Red Flags from China?

Natural Health Trends (OTCQB:NHTC) describes itself as an international direct-selling organization that “sells personal care, wellness, and quality of life” products. More specifically they state, “we are engaged in what is called network marketing or multi-level marketing (source 1)” It also mentions how important China is to its business:

“China has been and continues to be our most important business development project (source 2)”

A majority of the company’s business is done through China, coupled with Hong Kong, and any small stunt in growth in Hong Kong or China would likely be of material interest to shareholders. With that in mind, we began conducting preliminary due diligence on NHTC.

In doing so, the GeoTeam recently discovered an article on315online.com.cn, a Chinese website that discusses the types and characteristics of e-commerce multi-level marketing (“MLM”) campaigns. The August 28, 2013 article points to the prevalence of scams associated with MLM and goes into detail about what to be cautious of, since the ubiquity of fraud is apparent in so many facets of the World Wide Web.

What caught our eye was the mention of Natural Health Trends Corp., represented as “然健环球,” or “NHT Global”, which is NHTC’s Chinese brand name. The article discusses various multi-level marketing business models that are not permitted in China, including some applications of e-commerce platforms. On September 12, 2014 we reported that NHTC conducts its business in China through an e-commerce model as a work around China regulation, since it has not obtained a direct selling license in China since 2005.

Why can’t NHTC obtain a license?

Direct selling is prohibited in China without a direct selling license that we do not have. In December 2005, we submitted a preliminary application for a direct selling license. In June 2006, we submitted a revised application package in accordance with new requirements issued by the Chinese government. In June 2007, we launched a new e-commerce retail platform in China that does not require a direct selling license and is separate from our current worldwide platform. We believe this model, which offers discounts based on volume purchases, will encourage repeat purchases of our products for personal consumption in the Chinese market. The platform is designed to be in compliance withour understanding of current laws and regulations in China. In November 2007, we filed a new, revised direct selling application incorporating a name change, our new e-commerce model and other developments. These direct selling applications were not approved or rejected by the pertinent authorities, but did not appear to materially progress. By 2009, the information contained in the most recent application was stale. The Company applied to temporarily withdraw the license application in February 2009 to furnish new information and intends to amend its application with the goal to re-apply in the future. We are unable to predict whether we will be successful in obtaining a direct selling license to operate in China, and if we are successful, when we will be permitted to enhance our e-commerce retail platform with direct selling operations (source 4).

It is five years later and to our knowledge NHTC has not disclosed that it has applied for a direct selling license in China. Instead, the company seems to be relying on doing an “end around” the rules and regulations by operating their e-commerce business in China.

We encourage investors to read our September 12, 2014 blog post, the serious risk factors listed in NHTC’s 10K for the period ended December 31, 2013 and our below summarization of the 315online.com.cn article. Investors who choose to read NHTC’s 10K should note that the following risk factor has been omitted from its 10-Ks since the period ended December 31, 2007:

In 2006 and 2007 approximately 67% and 62% of our revenue, respectively, was generated in Hong Kong. Various factors could harm our business in Hong Kong, such as worsening economic conditions or other events that are out of our control. For example, on April 12, 2004, a television program was aired in China with respect to the operations of our Hong Kong subsidiary and our representative office located in Beijing. The television program alleged that our Hong Kong operations engaged in fraudulent activities and sold products without proper permits. Due to the adverse publicity caused by the airing of the television program, revenues from Hong Kong declined significantly. Page 12 2007 10K

We found this to be somewhat deceitful, not only because we believe NHTC may be operating a non-permitted MLM model in China, but also because this event is partly what set shares of NHTC into a tailspin from a high of $25.75 in April 2004 to eventually hit $0.20. We also note that Hong Kong represents a significantly material amount of NHTC’s business at this point. In the company’s last 10-Q, they point out that Hong Kong represented 88.1% of the company’s total revenue (source 3). (Also note that the company discloses that the majority of Hong Kong sales are generated from China).

We believe that this could be putting all of your eggs into one unstable and highly questionable basket.

Whatever conclusions investors want to draw on their own, they should know this: NHTC’s current e-commerce model was employed specifically because it does not have the proper direct selling licenses in China.

Summary of 315online.com Article

While most people are likely aware of what MLMs are, 315online aims to teach the general layperson the basic ins and outs of how the model works.

To summarize, the article describes the most obvious genres of MLMs, all of which garner lower-level members to create a pyramid structure that would benefit those on top:

1. Traditional Online Multi-Level Marketing – Physical products are marketed down-stream
2. Commission-based MLM – Rewards members through advertisement click-throughs, email campaigns and online registrations.
3. Information Marketing – Revolves around the dissemination of information and concepts to encourage users to join sites and perpetuate the cycle of perceived online services.

The article does a good job of identifying the myriad of terms that can represent possible attempts of deception to persuade individuals to engage in multi-level marketing activities, especially perpetrated upon people in middle and western areas (of the country), as well as minorities. The promise of getting rich is the common theme, a notion that is cleverly conveyed through the guise of seemingly legitimate companies. This is akin to the very same debate that is going on with other public multi-level marketing companies like Herbalife (NYSE:HLF) and NuSkin (NYSE:NUS).

While the article does admit that the traditional forms of multi-level marketing are waning in popularity, it states that deception in the other forms has become more prevalent and creative throughvirtualization, website vehicles, concealment, cross-regional propagation andtaking advantage of gray lines between legitimacy and what is open to industrial and commercial regulation.

315online leaves us with cautionary advice that is being stressed by Online Transaction Protection Centers and actions that can be taken per advice from the Industrial and Commercial Government Department. Basically:

• Do not put money into sites before doing the appropriate amount of due diligence.
• Issue complaints to regulators and police when you realize that illegal MLM scams are being conducted.

The GeoTeam found it alarming that after this comprehensive commentary regarding MLMs that NHTC was included with a list of companies that have been identified as suspected “e-commerce” multi-level marketing organizations.

The list in Mandarin is shown below, with NHTC highlighted for easy reference (some English names did not translate over from Mandarin, hence the additional English, and we have underlined and bolded where NHTC is listed):

世联发商贸网 安格电子 世界通 斐è´å›½é™… 斐è´å¥³äººæ¹¾å…¬å¸ E网商务 英国TVI旅游快车 MDG 体验中心 亚洲生活网 美国全球教育网 美亚国际Mycool 成都麦酷电子商务有限公司 MDG 国际公司 东泰购物网 梦圆国际会所 安è´ç‰¹å•†åœº æ­å·žå®‰è´­ç§‘技有限公司(安è´ç‰¹) 麦罗（MELO）国际 香港麦森(MESUN) 最牛ITä¼  新智培训网 新智网 新加å¡æ–°æ™ºå›½é™… 黑龙江科力奥 IPC异业联盟 E科士威 Ecosway 新加å¡4D博cai电子商务网络公司 莱科萨斯”雷克瑟且 辽宁天元生物公司 大众邮购 南京铠鼎商贸有限公司 北京中健泰和电子有限公司 北京欧亚伟业国际商务有限公司 幸福199工程 JAIP网络手机卡 林枫公司 北京金亿盟国际电子商务 æ­å·žå¤ªç«¹å«ç”Ÿç”¨å“æœ‰é™å…¬å¸ 香港长和国际有限公司 ç„¶å¥çŽ¯çƒ (**NHTC**) 十度空间 北京金兴信投资顾问有限公司 湖北林枫商贸集团有限公司 广西永乾 环球力金（GLB） EFT (邮寄产品) 北京顺兴鸿运科技 浙江衢州吾老七用品公司 德资本 美国迅联网 “日晖”CT70服务站 广东清远盈草堂科技 深圳万户商网络科技有限公司 假”爱舍集团 美国红酒” 财富壹佰 美国瑞纳(RENA)有限公司 全国兴æ‘富民互助社 特朗普股æƒæŠ•èµ„ 流动的财富 SMI 梦幻庄园 白宫资本 新加å¡LV（legendventure） SIQO环球创富基金 UNAICO 美国前程 ç‘žå…¸E时代 E玛国际 澳洲AD网络 通亿商城 FKC国际 千渡船搜云易购 通和商城 UDcap原始股 易百购(中国)消费联盟 中国明明商 开心部落 新加å¡AG原始股 万家购物 上海多购 上海家å¸è±ª 金路游戏世界 香港ABM 太平洋直购 至尊国际

**Chinese name of NHTC’s brand name

We suspect that there is more going on with NHTC than meets the eye. The facts that we do have should give long investors some pause. Namely:

• The company is deriving a majority of its revenues from Hong Kong, but it appears that most of these sales come from China where NHTC does not have a direct selling MLM license
• China is home to an e-commerce platform for the company
• The e-commerce platform is in place because NHTC can’t seem to obtain a direct selling license
• The 315online article above cautions people specifically from “virtualization, website vehicles, concealment, cross-regional propagation and taking advantage of gray lines between legitimacy and what is open to industrial and commercial regulation”

We remain extremely cautious on NHTC and urge investors who are considering buying the company’s shares to also consider the information that we have listed above before making their decisions. We will continue our due diligence on NHTC in coming days and continue to keep investors informed of new developments we are tying together.

Source:

1. Natural Health Trends Website
2. 10-Q for period ended June 30, 2014
3. 8-K, May 7, 2014
4. 10-K for the period ended December 31, 2013