Naturade Inc. (fka NRDCQ)

[JMC]

Form 10-Q for NATURADE INC

14-Nov-2007

Quarterly Report


ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion contains "forward-looking statements." Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, such statements are inherently subject to risk and the Company can give no assurances that such expectations will prove to be correct. Such forward-looking statements involve risks and uncertainties, and actual results could differ from those described herein. Future results may be subject to numerous factors, many of which are beyond the Company's control. Such risk factors include, without limitation, the risks set forth below under "Risk Factors." The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.

Contrary to the rules of the SEC and due to a lack of funding, the Company's unaudited condensed September 30, 2007 financial statements included in this filing have not been reviewed by an independent registered public accounting firm in accordance with professional standards for conducting such reviews. The Company intends to obtain a SAS 100 review of such financial statements if and when necessary funds become available.

All comparisons below are for the three and nine month periods ended September 30, 2007 compared to the three and nine month periods ended September 30, 2006.

The Company

Naturade, Inc. (the "Company") develops and markets branded natural products. The Company is focused on innovative products designed to nourish the health and well-being of consumers.

The Company competes primarily in the market for natural, nutritional supplements. The Company's products include:
· Naturade Total Soy®, a full line of nutritionally complete meal replacements for weight loss and cholesterol reduction available in several flavors of powders;

· Naturade® protein powders;

· Ageless Foundation Laboratories the Anti-Aging Company® anti-aging products;

· Symbiotics® Colostrum products; and

· Other niche natural products.

The Company's products are sold to the mass market, the health food market and the military in the United States, Canada and selected international markets. The mass market consists of supermarkets, mass merchandisers, club stores and drug stores. The health food market consists of natural food supermarkets and over 5,000 independent health food stores.

The Company's independent registered public accounting firm issued a going concern opinion on the Company's December 31, 2006 financial statements by including an explanatory paragraph in which they expressed substantial doubt about its ability to continue as a going concern.

The Company was incorporated in 1986 under the laws of the state of Delaware. The Company's principal executive offices are located at 2099 S. State College Blvd., Suite 210, Anaheim, CA 92806. The Company's website is located at www.naturade.com.

Recent Developments

Chapter 11 Filing

On August 31, 2006 (the " Petition Date"), the Company filed a voluntary petition for protection and reorganization (the "Chapter 11 Matter") under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the Central District of California (the "Bankruptcy Court"). Since the Petition Date, the Company has conducted activities as a debtor-in-possession under the Bankruptcy Code. See Note 1 for additional information. See also, Note 10 - Subsequent Event.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") applicable to a going concern, which assume that assets will be realized and liabilities are discharged in the normal course of business. As a result of the Chapter 11 Matter (see Note 1), such realization of assets and liquidation of liabilities is subject to uncertainty. A substantial portion of the Company's liabilities as of the Petition Date are subject to compromise or other treatment in the Chapter 11 Matter. For financial reporting purposes, those unsecured liabilities and obligations whose disposition is dependent on the outcome of the Chapter 11 Matter will be segregated and classified as liabilities subject to compromise in the September 30, 2007 balance sheet. Generally, actions to enforce or otherwise effect repayment of all pre-Chapter 11 liabilities and pending litigation against the Company are stayed while the Company continues as a debtor-in-possession during bankruptcy proceedings. Schedules have been filed by the Company with the Bankruptcy Court setting forth the assets and liabilities of the Company as of the Petition Date as reflected in the Company's accounting records. Differences between amounts reflected in such schedules and claims filed by creditors will be investigated and either amicably resolved or adjudicated by the Bankruptcy Court. The ultimate amount of and settlement terms for such liabilities are not presently determinable.

Financial accounting and reporting during a Chapter 11 Matter for an entity with the expectation of reorganizing is prescribed in Statement of Position No. 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7"). The Company has an expectation of reorganizing under the Bankruptcy Code. Accordingly, unsecured pre-petition liabilities, which may be subject to settlement, are classified as liabilities subject to compromise in the September 30, 2007 balance sheet. In addition, the Company has reported all transactions (other than interest expense) directly related to the Chapter 11 Matter as reorganization items in its statement of operations for the three and nine months ended September 30, 2007. SOP 90-7's definition of reorganization items excludes (1) interest expense and (2) transactions required to be reported as discontinued operations or extraordinary items in conformity with GAAP.

Basis of Presentation

The accompanying condensed balance sheet at September 30, 2007, the condensed statements of operations for the three and nine months ended September 30, 2007 and cash flows for the nine months ended September 30, 2007 and 2006 are unaudited. Such financial statements have been prepared on the same basis as the Company's audited consolidated financial statements and, in the opinion of management, reflect all adjustments, (except for the extinguishment of debt discussed in Note 2 which is recorded as reorganization income), consist only of a normal recurring nature, necessary for a fair presentation of the financial position and results of operations for such periods. However, the accompanying financial statements do not include any adjustments that may be required in connection with restructuring the Company under Chapter 11 of the Bankruptcy Code. These unaudited condensed financial statements should be read in conjunction with the December 31, 2006 audited financial statements included in the Company's Form 10-K as previously filed with the Securities and Exchange Commission on April 18, 2007.

On September 25, 2006, The Company's Common Stock was de-listed from the over-the-counter Bulletin Board and now trades on the "Pink Sheets."

Change in Control

Recapitalization/Change in Control - On August 10, 2006, Quincy Investments Corp. ("Quincy"), the principal shareholder of the Company, subsequent to executing a Letter of Intent of July 26, 2006 with Redux to transfer to Redux, Quincy's controlling interest in Naturade, as reported on the Company's Form 8-K filed with the Securities and Exchange Commission on August 2, 2006, entered into the Quincy Transfer Agreement ("the Quincy Transfer Agreement") pursuant to which:

· Quincy transferred 28 million shares of the Company's common stock, 4.2 million shares of Series C Convertible Preferred Stock ("Series C") and 14 million warrants to purchase common stock to Redux;

· Redux agreed to make cash contributions up to $500,000 at its sole discretion to the Company;

· Redux and Quincy agreed to attempt to complete a Definitive Agreement by August 31, 2006.

· Quincy withheld 3,372,345 shares of Common in violation of the Quincy Transfer Agreement.

Before the transactions described above, Quincy owned 31,372,345 shares of the Company's common stock, or 72.4% of the voting power of the Company's common stock. Quincy also owned 4.2 million shares of Series C which when added to Quincy's common stock holdings represented 55.3% of the combined voting power of the Company's common stock and the Series C. The holders of the Series C are entitled to vote along with the holders of the Company's common stock (on an as-converted basis) on all matters, including the election of directors, presented to the stockholders. As a result, Quincy had the power to elect a majority of the Board of Directors and to determine the outcome of any matter submitted to the stockholders, subject to the rights of Health Holdings and Botanicals, LLC holders of 12,600,000 shares of Series C who have the right to elect one director and to approve certain transactions.

The Definitive Agreement contemplated under the Letter of Intent was not been entered into and the Letter of Intent by its terms has expired. Although Quincy has threatened litigation against Redux related to the absence of a Definitive Agreement, no lawsuit has been commenced. In contrast, the Company has initiated a lawsuit against Quincy and Peter Pocklington. See Note 12 - Legal Proceedings.

On August 31, 2006 Laurus entered into an agreement with Redux, the principal shareholder of the Company, (the "Redux Agreement") pursuant to which:
· Laurus Master Fund, Ltd. ("Laurus") transferred 1,050,000 shares of the Company's common stock to Redux;

· Laurus transferred warrants to purchase 1,500,000 shares of the Company's common stock at $0.80 per share to Redux which were cancelled upon transfer;
("Laurus Warrant")

· Laurus transferred an option to purchase 8,721,375 shares of the Company's common stock at $0.001 per share to Redux ("Laurus Options"); and

· Redux issued 574,787 shares of Redux common stock to Laurus subject to certain provisions for anti-dilution and piggy back registration rights.

On November 16, 2006, Redux acquired 500,000 shares of the Company's common stock and warrants to purchase 3,647,743 shares of common stock from Liberty Company Financial, LLC ("Liberty") and in exchange issued to Liberty 28,116 shares of Redux common stock.

On January 3, 2007, Redux and Howard Shao entered into an agreement to exchange 23,413 shares of Redux Holding, Inc's restricted common stock for any and all of Mr. Shao's equity and/or debt instruments issued him and/or amounts owed him by Naturade, Inc. This exchange included 1,000,000 shares of Company's restricted common stock, unissued, but owed Mr. Shao under prior agreements. The 1,000,000 shares of Company restricted common stock have since been issued to Redux. See Exhibit 10.82.

On April 13, 2007, Redux issued Laurus a cashless warrant to purchase up to 700,000 shares of Redux common stock in consideration of Laurus waving all default interest of the Company's accrued default interest and fees.

As a result of the transactions described above, Redux controls voting rights of 30,550,000 shares of the Company's common stock and 4,200,000 shares of Series C, or 70.5% of the voting power of the Company's common stock, 20.0% of the voting power of the Series C, and 54% of the combined voting power of the Company's common stock and the Series C. The holders of the Series C are entitled to vote along with the Company's common stock (on an as-converted basis) on all matters, including the election of directors, presented to the stockholders. As a result, Redux has the power to elect a majority of the Board of Directors and to determine the outcome of any matter submitted to the stockholders, subject to the rights of the holders of the Series C described above. If the Laurus Options are included, these percentages increase.

The Company's reorganization plan as approved by the bankruptcy court became effective on November 9, 2007, (the "Plan"). On November 9, 2007 (the "Effective Date") all Company Series C Preferred shares, along with their voting and control rights, all options, all warrants, and all registration rights, are cancelled as required under the Plan. The Company, as required by the Plan, will issue Redux enough shares of restricted common stock to give Redux 95% equity and voting interest in the Company. All remaining shareholders will have a total of 5% equity interest in the Company. See Note 10 -Subsequent Event.

Financing

In July 2005, the Company obtained a $4,000,000 convertible financing facility from Laurus, consisting of a $3,000,000 revolving credit facility and a $1,000,000 term loan. In consideration of such financing facility, The Company issued to Laurus an option to purchase up to 8,721,375 shares of common stock at $0.0001 per share and a warrant to purchase up to 1,500,000 shares of common stock at $0.80 per share. The financing facility was amended on January 11, 2006, by among other things, increasing the term loan to $1,650,000 and eliminated the conversion features on the facility. The Company issued Laurus 1,050,000 shares of common stock in consideration for this amendment. See Note 5
- Financing.

On August 31, 2006, pursuant to the Company's filing under Chapter 11 of the US Bankruptcy Code, the Company agreed to the following:

· Laurus claim in the amount of $2,900,000 will be treated as fully secured and the liens granted Laurus pursuant to the Financing Agreement will remain without modification.

· Laurus will provide debtor in possession financing ("DIP") pursuant to the terms and conditions of the financing agreement.

· Interest will continue to accrue on the Term Loan pursuant the terms of the Financing Agreement however, payments will be suspended until the first day of the first full month after the Effective Date of the Chapter 11 filing.

· The maturity date of the Term loan will be extended to January 6, 2010 and principal payments will commence on the first day of the first full month after the Effective Date of the Chapter 11 filing and be payable in equal monthly installments until the maturity date.

Critical Accounting Policies and Use of Estimates

In preparing the financial statements, the Company is required to make estimates and judgments that affect the results of its operations and the reported value of assets and liabilities. Actual results may differ from these estimates. The Company believes that the following summarizes the critical accounting policies that require significant judgments and estimates in the preparation of the Company's financial statements.

Revenue Recognition. The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 101A, No. 101B and No. 104. SAB No. 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) require management's judgments regarding the fixed nature of the fee charged for services rendered and products delivered and the collectability of those fees. To satisfy the criteria, the Company: (1) inputs orders based upon receipt of a customer purchase order; (2) record revenue upon shipment of goods when risk of loss and title transfer under the Company's arrangements with customers or otherwise comply with the terms of the purchase order; (3) confirm pricing through the customer purchase order and; (4) validate creditworthiness through past payment history, credit agency reports and other financial data. Other than through warranty rights, the Company's customers do not have explicit or implicit rights of return. Should changes in conditions cause us to determine the revenue recognition criteria are not met for certain future transactions, such as a determination that an outstanding account receivable has become uncollectible, revenue recognized for any reporting period could be adversely affected.

The Company records revenues net of returns and allowances. Gross sales, which are defined as list price times units sold, include the following reductions for returns and allowances:

Distributor Allowances. Distributor allowances are provided to all distributors as a reduction from list price and are recorded as a reduction off the invoice at time of billing. Revenues and accounts receivable are recorded net of these allowances.

Promotional Allowances. Promotional allowances are related to specific promotions offered by Naturade related to in-store promotions being offered by a retailer and distributor promotions being offered to retailers. In most cases, the promotion is designed to correspond with a similar consumer promotion being offered by the retailer, the cost of which is borne by the retailer. Promotional allowances are based upon purchases by the retailer or distributor during the promotional period and are deducted from the customer invoice at the time of billing. Revenues and accounts receivable are recorded net of these allowances. Shipments during the promotional period are not subject to return after the end of the promotional period.

For the nine months ended September 30, 2007 and 2006, distributor and promotional allowances were $(16,934) or 0% of gross sales, and $949,654, or 9.7% of gross sales, respectively.

Damages & Returns. In the nine months ended September 30, 2007 and 2006, damages and returns were charged against revenues based upon historical return rates. Actual damages and returns are charged against the reserve when the product is returned, charges deducted or a consumer deduction is received. On a periodic basis, actual charges are compared to the reserve and, if required, the reserve rate is adjusted to reflect new trends. For the nine months ended September 30, 2007 and 2006, damages and returns charged against revenues were $331,586, or 7.4 % of gross sales, and $423,178, or 4.3 % of gross sales, respectively.

The following is a summary of the damages and returns reserve:

Nine Months Nine Months
Ended Ended
September 30, September
2007 30, 2006
Beginning balance $ 736,985 $ 42,910
Provision for damages and
returns 331,586 423,178
Actual damages and returns
during the period (1,002,765 ) (208,790) )
Ending balance $ 65,806 $ 257,298


Damages and returns are typically immaterial to the Company's overall results. As the majority of returns represent consumer returns, which trail sales by about a month, the reserve has been set based upon specific review of potential returns which are higher than normal as a result of the Company's Chapter 11 filing.

Cash Discounts. Cash discounts are recorded as deducted by customers from remittances, as the customer does not earn them until the customer pays according to terms. For the nine months ended September 30, 2007 and 2006, cash discounts were $71,847, or 15% of gross sales, and $100,265 or 1.0% of gross sales, respectively.

Slotting. Slotting charges related to new distribution (either a new customer or a new product introduced to an existing customer) are recorded as a prepaid expense as incurred and amortized over 12 months as a reduction of revenues. Should a customer cease purchasing from Naturade or discontinue the respective product line, the unamortized slotting costs are charged against revenues at that time. There have been no significant unamortized slotting charges charged against revenues in the periods reported.

For the nine months ended September 30, 2006 and 2005, slotting costs were $(4,035), or 0.0% of gross sales, and $119,254, or 1.2% of gross sales, respectively. Slotting expense was a credit during the period due to the fact that the Company no longer allows slotting charges; and, as a result, reserves were reversed resulting in a credit for the six month period.

Coupon & Rebate Redemption. Coupon and rebate costs are charged against revenues as redeemed. Historically, Naturade has incurred insignificant redemption of its consumer coupons or rebates. For the nine months ended September 30, 2007 and 2006, coupon and rebate costs were $0 and $1,544, respectively.

Inventory Valuation. Merchandise inventories are stated at the lower of cost (first-in, first-out basis) or market. The Company considers cost to include the direct cost of finished goods provided by co-packers as well as the cost of those components supplied to the co-packers. At each balance sheet date, the Company evaluates its ending inventories for excess quantities and obsolescence. This evaluation includes analyses of forecast sales levels by product and historical demand. The Company writes off inventories that are considered obsolete. Remaining inventory balances are adjusted to approximate the lower of cost or market value and result in a new cost basis in such inventory until sold. If future demand or market conditions are less favorable than the Company's projections, additional inventory write-down may be required, and would be reflected in cost of sales in the period the revision is made.

Accounts Receivable and Allowances for Uncollectible Accounts. Accounts receivable are unsecured, and the Company is at risk to the extent such amounts become uncollectible. Accounts receivable are stated net of applicable reserves for returns and allowances, bill backs and doubtful accounts. Management regularly reviews and monitors individual account receivable balances to determine if the reserve amounts are appropriate and provides for an allowance for uncollectible accounts by considering historical customer buying patterns, invoice aging, specific promotions and seasonal factors.

Results of Operations

The following table sets forth, for the periods indicated, the percentage which
certain items in the statement of operations data bear to net sales and the
percentage dollar increase (decrease) of such items from period to period.

Percentage Dollar Increase
Percent of Net Sales (Decrease)
Nine Months Ended June 30, Nine Months Ended March 30,
2007 2006 2007 2006
Net sales 100% 100% (46%) (10%)
Gross profit 34% 47% (61%) (12%)
Selling, general and
administrative expenses 75% 86% (47%) 19%
Depreciation & amortization. 5% 9% (144%) 336%
Operating loss (46%) (39%) (34%) (173%)
Interest expense 17% 26% (66%) 203%
Net Income (loss) before
provision for income taxes (14%) (109%) (93%) (337)%
Provision for income taxes 0% 0% (100%) 0%
Net Income (loss) (14%) (109%) (93%) (337)%


Major trends that affected the Company's results of operations in 2007

The major trends affecting the Company's results of operations in the nine months ended September 30, 2007 included the following:

· The Company's filing for protection under Chapter 11 Bankruptcy has had a negative effect on the Company's ability to purchase inventory for the nine months ended September 30, 2007. The Company believes this trend is likely to continue until the Company emerges from bankruptcy. See Note 10 - Subsequent Event.

· The Company's lack of sufficient cash to maintain proper inventory levels has had a negative effect on the Company's revenues for the three and nine months ended September 30, 2007. The Company believes this trend is likely to continue unless the Company obtains sufficient capital to bring inventory levels back to historical levels.

Net Sales

Net sales for the three months ended September 30, 2007 of $1,772,871, decreased $3,407 or 0.2% as compared to net sales of $1,769,464 for the three months ended September 30, 2006. Net sales for the nine months ended September 30, 2007 of $4,501,156, decreased 46.1% as compared to net sales of $8,351,598 for the nine months ended September 30, 2006. The decrease in net sales for the nine month period is due principally to the Company's filing for protection under the US Bankruptcy Code. The filing resulted in a disruption in shipping due to lack of capital to purchase sufficient inventory levels and an inability to maintain traditional order fill ratios.

Critical Accounting Policies and Use of Estimates - Revenue Recognition.

Mass Market Net Sales- For the three months ended September 30, 2007, mass market revenues increased $20,358 or 2.6% to $771,576 from $751,218 for the three months ended September 30, 2006. For the nine months ended September 30, 2007, mass market revenues decreased $1,777,216 or 53.9% to $1,518,019 from $3,295,235 for the nine months ended September 30, 2006. The decrease in net sales during the period is related to the to the lack of promotional funds available for consumer advertising coupled with decreased inventory availability due to the Company's Chapter 11 filing.

Health Food Net Sales- For the three months ended September 30, 2007, health food channel net sales decreased $16,951, or 1.7%, to $1,001,295 from $1,018,246 for the three months ended September 30, 2006. For the nine months ended September 30, 2007, health food channel net sales decreased $2,073,227, or 41.0%, to $2,983,136 from $5,056,363 for the nine months ended September 30, 2006.The sales decrease is principally related to sales of Ageless and Symco brands partially offset by reductions in sales of core protein powders related to lower fill rates on customer orders as a result of cash restrictions on inventory purchases. The health food decrease was lower than that seen in the mass channel as a result of the buying habits of health channels customers. Typically, the health food channel purchases through distributors who do not have a just in time need for product resulting in higher tolerance to out of stock situations caused by the Company's cash constraints.

Channels of Distribution- On a percent of net sales basis, the breakdown of sales between the mass market and health food channels was 56.5% for the health food channel and 43.5 % for mass market channel for the three months periods ended September 30, 2007 as compared to 57.5% for the health food channel and 42.5% for the mass market channel, respectively, for the same period in 2006. On a percent of net sales basis, the breakdown of sales between the mass market and health food channels was 66.3% for the health food channel and 33.7 % for mass . . .