Notes to Consolidated Financial Statements

(Unaudited)

March 31, 2018

FORWARD-LOOKING STATEMENTS

This quarterly report includes both historical and “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future results. Words such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this quarterly report on Form 10-Q. We disclaim any intent or obligation to update any forward-looking statements after the date of this annual report to conform such statements to actual results or to changes in our opinions or expectations.

Item No. 2 - Management ’ s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Quarterly Report on Form 10- Q . The following discussion and analysis discusses the financial condition and results of our operations on a consolidated basis, unless otherwise indicated.

Overview

We are a developer, manufacturer and marketer of a proprietary line of nutritional supplements addressing basic nutrition, specific wellness needs, weight management and sports nutrition. We sell our products through an international network marketing system utilizing independent distributors. Sales in the United States represented approximately 76.7% of worldwide net sales for the three months ended March 31, 2018 and 80.3% of worldwide net sales for the three months ended March 31, 2017. Our international operations currently generate sales through distributor networks with facilities in Australia, Canada, Indonesia, Malaysia, Mexico, the Philippines, and the United Kingdom. We also operate in Ireland, France, Germany, Austria and the Netherlands from our United Kingdom distribution center, in New Zealand from our Australia office, and in Singapore from our Malaysia office.

We derive our revenues principally through product sales made by our global independent distributor base, which, as of March 31, 2018, consisted of approximately 32,100 distributors and preferred customers. Our sales can be affected by several factors, including our ability to attract new distributors and retain our existing distributor base, our ability to properly train and motivate our distributor base and our ability to develop new products and successfully maintain our current product line.

All of our sales to distributors outside the United States are made in the respective local currency; therefore, our earnings and cash flows are subject to fluctuations due to changes in foreign currency rates as compared to the U.S. dollar. As a result, exchange rate fluctuations may have an effect on sales and gross margins. U.S. generally accepted accounting practices require that our results from operations be converted to U.S. dollars for reporting purposes. Consequently, our reported earnings may be significantly affected by fluctuations in currency exchange rates, generally increasing with a weaker U.S. dollar and decreasing with a strengthening U.S. dollar. Products manufactured by us for sale to our foreign subsidiaries are transacted in U.S. dollars. From time to time, we enter into foreign exchange forward contracts to mitigate our foreign currency exchange risk.

Components of Net Sales and Expense

Product sales represent the actual product purchase price typically paid by our distributors, after giving effect to distributor allowances, which can range from 10% to 40% of suggested retail price, depending on the rank of a particular distributor. Handling and freight income represents the amounts billed to distributors for shipping costs. We record net sales and the related commission expense when the merchandise is shipped.

Our primary expenses include cost of products sold, distributor royalties and commissions and selling, general and administrative expenses.

Cost of products sold primarily consists of expenses related to raw materials, labor, quality control and overhead directly associated with production of our products and sales materials, as well as shipping costs relating to the shipment of products to distributors, and duties and taxes associated with product exports. Cost of products sold is impacted by the cost of the ingredients used in our products, the cost of shipping distributors’ orders, along with our efficiency in managing the production of our products.

Distributor royalties and commissions are monthly payments made to distributors based on products sold in their downline organization. Based on our distributor agreements, these expenses have typically approximated 23% of sales at suggested retail. Wholesale pricing discounts on distributor orders are based on the retail value of the product. Distributor royalties and commissions are paid on an amount referred to as the business value (“BV”), which typically ranges between 80% and 90% of the retail price of each product. Also, we include other sales leadership bonuses, such as Ambassador bonuses, within this caption. Overall, distributor royalties and commissions remain directly related to the level of our sales and should continue at comparable levels as a percentage of net sales going forward.

Selling, general and administrative expenses include the compensation and benefits paid to our employees, except for those in manufacturing, all other selling expenses, marketing, promotional expenses, travel and other corporate administrative expenses. These other corporate administrative expenses include professional fees, non-manufacturing depreciation and amortization, occupancy costs, communication costs and other similar operating expenses. Selling, general and administrative expenses can be affected by a number of factors, including staffing levels and the cost of providing competitive salaries and benefits; the amount we decide to invest in distributor training and motivational initiatives; and the cost of regulatory compliance.

Results of Operations  

Net Sales. Overall net sales decreased by 21.7% in the three months ended March 31, 2018 compared to the same period in 2017. During the first quarter of 2018 (“Q1 2018”), sales in the United States decreased by 25.2% and international sales decreased by 7.4% over the prior-year period. International sales, when reported in U.S. dollars, were positively impacted by a weaker U.S. dollar versus most of the currencies we conduct business in, other than the Philippine peso. Excluding the impact of currency exchange fluctuation, international sales decreased by 13.0%.

          The following table summarizes net sales by geographic market for the three months ended March 31, 2018 and 2017.

The following table sets forth, as of March 31, 2018 and 2017, the number of our active distributors and Master Affiliates and above. The total number of active distributors includes Master Affiliates and above. We define an active distributor as one that enrolls as a distributor or renews his or her distributorship during the prior twelve months. Master Affiliates and above are distributors that have attained the highest level of discount and are eligible for royalties generated by Master Affiliate groups in their downline organization. We include Preferred Customers as part of our Active Distributor count, and Preferred Customers represent approximately 4,780 and 5,200 of the Active Distributor count as of March 31, 2018 and 2017, respectively.

The following table provides key statistics related to distributor activity by market and should be read in conjunction with the following discussion.

Use of Non-GAAP Financial Information

Net sales expressed in local currency or net sales adjusted for the impact of foreign currency fluctuation are non-GAAP financial measures. We use these measurements to assess the level of business activity in a foreign market, absent the impact of foreign currency fluctuation relative to the U.S. dollar, which our local management has no ability to influence. This is a meaningful measurement to management, and we believe this is a useful measurement to provide to shareholders.

United States  

International Operations

Costs and Expenses

The following table sets forth selected results of our operations expressed as a percentage of net sales for the three-month periods ended March 31, 2018 and 2017. Our results of operations for the periods described below are not necessarily indicative of results of operations for future periods.

Cost of Products Sold:  

Distributor Royalties and Commissions:

Selling, General and Administrative Expenses:

Other Income/Expense:

Income Taxes :

Net Incom e :

Financial Condition, Liquidity and Capital Resources  

During the first three months of 2018, we generated $500,000 of net cash from operating activities, $17,000 was provided by investing activities, and we used $108,000 in financing activities. This compares to $530,000 of net cash provided by operating activities, $235,000 used in investing activities, and $114,000 used in financing activities in the same period of 2017. Cash and cash equivalents increased by $404,000 to $3.68 million as of March 31, 2018 compared to December 31, 2017.

Significant changes in working capital items consisted of a decrease in inventory of $394,000, an increase in prepaid expenses/other current assets of $320,000, and an increase of $561,000 in accounts payable and accrued expenses in the first three months of 2018. The decrease in inventory is the result of a decrease in production to correspond to the decrease in sales, and the increase in prepaid expenses/other current assets primarily represents the annual premium payments made in the first quarter of 2018 on most of the corporate business insurance policies. The increase in accounts payable and accrued expenses is result of a financing arrangement for our annual corporate insurance policy renewals, coupled with an increase in payroll and payroll taxes payable as the result of our change from a semi-monthly to a bi-weekly payroll cycle in the United States.

Investing activities during the first three months of 2018 consisted of a net investment of $11,000 for capital expenditures, offset by payments received on a distributor note receivable of $28,000. Financing activities during the first three months of 2018 consisted of principal payments of $108,000 on long-term borrowings.

Stockholders’ equity decreased to $13.79 million at March 31, 2018 compared to $14.36 million at December 31, 2017. The decrease is primarily due to our net loss during the first three months of 2018 of $238,000 and a reduction of $368,000 due to the recognition of deferred revenue under ASU No. 2014-09. Our working capital balance was $1.77 million at March 31, 2018 compared to $2.14 million at December 31, 2017. The current ratio at March 31, 2018 was 1.25 compared to 1.34 at December 31, 2017.

Effective September 30, 2015, the Company entered into a series of lending agreements with our primary lender which included agreements for a $3.25 million term loan and a $3.5 million revolving credit facility. These lending agreements replaced similar borrowings under agreements with the Company’s former primary lender.

The $3.25 million term loan was for a period of three years and required monthly term loan payments, under a ten-year amortization, consisting of principal of $27,080 plus interest with a balloon payment for the outstanding balance due and payable on September 30, 2018. Effective with an April 11, 2018 loan agreement amendment, under similar monthly payment and interest rate terms, the term loan’s balloon payment due date has been extended from September 30, 2018 to April 29, 2019. The term loan's interest rate is based on the 30-day LIBOR plus 2.25% and was 3.94% at March 31, 2018.

The $3.5 million revolving line of credit agreement, originally dated September 30, 2015, accrues interest at a floating interest rate based on the 30-day LIBOR plus 2.25% and had an original term of one year. Effective September 30, 2016, the revolving line of credit agreement was extended under similar terms to April 30, 2018. Effective with an April 11, 2018 loan amendment, the revolving line of credit’s term has been extended from April 30, 2018 to April 29, 2019 and the revolver’s maximum borrowing amount has been reduced from $3.5 million to $2.0 million. At March 31, 2018, outstanding borrowings under the revolving line of credit are $500,000. The interest rate on revolver borrowings is identical to the term loan.

Borrowings under the lending agreements continue to be secured by all tangible and intangible assets of the Company, a whole life insurance policy on the life of the Company's Chief Executive Officer, which was assigned to the lender, and by a mortgage on the real estate of the Company's headquarters.

The loan agreements, including the April 2018 loan amendment, include quarterly financial covenants requiring the Company to maintain net tangible worth of not less than $9.5 million, and i) a cumulative minimum EBITDA requirement of $200,000; $400,000; $600,000; and $800,000 for the fiscal periods ending March 30, 2018; June 30, 2018; September 30, 2018; and December 31, 2018; respectively; and ii) a minimum EBITDA of $200,000 for the quarter ended March 31, 2019.

As defined, EBITDA equals the Company's consolidated net income for such period, before interest expense, income tax expense, depreciation and amortization, and management fees, and further adjusted to exclude any gain or loss on the sale of assets, other extraordinary gains or losses, and any one-time adjustment approved by the lender.

At March 31, 2018, we were not in compliance with our quarterly financial loan covenant requirements. On May 4, 2018, our lender agreed to waive our non-compliance with the tangible net worth and minimum EBITDA covenants for the March 31, 2018 reporting period; however, we cannot provide any assurance that the lender will waive any financial loan covenant non-compliance in any future quarterly reporting periods. Furthermore, we are unable to provide reasonable assurance that future operating results will achieve compliance with our quarterly financial loan covenant requirements. Accordingly, we have presented our outstanding loan balances as current liabilities in the March 31, 2018 condensed consolidated balance sheets.

We believe that our cash on hand and our ability, if necessary, to borrow a significant portion of or liquidate the cash surrender value of our key-man life insurance policy, will be sufficient to meet our working capital requirements and debt service requirements for the next twelve months.

Critical Accounting Policies  

A summary of our critical accounting policies and estimates is presented in our 2017 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2018. Except for the required adoption of ASU No. 2014-09, our critical accounting policies remain unchanged as of March 31, 2018.

Item No. 4 - Controls and Procedures

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, has reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2018. Based on such review and evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of March 31, 2018, to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, (a) is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and (b) is accumulated and communicated to our management, including the officers, as appropriate to allow timely decisions regarding required disclosure. There were no material changes in our internal control over financial reporting during the first quarter of 2018 that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

PART II – OTHER INFORMATION

I tem No. 6 – Exhibit s