from a number of sources, including in-house personnel with significant experience in product formulation and development, medical and nutrition professionals, trade publications, scientific and health journals, product suppliers and other third parties. Prior to introducing new products, we investigate product formulations to ensure that they are backed by sound scientific research and are in compliance with applicable regulations.
Governmental Regulations
Products. One or more of the following agencies regulates the formulation, manufacture, packaging, labeling, advertising, distribution and sale of our products: the Food and Drug Administration (“FDA”); the Federal Trade Commission (“FTC”); the Consumer Product Safety Commission; the U.S. Department of Agriculture; the Environmental Protection Agency; and various agencies of the states and foreign countries into which our products are shipped or sold.
We market both dietary supplements and medical devices. In the U.S., the FDA regulates our products under the Federal Food, Drug, and Cosmetic Act (“FDCA”) and related regulations. To ensure compliance with the FDCA and FDA regulations, the FDA has numerous enforcement tools, including the ability to issue warning letters, initiate product seizures and injunctions, order product withdrawals and recalls and pursue fines and criminal penalties.
The majority of our products are classified as dietary supplements, which are defined in the FDCA as products intended to supplement the diet that contain one or more of certain dietary ingredients, such as vitamins, minerals, herbs or botanicals, amino acids and other dietary substances used to supplement diets. The FDCA has been amended several times with respect to dietary supplements, most significantly by the Nutrition Labeling and Education Act of 1990 and the Dietary Supplement Health and Education Act of 1994 (“DSHEA”). This legislation governs the formulation, manufacturing, marketing and sale of dietary supplements, including the content and presentation of health-related information included on the labels or labeling of dietary supplements. We believe DSHEA generally provides a favorable regulatory climate to consumers and the dietary supplement industry. However, several bills to amend DSHEA in ways that would make this law less favorable to consumers and the dietary supplement industry have been proposed in Congress. We cannot predict whether this legislation will pass in its present form, an amended form or at all.
Pursuant to the FDCA, a dietary supplement that contains a new dietary ingredient ("NDI"), which is defined as an ingredient not on the market before October 15, 1994, must have a history of use or other evidence of safety establishing that it is reasonably expected to be safe. The manufacturer must notify the FDA at least 75 days before marketing products containing NDIs and provide the FDA with the information upon which the manufacturer based its conclusion that the product has a reasonable expectation of safety. In July 2011, the FDA published draft guidance for the industry to attempt to clarify the FDA's interpretation of the NDI notification requirements, and this guidance raises new challenges to the development of NDIs. In addition, increased FDA enforcement could lead the FDA to challenge dietary ingredients already on the market as "illegal" under the FDCA because of the failure to submit an NDI notification.
The FDCA permits dietary supplement products to include truthful, non-misleading and substantiated statements of nutritional support. Such claims include: (i) statements that claim a benefit related to a classical nutrient deficiency disease and disclose the prevalence of such disease in the U.S.; (ii) statements describing general well-being resulting from consumption of a dietary ingredient; (iii) statements that describe the role of a nutrient or dietary ingredient intended to affect the structure or function of the body; and (iv) statements that characterize the documented mechanism by which a dietary ingredient acts to maintain such structure or function. These claims are also known as “structure/function” claims. A dietary supplement that includes a structure/function claim on its labeling is required to include a disclaimer stating that the FDA has not evaluated the claim, and
the manufacturer must notify the FDA of the use of such claim.
The FDA distinguishes between statements of nutritional support, including structure/function claims, which do not require prior FDA approval, and claims that a product is intended to prevent, treat, cure, mitigate or diagnose disease, otherwise known as “drug claims,” which do require prior FDA approval. It is the intended use of a product that is determinative, and intended use can be derived from various sources, including labeling and advertising claims. The making of a drug claim in relation to a dietary supplement may result in the product being declared an unapproved new drug in violation of the FDCA. The FDA has issued a regulation intended to clarify the distinction between permissible structure/function and impermissible drug claims. While in some cases there is no clear distinction between the two, we believe that the labeling and advertising of our dietary supplements complies with these regulations. We do not make drug claims for any of our dietary supplements.
The FDCA requires that manufacturers possess substantiation demonstrating that structure/function claims made for dietary supplements are truthful and not misleading. The agency has issued a Guidance Document describing the amount and type of evidence it would consider adequate to support structure/function claims. According to the FDA Guidance, marketers should possess the type of evidence that experts in the relevant area of study would consider to be competent and reliable. Competent and reliable scientific evidence adequate to substantiate a claim, according to the Guidance, would consist of information derived primarily from human studies. Failure of a company to possess competent and reliable scientific evidence to substantiate structure/function claims made for its dietary supplement products may result in enforcement action and the FDA requiring that such claims be deleted or amended. We believe we possess competent and reliable scientific evidence to support structure/function claims made for our dietary supplement products.
In June 2007, as authorized by DSHEA, the FDA adopted good manufacturing practice regulations (“GMPs”) specifically for dietary supplements, which regulations are applicable to those who manufacture, package, label or hold dietary supplements. These new GMPs are more onerous than the GMPs that previously applied to dietary supplements and require, among other things, dietary supplements to be prepared, packaged and held in compliance with specific rules, and require quality control provisions similar to those in the GMPs for drugs. As a small business, our effective compliance date under the new GMPs was June 2009. Under these regulations, we are responsible to comply with GMPs applicable to the activities in which we engage, i.e. the holding and distribution of dietary supplements. We believe our practices are in compliance with these GMPs, but there can be no assurance that our operations or the manufacturing and distribution practices of our suppliers will be in compliance in all respects at all times. Additionally, there is a potential risk of increased audits as the FDA and other regulators seek to ensure compliance with the GMPs. We have experienced increases in product costs as a result of the necessary increase in testing of raw ingredients and finished products and compliance with higher quality standards.
In December 2006, Congress passed the Dietary Supplement and Nonprescription Drug Consumer Protection Act, which amended the FDCA and became effective in December 2007. These regulations, among other things, require companies that manufacture, pack or distribute nonprescription drugs or dietary supplements to report serious adverse events allegedly associated with their products to the FDA and institute recordkeeping requirements for all adverse events whether serious or non-serious. We believe that we have the necessary systems in place to comply with these regulations.
Most of our Medical Products are regulated under the FDCA as medical devices. Under the FDCA, medical devices are classified into one of three classes-Class I, Class II or Class III-depending on the degree of risk associated with each medical device and the extent of control needed to ensure safety and effectiveness. The class to which a device is assigned determines, among other things, the type of premarket submission or application required for marketing. Device classification depends on the intended use of the device and upon a product's indications for use. Most of our medical devices are classified as Class I, and we do not now nor do we intend to market any Class III medical devices.
Class I devices are those for which safety and effectiveness can be assured by adherence to a set of regulatory guidelines called General Controls. General Controls are the only level of controls that apply to Class I devices and include provisions of the FDCA pertaining to adulteration, misbranding, device registration and listing, premarket notification, banned devices, notification and repair/replacement/refund, records and reports, restricted devices, and GMPs. Class II devices are those for which General Controls alone are insufficient to provide reasonable assurance of its safety and effectiveness and there is sufficient information to establish Special Controls the FDA deems necessary to provide such assurance. Special Controls may include special labeling requirements, mandatory performance standards and postmarket surveillance. Most Class I devices are exempt from premarket notification (510(k)) requirements, and while a few Class II devices are exempt, most Class II devices require 510(k) premarket notification. A 510(k) premarket notification requires demonstration of substantial equivalence to another legally U.S. marketed device. Substantial equivalence means that the new device is at least as safe and effective as the predicate device. The process of obtaining a 510(k) clearance typically can take several months to a year or longer and may involve the submission of limited clinical data supporting assertions that the product is substantially equivalent to an already approved device or to a device that was on the market before the enactment of the Medical Device Amendments of 1976. We believe that our medical devices
are manufactured and marketed in accordance with these statutory requirements and the FDA’s related regulations.
In September 2010, the FDA conducted a routine inspection of our medical device quality systems. This inspection resulted in the issuance of a Form 483 Notice that contained four observations related to these quality systems. We submitted our initial written response to the Form 483 Notice in September 2010 and, after further analysis, additional responses in February 2011 and March 2011. In these responses, we described the corrective actions taken and the additional corrective procedures we planned to implement to address the FDA's observations. We are currently in the process of implementing these additional corrective procedures. We have not received any further communications from the FDA with respect to the Form 483 Notice; however, failure to fully address the FDA’s concerns could result in the issuance of warning letters, regulatory sanctions or enforcement actions that could have a material adverse effect on us.
Advertising of products in the U.S. is subject to regulation by the FTC under the FTC Act. The FTC Act prohibits unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce. The FTC Act also provides that the dissemination of any false advertisement pertaining to drugs or foods, which would include dietary supplements, is an unfair or deceptive act or practice. Under the FTC’s substantiation doctrine, an advertiser is required to have a “reasonable basis” for all objective product claims before the claims are made. Failure to adequately substantiate claims may be considered either deceptive or unfair practices. The FTC typically requires claims concerning the efficacy or safety of drugs and foods, including dietary supplements, to be supported by competent and reliable scientific evidence which is defined as tests, analyses, research, studies, or other evidence based on the expertise of professionals in the relevant area, that have been conducted and evaluated in an objective manner by persons qualified to do so, using procedures generally accepted in the profession to yield accurate and reliable results. Generally, the amount and type of evidence that will be sufficient is what experts in the relevant area of study would consider to be adequate. The FTC has issued a Dietary Supplement Advertising Guide for Industry that describes the amount and type of evidence the FTC will consider adequate for a dietary supplement. Advertising of our products is also regulated by state and local authorities under the various state consumer protection and consumer fraud acts. We believe that we have the necessary documentation to support our advertising and promotional claims.
In October 2009, the FTC issued new Guides Concerning the Use of Endorsements and Testimonials in Advertising ("Guides"). These new Guides significantly extend the scope of potential liability associated with the use of testimonials, endorsements and new media methods, such as blogging, in advertising. As of the December 1, 2009 effective date of the Guides, advertisers are required either to substantiate that the experiences conveyed by testimonials or endorsements represent typical consumer experiences with the advertised product or clearly and conspicuously disclose the typical consumer experience with the advertised product. In many instances, this will require advertisers to possess "competent and reliable scientific evidence" to substantiate the consumer or endorser representations.
Under the new Guides, advertisers also may be liable for statements made by consumers in the context of "new media," including blogs, depending on the relationship between the consumer and the advertiser. Although an advertiser's control over the consumer's comments will be relevant to a determination regarding liability for false or misleading statements, it will not necessarily be dispositive.
The FTC may enforce compliance with the law in a variety of ways, both administratively and judicially, including orders requiring limits on advertising, corrective advertising, consumer redress, divestiture of assets, rescission of contracts, cease and desist orders, injunctions and such other relief as the agency deems necessary to protect the public.
Self-regulatory agencies under the umbrella of the National Advertising Review Council, such as the National Advertising Division (“NAD”) of the Council of the Better Business Bureaus and the Electronic Retailing Self-Regulation Program (“ERSP”), may initiate investigations into product claims either on their own or upon the request of a complainant. Non-compliance with the recommendations of either the NAD or ERSP may result in referral of the matter to the FTC.
In Canada, most of our Nutritional Products are classified as natural health products (“NHPs”). The safety, quality, manufacturing, packaging, labeling, storage, importation, advertising, distribution and sale of NHPs are subject to regulation primarily under the federal Food and Drug Act (Canada) ("Canadian FDA") and associated regulations, including the Food and Drug Regulations and the Natural Health Products Regulations and related Health Canada guidance documents and policies (collectively, "Canadian Regulations"). Health Canada is primarily responsible for administering the Canadian FDA and the Canadian Regulations.
Effective January 2004, each NHP must have a product license issued by Health Canada before it can be sold in Canada, subject to certain transition periods. Health Canada assigns a natural health product number ("NPN") to each NHP once Health Canada issues the license for that NHP. The Canadian Regulations require that all NHPs be manufactured, packaged, labeled, imported, distributed and stored under Canadian GMPs or the equivalent thereto, and that all premises used for manufacturing,
packaging, labeling and importing NHPs have a site license, which requires GMP compliance. The Canadian Regulations also set out requirements for labeling, packaging, clinical trials and adverse reaction reporting.
Health Canada approval for marketing authorization can take time. The approval time for NHPs can vary depending on the product and the application or submission. For NHPs, the Canadian regulations indicate that certain product licenses should be processed within 60 days. However, the regulations also include provisions to extend this time frame if, for example, more information is required. There can be significant delays. Effective August 2010, regulations of the Canadian FDA came into force which provide that each application for an NPN that is in process, that has not been disallowed and is for a product that is neither a specified restricted product nor a product that contains an ingredient that is likely to result in injury to the health of a consumer, is to be issued an exemption number. Upon the completion of certain formalities, a product license is deemed to have been issued for a product with an exemption number and such license remains in effect until the associated application is processed. If Health Canada refuses to issue a product license, the NHP can no longer be sold in Canada until Health Canada issues such a license. We have adopted a compliance strategy to adhere to Health Canada's regulations. There is no assurance that product licenses will ultimately be issued for our products.
Health Canada can perform routine and unannounced inspections of companies in the industry to ensure compliance with Canadian Regulations. The overall risk factors for Canada, in general, are similar to those in the U.S., as outlined above. Health Canada can suspend or revoke licenses for lack of compliance. In addition, if Health Canada perceives a product to present an unacceptable level of risk, it can also impose fines and criminal penalties.
Prior to importing and distributing our products in international markets, our licensees are generally required to obtain approvals, licenses, or certifications from a country's department of health or comparable agency. Applications to request these approvals may require the submission of significant amounts of information related to product manufacturing processes and ingredients, which in many cases we must provide. After submission of the applications, final approvals may be conditioned on reformulation of our products for the market or may be withheld with respect to certain products or product ingredients. Licensees are also required to comply with local product labeling and packaging regulations that vary from country to country. We would be subject to similar regulatory requirements prior to commencement of operations in any new international market. The level of regulatory burden associated with a foreign country is a factor we consider prior to commencing operations in that country.
We cannot predict the nature of any future laws, regulations, interpretations or applications that may be administered by any federal, state or foreign regulatory authority, nor can we determine what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business in the future. They could include, however, requirements for the reformulation of certain products to meet new standards, the recall or discontinuation of certain products that cannot be reformulated, additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling and additional scientific substantiation. Any or all of these requirements could have a material adverse effect on our business, financial condition and results of operations.
Network Marketing. Our network marketing program is subject to laws and regulations in each country in which we operate. Generally these laws are directed at ensuring that product sales ultimately are made to consumers and that advancement within a sales organization is based on sales of the enterprise's products, rather than investments in the organization or other non-retail sales related criteria. These laws include anti-pyramiding, securities, lottery, referral selling, anti-fraud and business opportunity statutes, regulations and court cases. In addition to federal regulation by the FTC in the U.S., each state has enacted its own “Little FTC Act” to regulate sales and advertising. We actively strive to comply with all applicable state, federal and foreign laws and regulations affecting this distribution channel. We believe that our network marketing system satisfies the standards and case law defining a legal marketing system; however, the regulatory and legal requirements concerning network marketing systems do not include “bright line” rules and are inherently fact-based.
We cannot predict the nature of any future law, regulation, interpretation or application, nor can we predict what effect additional governmental legislation or regulations, judicial decisions or administrative orders, when and if promulgated, would have on our business in the future. It is possible that future developments may require that we revise our network marketing program. Any or all of these requirements could have a material adverse effect on our business, results of operations and financial condition.
Transfer Pricing. In the U.S. and other countries, we are subject to transfer pricing and other tax regulations designed to ensure that appropriate levels of income are reported as earned by our U.S. or foreign 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. We have adopted transfer pricing arrangements with respect to our foreign operations that we believe are in compliance with all applicable transfer pricing laws. If the U.S. Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully challenge these arrangements or require changes in our transfer pricing practices, we could
be required to pay higher taxes and our results of operations would be adversely affected if our foreign tax credit was limited on our U.S. federal income tax return. There can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws will not be modified, which as a result, may require changes in our operating procedures.
Employees
As of December 31, 2011 and 2010, we had 77 and 72 employees, respectively. We do not foresee a significant change in the number of our employees during 2012.
Additional Available Information
We are subject to the informational requirements of the Securities Exchange Act of 1934, and, accordingly, file reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). We make available free of charge through our website at www.rbclifesciences.com, as soon as reasonably practicable after such material is electronically filed with the SEC, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports. This information may also be obtained from the SEC’s on-line database located at www.sec.gov, which contains material regarding issuers that file electronically with the SEC. You may also obtain copies of any of our reports filed with, or furnished to, the SEC, free of charge, at the SEC’s public reference room at 100 F Street, NE, Washington, DC 20549 on official business days during the hours of 10:00 am to 3:00 pm. Information regarding the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.
Item 1A.
Item 1A.
Risk Factors.
Please carefully consider the following risk factors, which could materially adversely affect us. The fact that some of these risk factors may be the same or similar to those that we have filed with the SEC in past reports means only that the risks are present in multiple periods. We believe that many of the risks that are described here are part of doing business in the industries in which we operate and will likely be present in all periods. The fact that certain risks are endemic to these industries does not lessen their significance. Among others, risks and uncertainties that may affect our business, financial condition, performance, development, and results of operations include the following:
Two of our customers constitute a significant portion of our sales.
In 2011 and 2010, two of our customers accounted for approximately 59% and 69%, respectively, of consolidated net sales. One customer, CCI, a licensee that distributes Nutritional Products primarily in Russia and Eastern Europe, accounted for approximately 45% and 55% of consolidated net sales in 2011 and 2010, respectively. The other customer, a medical/surgical dealer that distributes Medical Products and provides services to the long-term care market, accounted for approximately 14% of consolidated net sales in 2011 and 2010. Accordingly, a loss of significant business from, or adverse performance by, either of these customers would be harmful to our business, results of operations and financial condition. Factors that could adversely affect our sales to these customers include, but are not limited to, the continued negative effects of global economic conditions, additional unfavorable changes in market conditions in the markets serviced by these customers, changes in government regulations that affect sales in markets serviced by these customers, competition from other entities that sell similar products in markets serviced by these customers or an unfavorable change in our business relationship with these customers. The president of CCI beneficially holds approximately 18% of our outstanding common stock and served as a member of our Board of Directors until June 2004.
On February 27, 2012, we were notified that the medical/surgical dealer that accounted for approximately 14% of our consolidated net sales in 2011 and 2010, filed a voluntary petition for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Central District of California in Santa Ana, California on February 24, 2012. According to its bankruptcy petition, this dealer filed its petition as the most effective means of stabilizing its finances as it resolves a recent reimbursement guidelines dispute with Medicare, which the dealer believes is improperly withholding payments. The reimbursement dispute does not involve products we supply to this dealer. The petition states that this dealer relies on Medicare payments for more than 90% of its revenue and that Medicare has currently suspended all of its payments to the dealer. In a press release issued by the dealer at the time of the filing, the dealer stated that the Chapter 11 filing will allow it to continue operating without interruption while it resolves its payment dispute with Medicare as expeditiously as possible. As of the date of the bankruptcy filing, we had approximately $436,000 in accounts receivable that are owed by this dealer, and we have continued to fill this dealer's post-petition purchase orders. The accounts receivable balance as of March 23, 2012 was $684,000. While we believe the amounts due to us from this dealer will be collected in full, we will continue to monitor these proceedings as they progress in order to appropriately assess and enforce our rights in this matter. A loss of significant business from this customer would be harmful to our business, results of operations and financial condition.
Net sales of our Nutritional Products are dependent upon an independent sales force and third-party licensees, and we do not have direct control over the marketing of our Nutritional Products.
We rely on non-employee, independent Associates and third-party licensees to purchase, market and sell our Nutritional Products. Licensees, which accounted for 46%, 56% and 51% of our consolidated net sales in 2011, 2010 and 2009, respectively, are third parties that have entered into license agreements with us pursuant to which they purchase products for distribution in the licensed territories. License agreements generally require licensees to market our products using the RBC brand and impose minimum sales requirements throughout the term that the licensee must meet to retain the distribution rights conveyed by the license agreements. Licensees are responsible for satisfying all regulatory requirements in the licensed territories related to the importation, labeling, storage, distribution and sale of our products. Licensees are also responsible for all marketing and sales activities in the licensed territories. Accordingly, net sales to licensees are directly dependent upon the efforts of the licensees and our future sales volume will depend in large part upon their success in the importation, marketing, sales and distribution of our products in the licensed territories.
In 2011, 2010 and 2009 net sales from our Associates contributed 30%, 21% and 24%, respectively, of our consolidated net sales. Net sales to our Associate network increased 45% in 2011 and less than 1% in 2010, but declined 4% in 2009. Associates are independent contractors who purchase products directly for their own use or for resale. Associates typically engage in the distribution of our products on a part-time basis and likely engage in other business activities, some of which may compete with us. We have a large number of Associates in relation to the size of the corporate staff that implements our marketing programs and provides motivational support to our Associates. We undertake minimal effort to provide individual training to Associates. Accordingly, there can be no assurance that our Associates will participate in our marketing strategies, plans or Associate compensation plan or accept our introduction of new products. Associates may voluntarily terminate their agreements with us at any time and, like most network marketing companies, we experience high turnover in Associates from year to year. Because of this high turnover, we must continually recruit new Associates. To increase net sales, we must increase the number and/or productivity of our Associates. 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 Associates and to attract new Associates. Several factors affect our ability to attract and retain Associates, including:
•on-going motivation of our Associates;
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perception of our products, service level and business opportunity among our Associates and within our industry
•significant changes in the amount of commissions paid;
•general business and economic conditions;
•public perception and acceptance of the nutritional supplement industry and network marketing;
•public perception and acceptance of RBC and our products;
•the limited number of people interested in pursuing network marketing as a business;
•our ability to provide products that satisfy market demands; and
•competition in recruiting and retaining active Associates.
The phase-out of the Associate compensation plan transition rules and the modification of the Associate compensation plan may increase turnover of existing Associates and may reduce recruiting of new Associates.
In September 2009, we introduced a new Associate compensation plan to all of our Associates. While we believe the new compensation plan is more attractive to potential Associates than our former plan, there was no assurance that existing Associates, who were previously compensated under the former plan, would receive the new plan favorably and, accordingly, continue to participate as active Associates of the Company. To affect a transition of existing Associates from the former compensation plan to the new compensation plan, we implemented a 12-month, performance-based commission subsidy program that allowed existing Associates to become accustomed to the new plan without a significant decrease in commission income. Prior to the end of this 12-month period, we extended one portion of the program through August 2011, and extended a second portion of the program through December 2012. Accordingly, the rate of acceptance of the new plan will not be fully known until 2013.
Effective January 1, 2012, we introduced certain modifications to the Associate compensation plan to (i) better balance commissions that may be earned from sales to existing Associates as compared to sales to new Associates and (ii) provide additional incentives for existing Associates to remain active. One effect of these modifications is to reduce the commissions paid on sales to new Associates, which may result in a reduction in sponsorship of new Associates. Existing Associates may also not respond favorably to these modifications and, as a result, become less active or terminate their agreements with us.
An increase in turnover of existing Associates and/or a reduction in sponsorship of new Associates as a result of either
or both of these factors could adversely affect our results of operations and financial condition.
Three of our products constitute a significant portion of our net sales, one of which is marketed under a license agreement with the product's developer.
Three of our Nutritional Products, Microhydrin, Microhydrin Plus and Stem-Kine, constitute a significant portion of our sales, accounting for approximately 15% of net sales in 2011. In addition, we do not own the marketing rights to one of these products, Stem-Kine, which was launched in May 2011. Stem-Kine is marketed by us under the terms of a license agreement with the product's developer. While this license agreement has a 20-year term, it is subject to termination at the option of the licensor if we fail in any year to meet the annual minimum purchase requirements set forth in the license agreement. If our marketing rights with respect to Stem-Kine are terminated, the demand for any of these products decreases significantly, government regulation restricts the sale of these products, we are unable to adequately source or deliver these products or we cease offering these products for any reason without a suitable replacement, then our financial condition and operating results would be adversely affected.
Failure to succeed in, or expand into, international markets will limit our ability to achieve future growth.
In 2010 we initiated sales in certain countries located in Southeast Asia under an NFR program. Based on the favorable response to this program, we opened an office and distribution facility in Taiwan on October 1, 2011. We believe that our ability to achieve future growth is dependent in part on our ability to operate successfully in Taiwan and then continue to expand internationally. However, there can be no assurance that Taiwan operations will be successful or that we will be successful in establishing operations in any other international markets. Our failure to operate successfully in Taiwan could have a material adverse effect on our business, financial condition, or results of operations.
Expanding into international markets requires that we overcome significant regulatory and legal barriers, and also problems encountered as a result of differences in language, culture and legal systems. Once we have entered a market, we must adhere to the regulatory and legal requirements of that market. As is the case in Taiwan, we may be required to reformulate certain of our products before they can be sold in a given country. Given these circumstances, we cannot make any assurances that we will be able to successfully reformulate our products in a manner that meets local regulatory requirements and remains attractive to local customers. Prior to entering a new international market, it is difficult to assess the extent to which our products and sales techniques will be accepted or successful in that market. In many market areas, including Taiwan, other network marketing companies already have significant market penetration, the effect of which could be to desensitize the local Associate population to a new opportunity, or to make it more difficult for us to attract qualified Associates. There can be no assurance that we will be able to obtain and retain necessary permits and approvals in new markets, or that we will have sufficient capital to finance our expansion efforts in a timely manner. Even if we are able to commence operations in new markets, there may not be a sufficient population of persons who are interested in our network marketing system.
Adverse economic conditions may harm our business.
Our business, financial condition and results of operations may be affected by various general economic factors and conditions. Periods of economic slowdown or recession in any of the countries in which we operate or in which our products are marketed and sold could lead to a decline in the use of our products and therefore could have an adverse effect on our business. Global economic conditions have deteriorated significantly over the past several years and continue to be challenging and unpredictable. The uncertainty with respect to the timing and extent of economic recovery pose a risk as consumers and businesses, including health care providers, may postpone spending, or seek new ways to eliminate spending, in response to uncertain and challenging economic conditions. Other risks related to an economic downturn include difficulties in obtaining credit, foreign currency exchange rate fluctuations, insolvency of key suppliers and customer insolvencies. We cannot predict the timing or duration of any economic slowdown or recession or the timing or strength of a subsequent recovery, or how the markets may continue to be impacted by these general economic conditions. If the markets for our products significantly deteriorate due to economic conditions, our business, financial condition and results of operations may be materially and adversely affected.
Changes in customer preferences and demand could negatively impact our operating results.
Our business is subject to changing customer preferences and demand. The industries in which we operate are characterized by changes in demand for existing products and demand for new products and enhancements. Our success depends in part on our ability to anticipate and respond to these changes. Our failure to accurately predict these trends could negatively impact customer opinion of our products, which in turn could harm our customer relationships and cause the loss of sales. The success of our new product offerings and enhancements depends upon a number of factors, including our ability to:
•accurately anticipate customer needs;
•innovate and develop new products or product enhancements that meet these needs;
•successfully commercialize new products or product enhancements in a timely manner;
•price our products competitively;
•manufacture and deliver our products in sufficient volumes and in a timely manner;
•differentiate our product offerings from those of our competitors; and
•satisfy government regulations related to the manufacture, labeling, sale and distribution of our products.
If we do not introduce new products or make enhancements to meet the changing needs of our customers in a timely manner, some of our products could be rendered obsolete, which could negatively impact our business, financial condition and operating results. Demand for our products could also be adversely affected by changes in demographic trends, changes in government regulations or policies and particularly with regard to Nutritional Products, changes in disposable consumer income.
Our Associate network business is subject to the effects of adverse publicity and negative public perception.
Our ability to attract and retain Associates and to sustain and enhance sales through our Associates may be affected by adverse publicity or public perception regarding our industry, our competition or our business generally. This adverse public perception may include publicity regarding the legality of network marketing despite the fact that U.S. courts have established standards defining a legal network marketing system. This adverse public perception may also include publicity regarding the quality or efficacy of nutritional supplement products or ingredients in general or our products or ingredients specifically, and regulatory investigations, regardless of whether those investigations involve us or our Associates or the business practices or products of our competitors or other network marketing companies. There can be no assurance that we will not be subject to adverse publicity or negative public perception in the future or that such adverse publicity will not have a material adverse effect on our business, financial condition and results of operations.
We may have to obtain regulatory approvals before we market and sell certain new products.
Pursuant to FDA regulations, a dietary supplement that contains an NDI, which is defined as an ingredient not on the market before October 15, 1994, must have a history of use or other evidence of safety establishing that it is reasonably expected to be safe. The manufacturer must notify the FDA at least 75 days before marketing products containing NDIs and provide the FDA with the information upon which the manufacturer based its conclusion that the product has a reasonable expectation of safety. In July 2011, the FDA published draft guidance for the industry to attempt to clarify the FDA's interpretation of the NDI notification requirements. This guidance raises new challenges to the development of NDIs, which could limit our ability in the future to introduce new products to the market and thereby limit our ability to generate additional net sales. In addition, increased FDA enforcement could lead the FDA to challenge dietary ingredients already on the market as "illegal" under the FDCA because of the failure to submit an NDI notification. Although we do not believe that any of our products require additional approval by the FDA, if the FDA were to conclude that we failed to properly file an NDI notification, then we could be subject to enforcement actions by the FDA, which could result in a significant loss of net sales and harm to our business, financial condition and results of operations.
Most of our Medical Products are classified as medical devices under FDA regulations. Before certain medical devices can be sold, they require premarket review and clearance by the FDA, which is generally accomplished through the 510(k) premarket notification procedure. Clearance through this procedure requires demonstration that a new device is substantially equivalent to another device with 510(k) clearance or grandfather status. There is no assurance that the FDA will act favorably or quickly in its review of any 510(k) submissions, or that we will not encounter significant difficulties and costs in our efforts to obtain FDA clearance or approval, all of which could delay or preclude the sale of new products in the U.S. Any delays or failure to obtain FDA clearance or approvals of new products we develop, or the costs of obtaining FDA clearance or approvals, could have an adverse effect on our business, financial condition and results of operations. We do not have any submissions pending approval and none are presently being prepared.
Growth of Medical Products sales depends in part upon the availability of adequate third-party reimbursement.
The continued growth of our Medical Products segment will depend in part on the availability of adequate reimbursement to health care providers who use our products from third-party health care payers, such as Medicare, Medicaid, private insurance plans and managed care organizations. At present, third-party payers increasingly are challenging the pricing of medical products and services. Also, in response to national attention focused on health care, significant health care reform initiatives have been adopted and others have been proposed that may affect the availability and amount of third party reimbursements. Accordingly, reimbursement may not be at, or remain at, price levels adequate to allow health care providers to realize an appropriate return on the purchase of our products. In addition, third-party payers may not cover all or a portion of the cost of our products and related
services, or they may place significant restrictions on the circumstances in which coverage will be available. Should adequate reimbursement from third-party payers become restricted or unavailable, our business, financial condition and results of operations could be adversely affected.
We must rely on independent third parties for the supply of our products.
We depend on outside suppliers to supply certain raw materials used in the manufacture of our products. In addition, all of our finished products are manufactured by independent third parties. There is no assurance that our current suppliers and manufacturers will continue to reliably supply products to us at the level of quality or quantity we require. If any of our third-party suppliers and 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 suppliers and manufacturing sources. Although we believe that we could establish alternate sources for most of our products, any delay in locating and establishing relationships with other sources could result in product shortages and back orders for the products, with a resulting loss of net 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 net sales or result in increased product returns.
Shortages of raw materials may temporarily affect our margins or our profitability related to the sale of those products.
In the past, we have experienced temporary shortages of the raw materials used in certain of our nutritional products. Although multiple sources were available to supply such raw material ingredients, quantities of the materials we purchased during these shortages were at higher prices, which negatively impacted our gross margins for those products. While we periodically experience price increases due to unexpected raw material shortages and other unanticipated events, this has historically not resulted in a material effect on our overall cost of goods sold. However, there is no assurance that our raw materials will not be significantly adversely affected in the future, causing our profitability to be reduced.
As a product manufacturer and distributor we may be subject to product liability claims.
As a manufacturer of ingredients used in and a distributor of products produced for human consumption and topical application, we could become exposed to product liability claims and litigation to prosecute such claims. Additionally, the distribution of these products involves the risk of injury to consumers as a result of tampering by unauthorized third parties or product contamination. To date, we have had a very limited product claims history and such matters have not materially affected our business, financial condition or results of operations. We are not aware of any instance in which any of our products are or have been defective in any way that could give rise to material losses or expenditures related to product liability claims. Although we maintain product liability insurance, which we believe to be adequate for our needs, there can be no assurance that we will not be subject to claims in the future or that our insurance coverage will be adequate or that we will be able to maintain adequate insurance coverage.
Nutritional supplement products may be supported by only limited availability of conclusive clinical studies.
Our products include nutritional supplements that are made from vitamins, minerals, herbs, and other substances for which there is a long history of human consumption. Some of our products contain innovative ingredients or combinations of ingredients. Although we believe that all of our products are safe when taken as directed, there is little long-term experience with human consumption of certain of these product ingredients or combinations of ingredients in concentrated form. We conduct research and test the formulation and production of our products, but, in many cases, product formulations are supported by only limited clinical studies or no clinical studies. Furthermore, because we are highly dependent on consumers’ perception of the efficacy, safety, and quality of our products, as well as similar products distributed by other companies, we could be adversely affected in the event that those products prove or are asserted to be ineffective or harmful to consumers or in the event of adverse publicity associated with any illness or other adverse effects resulting from consumers’ use or misuse of our products or similar products of our competitors.
A violation of marketing or advertising laws by Associates in connection with the sale of our products or the promotion of our Associate compensation plan or the sale of our products by Associates in foreign markets where our products are not approved for sale could adversely affect our business.
New Associates enter into a written contract and agree to adhere to our Associate policies and procedures. Although these policies and procedures provide direction to our Associates regarding acceptable sales and marketing activities, including prohibiting Associates from making certain claims regarding products or income potential from the distribution of the products, Associates may from time to time, without our knowledge and in violation of our policies, create promotional materials or otherwise
provide information that does not accurately describe our products or our marketing program. They also may sell our products in international markets where our products are not approved for sale or make statements regarding potential earnings, product claims or other matters in violation of our policies or applicable laws and regulations concerning these matters. These violations may result in legal action against us by regulatory agencies or state attorneys general or negatively affect our ability to sell our products in foreign markets. We take what we believe to be commercially reasonable steps to monitor Associate activities to guard against misrepresentation and other illegal or unethical conduct by Associates. There can be no assurance that our efforts in this regard will be sufficient to accomplish this objective. Publicity resulting from these Associate activities can also make it more difficult for us to attract and retain Associates and may have an adverse effect on our business, financial condition and results of operations.
Laws and regulations may prohibit or severely restrict our sales efforts and could adversely affect our ability to do business.
The formulation, manufacturing, packaging, labeling, distribution, importation, sale, marketing and storage of our products are subject to extensive regulation by various federal agencies, including the FDA, the FTC, the Consumer Product Safety Commission, the U.S. Department of Agriculture the Environmental Protection Agency and by various agencies of the states, localities and foreign countries in which our products are manufactured, distributed and sold. Our failure to comply with those regulations could lead to the imposition of significant penalties or claims, including civil penalties, product recalls or product seizures, cease and desist orders, injunctions, criminal sanctions, limits on advertising, consumer redress, divestitures of assets, and rescission of contracts and could materially and adversely affect our business. In addition, the adoption of new regulations or changes in the interpretation of existing regulations may result in significant compliance costs or discontinuation of product sales and may adversely affect the marketing of our products, resulting in a significant loss of net sales.
In September 2010, the FDA conducted a routine inspection of our medical device quality systems. This inspection resulted in the issuance of a Form 483 Notice that contained four observations related to these quality systems. We submitted our initial written response to the Form 483 Notice in September 2010 and, after further analysis, additional responses in February 2011 and March 2011. In these responses, we described the corrective actions taken and the additional corrective procedures we planned to implement to address the FDA's observations. We are currently in the process of implementing these additional corrective procedures. We have not received any further communications from the FDA with respect to the Form 483 Notice; however, failure to fully address the FDA’s concerns could result in the issuance of warning letters, regulatory sanctions or enforcement actions that could have a material adverse effect on us.
The FDA has adopted GMPs relating to the manufacture, packaging and holding of dietary supplements. These GMPs, which became effective for us in June 2009, establish standards to ensure that dietary supplements and dietary ingredients are not adulterated with contaminants or impurities and are labeled to accurately reflect the active ingredients and other ingredients in the products. These GMPs also include requirements for designing and constructing physical plants, establishing quality control procedures, and testing manufactured dietary ingredients and dietary supplements, as well as requirements for maintaining records and for handling consumer complaints related to GMPs. The adoption of these GMPs has increased the cost of our products and may result in additional cost increases in the future. In addition, there is no assurance that all of our current suppliers will remain in compliance with these GMPs. To the extent any current supplier is unable to comply, we will be required to find an alternate source of supply. Suppliers that remain in compliance with these new regulations may incur additional compliance costs that will be passed on to us. These factors could affect our business, financial condition and results of operations.
In markets outside the U.S., we, or a licensee, as the case may be, may be required to obtain approvals, licenses or certifications from a country's ministry of health or a comparable agency prior to importing our products. Approvals or licensing may be conditioned on reformulation of products or may be unavailable with respect to certain products or product ingredients. In addition, changes to laws, regulations or standards governing the issuance of these approvals and licenses may adversely affect the ability of our products to be imported, which could affect our business, financial condition and results of operations.
Network marketing systems such as ours are subject to laws and regulations directed at ensuring that product sales are made to consumers of the products and that compensation, recognition and advancement within the marketing organization are based on the sale of products rather than investment in the sponsoring company. We are subject to the risk that, in one or more of our present or future markets, the marketing system used by us or one of our licensees could be found not to comply with these laws and regulations or may be prohibited. Failure to comply with these laws and regulations or such a prohibition could have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to the risks associated with intense competition from larger, wealthier and more established competitors.
We face intense competition in the business of distributing and marketing Nutritional Products and Medical Products. Numerous competitors compete actively for customers and, in the case of other network marketing companies, for
Associates. Many of our competitors have longer operating histories, significantly greater financial, technical, product development, marketing and sales resources, greater name recognition, larger established customer bases and more developed distribution channels than we do. We currently do not have significant patent or other proprietary protection, and our competitors may introduce products with the same or similar ingredients that we use in our products. There can be no assurance that we will be able to compete successfully in this intensely competitive environment.
We are also subject to significant competition from other network marketing organizations for the time, attention and commitment of new and existing Associates. Because the network marketing industry is not particularly capital-intensive or otherwise subject to high barriers to entry, it is relatively easy for new competitors to emerge who compete with us for our Associates. In addition, the fact that our Associates may easily enter and exit our network marketing program contributes to the level of risk that we face from competitors. The pool of individuals interested in the business opportunities presented by network marketing tends to be limited in each market, and it is reduced to the extent other network marketing companies successfully recruit these individuals into their businesses. Although we believe we offer an attractive opportunity for Associates, there can be no assurance that other network marketing companies will not be able to recruit our existing Associates or deplete the pool of potential Associates in a given market.
Our business is subject to intellectual property risks.
Patent protection for our Nutritional Supplements and Medical Products generally is impractical given the large number of manufacturers who produce similar products having many ingredients in common. To the extent we deem commercially reasonable, we endeavor to seek trade dress protection for our products, which protection has been sought in the U.S., Canada and certain other countries in which we are either presently operating or may operate in the future. Notwithstanding these efforts, there can be no assurance that our efforts to protect our trade secrets and trademarks will be successful. Nor can there be any assurance that third parties will not assert claims against us for infringement of the proprietary rights of others. Litigation with respect to protection of our intellectual property or claims of others against us could result in substantial costs and diversion of management and other resources and could have a material adverse effect on our business, financial condition and operating results.
During 2002, we developed proprietary formulations and manufacturing processes to produce certain raw materials, which are principal ingredients in our leading products. We have not filed for patent protection related to our proprietary formulations or manufacturing processes. Therefore, there can be no assurance that another company will not replicate one or more of our products and thereby adversely affect our business, operating results or financial condition.
The developer of Stem-Kine, from whom we license marketing rights, has filed a patent application in the U.S. that covers compositions of matter, uses and formulations associated with Stem-Kine. There can be no assurance that this patent will be issued, that it will exclude competitors or provide us with competitive advantages or that others have not or will not develop similar products, the occurrence of any of which may adversely affect our business, operating results or financial condition.
We are subject to risks associated with our reliance upon information technology systems.
Our success is dependent in part on the accuracy, reliability and proper use of sophisticated and dependable information processing systems and management information technology. Our information technology systems are designed and selected in order to facilitate order entry and customer billing, maintain customer records, accurately track purchases and incentive payments, manage accounting, finance and manufacturing operations, generate reports and provide customer service, technical support and an interactive website for use by our Associates. We have encountered, and may encounter in the future, errors in our software or our enterprise network, or inadequacies in the software and services supplied by our vendors. Any such errors or inadequacies that we may encounter in the future may result in interruptions to our services and may damage our relationships with, or cause us to lose, our Associates, licensees or customers, which would harm our financial condition and operating results. Such errors may be expensive or difficult to correct in a timely manner, and we may have little or no control over whether any inadequacies in software or services supplied to us by third parties are corrected in a timely manner, if at all. Despite our precautions, the occurrence of a natural disaster or other unanticipated problems could result in interruptions in services and adversely affect our business, operating results or financial condition.
Our future financial results could be adversely impacted by asset impairments.
We test our goodwill, which is related to the Nutritional Products segment, for impairment at the end of each year, or on an interim basis if events occur or circumstances change that might indicate a reduction of the fair value of the reporting unit below its carrying value. No impairment losses have been recognized as a result of this testing; however, no assurance can be given that an impairment charge will not be required in future periods. The amount of any such annual or interim impairment charge could be significant, and could have a material adverse effect on reported financial results for the period in which the charge
is taken.
Changes in conditions in foreign territories and exchange rate fluctuations affect our foreign operations and could reduce our net sales and earnings.
In 2011, approximately 55% of consolidated net sales came from foreign territories. Of this 55%, 6% was generated from our Canadian operation, 4% was generated collectively from our Taiwan operation and NFR program, and the remainder came from foreign territories through export sales to our licensees who are subject to license agreements with us. We intend to continue to expand foreign sales of our products, exposing us to risks of changes in social, political and economic conditions in foreign countries, including changes in the laws, regulations and policies that govern the importation, distribution and sale of foreign-made products. While transactions with our licensees and customers in NFR markets are denominated in U.S. dollars, exchange rate fluctuations can have a significant impact on the ability of customers to purchase our products and of our licensees to conduct successful businesses in the licensed territories. 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 overall financial condition.
Taxation and transfer pricing considerations affect our international operations.
Our principal domicile is the U.S. Under tax treaties, we are eligible to receive foreign tax credits in the U.S. for taxes actually paid abroad. Because we have foreign operations, taxes paid to foreign taxing authorities may exceed amounts of the credits available to us, resulting in the payment of a higher overall effective tax rate on our worldwide operations. We have adopted transfer pricing arrangements with respect to our foreign operations to regulate intercompany transfers, which arrangements 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 Associate incentives. If the U.S. Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully challenge these arrangements or require changes in our transfer pricing practices, we could be required to pay higher taxes and our operating results would be adversely affected. We believe that we operate in compliance with all applicable transfer pricing laws. However, there can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws will not be modified, which, as a result, may require changes in our operating procedures.
We may be held responsible for certain taxes relating to our distributors.
Our Associates are subject to taxation, and in some instances, legislation or governmental agencies impose an obligation on us to collect taxes, such as sales taxes, withholding or value added taxes, and to maintain appropriate records. In addition, under current law, our Associates in the U.S., Canada and Taiwan are treated for income tax purposes as independent contractors and, accordingly, compensation is not subject to employment taxes or other employment benefit expenses. The definition of independent contractor has been challenged in the past and any changes to the definition of an independent contractor could possibly jeopardize the exempt status enjoyed by direct sellers and impose on us the responsibility for social security and similar taxes. There is no assurance that future legislation at the federal or state level, or in countries other than the U.S., affecting direct sellers will not be enacted, which could harm our financial condition and results of operations.
Our stock price has been volatile and subject to various market conditions, and there is a limited public trading market for our common stock.
The trading price of our common stock has been subject to wide fluctuations. The price of the common stock may fluctuate in the future in response to quarter-to-quarter variations in operating results, material announcements by us or our competitors, scientific discoveries or technological innovations, governmental regulatory action, conditions in the industry segments in which we operate or other events or factors. The price of our common stock could fluctuate based upon factors that have little or nothing to do with us or that are outside of our control. These fluctuations could cause our stock price to decline materially.
Our common stock trades on the OTCQB, which is operated by the OTC Markets Group Inc., and there is a limited public trading market for our common stock. 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 beneficial ownership of a significant percentage of our common stock gives Clinton H. Howard effective control and limits the influence of other shareholders on important policy and management issues.
My Garden, Ltd., a limited partnership controlled by Clinton H. Howard who is the Company's founder, Chief Executive Officer and Chairman of the Board, owned 42% of our outstanding common stock at December 31, 2011. Collectively with My
Garden, Ltd.'s stock ownership, Mr. Howard beneficially owned 44% of our outstanding common stock at December 31, 2011. By virtue of this stock ownership, Mr. Howard is able to exert significant influence over the election of the members of our Board of Directors and our business affairs. This concentration of ownership could also have the effect of delaying, deterring or preventing a change in control that might otherwise be beneficial to shareholders. Since Mr. Howard currently serves on the Board of Directors, there can be no assurance that conflicts of interest will not arise with respect to this directorship or that conflicts will be resolved in a manner favorable to other shareholders of the Company.
If our shareholders sell a substantial number of shares of our common stock in the public market, the market price of our common stock could fall.
Two of our principal shareholders hold a large number of shares of our outstanding common stock. Any decision by either of our principal shareholders to aggressively sell their shares could depress the market price of our common stock.
We depend on our key personnel, and the loss of the services provided by any of our executive officers or other key employees could harm our business and results of operations.
Our success depends to a significant degree upon the continued contributions of our senior management, many of whom would be difficult to replace. These employees may voluntarily terminate their employment with us at any time. We may not be able to successfully retain existing personnel or identify, hire and integrate new personnel. We do not carry key person insurance for any of our personnel. If we lose the services of our executive officers or key employees for any reason, our business, financial condition and results of operations could be harmed.
Item 1B.
Item 1B.
Unresolved Staff Comments.
None.
Item 2.
Item 2.
Properties.
We own an approximately 119,000 square foot facility that houses our executive offices, manufacturing operations and warehousing and distribution operations. This facility is located in Irving, Texas, and is subject to a deed of trust as collateral on a term loan with a balance of approximately $1.7 million as of December 31, 2011. We use this facility for both the Nutritional Products and Medical Products business segments.
We lease facilities in Canada and Taiwan to conduct operations in these countries. These facilities are used only for the Nutritional Products business segment.
Canada. Until expiration of the lease on June 30, 2010, we leased administrative and distribution facilities in Burnaby, British Columbia to support distribution operations in Canada at an annual rental of approximately $89,000. Upon expiration of this lease, we relocated Canadian distribution operations to our U.S. facility and leased new Canadian administrative offices in Burnaby, British Columbia. We lease these offices on a month-to-month basis at a annualized rental of approximately $36,000.
Taiwan. We lease facilities in Taipei, Taiwan to support warehousing, distribution and administrative operations in Taiwan at an annual rental of approximately $75,000. The lease agreement on these facilities expires March 31, 2012.
We believe these facilities are suitable and adequate in relation to our present and immediate future needs.
Item 3.
Item 3.
Legal Proceedings.
From time to time we are involved in litigation arising out of our operations. We maintain liability insurance, including product liability coverage, in amounts we believe are adequate. We also believe that Associate compliance is critical to the integrity of our business; we therefore actively enforce our agreements with Associates. As a result, we periodically become involved in Associate compliance actions and consider these actions routine and incidental to our business. These compliance actions may from time to time involve litigation. We are not currently engaged in any legal proceedings that we expect would materially harm our business or financial condition.
Item 4.
Item 4.
Removed and Reserved.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is traded on the OTCQB, which is operated by the OTC Markets Group Inc. The following reflects the range of high and low bid quotes for our common stock for each calendar quarter during each of the past two years. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
As of February 28, 2012 there were approximately 575 holders of our common stock. Since our inception, we have paid no dividends on our stock. We do not anticipate that we will pay dividends in the foreseeable future.
We did not sell any of our equity securities that were not registered under the Securities Act of 1933 during 2011. We also did not repurchase any of our equity securities during the fourth quarter of 2011.
For information concerning securities authorized for issuance under our equity compensation plans, refer to Part III, Item 12.
Item 6.
Item 6.
Selected Financial Data.
The financial data included in the table shown below has been selected by us and has been derived from the financial statements for the periods indicated. The following financial data should be read together with the information in Part II, Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the audited consolidated financial statements and notes thereto appearing elsewhere in this report.
Overview
We operate in two industry segments, Nutritional Products and Medical Products.
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Through the Nutritional Products segment, we distribute products in three broad categories: (i) wellness products; (ii) fitness products; and (iii) skin care products. Products include herbal formulas, vitamins, minerals, antioxidants and personal care products. In certain markets, principally in the U.S., Canada and, as of October 1, 2011, Taiwan, we distribute Nutritional Products directly through a network of independent Associates. In certain international markets, we distribute Nutritional Products through exclusive license arrangements with third parties, who for the most part, distribute our products through an independent Associate network in the licensed territory.
Industry-wide factors that affect us and our competitors include the aging population, who tend to purchase more nutritional supplements as they age; the general public's heightened awareness and understanding of the connection between diet and long-term health; and a growing interest in natural alternatives related to prevention of illness. We expect these trends to continue. In addition, the economic challenges that have affected the U.S. and international markets have likely increased the desire of individuals to seek a second source of income through a network marketing opportunity, although potentially offsetting that trend is the economic downturn's negative impact on consumer spending and disposable income.
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Through the Medical Products segment, we distribute wound care products. These products are distributed primarily in the U.S. to hospitals, nursing homes, clinics and pharmacies through traditional medical/surgical supply dealers and pharmaceutical distributors. Medical Products are used to prevent and treat wounds, and manage pain associated with wounds, in the acute care, long-term care and oncology markets.
Industry-wide factors affecting this segment include the increasing prevalence of chronic wounds, which is driven by the large and growing elderly, diabetic and obese populations as these groups are more likely to suffer from chronic wounds. However, the increasing national focus on rising health care costs continues to provide impetus for third-party payers, including government-related payers such as Medicare, to challenge the pricing of medical products and services. We expect these trends to continue.
Net sales. Consolidated net sales in dollars and as a percentage of consolidated net sales are as follows:
Licensees. We sell Nutritional Products to third parties who purchase products from us in accordance with a license arrangement that gives the licensee exclusive rights to distribute our products in the licensed territory. For the most part, licensees are required to distribute our products in their territories through network marketing. We do not maintain inventory to fulfill licensee orders; licensees are generally required to pay us a 50% deposit with their orders and then pay the balance when products are ready to ship. We recognize sales when we ship products to the licensees. In general, licensees also pay us a monthly royalty based on sales in their territories. We record these royalties as sales. Gross profit on net sales to licensees is significantly less than on sales to our Associate network because we do not pay Associate commissions or incur other expenses related to marketing or distribution in the licensed territory.
Our net sales in this distribution channel are dependent upon the licensee's success in building the market for our products in the licensed territory. Factors that may affect the success of our licensees include (i) global and regional economic conditions, which can impact customer spending practices and the licensee's ability to appropriately finance and operate its business; (ii) changes in currency exchange rates, which can impact licensee profit margins; (iii) the licensee's ability to attract new Associates and retain existing Associates to sell and consume products, which requires the implementation of effective marketing, sales and support programs by the licensee; and (iv) competition from other suppliers of nutritional supplements and other network marketing companies operating in the licensee's territory. We support the business of our licensees by making available to the licensee high-quality products, innovative new products, technical information required to obtain product approvals in the licensee's territory and materials related to marketing, sales and support programs we use to manage and market to our Associate network.
Our principal licensee is CCI. In July 2004, we entered into a ten-year exclusive license agreement, which replaced the expiring five-year license agreement, giving CCI distribution rights in 31 countries, including mainly Russia and countries in Eastern Europe. CCI accounted for 99%, 98% and 97% of licensee net sales in 2011, 2010 and 2009, respectively. The President of CCI is a former member of our Board of Directors and beneficially owns approximately 18% of our outstanding common stock.
Associate network. We sell Nutritional Products to Associates who purchase products for personal consumption or for resale to retail customers; Associates also sponsor new Associates who also engage in these activities. Associates pay for product purchases prior to shipment, mainly through the use of credit cards, and we recognize sales when we ship products to the Associates. We compensate Associates for their sales activities through our Associate compensation plan. This plan allows Associates to earn higher commissions as their sales and the sales of their downline Associates increase.
In late March 2010, we began selling selected Nutritional Products in Taiwan under a not-for-resale (“NFR”) program. This program was later expanded to include Brunei, Singapore and Hong Kong, which are also countries in Southeast Asia. The NFR program allows consumers in the NFR market to sign up as customers, purchase products, refer others to our network marketing program and receive commissions. Based on the favorable response to this program, we opened an office and distribution facility in Taiwan on October 1, 2011. We believe that providing local marketing and sales support, customer service and product order fulfillment provides a better platform to generate additional sales growth in the Taiwan market. Subject to achieving positive results in Taiwan, we will consider opening additional offices in Southeast Asia as expansion opportunities develop.
Sales in this distribution channel are dependent upon the number and productivity of our Associates. The opportunities and challenges that affect us in this channel are similar to those that affect our licensees, including (i) global and regional economic conditions; (ii) our ability to attract new Associates and retain existing Associates to sell and consume products; and (iii) competition from other suppliers of nutritional supplements and other network marketing companies operating in these markets. We attempt to effectively address these opportunities and challenges by offering, among other things, (i) high-quality products, (ii) innovative new products, (iii) a financially rewarding, up-to-date Associate compensation plan, which was introduced to all of our Associates in September 2009, (iv) Company-sponsored meetings and sales tools, and (v) a website maintained exclusively for Associates where Associates can obtain sales and marketing materials, place orders, sign up new Associates and track and manage their business activity.
The following table sets forth the Associate network net sales by geographic region as a percentage of total Associate network net sales for the periods indicated:
Medical Products. We sell Medical Products primarily to wholesalers such as medical/surgical dealers and pharmaceutical distributors. These wholesalers supply various health care providers such as hospitals, nursing homes, clinics and pharmacies. Our sales force, which is comprised of employed sales representatives and independent manufacturer representatives, markets our products to both wholesalers and health care providers. In some cases, wholesalers maintain their own sales forces, including health care professionals, to market and provide services related to products that they supply, which include our products. We sell to wholesalers on terms that generally require payment within 30 to 60 days. We recognize sales when products are shipped. Manufacturer representatives receive a percentage of sales as compensation, which percentage varies by product.
In this segment we compete against a number of companies, most of which are significantly larger, have far greater
financial resources and have broader name recognition. We endeavor to compete in this segment by offering products that have unique features and are high quality and competitively priced. We place a high degree of emphasis on identifying market needs and trends to ensure our product line remains current with developing trends and new scientific evidence. By offering unique products, we are able to service niche markets not serviced by our larger competitors.
Since 2004, a medical/surgical dealer, which distributes our products and provides services to the long-term care market, has significantly expanded its business and, as a result, increased its purchases of our Medical Products. This dealer accounted for 59%, 61% and 62% of Medical Products net sales in 2011, 2010 and 2009, respectively. On February 24, 2012, this dealer filed for Chapter 11 bankruptcy protection, as further described in Part I, Item 1. Business and Item 1A. Risk Factors.
Cost of Sales. Cost of sales primarily consists of costs related to (i) raw materials, labor and overhead directly associated with in-house production activities, (ii) product components, products and sales materials purchased from third-party manufacturers and suppliers, (iii) quality control testing performed by our in-house quality control laboratory and by outside testing laboratories, (iv) import duties, (v) freight and (vi) provisions for slow moving or obsolete inventory. Cost of sales and gross profit vary based on the sales mix of products sold within a distribution channel as well as the mix of product sales among distribution channels.
Distributor Commissions. We pay sales incentives to Associates that are calculated in accordance with our Associate compensation plan. A portion of these sales incentives are rebates and, accordingly, are recorded as a reduction of sales. Associates earn rebates based on the amount of their personal monthly purchases.
Most sales incentives paid to Associates are classified as distributor commissions. These commissions are calculated based on the total monthly sales by the Associate and his or her downline organization, and Associates can qualify to receive additional commissions as sales in their organizations expand. Most commissions are paid to Associates monthly.
In September 2009, we adopted a new Associate compensation plan under which all of our Associates are now compensated. After adoption of the current compensation plan, the portion of sales incentives classified as rebates decreased while the portion of sales incentives classified as distributor commissions increased. In order to help provide a smooth transition from the former compensation plan to the current compensation plan, we provided performance-based commission subsidies to certain Associates, which increased overall commission expense during 2010 and 2011. One portion of this commission subsidy program ended as of August 31, 2011, while the remainder of the program will end December 31, 2012.
We also classify commissions paid to manufacturer representatives who sell Medical Products as distributor commissions. Total commissions to manufacturer representatives average less than 2% of Medical Products net sales.
General and Administrative. General and administrative expenses include wages and benefits, rents and utilities, travel, professional fees, promotion and advertising, along with other marketing and administrative expenses. Wages and benefits represent the largest component of selling, general and administrative expenses.
Critical Accounting Policies and Estimates
Our consolidated financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the U.S. (“US GAAP”). Our significant accounting policies are described in Note B to the consolidated financial statements included elsewhere in this report. The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes. Those estimates and assumptions are based on historical experiences and changes in the business environment. However, actual results may sometimes differ materially from estimates under different conditions. 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 that require management’s most subjective judgments. We believe our most critical accounting policies and estimates are as described in this section.
Revenue Recognition. We recognize revenue at the point products are shipped, which is the point the risks and rewards of ownership pass to the customer. Under the terms of our license agreements, our licensees are generally required to make a cash deposit equal to 50% of the purchase order amount at the time the purchase order is placed, and allow two to three months for delivery. In addition, under our agreement with CCI, we segregate and store products for CCI in our warehouse and then ship them at a later date to locations designated by CCI in accordance with its business needs. As part of this agreement, CCI accepts ownership of and pays for the products as they are segregated in our warehouse for CCI’s account; however, we do not recognize revenue until the products are shipped. Deposits and payments received for unshipped products are recorded as deferred revenue. Amounts billed to customers for shipping and handling are classified as sales. Also, sales are recorded net of the rebate portion of sales incentives paid to Associates.
Intangible Assets. We review the carrying value of our goodwill and other intangible assets at the end of each year and at other times if events and circumstances warrant such a review. One of the methods used for this review is performed using estimates of future cash flows. If the carrying value of our goodwill or other intangible assets is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the goodwill or intangible assets exceeds its fair value. We believe that the estimates of future cash flows and fair value are reasonable. Changes in estimates of these cash flows and fair value, however, could affect the evaluation.
Income Taxes. The process by which we calculate income taxes in each of the jurisdictions in which we operate involves estimating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. Based on our estimates of the expected future tax consequences related to these differences, we record deferred tax assets and liabilities in our consolidated balance sheet. We recognize in our financial statements the impact of a tax position if that position is “more likely than not” to be sustained on audit, based on the technical merits of the position. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance against the deferred tax asset.
Actual income taxes could differ significantly from these estimates due to future changes in income tax law or changes or adjustments resulting from final review of our tax returns by taxing authorities. These differences could have an impact on the income tax provision and operating results in the period in which such determination is made.
Share-based Payments. We recognize share-based compensation expense based on the fair value of share-based awards. Share-based compensation is estimated at the grant date based on the fair value of the awards expected to vest and recognized as expense ratably over the requisite service period of the award.
We use the Black-Scholes option-pricing model to estimate the fair value of share-based awards. Option valuation models require the input of assumptions, including the expected life of the share-based awards, the expected stock price volatility, the risk-free interest rate and the expected dividend yield. The expected life is based on the term of the award. The expected volatility is based on historical volatility rates. The risk-free interest rate is based on U.S. Treasury issues whose term is consistent with the expected life of the share-based award. The expected dividend yield is 0.0% since we do not pay dividends and have no current plans to do so in the future. We recognized share-based compensation expense of approximately $44,500, $56,400 and $139,100 for the years ended December 31, 2011, 2010 and 2009, respectively.
Results of Operations
The following table sets forth our operating results as a percentage of net sales for the periods indicated:
2011 Compared with 2010 (000's except per share amounts)
Net sales. Net sales for the year ended December 31, 2011 were $28,448 compared with net sales for the prior year of $28,157, an increase of $291 or 1%. This increase was due to an increase of $316 in net sales of Medical Products that was partially
offset by a $25 decrease in net sales of Nutritional Products. The decrease in net sales of Nutritional Products was attributable to a decline in net sales to our licensees of $2,731, which was mostly offset by an increase in net sales to our Associate network of $2,706.
The decrease in net sales to our licensees of $2,731 resulted primarily from a decrease in sales to CCI. Net sales to CCI decreased $2,590, or 17%, in 2011 compared with 2010. Since 2009, CCI's business has been negatively affected by the global economic recession and other factors within its markets; accordingly, its shipping patterns during the last three years have been somewhat volatile. After reducing its purchases from us by 30% in 2009, shipments increased 23% in 2010 then declined 17% in 2011. We believe this volatility is attributable to CCI's efforts to align inventory levels with anticipated sales volumes and meet challenges presented by increasing regulatory requirements in the U.S. and other markets within its territory. While the degree of volatility has declined during the past three years, we believe that shipping patterns may continue to be somewhat volatile in future periods.
Net sales in the Associate network channel are generally dependent on the number and productivity of our Associates. Net sales through the Associate network increased $2,706, or 45%, during 2011 compared with 2010, while new Associate recruiting increased 75% during the same period. We attribute these increases to the following:
•
In March 2010, we initiated a program whereby we began selling selected nutritional supplement products in Taiwan under an NFR program. The program was later expanded to include the Southeast Asian markets of Brunei, Singapore and Hong Kong. The opening of these markets not only generated growth in net sales and new Associate recruiting, it also generated growth in the North American market among North American Associates with ties to Southeast Asia.
•
In May 2011, we launched a new dietary supplement product, Stem-Kine. Stem-Kine has been shown in published human clinical studies to nutritionally enable bone marrow and other stem cell-producing tissues, which form the natural repair and renewal system of the body, to increase their production of stem cells. In connection with this launch, we promoted sales of Stem-Kine through special purchase offers, sales contests and a series of Company-sponsored events. Stem-Kine became one of our top-selling products during 2011.
The $316 increase in net sales of Medical Products resulted from increased sales to new customers as well as existing customers. Sales to the largest customer in this segment, which distributes wound care products and provides services to the long-term care market, increased $64 during 2011 compared with 2010. Also supporting increased sales in 2011 was an increase in sales to home health care providers, which resulted from growth in sales to distributors that target sales in this market.
Cost of sales. Cost of sales for the year ended December 31, 2011 was $14,132 compared with cost of sales in the prior year of $14,471, a decrease of $339 or 2%. As a percentage of net sales, cost of sales was 50% in 2011 and 51% in 2010. The increase in gross profit as a percentage of net sales primarily resulted from a change in sales mix in our Nutritional Products segment.
General and administrative. General and administrative expenses for the year ended December 31, 2011, were $9,634 compared with 2010 expenses of $9,228, an increase of $406, or 4%. As a percentage of net sales, general and administrative expenses were 34% in 2011 compared with 33% in 2010. This increase in general and administrative expenses was mainly attributable to expenses incurred in connection with establishing branch operations in Taiwan, which opened on October 1, 2011.
Distributor commissions. Distributor commissions for the year ended December 31, 2011 were $4,312 compared with distributor commissions in 2010 of $2,938, an increase of $1,374 or 47%. With regard to our Associate network, distributor commissions as a percentage of commissionable sales, exclusive of rebates, which are recorded as a reduction of sales, were 50% in 2011 compared with 48% in 2010. This percentage increase was mainly due to (i) an increase in sales of product "entry packs" that are available for purchase by newly enrolling Associates, which provide a higher percentage of commissions than non-entry pack sales, (ii) special price promotions offered in connection with the launch of Stem-Kine, and (iii) the qualification of certain Associates at higher commission levels of the Associate compensation plan, which was attributable to the overall increase in Associate network sales. On a consolidated basis, distributor commissions as a percentage of net sales were 15% in 2011 compared with 10% in 2010.
Income taxes. We recorded an income tax benefit of $139 in 2011 based on our estimate of the effective annual income tax rate, giving effect to certain credits and deductions, primarily research and development credits and domestic production activities deductions, that were available to recover taxes paid in prior periods. We recorded income tax expense of $333 in 2010 based on our estimate of the effective annual income tax rate. Our effective income tax rate in 2010 was 37.4%.
Net earnings (loss). The net loss for the year ended December 31, 2011 was $71, or $0.00 per diluted share, compared
with net earnings in the prior year of $558, or $0.02 per diluted share. This decline resulted from the factors described above.
2010 Compared with 2009 (000's except per share amounts)
Net sales. Net sales for the year ended December 31, 2010 were $28,157 compared with net sales for the prior year of $24,925, an increase of $3,232 or 13%. This increase was due to increases of $2,834 and $398 in net sales of Nutritional Products and Medical Products, respectively. Net sales of Nutritional Products to our licensees increased $2,824, while net sales of Nutritional Products to our Associate network increased $10.
The increase in net sales to our licensees of $2,824 resulted from an increase in sales to CCI. Net sales to CCI increased $2,898, or 23%, in 2010 compared with 2009. CCI's sales in 2009 were negatively affected by the global economic recession; accordingly, it significantly reduced its purchases from us in 2009 to appropriately align its inventories with the reduced sales volumes. We believe that CCI completed this inventory reduction process during the fourth quarter of 2009 and, as a result, increased its shipping requests in 2010 to maintain rather than to reduce its inventory further.
Net sales through the Associate network channel were essentially flat, increasing $10 during 2010 compared with 2009. In 2010, Associate network sales were positively affected by the NFR program, which generated sales of approximately $574. However, because the NFR program allows independent Associates in North America to expand their distributorships into these NFR markets, a number of North American Associates devoted significant efforts to building their businesses in the NFR markets during 2010 rather than in North America. As a result, net sales in North America in 2010 were negatively affected by normal attrition of the Associate base, which was not offset by the sponsorship of new Associates in the U.S. market. Accordingly, we have undertaken and plan to undertake a number of marketing and sales initiatives that we believe will result in increased sponsorship among the Associate network base in all of our markets and support increased sales in this channel. However, no assurance can be given that sponsorship of new Associates or Associate network sales will increase.
The increase in net sales of Medical Products of $398 resulted from increased sales to the largest customer in this segment and also sales to new customers. Sales to the largest customer in this segment, which distributes wound care products and provides services to the long-term care market, increased $155 during 2010 compared with 2009. Also supporting increased sales in 2010 was an increase in sales to home health care providers, which resulted from the addition of new distributors that target sales in this market.
Cost of sales. Cost of sales for the year ended December 31, 2010 was $14,471 compared with cost of sales in the prior year of $12,123, an increase of $2,348 or 19%. As a percentage of net sales, cost of sales was 51% in 2010 and 49% in 2009. The increase in cost of sales as a percentage of net sales primarily resulted from a change in sales mix associated with Nutritional Products sold to our licensees.
General and administrative. General and administrative expenses for the year ended December 31, 2010, were $9,228 compared with 2009 expenses of $10,061, a decrease of $833, or 8%. As a percentage of net sales, general and administrative expenses decreased to 33% in 2010 compared with 40% in 2009. This decrease in general and administrative expenses resulted from (i) reduced Associate network sales and marketing expenses, primarily salaries and meeting and travel expenses, (ii) reduced expenses related to the Company's Canadian operation following the relocation of fulfillment operations to our U.S. distribution facility in the second quarter of 2010 and (iii) reduced facilities maintenance expenses.
Distributor commissions. Distributor commissions for the year ended December 31, 2010 were $2,938 compared with distributor commissions in 2009 of $2,498, an increase of $440 or 18%. With regard to our Associate network, distributor commissions as a percentage of commissionable sales, exclusive of rebates, which are recorded as a reduction of sales, were 48% in 2010 compared with 38% in 2009. This increase in distributor commissions as a percentage of commissionable sales partially resulted from the adoption of a new Associate compensation plan that became effective for the entire Associate network in September 2009. Under the new Associate compensation plan, the portion of sales incentives classified as rebates decreased while the portion of sales incentives classified as distributor commissions expense increased. Also contributing to the increase in distributor commissions were performance-based commission subsidies paid to certain Associates to facilitate the transition from the former Associate compensation plan to the new plan. On a consolidated basis, distributor commissions as a percentage of net sales were 10% in 2010 and 2009.
Income taxes. We recorded income tax expense of $333 in 2010 based on our estimate of the effective annual income tax rate. Our effective income tax rate in 2010 was 37.4%. We recorded income tax expense of $11 in 2009 even though we reported a loss before income taxes because adjustments to the statutory federal income tax rate more than offset tax benefits related to the consolidated loss before income taxes. The most significant of these adjustments was the increase in the valuation allowance related to net operating loss carryforwards in Canada and share-based compensation expense.
Net earnings (loss). Net earnings for the year ended December 31, 2010 were $558, or $0.02 per diluted share, compared with a net loss in the prior year of $335, or $0.02 per diluted share. This improvement resulted from the factors described above.
Variations in Period-to-Period Results
We may experience variations in the results of operations from quarter to quarter and/or year to year as a result of factors that include the following:
•
The level of recruiting and retention of Associates in the U.S., Canada, Taiwan, NFR markets and territories served by our licensees;
•
Variations in the level of business activity generated by our key customers;
•
The opening of new markets;
•
The timing and efficacy of Company-sponsored events, promotions and other marketing and sales initiatives;
•
New product introductions;
•
The negative impact of new regulations or changes in existing regulations domestically and/or internationally that may limit or restrict the sale of certain products;
•
The integration and operation of new information technology systems;
•
The inability to introduce new products or the introduction of new products by competitors;
•
Entry into one or more of our markets by competitors;
•
General conditions in the nutritional supplement industry, the network marketing industry and the wound care industry; and
•
General economic conditions globally and/or in markets where we or our licensees conduct business.
As a result of these and other factors, sales, 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.
Liquidity and Capital Resources (000's)
Historically, our principal need for funds has been for operating expenses, working capital and capital expenditures. We have funded our cash requirements through equity financing, debt financing and cash flow from operations. We have also used operating leases to finance the use of certain buildings and equipment required for our operations. We require working capital primarily to fund inventory purchases and, to a lesser extent, accounts receivable balances associated with sales of our Medical Products. We do not rely on lines of credit or other similar short-term financing arrangements to finance working capital needs.
Cash and working capital. During the year ended December 31, 2011, we had a net decrease in cash of $362, which compares to a net increase in cash in 2010 of $248. At December 31, 2011, we had working capital of $5,568, a $55 increase from working capital at December 31, 2010 of $5,513. This increase in working capital reflects an increase in current assets of $718 and an increase in current liabilities of $663. The reasons for the changes in cash and working capital are further described below.
Operating activities. In 2011, our operating activities provided cash flows of $125 compared with providing cash flows of $545 in 2010. In 2011, net earnings (loss) adjusted for non-cash activities, mainly depreciation and amortization, share-based compensation, (gain) loss on disposition of equipment and deferred taxes, provided cash flows of $423 compared with $1,281 in 2010.
Operating activities include the management of working capital accounts such as accounts receivable, inventories, prepaid expenses and other current assets, accounts payable, accrued operating expenses and deferred revenues. Because net sales to licensees represent close to 50% of consolidated net sales, one of the most significant factors affecting our working capital accounts is the arrangement we maintain with our licensees, principally CCI. In accordance with our license agreements, product orders from licensees are generally accompanied by a cash deposit equal to 50% of the value of the order. These deposits are used in part to make deposits with our suppliers against orders we place to fulfill licensee product orders. In addition, in accordance with our license agreement with CCI, we segregate and store finished products for CCI in our warehouse and then ship them at a later date based on CCI’s business needs. CCI pays the remaining 50% due on its product orders when goods are segregated in our warehouse for CCI’s account. Accordingly, because we do not recognize a sale to CCI until products are shipped from our warehouse, there can be a significant difference in timing between the date we receive cash from CCI and the date we recognize the related gross profit in our statement of operations. Cash received as deposits for product orders and as payment for stored products are recorded as deferred revenue. Deposits we make with our suppliers are recorded as prepaid expenses. Inventory
held in our warehouse for CCI’s account is reported as inventory in our financial statements until it is shipped to CCI. The $501 of cash provided by an increase in deferred revenue in 2011 was primarily related to an increase in order deposits from CCI. Also during 2011, we used cash of $1,111 to increase inventory to help buffer the impact of increased uncertainty related to inventory production lead times, which resulted from the adoption of GMPs by us and our suppliers.
Investing activities. During 2011, we used cash of $350 to purchase property and equipment.
Financing activities. During 2011, financing activities used net cash flows of $169, which represented repayment of long-term debt.
General liquidity and cash flows. We believe that our working capital requirements can be met through available cash and cash generated from operating activities for the foreseeable future; however, an overall decrease in demand for our products could adversely affect our liquidity. In the event of a significant decrease in cash provided by our operating activities, we may seek outside sources of capital including bank borrowings and other types of debt or equity financings. We can give no assurance, however, that we would be able to obtain any outside financing or obtain financing on terms we would find acceptable.
We have no plans or requirements for any significant capital expenditures during the next 12 months.
Contractual Cash Obligations
The table below summarizes our contractual obligations outstanding as of December 31, 2011:
____________________
(1) Purchase obligations consist of outstanding purchase orders issued in the ordinary course of our business. These purchase orders are primarily related to the purchase of inventory.
Off-Balance Sheet Arrangements
As of December 31, 2011, we had no material off-balance sheet arrangements, other than the operating leases and certain purchase commitments described above.
Inflation
We do not believe that inflation has had a material impact on our operating results. Substantial increases in costs, however, could have an impact on us and the industries in which we operate. We believe that, to the extent inflation affects our costs in the future, we could generally offset inflation by increasing prices if competitive conditions permit.
Recent Accounting Pronouncements
See Note B to the consolidated financial statements included elsewhere in this report for information regarding recent accounting pronouncements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
The following discussion about our market risk includes “forward-looking statements” that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. We do not use derivative financial instruments for speculative or trading purposes. We are exposed to market risk from changes in foreign currency exchange rates which could affect our future results of operations and financial condition. We manage our exposure to these risks through our regular operating and financing activities.
Foreign exchange. We have foreign-based operations in Canada which accounted for 6% of 2011 net sales. We also
opened a branch in Taiwan on October 1, 2011. We advance funds to and from our foreign operations denominated in U.S. dollars, exposing the foreign operation to the effect of changes in spot exchange rates of the local currency relative to the U.S. dollar. We do not regularly use forward-exchange contracts to hedge these exposures. Based on our foreign currency exchange rate exposure for intercompany advances of approximately $784,000 and $727,000 to our Canadian operation and Taiwan operation, respectively, at December 31, 2011, a 10% adverse change in the currency rate would reduce earnings (loss) before income taxes by approximately $151,100.
All transactions with our licensees are denominated in U.S. dollars so the licensee bears the currency exchange risk. Accordingly, exchange rate fluctuations in international markets served by our licensees do not directly affect our results of operations. However, exchange rate fluctuations in these markets may affect the ability of our licensees to conduct successful businesses.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
The financial statements and supplementary data are listed in the Index to Financial Statements on Page of this report.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
As required by Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934 (the "Exchange Act"), our management, including our Chief Executive Officer and Chief Financial Officer, evaluated as of December 31, 2011, the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of December 31, 2011, were effective for the purpose of ensuring that information required to be disclosed by us in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosures.
Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles. We believe, however, that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, within a company have been detected.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2011 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.
Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission. Accordingly, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.
Changes in Internal Control over Financial Reporting
There has been no change in internal control over financial reporting that occurred during the quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Certain information required by Part III is omitted from this report as we will file a definitive proxy statement for the Annual Meeting of Shareholders to be held on June 7, 2012, pursuant to Regulation 14A under the Exchange Act not later than 120 days after the end of the fiscal year covered by this report, and certain information included in such proxy statement is incorporated herein by reference. Only those sections of the proxy statement that specifically address the items set forth herein are incorporated by reference.
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
The information for this Item is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report.
Item 11.
Item 11.
Executive Compensation.
The information for this Item is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information for this Item is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
The information for this Item is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information for this Item is incorporated herein by reference to our proxy statement to be filed with the SEC pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements. The following financial statements and related documents are filed as part of this report:
Report of Independent Registered Public Accounting Firm - Lane Gorman Trubitt, PLLC
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules. None.
(a)(3) Exhibits. The following exhibits are filed as part of this report:
* Filed herewith
** Filed electronically herewith
(1) Incorporated by reference to the Annual Report on Form 10-K/A filed May 7, 1999
(2) Incorporated by reference to the Annual Report on Form 10-K filed April 26, 2000
(3) Incorporated by reference to the Quarterly Report on Form 10-Q filed November 13, 2000
(4) Incorporated by reference to the Current Report on Form 8-K filed September 29, 2003
(5) Incorporated by reference to the registration statement filed on Form S-8 filed October 15, 2003
(6) Incorporated by reference to the Quarterly Report on Form 10-Q filed November 14, 2003
(7) Incorporated by reference to the Annual Report on Form 10-K filed April 14, 2004
(8) Incorporated by reference to the Current Report on Form 8-K filed July 27, 2004
(9) Incorporated by reference to the registration statement filed on Form S-8 filed December 22, 2006
(10) Incorporated by reference to the Annual Report on Form 10-K filed March 13, 2009
(11) Incorporated by reference to the Annual Report on Form 10-K filed March 11, 2010
(12) Incorporated by reference to the Current Report on Form 8-K filed April 9, 2010
(13) Incorporated by reference to the Current Report on Form 8-K filed June 17, 2010
(14) Incorporated by reference to the Current Report on Form 8-K filed August 5, 2010
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements to the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
RBC Life Sciences, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of RBC Life Sciences, Inc. and Subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2011. The Company'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. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of RBC Life Sciences, Inc. and Subsidiaries as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
We were not engaged to examine management's assertion about the effectiveness of RBC Life Sciences, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2011 included in the accompanying Management's Annual Report on Internal Control over Financial Reporting and, accordingly, we do not express an opinion thereon.
LANE GORMAN TRUBITT, PLLC
Dallas, Texas
March 28, 2012
RBC Life Sciences, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
The accompanying notes are an integral part of these consolidated financial statements.
RBC Life Sciences, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
The accompanying notes are an integral part of these consolidated financial statements.
RBC Life Sciences, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
RBC Life Sciences, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
The accompanying notes are an integral part of these consolidated financial statements.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF OPERATIONS AND ORGANIZATION
RBC Life Sciences, Inc. (along with its subsidiaries, sometimes hereinafter referred to collectively as “RBC” or the “Company”) is principally engaged in the marketing and distribution of nutritional supplements and personal care products (collectively “Nutritional Products”) through subsidiaries in the U.S. and Canada and, effective October 1, 2011, branch operations in Taiwan. This product line is marketed under the “RBC Life” brand name. In certain markets, primarily the U.S., Canada and Taiwan, the Company markets its products through a network of distributors that are referred to as “Associates.” The Associates are independent contractors who purchase products for personal use, purchase products for resale to retail customers and sponsor other individuals as Associates. Accordingly, Associates may be product consumers only or they may also seek to derive compensation both from the direct sales of products and from sales generated by sponsored Associates.
RBC also markets its Nutritional Products in certain international markets through license arrangements. The licensees are third parties who are granted exclusive rights to distribute RBC products in their respective territories and, for the most part, distribute these products through an independent distributor network in a licensed territory. Under these arrangements, the independent distributor network in a licensed territory is compensated by the licensee in accordance with a compensation plan similar to the one used by RBC for its Associates.
In addition to its Nutritional Products, RBC also markets a line of wound care products (“Medical Products”) under the MPM Medical brand name through a U.S. subsidiary. Medical Products are primarily distributed in the U.S. to hospitals, nursing homes, clinics and pharmacies through traditional medical/surgical supply dealers and pharmaceutical distributors. Medical Products are used to prevent and treat wounds, and manage pain associated with wounds, in the acute care, long-term care and oncology markets.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Reporting - The consolidated financial statements include the accounts of RBC and its wholly owned subsidiaries, RBC Life Sciences USA, Inc., RBC Life Sciences Canada, Inc. and MPM Medical, Inc. All significant intercompany accounts and transactions have been eliminated. Subsequent events were evaluated through the issuance date of the financial statements.
Cash and Cash Equivalents - The Company holds cash deposits in foreign bank accounts from time to time. At December 31, 2011 and 2010, $47,000 and $127,000, respectively, were held in a Canadian bank and at December 31, 2011, $106,000 was held in a Taiwanese bank. For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Accounts Receivable - The Company’s accounts receivable arise in the normal course of business and primarily relate to sales of Medical Products to various businesses and individuals. Accounts receivable are generally due within 30, 45 or 60 days and are stated at amounts due from customers net of an allowance for doubtful accounts.
Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time accounts are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the industry as a whole. The Company charges accounts receivable against the allowance when they become uncollectible, and any payments subsequently received on such accounts are credited to the allowance for doubtful accounts.
Inventories - Inventories consisting of raw materials and bulk products, packaging materials and finished goods are stated at the lower of cost or market. The cost of inventories is determined using the first in, first out method.
Property and Equipment - Property and equipment are recorded at cost. Depreciation and amortization are provided over the estimated useful lives of the related assets, principally on the straight-line method, ranging from three to 25 years.
Intangible Assets and Amortization - Goodwill and other intangible assets with indefinite useful lives are not amortized, but are reviewed annually for impairment or when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Intangible assets with finite lives are amortized over their useful lives. At December 31, 2011 and 2010, the Company’s intangible assets with finite lives consisted of copyrights, trademarks, other registrations and other intangibles, which are amortized over an average life of 19 years.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has designated year end as the date of its annual goodwill impairment test. The Company tests goodwill for impairment by comparing the carrying value of a reporting unit, including goodwill, to the fair value of the unit. Fair value is determined by estimating the present value of future cash flows. An impairment loss would be recognized if the carrying value of a reporting unit exceeds the implied fair value. To date, the Company has not recognized any impairment losses related to the carrying value of its goodwill.
Impairment of Long-Lived Assets - Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Revenue Recognition and Deferred Revenue - Sales are recorded when products are shipped, which is the point the risks and rewards of ownership pass to the customer. Sales include amounts billed to customers for shipping and handling and are recorded net of sales taxes. The Company generally requires a cash or credit card payment at the point of sale for Nutritional Products sold to its Associates. With regard to orders received from its third-party licensees, the Company generally requires the licensee to make a cash deposit equal to 50% of the order at the time an order is placed, and to pay the remaining 50% when the products are segregated in the Company's warehouse and ready to ship; however, sales are not recognized until the products are shipped. Deposits and payments received for unshipped products are recorded as “deferred revenue.”
The Company’s agreements with its third-party licensees generally provide that licensees pay to the Company a monthly royalty, which is calculated as a specified percentage of the licensees’ sales, as defined, in the territories covered by the license agreements. Royalties paid by licensees are recorded as sales and amounted to $2,085,000, $2,192,000 and $2,427,000 in 2011, 2010 and 2009, respectively.
Distributor Commissions - Distributor commissions consist primarily of commissions paid to Associates in accordance with the Associate compensation plan. These commissions are calculated based on the total monthly sales by the Associate and his or her downline organization. Most commissions are paid to Associates monthly. Sales incentives paid to Associates that represent rebates are recorded as a reduction of sales rather than distributor commission expense. Associates can earn rebates if the amount of their personal monthly sales exceeds a threshold amount set forth under the Associate compensation plan. In September 2009, the Company adopted changes to its Associate compensation plan, which had the effect of reducing the portion of Associate incentives that are classified as rebates while increasing the portion of Associate incentives that are classified as distributor commission expense. Associate rebates recorded as a reduction of sales were $273,000, $261,000 and $609,000 in 2011, 2010 and 2009, respectively.
Income Taxes - The Company utilizes the liability method of accounting for income taxes. Under the liability method, deferred income tax assets and liabilities are provided based on the difference between the financial statement and tax bases of assets and liabilities as measured by the currently enacted tax rates in effect for the years in which these differences are expected to reverse. Deferred tax expense or benefit is the result of changes in deferred tax assets and liabilities. An allowance against deferred tax assets is recorded in whole or in part when it is more likely than not that such tax benefits will not be realized.
Earnings (Loss) Per Share - Basic earnings (loss) per common share is based upon the weighted average number of common shares outstanding during each period presented. Diluted earnings (loss) per share is based upon the weighted average number of common shares outstanding and, when dilutive, common shares issuable for stock options.
Accounting Estimates - In preparing financial statements in conformity with accounting principles generally accepted in the U.S. ("US GAAP"), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues during the reporting period. Actual results could differ from those estimates.
Financial Instruments - The carrying value of cash, interest-bearing deposits, accounts receivable and payable, accrued liabilities and lines of credit approximate fair value due to the short-term maturities of these assets and liabilities. Fair value of long-term debt is estimated based on interest rates for the same or similar instruments offered having the same or similar maturities
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and collateral requirements. At December 31, 2011, fair value of fixed-rate long-term debt was $1,931,000, which was $203,000 above the carrying value of $1,728,000. At December 31, 2010, fair value of fixed-rate long-term debt was $2,041,000, which was $145,000 above the carrying value of $1,896,000.
Segment Information - The Company’s operations involve two operating segments: the Nutritional Products segment and the Medical Products segment. Nutritional Products are developed and distributed to a network of independent Associates operating primarily in North America and Southeast Asia and to licensees operating in certain other countries outside of North America and Southeast Asia. Medical Products are developed and sold primarily throughout the U.S. through medical/surgical supply dealers and pharmaceutical distributors to medical institutions such as hospitals, nursing homes and pharmacies.
Product Return Policy - Up to one year from the date of purchase, Nutritional Products that are unused and resalable may be returned by an Associate for a refund equal to 100% of the sales price to the Associate less a 10% restocking fee and commissions paid. The return of product by an Associate, other than product damaged at the time of receipt, constitutes potential cancellation of the distributorship. Generally, unused Medical Products may be returned up to six months from date of purchase for a refund equal to 100% of the sales price less a 25% restocking fee. Returned products damaged during shipment are replaced by the Company. Nutritional Products purchased by licensees may not be returned to the Company for a refund except in the case of a product defect.
Advertising - Advertising expense is charged to operations when incurred. Advertising expenses were $64,000, $57,000 and $100,000 in 2011, 2010 and 2009, respectively.
Translation of Foreign Currencies - All assets and liabilities of foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect at the balance sheet date. Revenue and expense accounts are translated at weighted average exchange rates. Translation gains and losses are reflected as a component of other comprehensive income (loss) in shareholders' equity. Gains and losses on foreign currency transactions are included in the consolidated statements of operations.
Other Comprehensive Income (Loss) - Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under US GAAP are included in comprehensive income (loss) but are excluded from net earnings (loss) as the amounts are recorded directly as an adjustment to shareholders’ equity. The Company’s other comprehensive income (loss) is attributed to translation gains or losses of foreign currencies.
Share-Based Compensation - The Company recognizes share-based compensation expense based on the fair value of share-based awards. Share-based compensation is estimated at the grant date based on the fair value of the awards expected to vest and recognized as expense ratably over the requisite service period of the award. The Company uses the Black-Scholes valuation model to estimate fair value of share-based awards, which requires various assumptions including estimating stock price volatility, risk-free interest rate and expected life.
Recent Accounting Pronouncements - In September 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2011-08, Testing for Goodwill Impairment (“ASU 2011-08”), which is intended to simplify how entities test for impairment of goodwill. Under the new guidance, an entity will have the option of first assessing qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, although early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 requires an entity to present components of net income and other comprehensive income either in one continuous statement of comprehensive income or in two separate but consecutive statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in shareholders' equity. In December 2011, FASB issued ASU No. 2011-12 which deferred certain aspects of ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and must be applied retrospectively. We are assessing the impact of ASU 2011-05 on our comprehensive income presentation.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS ("ASU 2011-04"). ASU 2011-04 generally provides a uniform framework for fair value measurements and related disclosures between US GAAP and international financial reporting standards (“IFRS”). The amendments in ASU 2011-04 change the wording used to describe many of the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements, and provide additional disclosure requirements. This standard is effective during interim and annual periods beginning on or after December 15, 2011. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.
NOTE C - ACCOUNTS RECEIVABLE
At December 31, 2011 and 2010, accounts receivable consist of the following:
Changes in the Company’s allowance for doubtful accounts for the years ended December 31, 2011 and 2010 are as follows:
NOTE D - INVENTORIES
At December 31, 2011 and 2010, inventories consist of the following:
NOTE E - PREPAID EXPENSES AND OTHER CURRENT ASSETS
At December 31, 2011 and 2010, prepaid expenses and other current assets consist of the following:
At December 31, 2011 and 2010, the Company held certificates of deposit in the amount of approximately $84,000 and $85,000, respectively, which were pledged to secure surety bonds.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - PROPERTY AND EQUIPMENT
At December 31, 2011 and 2010, property and equipment consist of the following:
Depreciation expense totaled approximately $500,600 , $533,300 and $431,600 for the years ended December 31, 2011, 2010 and 2009, respectively.
NOTE G - GOODWILL AND OTHER INTANGIBLE ASSETS
The Company measures its goodwill for impairment at the end of each year or in the event of an impairment indicator. No impairment losses have been recognized as a result of this testing.
Goodwill balances are summarized as follows:
At December 31, 2011 and 2010, other intangible assets consist of the following:
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amortization expense related to other intangible assets totaled approximately $6,000 for the years ended December 31, 2011 and 2010. The aggregate estimated amortization expense for other intangible assets is as follows:
NOTE H - ACCRUED LIABILITIES
At December 31, 2011 and 2010, accrued liabilities consist of the following:
NOTE I - LONG-TERM OBLIGATIONS
At December 31, 2011 and 2010, long-term obligations consist of the following:
Long-term obligation payments payable in the next five years are as follows:
NOTE J - SHARE-BASED COMPENSATION
Stock incentive plans - On July 1, 1998, the Company’s shareholders adopted the 1998 Stock Option Plan and reserved 500,000 shares of common stock for issuance under this plan. Effective September 4, 2003, the Company’s shareholders adopted an amendment and restatement of this plan, which, among other things, increased the number of shares reserved under this plan
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to 3,500,000. This plan expired July 1, 2008 although options granted under this plan remain outstanding at December 31, 2011.
On June 1, 2006, the Company’s shareholders adopted the 2006 Stock Incentive Plan (the “2006 Plan”) under which 2,500,000 shares of common stock were reserved for issuance. The 2006 Plan provides for the issuance of non-qualified stock options, ISOs, restricted stock awards and stock appreciation rights, and permits grants to employees, non-employee directors and consultants of the Company.
Generally, stock options granted under these plans vest over a period from four to five years and have a term of nine years. Certain stock options granted under these plans were fully vested upon grant and certain options have terms of five years.
Stock Option Accounting - The Company recognizes share-based compensation expense based on the fair value of share-based awards as estimated at the grant date. Share-based compensation expense for 2011, 2010 and 2009 was approximately $44,500, $56,400 and $139,100, respectively, and is classified as a general and administrative expense. Tax benefits related to this expense were immaterial because virtually all share-based compensation resulted from grants of ISOs. No tax benefit is recorded for an ISO unless upon exercise a disqualifying disposition occurs. The Company will prospectively record any excess tax benefits from the exercise of stock options as cash flows from financing activities. There were no material excess tax benefits in 2011, 2010 or 2009.
Fair Value - The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
The weighted average expected life is based on the option term. The risk-free interest rate is based on U.S. Treasury issues with a term equal to the expected life of the option. The expected volatility is based on historical volatility rates. The expected dividend yield is 0.0% since the Company has no history of paying dividends and currently has no plans to do so.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Activity - A summary of stock option activity for the three years ended December 31, 2011 is as follows:
A summary of the status of the Company’s non-vested stock options as of December 31, 2011, and changes during the year then ended, is presented below:
Additional information related to stock options granted, vested and exercised for the three years ended December 31, 2011 is a follows:
As of December 31, 2011, there was approximately $79,000 of total unrecognized compensation cost related to stock option grants. That cost is expected to be recognized over a weighted average period of 1.7 years.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE K - INCOME TAXES
The income tax expense (benefit) reconciled to the tax computed at the statutory Federal rate of 34% is as follows:
Deferred tax assets and liabilities at December 31, 2011 and 2010 are comprised of the following:
The Company’s valuation allowance relates to deferred tax assets of its Canadian subsidiary. This valuation allowance was decreased approximately $2,000 during 2011.
At December 31, 2011 and 2010, the Company had no unrecognized tax benefits. The Company’s policy is to record any interest and penalties related to gross unrecognized tax benefits within its provision for income taxes.
The Company files income tax returns in the U.S., Canada and Taiwan on a federal basis, in certain U.S. state jurisdictions; the most significant taxing jurisdiction is the U.S. federal jurisdiction. The Company’s 2009 through 2011 tax years remain subject to examination by the IRS for U.S. federal tax purposes. As of December 31, 2011, no tax years were under examination in any taxing jurisdiction except for tax years 2008 through 2010, which were under examination by the Canada Revenue Agency.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income tax expense (benefit) for continuing operations consists of the following:
NOTE L - COMMITMENTS AND CONTINGENCIES
Leases - The Company leases office and warehouse space and certain equipment using operating leases for various periods through 2013. Rental expense under non-cancelable operating leases totaled $230,000, $241,000 and $266,000 in 2011, 2010 and 2009, respectively. Future minimum payments under non-cancelable operating leases are as follows:
Employee Arrangements - The Company has entered into employment agreements with certain of its key executives as follows: (i) in December 2009, the Company entered into an employment agreement expiring December 31, 2012, which agreement automatically renews for an additional one-year term unless either party provides notice to the other 30 days prior to the last day of the then current term, (ii) in July 2010, the Company entered into an employment agreement with the Company's Chief Executive Officer expiring December 31, 2013, which agreement automatically renews for an additional one-year term unless either party provides notice to the other 60 days prior to the last day of the then current term, (iii) in September 2011, the Company entered into an employment agreement expiring December 31, 2012 and (iv) in December 2011, the Company entered into two employment agreements, which replaced expiring employment agreements, for one-year terms ending on December 31, 2012. All of these agreements provide that if employment is terminated for certain reasons set forth in the agreement, which reasons do not include a change of control, the Company will be required to make a severance payment in an amount equal to the greater of (i) the remaining compensation due through the end of the current term or (ii) one-half of the annual base salary, in addition to other compensation due under the terms of the agreement. With respect to the employment agreement with the Company's Chief Executive Officer, upon termination of the this agreement, the Company is obligated to pay a specified portion of his salary for an additional three-year period for consulting services.
The Company’s employees can participate in an employee benefit plan under Section 401(k) of the Internal Revenue Code offered through its Professional Employer Organization. This plan covers employees in the U.S. who are at least 18 years of age and have been employed by the Company longer than three months. The Company makes discretionary matching contributions equal to 10% of the employees’ contributions. Total matching contributions made by the Company during 2011, 2010 and 2009 were approximately $14,000, $18,000 and $22,000, respectively.
Litigation - The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters.
NOTE M - SEGMENTS AND GEOGRAPHIC AREA
The Company's segments are based on the organization structure that is used by management for making operating and investment decisions and for assessing performance. Based on this management approach, the Company has two operating segments: Nutritional Products and Medical Products.
The Nutritional Products segment manufactures and distributes a line of over 75 nutritional supplements and personal care
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
products, including herbs, vitamins and minerals, as well as natural skin, hair and body care products. Nutritional Products are marketed under the “RBC Life” brand name through subsidiaries in the U.S. and Canada, and, effective October 1, 2011, branch operations in Taiwan. These products are distributed by a network of independent Associates in certain markets, primarily in the U.S., Canada and Taiwan, and by licensees operating in certain other international markets. For the most part, licensees also market the Nutritional Products in their respective territories through a network of independent Associates.
The Medical Products segment markets a line of approximately 28 wound care products under the MPM Medical brand name through a U.S. subsidiary operating primarily in the U.S. The wound care products are distributed to hospitals, nursing homes, home health care agencies, clinics and pharmacies through a network of medical/surgical supply dealers and pharmaceutical distributors. Medical Products are used to prevent and treat wounds, and manage pain associated with wounds, in the acute care, long-term care and oncology markets.
The accounting policies of the segments are the same as those described in Note B. The Company evaluates the performance of its segments primarily based on operating profit. All intercompany transactions have been eliminated, and intersegment revenues are not significant. In calculating operating profit (loss) for these two segments, administrative expenses incurred that are common to the two segments are allocated on a usage basis.
Segment information is as follows (in thousands):
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial information summarized geographically based on the customer’s ordering location for the years ended December 31, 2011, 2010 and 2009 is listed below (in thousands):
Significant Customers - The Company recorded sales to CCI, a licensee of the Company, in the amount of $12,785,000, $15,375,000 and $12,477,000 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company also recorded sales to a medical/surgical dealer (see Note Q for additional information related to this dealer) in the amount of $4,043,000, $3,979,000 and $3,824,000 for the years ended December 31, 2011, 2010 and 2009, respectively. These sales accounted for more than 10% of net sales in these years. In no other case did a customer of the Company account for more than 10% of net sales for the years ended December 31, 2011, 2010 or 2009.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE N - EARNINGS (LOSS) PER SHARE
Summarized basic and diluted earnings (loss) per common share were calculated as follows:
For 2011, 2010 and 2009, the number of stock options that were outstanding but not included in the computation of diluted earnings (loss) per common share because their exercise price was greater than the average market price of the common stock or were otherwise anti-dilutive, was approximately 1,191,000, 826,000 and 2,130,000, respectively.
NOTE O - RELATED PARTY TRANSACTIONS
Debt Guarantees - The Company’s Chairman of the Board has guaranteed a mortgage note of the Company. The balance of this note was $1,728,000 at December 31, 2011.
Customer Arrangement - In July 2004, the Company entered into a ten-year exclusive license agreement with CCI, which replaced an expiring five-year exclusive license agreement. In connection therewith, the Company received a license fee of $65,000, which was recorded as deferred revenue and is being recognized as sales over the term of the agreement. Deferred revenue associated with CCI’s account, which included (i) deposits received against purchase orders issued to the Company by CCI, (ii) payments received for products held by the Company for shipment to CCI at a later date, and (ii) the unrecognized portion of the license fee, totaled $2,976,000 and $2,441,000 at December 31, 2011 and 2010, respectively. The Company recorded sales to CCI in the amount of $12,785,000, $15,375,000 and $12,477,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Pursuant to the license agreement between CCI and the Company, CCI also paid royalties to the Company for the years ended December 31, 2011, 2010 and 2009 in the amount of $2,079,000, $2,186,000 and $2,409,000, respectively, which are included in sales. The president of CCI beneficially owned approximately 18% of the Company’s outstanding common stock at December 31, 2011 and was a member of the Company’s Board of Directors until June 2004.
RBC Life Sciences, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial data for the years ended December 31, 2011 and 2010 is summarized as follows:
NOTE Q - SUBSEQUENT EVENT
On February 27, 2012, the Company was notified that a medical/surgical dealer, which accounted for 14%, 14% and 15% of consolidated net sales in 2011, 2010 and 2009, respectively, filed a voluntary petition for protection under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Central District of California in Santa Ana, California on February 24, 2012. According to its bankruptcy petition, this dealer filed its petition as the most effective means of stabilizing its finances as it resolves a recent reimbursement guidelines dispute with Medicare, which the dealer believes is improperly withholding payments. The reimbursement dispute does not involve products the Company supplies to this dealer. The petition states that this dealer relies on Medicare payments for more than 90% of its revenue and that Medicare has currently suspended all of its payments to the dealer. In a press release issued by the dealer at the time of the filing, the dealer stated that the Chapter 11 filing will allow it to continue operating without interruption while it resolves its payment dispute with Medicare as expeditiously as possible. As of the date of the bankruptcy filing, the Company had approximately $436,000 in accounts receivable that were owed by this dealer, and the Company has continued to fill this dealer's post-petition purchase orders. The accounts receivable balance as of March 23, 2012 was $684,000. While the Company believes that the amounts due from this dealer will be collected in full, it intends to monitor these proceedings as they progress in order to appropriately assess and enforce its rights in this matter.
Exhibit Index
** Filed electronically herewith