Gary Zagami, et al. v. Natural Health Trends Corporation, et al. 06-CV

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UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS GARY ZAGAMI, on behalf of himself and all others similarly situated, Plaintiff(s), v. NATURAL HEALTH TRENDS CORP, MARK WOODBURN, TERRY L. LaCORE, CHRIS SHARNG, SIR BRIAN WOLFSON, TIMOTHY DAVIDSON, RANDALL A.

MASON, Defendants. ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) CIVIL ACTION NO. CLASS ACTION COMPLAINT FOR VIOLATION OF SECURITIES LAWS JURY TRIAL DEMANDED CLASS ACTION Plaintiff, individually and on behalf of all other persons similarly situated, by plaintiff 9s undersigned attorneys, for plaintiff 9s complaint, alleges upon the investigation made by and through plaintiff 9s counsel, which included, relevant public filings made by Natural Health Trends Corp ( cNatural Health d or the cCompany d) with the Securities and Exchange Commission (the "SEC"), as well as press releases, news articles, analyst reports, court filings, and media reports concerning the Company.

This complaint is based upon plaintiff 9s personal knowledge as to plaintiff 9s own acts, and upon information and belief as to all other matters, except where indicated otherwise. 2 NATURE OF ACTION 1. Plaintiff brings this action as a class action on behalf of himself and all other persons ... more. less.

or entities who purchased Natural Health common stock on the open market, other than defendants and certain persons and entities related to defendants, during the period beginning March 31, 2003 through August 11, 2006 (the "Class Period"), all to recover damages caused to the Class by defendants' violations of the federal securities laws. JURISDICTION AND VENUE 2. This action arises under Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (the cExchange Act d), 15 U.S.C. § 78j(b) and 78t, and Rule 10b-5, 17 C.F.R. § 240.10b-5. 3. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C. § 1331 and Section 27 of the Exchange Act, 15 U.S.C. § 78aa. 4. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and 28 U.S.C. § 1391(b). Defendants maintain their principal executive offices in this District and many of the acts, practices and transactions complained of herein occurred in substantial part in this District. 5. In connection with the acts alleged in this complaint, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to, the mails, interstate telephone communications and the facilities of the national securities markets. 3 PARTIES 6. Plaintiff Gary Zagami purchased Natural Health shares during the Class Period and was damaged thereby as set forth in the plaintiff 9s certification annexed hereto. 7. Defendant Natural Health is a Delaware Corporation with its principal place of business located at 2050 Diplomat Drive, Dallas, Texas 75234. The Company through its various operating subsidiaries purports to be an international direct- selling company operating in more than 29 markets throughout Asia, North America and Eastern Europe. The Company markets personal care products under the Lexxus brand and markets its nutritional supplement products under the Kaire brand. 8. Defendant Mark Woodburn, ( cWoodburn d) served in the capacity as President and Secretary for the Company beginning April 1999, as a director of the Company beginning August 2000, as Chief Financial Officer from April 1999 through August 1, 2004, and as the Company's Global Managing Director - Operations beginning October 3, 2005. Defendant Woodburn also served as the Chief Financial Officer of Lexxus International beginning March 2001. 9. Defendant Terry L LaCore, ( cLaCore d) served as a director of the Company beginning March 2003, as the Chief Executive Officer of Lexxus International, Inc., a wholly owned subsidiary of the Company, beginning March 2001, and as the Company 9s Global Managing Director - Business Development beginning October 3, 2005. 10. Defendant Randall A. Mason ( cMason d) served as an independent director beginning May 2003 and as the Chairman of the Board of Directors beginning March 28, 2006. During this period, Defendant Mason served as the Chair of the Audit Committee and as a member of the Compensation and Nominating Committees. As a member of the Audit 4 Committee, Defendant Mason was charged with reviewing and helping to ensure the integrity of the Company 9s financial statements as well as reviewing the adequacy of the Company 9s internal accounting controls. 11. Defendant Chris Sharng, ( cSharng d) has served as the Company 9s Executive Vice President and Chief Financial Officer ( cCFO d) since August 2, 2004 and as the Company 9s interim principal executive officer since April 20, 2006. Defendant Sharng also served from October 3, 2005 through March 28, 2006 alongside defendant Hess as one of three members comprising the Company 9s Office of the Chief Executive, an administrative committee established on October 3, 2005 that was responsible for managing the day-to-day operations of the Company. On March 28, 2006, when the Office of the Chief Executive was terminated, Defendant Sharng began serving as a member of the Company 9s Executive Management Committee, a three member administrative committee that replaced the Office of the Chief Executive and was charged with analogous duties. 12. Defendant Sir Brian Wolfson ( cWolfson d) served as the Chairman of the Company 9s Board of Directors from 1998 and 2000, and again from May 2003 until his resignation from that position on March 28, 2006. Thereafter, Defendant Wolfson served as a Vice Chairman to the Board. While serving as the Chairman, defendant Wolfson served as a member of the Audit Committee and Chair of the Compensation and Nominating Committees. As a member of the Audit Committee, Defendant Wolfson was charged with reviewing and helping to ensure the integrity of the Company 9s financial statements as well as reviewing the adequacy of the Company 9s internal accounting controls. 13. Defendant Timothy Davidson, ( cDavidson d), has served as the Company 9s Chief Accounting Officer since September 2004. 5 14. Defendants Woodburn, LaCore, Sharng, Wolfson, Davidson and Mason are collectively referred herein as the cIndividual Defendants. d 15. By virtue of their positions at Natural Health, the Individual Defendants had access to the adverse and undisclosed information about Natural Health 9s business condition and financial results. The Individual Defendants directly participated in the management of Natural Health, were directly involved in the operations of Natural Health at the highest levels, were privy to information concerning he undisclosed business conditions and financial results of Natural Health and were involved in the dissemination of the materially false and misleading statements and information alleged herein. 16. By reason of their positions as executive officers and/or directors of Natural Health, the Individual Defendants were at all relevant times controlling persons within the meaning of Section 20(a) of the Exchange Act. Because of their executive and directorial positions with Natural Health, the Individual Defendants had access to the adverse and undisclosed information about Natural Health 9s business conditions and financial results. Further, as particularized herein, the Individual Defendants were culpable participants and did control the contents of various reports and public statements regarding Natural Health. Any acts attributed to Natural Health were caused and/or influenced by the Individual Defendants by virtue of their controlling-person positions at Natural Health. 17. As the senior officers and/or directors of a publicly-held company whose securities were, and are, registered with the SEC pursuant to the Exchange Act, traded on The NASDAQ National Market, and governed by the provisions of the federal securities laws, the Individual Defendants have a duty to promptly disseminate accurate and truthful information about the undisclosed and material business conditions of Natural Health, so that the market 6 price of Natural Health publicly-traded securities would be based upon truthful and accurate information. The Individual Defendants 9 misrepresentations and omissions during the Class Period violated these specific requirements and obligations. By virtue of their positions of control and authority at Natural Health, the Individual Defendants had the power to and did control the content of the various public statements concerning Natural Health, its business conditions and financial results during the Class Period and indeed made many of the challenged statements described herein. Accordingly, the Individual Defendants were responsible for the accuracy of the public statements and releases detailed herein and are primarily liable for the misrepresentations contained therein. PLAINTIFF 9S CLASS ACTION ALLEGATIONS 18. Plaintiff brings this action as a class action pursuant to Federal Rule of Civil Procedure 23(a) and (b)(3) on behalf of all those who purchased or otherwise acquired the securities of Natural Health during the Class Period and who suffered damages (the "Class"). Excluded from the Class are defendants, the officers and directors of the Company, members of their immediate families and their legal representatives, heirs, successors, or assigns and any entity in which defendants have or had a controlling interest. 19. The members of the Class are so numerous that joinder of all members is impracticable. While the exact number of Class members is unknown to plaintiffs at this time and can only be ascertained through appropriate discovery, plaintiffs believe that there are hundreds or thousands of members in the proposed Class. According to the Company 9s Quarterly Report filed with the Securities and Exchange Commission ( cSEC d) on August 11, 2006, the Company has 8,199,933 shares outstanding as of August 7, 2006. Record owners and other members of the Class may be identified from records maintained by 7 Natural Health or its transfer agent and may be notified of the pendency of this action by mail, using the form of notice similar to that customarily used in securities class actions. 20. Plaintiffs 9 claims are typical of the claims of the members of the Class as plaintiffs purchased Natural Health shares during the Class Period and all members of the Class are similarly affected by defendants' wrongful conduct in violation of federal law that is complained of herein. 21. Plaintiff will fairly and adequately protect the interests of the members of the Class and have retained counsel competent and experienced in class and securities litigation. 22. Common questions of law and fact exist as to all members of the Class and predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are: (a) whether the federal securities laws were violated by defendants' acts as alleged herein; (b) whether defendants misrepresented material facts and omitted to state material facts necessary to prevent the statements made to the investing public from being misleading during the Class Period concerning its financial statements; (c) whether defendants acted knowingly or recklessly in making materially misleading representations or omitting to state material facts during the Class Period; (d) whether the market prices of the Company's common share was artificially inflated or distorted during the Class Period because of defendants' conduct complained of herein; and (e) whether the members of the Class have sustained damages and the proper measure of such damages. 8 23. A class action is superior to all other available methods for the fair and efficient adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the damages suffered by individual Class members may be relatively small, the expense and burden of individual litigation make it impossible for members of the Class to individually redress the wrongs done to them. There will be no difficulty in the management of this action as a class action. SUBSTANTIVE ALLEGATIONS Background 24. The Company is a multi-level marketing operation that offers various cosmetic and lifestyle enhancement products through its wholly-owned subsidiary Lexxus International, Inc., and distributes nutraceutical products in a range of categories through its wholly-owned eKaire.com, Inc. ( ceKaire d) subsidiary. The company distributes its products through a network of distributors in North America, Latin America, Australia, Asia, and New Zealand. The Company has described its distribution model as follows: Generally, network marketing is based upon an organizational structure where independent distributors of a company's products are compensated for sales made to consumers. But, even more significantly, distributors are compensated for sales generated by distributors recruited by such distributor and all subsequent distributors recruited by their "down line" network of distributors. This can be very lucrative for individual distributors who develop extensive networks of distributors that sell company products and recruit additional distributors. * * * Distributors are independent contractors who purchase products directly from the respective subsidiary for resale to retail consumers or for personal consumption. Distributors may elect to work on a full-time or a part-time basis. The growth of a distributor's business depends largely upon the ability to recruit a down-line and the strength of our products in the marketplace. 25. The Company, in its present constitution, was formed as the result of a reverse 9 merger of Kaire Nutraceutical, Inc. ( cKaire d), originally incorporated in 1998, into the publicly traded shell of Natural Health Trends Corp. in 1999. Defendant Woodburn either served as the President of Kaire at the time of the reverse merger or had served as a director and Secretary from October 1992 until February 1999. During the same period, Defendant LaCore served as either a cdirect selling consultant d or as the President of Kaire. 1 In 2000, Kaire was sold to certain private investors. However, defendant LaCore continued to serve as President of Kaire until February 2001. 26. Prior to December 7, 2005, the Company maintained a Board of Directors comprised of a mere three members 3 Sir Brian Wolfson, Randall A. Mason and Robert H. Hesse. On December 7, 2005, the Company expanded the Board to six members and added Anthony B. Martino, Terrence M. Morris, and Colin J. O 9Brien as directors. 27. In January 2001, the Company along with certain minority investors launched the Lexxus business in the United States. Defendant Woodburn served as the CFO of Lexxus from March 2001 through November 10, 2005. Defendant LaCore served as the CEO of Lexxus from March 2001 through November 10, 2005. The Lexxus subsidiaries ( cLexxus d) comprised the largest operation of the Company, accounting for 99% of the Company 9s consolidated net revenues for its fiscal year 2005. Lexxus conducts business in 15 countries and purports to have approximately 119,000 active distributors. 2 The Company 9s expansion into international markets through Lexxus served as the foundation of the Company 9s purported growth leading up to, and through, the Class Period. 1 Inconsistencies in the roles of defendants are attributable to the Company 9s public filings. 2 The Company considers a distributor cactive d if he or she has placed at least one product order with the Company 10 Materially False and Misleading Statements Made During the Class Period 28. The Class Period begins on March 31, 2003 when the Company filed its Annual Report with the SEC on Form 10-KSB for its fiscal year ended December 31, 2002 (the c2002 Annual Report d). Therein, the Company reported annual revenues for the period of $39,662,347 and net income of $4,102,020, increases over its prior fiscal year of 60% and 103%, respectively. Throughout, the Class Period, the Company made certain representations concerning the structure of its business, its distributor base, and the methodology it used in accounting for its sales. The following statements from the Company 9s 2002 Annual Report reflect the Company 9s representations about certain key characteristics of its business model and accounting practices: To become a Lexxus distributor, a person must accept an agreement (posted on our website) to comply with our policies and procedures and to pay a nominal $100 fee. Each potential distributor joins Lexxus by visiting our website and paying the initial fee. To be considered "active", the distributor must order a minimum of $100 of products each year. Out of approximately 75,000 accounts, Lexxus currently has approximately 37,000 active distributors. To become an eKaire distributor, a person must sign an agreement to comply with our policies and procedures. To remain "active", the distributor must order a minimum of $50 of products each year. Out of approximately 12,000 accounts, eKaire currently has approximately 3,000 active distributors. We pay commissions to qualified distributors based on sales volumes for each commission period. We offer one of the highest payouts in the MLM industry. * * * Distributors generally pay for products by credit card in connection with orders placed through their Internet page at www.mylexxus.com or www.mykaire.com prior to shipment. Accordingly, we carry minimal accounts receivable. * * * during the preceding year. 11 Sponsoring activities are not required of distributors and we do not pay any commissions for sponsoring new distributors. However, because of the financial incentives provided to those who succeed in building a distributor network that consumes and resells products, we believe that many of our distributors attempt, with varying degrees of effort and success, to sponsor additional distributors. People are often attracted to become distributors after using our products and becoming regular customers or after attending introductory seminars because they are seeking new business opportunities. Once a person becomes a distributor, he or she is able to purchase products directly from us at wholesale prices. The distributor is also entitled to sponsor other distributors in order to build a network of distributors and product users. A potential distributor must agree to our standard terms and conditions, which obligates the distributor to abide by our policies and procedures. * * * Product Warranties and Returns Lexxus The Lexxus refund policies and procedures closely follow industry and country standards. Distributors may return unopened product that is in resalable condition for a partial refund. All products must be returned within twelve months of the original purchase date for refund eligibility. Lexxus must be notified of the return in writing and such written requests will be considered a termination notice of the distributorship. The Lexxus refund policies and procedures in other various countries are similar to those of United States and Canada, but vary from fourteen days to twelve months for the return of products for refund eligibility. eKaire eKaire product warranties and refund policies are similar to those of other companies in the industry. If a distributor is not satisfied with the product then he/she can return the product to eKaire within 90 days of the first time the product was purchased for a full refund. A distributor may return or exchange products that are unopened and in resalable condition 30 days after the date of purchase. * * * Revenue Recognition Revenue from the sale of products is recorded when the products are shipped. Amounts in the sales transaction relating to shipping and handling are included in "net sales," and costs incurred for shipping and handling are classified as "cost of goods sold" in the 12 Consolidated Statements of Operations. 29. Included in the 10-KSB filed March 31, 2003, was a certification, made pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ( cSarbanes-Oxley d), of defendant Woodburn, as President and CFO, attesting to the following: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. 30. Also included in the 10-KSB was a certification by defendant Woodburn pursuant to Section 302 of the Sarbanes-Oxley attesting to the accuracy of the financial report and the integrity of the Company 9s internal controls and accounting applications. In the certification, defendant Woodburn attested to the following: 1. I have reviewed this annual report on Form 10-KSB of Natural Health Trends Corp.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and I have: a) designed such internal controls to ensure that material information relating to the registrant and its subsidiaries (collectively, the "Company") is made known to me by others within the Company, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's internal controls as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and 13 c) presented in this annual report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date; 5. I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors: a) all significant deficiencies (if any) in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 31. On April 1, 2003, the Company repeated and reiterated its 2002 annual results through the issuance of a press release announcing crecord revenues and earnings d for its fiscal year ended December 31, 2002. The press release provided that the Company reported net sales of $39.7 million for the year, a 60% increase over the prior year, and net income of $4.1 million, an increase of 203% from the prior year. The press release attributes Defendant Woodburn as commenting on the Company 9s financial results as follows: We are very encouraged with our results for last year. Currently with 4,628,731 common shares issued and outstanding and our last year's earnings of $4,102,020 we feel that the Company has made great strides over the past two years and we attribute our success to our management team and our dedicated distributors around the globe. In just the past year, we have stabilized our capital structure, successfully deployed our resources in expanding into foreign markets and built a solid platform to support additional growth. The direct selling industry is attracting the attention of both investors and career based individuals and we are committed to enhancing shareholder value. 14 32. On April 4, 2003 the Company announced that it would enter the South Korean market in the second quarter of 2003. The press release in relevant part states as follows: Terry LaCore, Chief Executive Officer of Lexxus commented, "South Korea will be the next market we open in our record setting international expansion. Personally, I am so committed to the Korean market that I have been living in Korea for the past three weeks, and I plan to continue living here until we open for business. We have waited for over two years to assemble both the capital and management experience to succeed in this venue, and we are positioning ourselves to thrive in this market." Mark Woodburn, President of Natural Health Trends Corp. added, "We have been putting an infrastructure in place in Korea as quickly as possible, and we are excited about the potential of the Korean market. The World Federation of Direct Selling Associations reports that South Korea is the third largest market in the world for direct sales, with sales in excess of $2.9 billion annually. A small fraction of this business could be very significant to our overall success." 33. On April 13, 2004 the Company filed an amendment to its Form 10-K for fiscal year ended December 31, 2002 to restate certain items in its financial statements as identified as follows: During the quarters ended September 30 and December 31, 2003, the Company re-evaluated its financial statements for the years ended December 31, 2002 and 2001, the quarterly periods included in such years and the quarterly periods ended March 31, June 30 and September 30, 2003. As a result of such review, the Company determined that it inadvertently applied the incorrect accounting treatment with respect to the following items: (i) revenue recognition with respect to administrative enrollment fees; (ii) revenue cut-off between 2002 and 2003; (iii) reserves established for product returns and refunds; (iv) the gain recorded in connection with the sale of a subsidiary in 2001; (v) income tax provisions; and (vi) stock option based compensation. * * * In connection with the engagement of a new independent accounting firm and the review of the Company's financial statements, the Company has revised its accounting treatment for administrative enrollment fees received from distributors 15 in accordance with the principles contained in Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements", ("SAB 101") and related guidance. The Company determined that under SAB 101, such fees actually received and recorded as current sales in prior quarters should have been deferred and recognized as revenue on a straight-line basis over the twelve-month term of the membership. The restatement resulted in net sales for the years ended December 31, 2002 and 2001 being decreased by approximately $1,336,000 and $1,155,000, respectively. The restatement in net sales resulted in a corresponding adjustment to cost of sales for direct costs paid to a third party associated with the administrative enrollment fees received from distributors. Compared to amounts previously reported, the restatement decreased cost of sales by approximately $336,000 and $416,000 for the years ended December 31, 2002 and 2001, respectively. In connection with the 2003 annual audit, the Company reviewed its revenue cut-off as of the beginning of 2003. It was noted that approximately $1,008,000 of sales originally recorded in 2002 were not actually shipped until early 2003. The restatement resulted in net sales for the year ended December 31, 2002 being decreased by $1,008,000 and net sales for the three months ended March 31, 2003 being increased by the same amount. The restatement also resulted in distributor commissions for the year ended December 31, 2002 being decreased by $459,000 and distributor commissions for the three months ended March 31, 2003 being increased by the same amount. The Company had not recorded reserves for distributor returns and refunds as of September 30, 2003 and for prior periods. Based upon analysis of the Company's historical returns and refund trends by country, it was determined that the reserves for returns and refunds for prior quarters were required and should be recorded. The restatement resulted in net sales for the years ended December 31, 2002 and 2001 being decreased by approximately $350,000 and $650,000, respectively, with corresponding adjustments to cost of sales for the estimated cost of products returned. 34. On May 15, 2003, in a press release entitled cNatural Health Trends Corp Q1 Revenue Jumps 57% to $9.6 Million - Profitable Growth Fueled by Strong Lexxus Sales Worldwide d the Company reported crobust sales d and the defendant Woodburn stated, in relevant part: Our products are rapidly gaining market acceptance and, given our current outlook, we expect this trend to continue. * * * 16 We will soon launch our operations in Seoul, where even obtaining a small market share should substantially increase our revenues." Woodburn concluded, "Overall, we are excited with our achievements to date and look forward to the many growth opportunities before us. We entered 2003 built on a strong foundation, where we achieved milestones in terms of sales growth and international expansion. We are confident in continuing this momentum throughout the coming year." 35. Also on May 15, 2003, the Company filed a quarterly report for its fiscal 2003 first quarter with the SEC on Form 10-QSB. The quarterly report essentially repeated and confirmed the financial results presented in the Company 9s May 15, 2003 press release. The quarterly report provided additional details concerning the sources of the Company 9s revenues and income. In addition to certifications filed pursuant to Sarbanes-Oxley attesting to the truthfulness of the quarterly report and adequacy of the Company 9s internal controls, the Form 10QSB also made the following assertion with regard to the Company 9s controls and procedures: Within the 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as defined in Exchange Act Rules 13a-14(c) and 15d-14(c). Based upon that evaluation, the Company's President and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in enabling the Company to record, process, summarize and report information required to be included in the Company's periodic SEC filings within the required time period. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation. 36. Every quarterly and annual report filed with the SEC by the Company during the Class Period contained similar, if not the same, certifications pursuant to the Sarbanes-Oxley Act of 2002 and affirmations concerning the Company 9s controls and procedures, as set forth in ¶¶29, 30, 35. 17 37. On June 23, 2003, the Company announced the opening of its subsidiary in South Korea and issued a press release that stated, in relevant part: Mark Woodburn, President of Natural Health Trends Corp. stated, "We are very committed to the Korean market and believe it will be one of our stronger international markets in the long term. I was very impressed with the enthusiasm of our new Lexxus distributors and with the job that our management team has done in such a short period of time to open up our 30th country." [Natural Health] has so far received 14,000 requests for distributorships in South Korea, and of that, some 2,500 have already paid to begin training. Products are already being shipped to the country, and the Korean staff of 20 has met with senior American management to ensure a smooth take-off. 38. On August 14, 2003 the Company announced its second quarter 2003 results in a press release entitled cNatural Health Trends Corp. Reports Strong Growth in Sales and Earnings for Second Quarter - Operating Income and Net Income More Than Double d which stated in relevant part as follows: Net sales for the quarter rose by 33% to $12.16 million from $9.12 million in the second quarter of 2002. The increased sales were primarily from additional sales of Lexxus products and the expansion of Lexxus into new international markets, including the launch of Lexxus into South Korea in June 2003. Second quarter 2003 gross profit climbed to $10.48 million from $7.54 million in the second quarter of 2002. * * * Mark Woodburn, President of Natural Health Trends Corp., stated, "We are pleased with the results for the second quarter and for the six months of 2003. Our expansion outside the United States is proceeding according to plan, and our higher sales figures speak clearly for themselves. We anticipate the second half of the year to build on these results." * * * Mr. Woodburn observed, "The South Korean market, where we have just started operations, represents huge growth potential. The World Federation of Direct Selling Associations says that South Korea is the third largest market in the world for direct sales, with sales in excess of $2.9 billion annually. Even a small market 18 share will translate into significant sales, and we have more than sufficient interest to make an early success of South Korea." 39. On September 23, 2003, Natural Health issued a press release announcing the launch of two new products, wherein Defendant Woodburn is quoted as stating: This is a very exciting time for Natural Health Trends Corp. and for its Lexxus distributors. We have established ourselves in over 30 countries around the world, and we are planning further expansion internationally, as well as increasing our domestic United States activities. This international growth, the development of our distributor base and the increasing product line have put us on target to set more sales records in the third quarter. 40. On November 7, 2003, the Company announced that it was filing a Notification of Late Filing for the quarterly report for its third quarter 2003. In the press release issued by the Company, Defendant Woodburn stated in relevant part: The Company will require a few more days to prepare its final results for the third quarter of 2003 and we plan to file within the five day extension period. We are currently reviewing our prior accounting practices, particularly with respect to certain revenue recognition matters relating to administrative enrollment fees received from distributors. We have not concluded our analysis, but believe that these revenues actually received and recorded as current income may need to be deferred under generally accepted accounting principles. This would require us to reduce such revenues recorded in fiscal years 2001 and 2002 and increase such revenues for the current year. During this analysis, we are reviewing the adequacy of our reserves for returns and refunds. In addition, we are reviewing the accounting treatment for a disposition of a subsidiary dating back to 2001. While we are not prepared to disclose financial results at this time, I will say that we are extremely pleased with the performance of the business during the third quarter. Management believes that product shipments, the number of independent distributors of our products, and total revenues have all increased substantially compared with the second quarter of this year as well as the third quarter of 2002. 41. In December 22, 2003 Natural Health announced that it had retained the services of BDO Seidman, LLP as its new independent accountants. At the same time the Company also stated that it had disclosed in its Form 10-QSB for the third quarter of 2003 that it intended to restate the Company's quarterly and annual reports for the years ended December 31, 2001 and 2002 as well as the quarterly reports for the first two quarters of 2003 due to 19 misinterpretation of certain accounting standards and related guidance pertaining to a) revenue recognition of administrative enrollment fees, b) reserves for returns and refunds, c) a gain on sale of a subsidiary, and d) income tax provisions. This would be the second restatement of the Company 9s financial performance during the Class Period. 42. On March 30, 2004, the Company issuing a press release announcing that it would be unable to timely file its Annual Report for the year ended December 31, 2003 on Form 10-KSB with the SEC. The press release further provided that management was cvery excited and eagerly anticipate reporting [its] year end financial results. d Contemporaneously, the Company filed a Notification of Late Filing with the SEC. The Notification of Late Filing provided the following reasons for the Company 9s failure to timely file the Annual Report: Late Filing ----------- As previously reported, Natural Health Trends Corp. (the "Company") will be restating its financial statements for the years ended December 31, 2002 and 2001, the quarterly periods included therein, as well as the first three fiscal quarters during 2003. As a result, the Company has yet to finalize its financial statements. Accordingly, the Company could not file its Annual Report on Form 10-KSB within 90 days following its year end without unreasonable effort or expense. Significant Change in Results of Operations ------------------------------------------- It is anticipated that there will be a significant change in the Company's results of operations for the year ended December 31, 2003 compared to its results of operations for the year ended December 31, 2002, as restated. It is expected that net sales increased to approximately $62 million for 2003 from the expected restated net sales of $37 million for 2002. This increase was primarily attributable to (i) an increased number of active Lexxus distributors, (ii) increased sales of Lexxus products, and (iii) Lexxus' expansion into new markets, including Europe, Hong Kong, India, Singapore and the Philippines at varying times during 2002 and in South Korea in 2003. 20 43. On April 13, 2004, the Company announced its financial results for the fiscal year ended December 31, 2003 in a press release that stated, in relevant part: Net sales were approximately $62.9 million for the year ended December 31, 2003 compared to net sales of just under $37.0 million for the previous year. The 70% increase stems primarily from the increased number of active distributors for its Lexxus division. The expansion of the Lexxus sales network into South Korea in the second quarter of 2003 amounted to 10% of the entire gain, and a further 5% came from the sale of new products introduced during the year. Due to the tremendous growth in certain Asian markets, the Company had a sales backlog at the end of the year of approximately $4.0 million, which is included in deferred revenue and will be recognized into revenue in the first quarter of 2004. Year-end gross profit for 2003 was approximately $50.4 million compared to gross profit for 2002 of just under $30.0 million. Increased sales of Lexxus products accounted for this 68% increase, which was tempered by an increase in the cost of sales due to the change of product mix sold in 2003 and higher transportation costs. * * * For the fourth quarter ended December 31, 2003, net sales were $22.9 million, compared to $12.4 million for the quarter ended December 31, 2002, an increase of 81.5%. Gross profit for the fourth quarter 2003 was $17.8 million compared to $9.8 million in the same period prior year. Net income reached $1.7 million, or $0.30 per fully diluted share, in the last quarter of 2003 versus $1.9 million, or $0.56 per fully diluted share, in the last quarter of 2002. The drop in the earnings per fully diluted share of $0.26 between the quarters ended December 31, 2002 and December 31, 2003 is the result of the $2.4 million gain recognized in 2002 related to a gain on discontinued operations. 44. In the April 13, 2004 press release, Defendant Woodburn stated, in relevant part: We look forward to a prosperous 2004, with continued growth in our existing markets, some additional international expansion and new product introductions. With the restatements behind us, and the revenue recognition issues no longer playing a part in the Company's financial results, we feel that the future is an opportunity for Natural Health Trends Corp. to seek its full potential. 45. For the third consecutive reporting period, the Company announced, on May 18, 2004, that it would be unable to timely file its quarterly results. 21 46. On May 25, 2004, Natural Health announced its first quarter 2004 results in a press release entitled cNatural Health Trends Corp. Net Sales Rise 242% to Top $38 Million for First Quarter; Net Income Increases to $3.1 Million from $1.4 Million d. The press release states, in relevant part: Net sales were approximately $38.4 million for the first quarter of 2004 compared to approximately $11.2 million for the three months ended March 31, 2003. This 242% increase was primarily attributable to the increased number of active Lexxus distributors (amounting to approximately $17.4 million), primarily in the Hong Kong subsidiary, Lexxus' expansion into new markets including South Korea in the second quarter of 2003 (approximately $1.1 million), sales of new products (approximately $4.7 million) and the shipment of Hong Kong orders in backlog as of December 31, 2003 (approximately $4.0 million). 47. In the same press release, Defendant Woodburn states, in relevant part: As the first quarter closed, Natural Health Trends bought Marketvision Communications Corp., which is the exclusive developer and service provider of the direct-selling software we have used since mid-2001. This gives us an opportunity to reduce operating costs and retain control of the development of this mission critical software. I expect more of our top-line growth to reach the bottom line because of this transaction. 48. On June 25, 2004, the Company issued a press release entitled cNatural Health Trends Corp. Obtains China Business License and Announces Completion of First "Lexxus Experience Store'' in Beijing d that stated, in relevant part: Natural Health Trends Corp. announced today that its wholly-owned subsidiary, Lexxus International (China) Corporation, a company organized under the laws of the People's Republic of China ("PRC") has recently obtained a license to open wholesale-retail establishments within the PRC. The wholesale-retail stores will be called "Lexxus Experience Stores" and will be used to demonstrate and promote the Company's line of premium quality personal care products under the Lexxus brand name. Since 1998, China has prohibited direct selling, except for certain previously licensed enterprises that agreed to convert their network marketing organization into a "retail store" model. Currently, in order for China to comply with its obligations to the World Trade Organization, the Chinese Ministry of Commerce 22 is drafting a Direct Sales Law that we expect, when enacted, will permit direct selling, subject to compliance with various requirements. We anticipate that the Direct Sales Law will be implemented later this year or early in 2005 and that this new law will also require a "retail store" model. Mark Woodburn, President of Natural Health Trends Corp. said, "We view the potential direct selling market in China to be a unique opportunity. It may well become the largest direct selling market in the world. We have successfully recruited more than 33,000 active distributors in the Hong Kong market and we feel it is crucial for us to be one of the first entrants into the Chinese marketplace. I believe that our recently issued retail license will provide us with a critical first step towards obtaining a direct selling license. Our recently acquired retail license has a duration of 30 years and requires a capital investment of $12 million, of which $8 million must be funded in cash over a three-year schedule. We are committed to China and will devote all necessary resources to expand and, if required, modify our existing operations. I am very excited about this very positive development in China and we are more optimistic than ever about our future business prospects in China." Terry LaCore, CEO of Lexxus International Inc., a wholly-owned subsidiary of NHTC, said "Our retail license will allow us to open wholesale-retail establishments within the People's Republic of China to be called "Lexxus Experience Stores". We expect to open numerous stores in major metropolitan areas. These Experience Stores will be used to demonstrate and promote to our customers and sales personnel the Company's line of premium quality personal care products under the Lexxus brand name. These "brick and mortar" establishments should enable us to enhance our product sales and recruit additional sales personnel. We eagerly await the passage of the new Direct Sales Law so that we can apply for approval, obtain a direct selling license and begin operating in China." 49. On August 13, 2004, the Company issued a press release announcing the financial results for its second quarter 2004 that stated, in part, c[n]et sales& were up 48%, compared to& for the same period in the prior year d despite lower gross margins, higher selling, general and administrative expenses, and a higher commission-to-net sales ratio. The press release detailed the impact of the Company 9s Hong Kong subsidiary on its quarterly results as follows: The financial results for the Company's Hong Kong subsidiary for the second quarter were adversely impacted by the broadcast of an investigative television program in the People's Republic of China on April 12, 2004. As previously 23 disclosed, after thoroughly investigating the issues noted in the broadcast, the Company's Hong Kong subsidiary instituted intensive training and development sessions for its Hong Kong distributors with regard to applicable Chinese laws and appropriate business communications. The Company also elected to suspend product shipments to its Hong Kong distributors until they had completed the required training sessions. In addition, the Company's Hong Kong subsidiary extended the regular 14-day product return policy to 180 days for orders placed during the two weeks before, as well as two weeks after, the date of the airing of the Chinese television program. As a consequence of these events, net sales for the second quarter were adversely impacted by approximately $13.9 million, comprised of the following: (i) order backlog at June 30, 2004 totaling approximately $6.6 million that were not shipped because certain distributors had not yet attended training sessions offered by the Company's Hong Kong subsidiary, (ii) sales were reduced by incremental product returns of approximately $1.9 million pertaining to the two week period before and after April 12th, and (iii) approximately $5.4 million of sales were deferred because of accounting implications of the newly implemented return policy. In addition, distributor commissions as a percentage of net sales increased significantly during the second quarter because the Company did not require the refund of commissions paid on certain returned products and commissions were paid on the $5.4 million of deferred sales. Gross margin for the second quarter was 81% of net sales, compared to 86% for the comparable period a year ago. The decrease in gross margin was mainly attributable to product mix change and higher air freight to transport products overseas. Distributor commissions of approximately $12.6 million were 71% of net sales, compared to 41% in the second quarter 2003. This substantial increase resulted from the Company electing not to seek the refund of the commissions paid to independent distributors of its Hong Kong subsidiary, even though products sold by such distributors were returned following the broadcast of the investigative television program in China on April 12, 2004. In addition, commissions were paid on the $5.4 million of deferred sales. (See Exhibit A to this press release for the financial impact to the Company as a result of the events in Hong Kong). 50. In the August 13, 2004 press release, Defendant Woodburn commented on the Company 9s financial performance by stating, in part: Despite the short-term financial hits from these corrective measures, we believe that we are poised to maintain a long-term and profitable relationship with our independent distributors in Hong Kong. We believe that the proactive steps taken during the second quarter have been well received and we look forward to 24 commencing operations in China when the new direct selling laws are passed, and we obtain the necessary permits and licenses. 51. In October 2004, certain investors including defendants Wolfson, Woodburn, LaCore and Sharng entered into a securities purchase agreement with the Company (the c2004 Purchase Agreement d). Pursuant to the 2004 Purchase Agreement, the Company offered to sell to the investors a total of 1,369,704 cunits d of the Company 9s securities at a price of $12.595 per unit. Each unit consisted of one share of the Company 9s common stock and one warrant exercisable for one share of common stock at an exercise price of $12.47 per share. Defendants Wolfson, Woodburn, LaCore and Sharng each purchased 1,984 units for an investment of $25,000. In total, this financing resulted in net proceeds to the Company of $16 million. Beginning January 2005, the price of the Company 9s common stock increased dramatically from the $10 per share to $12.50 per share range to hit a high of $18.89 per share on March 10, 2005. From March 10, 2005 through September 2004, the price of the Company 9s common stock mostly traded for above $12 per share and, from July 1, 2005 through October 6, 2005 traded in the approximate price range of $14 per share to $17 per share. 52. On November 12, 2004, the Company issued a press release announcing the financial results for its third quarter of 2004 which reported, inter alia , that the Company experienced quarterly net sales increase of 142% over the prior year and net income for the quarter of approximately $5 million compared to the same period during the previous year of $1.3 million. In discussing the sales recognized during the quarter, the press release states, in relevant part: The third quarter sales incorporated approximately $11.9 million in revenue deferred from the second quarter, including $6.6 million in orders taken but not shipped as of June 30, $5.4 million shipped but not recognized until the third quarter and partly offset by $120,000 in incremental product returns. 25 53. On February 16, 2005, the Company 9s common stock began trading on the NASDAQ National Market System. In a related press release issued the same day, Defendant Woodburn commented on the Company 9s operations as follows: In addition to expanding our range of operations, we are constantly developing new and revolutionary products for our distributors. Our strategic plan calls for deepening existing markets as well as broadening our global reach. With that in mind, we intend to unveil several new products in the coming months. For these reasons we have chosen the stock symbol BHIP. By definition "hip" means keenly aware of or knowledgeable about the latest trends or developments. I cannot think of a better definition of what this company stands for, and the type of products that we plan to introduce in the years ahead. Over the last couple of years, Natural Health Trends Corp. is one of the fastest growing direct-selling companies in the world, growing to approximately $63 million in revenues for the year 2003 and $97 million in revenues for the first nine months of 2004. We have approximately 100,000 active distributors in over 30 countries worldwide and have appointed management teams that will help us in the near future enter the Mexican and Japanese markets, the world's 4th and 2nd largest direct-selling markets, respectively. We expect to grow considerably during 2005 and anticipate doing business in five of the top 10 direct-selling markets in the world by the end of this year. The proceeds from our $17 million private placement last fall, along with the recent expansion of our senior executive team, should help us fund and manage our growth prospects. 54. On March 23, 2005, the Company issued a press release announcing fiscal 2004 fourth quarter and fiscal year 2004 financial results that states, in relevant part: Fourth quarter net sales in 2004 were approximately $36.3 million, up 61% from $22.6 million for the comparable period a year ago. The growth in sales was attributable to an increase in the number of distributors. As of December 31, 2004, the operating subsidiaries of Natural Health Trends Corp. had approximately 133,000 active distributors, up from 76,000 at the end of 2003. Gross profit margin for the fourth quarter was $29.0 million, or 79.8%, versus $17.1 million, or 75.5% a year ago. The improvement can be mainly attributed to the elimination of commissions paid to Marketvision Communications Corp., the Company's Internet-based distributor system service provider, which was acquired by the Company on March 31, 2004. For the fourth quarter, the Company recorded a net loss of approximately $802,000, or a loss of $0.12 per fully diluted share. In the fourth quarter of 2003, the Company had a net income of $1.1 million, or $0.19 per fully diluted share. 26 The decrease in net income was due to higher commissions paid to distributors and selling, general and administrative expenses, or SG&A, partly offset by the margin flow-through of the higher volume. * * * For the twelve months ended December 31, 2004, net sales rose 113% to approximately $133.2 million compared to $62.6 million for fiscal year 2003. Two-thirds of this rise was attributable to the increased number of active Lexxus distributors while the balance represented higher sales generated per distributor. * * * As disclosed in a Form 8-K filed on March 23, 2005, the financial statements of the fourth quarter of 2003 and the first quarter of 2004 have been revised to address certain 2003 revenue and expense cut-off issues. With the revisions, the revenue in the fourth quarter of 2003 was reduced by approximately $310,000, and the net income was reduced by approximately $650,000. The revenue and net income of the first quarter of 2004 were increased by $310,000 and $650,000 respectively. * * * Woodburn concluded, "During 2004, we began to devote more of our resources to building a solid infrastructure upon which we can continue to drive our business forward. With an experienced management team now in place, combined with strong distributor growth in 2004, we are optimistic about our performance in the coming year. We expect to start generating revenue from the Japanese and Mexican markets, the world's 2nd and 4th largest direct-selling markets, in the next few months. We also foresee continuing to increase our reach inside our established markets. New products are in the pipeline which we hope will have a significant positive impact on our revenues before the end of the year." 55. On April 29, 2005, the Company issued a press release announcing its fiscal 2005 first quarter results. Therein, Defendant Woodburn states, in relevant part: We are extremely pleased with our strong start in the new year. Our top line continues to grow significantly. Our KGC subsidiary just hosted an event in Moscow with 10,000 people in attendance. We are looking forward to our North American convention in Dallas on April 29th and 30th, where we are expecting up to 1,500 attendants. These events have proven to be highly effective in increasing the number of distributors. We are also very enthusiastic about our new products currently in the pipeline which we hope will have a significant positive impact on our future revenues. Furthermore, we expect to start generating revenue from our Mexican subsidiary toward the end of the second quarter. Also planned 27 for in the second quarter, we intend to begin opening as many as four "experience centers" in China, where prospective consumers can sample our products. In order to fully and effectively serve our Chinese consumers, we plan on opening a manufacturing facility in China during the second half of this year. Finally, our Japanese subsidiary is expected to start producing sales in the third quarter. As you can see, we have a very ambitious schedule for this year. Fortunately, we hired experienced executives and professionals to expand our senior management team in the last several months to help execute this very aggressive slate of projects. 56. On March 31, 2005 the Company filed its Form 10-K for fiscal year ended December 31, 2004 which provided, in relevant part: Product Warranties and Returns Lexxus. The Lexxus refund policies and procedures closely follow industry and country-specific standards, which vary greatly by country. For example, in the United States, the Direct Selling Association recommends that direct sellers permit returns during the twelve-month period following the sale, while in Hong Kong the standard return policy is 14 days following the sale. We have conformed our return policies to local laws or the recommendation of the local direct selling association. In most cases, distributors may return unopened product that is in resalable condition for a partial refund. Lexxus must be notified of the return in writing and such written requests would be considered a termination notice of the distributorship. From time to time we alter our return policy in response to special circumstances. For example, in April 2004, an investigative television program was aired in the People 9s Republic of China with respect to the operations of the Company 9s Hong Kong subsidiary and the Lexxus representative office located in Beijing. The television program made allegations that Lexxus 9s Hong Kong operations engaged in fraudulent activities and sold products without proper permits. In order to address the concerns of many independent distributors, Lexxus extended its existing 14-day return policy in Hong Kong to 180 days to allow distributors and customers who purchased products during the two-week period prior to, and the two-week period after, the airing of the television program to return purchased merchandise for a full refund. See cRecent Developments d in Item 1. In October 2004, this special extended product return policy expired. eKaire. eKaire product warranties and refund policies are similar to those of other companies in the industry. If a distributor is not satisfied with the product then he/she can return the product to eKaire for a full refund within ninety (90) days of the first time the product was purchased. A distributor may return or exchange products that are unopened and in resalable condition thirty (30) days after the date of purchase. 28 * * * Inventory Valuation. The Company reviews its inventory carrying value and compares it to the net realizable value of its inventory and any inventory value in excess of net realizable value is written down. In addition, the Company reviews its inventory for obsolescence and any inventory identified as obsolete is reserved or written off. The Company 9s determination of obsolescence is based on assumptions about the demand for its products, product expiration dates, estimated future sales, and management 9s future plans. Also, if actual sales or management plans are less favorable than those originally projected by management, additional inventory reserves or write-downs may be required. The Company 9s inventory value at December 31, 2004 was approximately $13,991,000. Inventory write-downs for years 2002, 2003, and 2004 were not significant. * * * Allowance for Sales Returns. An allowance for sales returns is provided during the period the product is shipped. The allowance is based upon the return policy of each country, which varies from 14 days to one year, and their historical return rates, which range from approximately 1% to approximately 18% of product sales. Sales returns are approximately 4% and 5% of product sales for the years ended December 31, 2003 and 2004, respectively. The allowance for sales returns was approximately $381 thousand and $1,541 thousand at December 31, 2003 and 2004, respectively. No material changes in estimates have been recognized for the years ended December 31, 2003 and 2004. Revenue Recognition. Product sales are recorded when the products are shipped and title passes to independent distributors. Product sales to distributors are made pursuant to a distributor agreement that provides for transfer of both title and risk of loss upon our delivery to the carrier, which is commonly referred to as cF.O.B. Shipping Point. d The Company primarily receives payment by credit card at the time distributors place orders. The Company 9s sales arrangements do not contain right of inspection or customer acceptance provisions other than general rights of return. Amounts received for unshipped product are recorded as deferred revenue. Such amounts totaled $4.3 million and $4.8 million at December 31, 2003 and 2004, respectively. Enrollment package revenue, including any nonrefundable set-up fees, is deferred and recognized over the term of the arrangement, generally twelve months. Enrollment packages provide distributors access to both a personalized marketing website and a business management system. Prior to the acquisition of MarketVision Communications Corp. ( cMarketVision d) on March 31, 2004, the Company paid MarketVision a fixed amount in exchange for MarketVision creating and maintaining individual web pages for such distributors. These 29 payments to MarketVision were deferred and recorded as a prepaid expense. The related amortization was recorded to cost of sales over the term of the arrangement. The remaining unamortized costs were included in the determination of the purchase price of MarketVision. Subsequent to the acquisition of MarketVision, no upfront costs are deferred as the amount is nominal. At December 31, 2004, enrollment package revenue totaling $4.7 million was deferred. Although the Company has no immediate plans to significantly change the terms or conditions of enrollment packages, any changes in the future could result in additional revenue deferrals or could cause us to recognize

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