SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE
ACT OF 1934
Commission file number 002-97690-D
INTERNATIONAL HERITAGE, INCORPORATED
(Name of Small Business Issuer as specified in its charter)
Nevada 84-1398635
(State or other jurisdiction of (I.R.S. employer identification no.)
Incorporation or organization)
Carolina Place
2626 Glenwood Ave., Suite 200
Raleigh, North Carolina 27608
(Address of Principal Executive Offices)
(919) 571-4646
Registrant's Telephone Number
Securities registered pursuant to Section 12(b) of the Exchange Act: none
Securities registered pursuant to Section 12(g) of the Exchange Act: none
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
Common stock outstanding at June 30, 1998 33,984,435 shares at $0.001 par
value Common Stock.
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
June 30, 1998 Dec. 31,1997
------------- ------------
ASSETS
CURRENT ASSETS
Cash $ 211,010 $ 409,710
Certificates of deposit 667,186 1,079,053
Inventory 3,903,929 1,280,902
Employee and shareholders advances 55,545 59,220
Due from representatives (net of
allowance of $86,126 and $71,797) 621,121 686,365
Due from placement agent - 346,000
Due from credit card merchants 21,533 1,170,573
Other receivables 489,963 301,798
Deposits and prepaid expenses 6,452,940 434,181
------------- ------------
Total Current Assets 12,423,227 5,767,802
------------- ------------
PROPERTY AND EQUIPMENT AT COST
Assets not placed in service - 103,166
Computer software 979,589 873,725
Computer hardware 918,672 810,288
Office furniture and equipment 545,441 413,937
Vehicles 14,267 -
Leasehold improvements 478,616 257,900
Warehouse equipment 5,460 -
-------------- ------------
2,942,045 2,459,016
Less accumulated depreciation and
amortization 580,979 392,610
-------------- -------------
Net Property and Equipment 2,361,066 2,066,406
-------------- -------------
OTHER ASSETS
Deferred registration costs 266,639 1,673,401
Organization costs, net 106,606 131,989
Start-up costs, net 8,559 9,859
Acquisition costs, net 539,352 620,933
-------------- -------------
Total Other Assets 921,156 2,436,182
-------------- -------------
TOTAL ASSETS $ 15,705,449 $ 10,270,390
============== =============
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
June 30, 1998 Dec. 31,1997
----------------- ------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Trade accounts payable $ 6,540,683 $ 2,828,513
Product ordered payable to IRSRs 818,344 510,940
Other payable to IRSRs 21,605 243,117
Short-term notes payable 5,750,000 -
Cash overdrafts 1,027,040 321,304
Deferred revenue 2,438,999 2,473,780
Sales tax payable 191,954 21,845
Accrued payroll and payroll taxes 473,758 831,955
Accrued commissions 3,523,988 1,751,632
Accrued interest 901,671 161,660
------------- -------------
Total Current Liabilities 21,688,042 $ 9,144,746
------------- -------------
CONVERTIBLE SECURITIES
10% Convertible notes 448,000 4,335,662
8.5% Subordinated convertible
debentures 1,030,000 8,750,000
------------- -------------
Total Long-Term Liabilities 1,478,000 13,085,662
------------- -------------
TOTAL LIABILITIES 23,166,042 22,230,408
------------- -------------
STOCKHOLDERS' DEFICIT
Common stock, $.001 par value; authorized
100,000,000; issued and outstanding
33,984,435 at June 30, 1998 and
26,698,340 at December 31, 1997 33,985 26,698
Additional paid-in capital 13,563,948 1,169,911
Accumulated deficit (21,099,236) (13,178,393)
Accumulated other comprehensive income 40,710 21,766
------------- --------------
Total Stockholders' Equity
(Deficit) (7,460,593) (11,960,018)
------------- --------------
TOTAL LIABILITIES AND
STOCKHOLDERS' DEFICIT $ 15,705,449 $ 10,270,390
============= =============
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales $ 10,724,171 $ 28,376,132 $ 30,442,903 $ 64,820,585
Total Cost of Sales $ 12,027,706 $ 29,601,809 $ 26,251,204 $ 62,894,421
------------- ------------- ------------- -------------
GROSS INCOME $ (1,303,535) $ (1,225,677) $ 4,191,699 $ 1,926,164
SELLING & ADMINISTRATIVE
EXPENSES $ 6,954,593 $ 5,142,888 $ 12,112,542 $ 9,301,513
------------- ------------- ------------- -------------
Income before taxes $ (8,258,128) $ (6,368,565) $ (7,920,843) $ (7,375,349)
Provision for income taxes - - - -
NET INCOME/(LOSS) $ (8,258,128) $ (6,368,565) $ (7,920,843) $ (7,375,349)
Other comprehensive income, net of tax
Foreign currency translation
adjustments 22,444 919 18,944 1,738
COMPREHENSIVE INCOME/(LOSS) $ (8,235,684) $ (6,367,646) $ (7,901,899) $ (7,373,611)
Loss per common share
Basic (.2518) (.2945) (.2654) (.3410)
Diluted (.2518) (.2945) (.2654) (.3410)
Weighted average number of common shares
Outstanding 32,709,940 21,626,888 29,846,844 21,626,888
</TABLE>
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-------------------------------------
1998 1997
----------------- ------------------
NET CASH PROVIDED BY OPERATING
ACTIVITIES $ (3,243,951) $ (232,644)
----------------- ------------------
CASH FLOWS FROM INVESTING
ACTIVITIES
Purchases of property and equipment (483,029) (970,024)
Purchases of certificates of deposit 411,867 (288,536)
Maturity of certificate of deposit - 10,000
----------------- -------------------
NET CASH USED IN INVESTING ACTIVITIES (71,162) (1,248,560)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments for deferred registration costs (151,532) 568,100
Proceeds from convertible notes and
debentures 1,797,000 -
Proceeds from short-term note 750,000 -
Payments for acquisition cost (3,735) (441,000)
Cash overdraft 705,736 (95,708)
----------------- ------------------
NET CASH PROVIDED BY FINANCING 3,097,469 31,392
ACTIVITIES
EFFECT OF EXCHANGE RATE CHANGES
ON CASH 18,944 -
----------------- ------------------
NET INCREASE IN CASH AT END OF PERIOD (198,700) (1,449,812)
Cash at beginning of period 409,710 38,004
----------------- ------------------
CASH AT END OF PERIOD $ 211,010 $ (1,411,808)
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
CONDENSED STATEMENTS OF STOCKHOLDERS' EQUITY(DEFICIT)
YEAR ENDED DECEMBER 31, 1997 AND QUARTER ENDED JUNE 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Common Stock:$.001 par value Accumulated Total
100,000,000 shares authorized Additional Other Shareholder's
Paid-in Comprehensive Accumulated Equity
Shares* Amount* Capital* Income Deficit (Deficit)
------------- -------------- ---------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance-December 31, 1996 25,717,009 $ 25,717 $ 894,879 $ 2,803 $ (616,572) $ 305,827
Exercise of Options 35 - 13 - - 13
Issuance of Common Stock
For services rendered and
Acquisition costs 961,196 981 265,019 - - 266,000
Value attributed to options
Granted for services - - 10,000 - - 10,000
Adjustment for foreign
Currency translation - - - 18,963 - 18,963
Net Loss - - - - (12,560,821) (12,560,821)
Balance-December 31, 1997 26,698,240 25,698 1,169,911 21,766 (13,178,393) (11,960,018)
Net assets acquired in
Reverse acquisition - - (4,013) - - (4,013)
Issuance of common stock
For convertible notes 7,286,195 7,287 12,398,050 - - 12,405,337
Adjustment for foreign
Currency translation - - - 18,944 - 18,944
Net loss - - - - 7,920,843 7,920,843
------------ ------------- ------------ --------- -------------- -------------
Balance-June 30, 1988 33,984,435 $ 33,985 $13,563,948 $ 40,710 $ (21,099,236) $ (7,460,593)
*Restated to reflect capitalization. See Note 7 for additional information.
</TABLE>
<PAGE>
INTERNATIONAL HERITAGE, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 1998
NOTE 1: THE COMPANIES AND SIGNIFICANT ACCOUNTING POLICIES
OVERVIEW International Heritage, Inc. ("IHI") was incorporated in North
Carolina on April 28, 1995. It is principally engaged in the direct sale of
high quality nutritional and skin care products, fine jewelry, collectibles,
pro-line golf products and accessories, premium incentive products and
telecommunications products and services in forty-nine states. The Company
recruits Independent Retail Sales Representatives ("IRSRs") who build retail
sales organizations. IRSRs purchase products from the Company and retail them
to the public.
IHI has a wholly-owned subsidiary, International Heritage of Canada, Inc. that
was incorporated in Ontario, Canada on July 26, 1995, and is engaged in the
same direct sales networking business in Canada as the parent Company. The
accounts of the Canadian Company have been consolidated with the Company and
all significant intercompany accounts and transactions have been eliminated.
Kara International, Inc. ("Kara") was incorporated in the State of Nevada
under the then name of R & D Connections on April 22, 1985. Kara completed a
public offering of common stock during 1986. On September 22, 1986, Kara
acquired all of the outstanding shares of Kara Incorporated, a Utah
corporation, that manufactured and marketed candy, and changed its name to
Kara International, Inc. From September 1986, Kara commenced operating the
business of marketing and developing confectionery products. Kara abandoned
its subsidiary operation during the last quarter of 1988. Kara is not
currently engaged in any business activity.
On March 6, 1998, IHI entered into a share-for-share exchange with Kara, as
described further in Note 7 to the Condensed Consolidated Financial
Statements. The combined Companies are herein referred to as International
Heritage, Incorporated or Company.
MANAGEMENT REPRESENTATION The financial information included herein is
unaudited; however, the information reflects all adjustments (consisting
solely of normal recurring adjustments) that are, in the opinion of
management, necessary to a fair presentation of the financial position,
results of operations, and cash flows for the interim periods. The balance
sheet statements of operations and comprehensive income and statements of
cashflows as of December 31, 1997 were derived from audited financial
statements.
USE OF ESTIMATES - The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect certain reported amounts and
disclosures. Accordingly, actual results could differ from those estimates.
NOTE 2: INVENTORY Inventory is stated at the lower of cost or market, with
cost determined under the first-in first-out (FIFO) method. Inventory consists
primarily of skin care and nutritional products, retail business career kits,
promotional items and display jewelry and collectibles. A write down of $2
million occurred in the second quarter ending June 30, 1998 as a direct result
of the Court Order dated April 3, 1998 in the action: Securities and Exchange
Commission v. International Heritage, Inc. et. al., U.S.D.C., Northern
District Georgia, Atlanta Division, 1:98-0803-RWS ("SEC action").
June 30 March 30
1998 1998
-------------- --------------
Skin Care $ 473,121 $ 1,535,228
Nutritional Products $ 1,092,400 $ 1,569,866
Jewelry $ 307,457 $ 223,205
Marketing Materials $ 2,030,950 $2,546,028
-------------- --------------
$ 3,903,929 $ 5,874,328
NOTE 3: CONTINGENCIES
Subsequent to the initial issuance of common stock by the Company's
subsidiary, International Heritage, Inc. ("IHI") in 1995 and 1996, for
$111,491 in cash and services, IHI received $809,105 of funds and services
from potential investors. IHI sold these securities under an exemption from
registration; however, it was later determined that the exemption may have
been technically deficient in some states. Thus, IHI voluntarily (under no
regulatory directive) offered to rescind such prior sales to all investors
who deposited monies during the period from May to December 1995 by refunding
the price paid for the securities plus interest (the "Rescission Offer"). IHI
has recorded deposits made by investors who rejected the Rescission Offer as
equity. Four investors, for a total of $20,000, accepted the Rescission Offer
and received a refund. In addition, IHI refunded $100,650 plus interest to
potential investors from the state of Washington, since IHI withdrew its
offering in that state. All other investors rejected the Rescission Offer. Any
investor who rejected the Rescission Offer received shares of the Company's
stock at the rate of 7.5 shares for each $10 investment. As a result of these
transactions leading to the Rescission Offer, the Company may be liable for
administrative penalties and sanctions. The Company knows of no
administrative proceedings or regulatory investigations related to the
Rescission Offer that are currently pending or proposed. The amount of any
such penalties and sanctions cannot be estimated.
On June 3, 1997, the Company entered into an agreement with the North Carolina
Attorney General ("NCAG") ending the NCAG's threat to bring action against the
Company for alleged violation of the North Carolina Pyramid Schemes Act and
the North Carolina Unfair and Deceptive Trade Practices Act. The agreement
resulted in the payment of $100,000 to cover attorneys' fees, costs of
investigation and for consumer protection enforcement purposes, and the
imposition of certain remedial measures including the modification of the
Company's marketing plan in North Carolina, ongoing reporting by the Company
and monitoring of the Company's activities by the NCAG. The violation of the
agreement would likely result in injunctive action by the NCAG. Management
believes the Company remains in compliance with the provisions of the
agreement.
On February 6, 1998, an Assurance of Voluntary Compliance (the "Assurance")
was accepted by the Georgia Office of Consumer Affairs. The Assurance was
entered into by the Company without admission to alleged violation of the
Georgia Fair Business Act of 1995, as amended, in order to resolve an
investigation and examination of certain acts and practices of the Company
without the necessity of formal legal action. The Assurance resulted in the
Company paying $20,000 to reimburse the Georgia Office of Consumer Affairs for
investigative costs, $70,000 to be applied to the Georgia Consumer
Preventative Education Plan, and the imposition of certain remedial measures
including the provision of refunds. On July 7, 1998, a Supplemental Assurance
of Voluntary Compliance was entered into, establishing an orderly course of
payment for all refunds to Georgia residents entitled to the same by December
31, 1998.
On October 3, 1998 the Michigan Attorney General's office issued a Notice of
Intended Action to IHI. IHI had 10 days to respond to this Notice that alleged
that IHI's marketing plan violated the Michigan Consumer Protection Act. IHI
responded within the 10-day period, and the Attorney General's office and IHI
agreed to enter into an Assurance of Voluntary Compliance on March 2, 1998
without admission by either party as to any issue of fact or law. IHI agreed
to maintain a system to verify that compensation to participants is based on
the sale of products to verified end users, including the Amway 70% rule and a
policy requiring the participant to have made at least 2 retail sales to end
users within the previous month. IHI also agreed to maintain a one year, 90%
buy back provision; maintain a policy and practice that restricts purchases to
a maximum of $500 during the first six months of participation, exclusive of
products purchased for sales to consumers; offer refunds to those participants
who purchased more than $500 during the first six months of their
participation; and pay $25,000 to cover investigative costs. IHI is only
required to pay $1,000 with the balance of $24,000 suspended for 1 year. If
after 1 year there are no violations of the Michigan Consumer Protection Act,
the balance will be waived.
The Company periodically receives inquiries and/or investigative demand
letters from various state agencies. The Company is not currently aware of
any pending or threatened litigation pursuant to which fines may be imposed,
except as disclosed herein. Regulations regarding network marketing companies
vary from jurisdiction to jurisdiction. Failure to comply with the laws of any
jurisdiction can result in the inability to operate therein for indefinite
periods of time. The Company may also become involved in other matters of
litigation in the normal course of business. The Company is not aware of any
pending or threatened proceeding, except as disclosed herein.
On October 23, 1997, in the General Court of Justice, Superior Court Division,
Wake County, North Carolina, an action was filed by Eric S. Block and Tina
Block against the Company. The plaintiffs alleged fraud, breach of contract,
unfair and deceptive trade practices in violation of North Carolina law, and
punitive damages. Plaintiffs sought relief in the form of actual and
compensatory damages, consequential damages, punitive damages, and treble
damages (all in excess of $10,000), attorney's fees and other relief. This
matter was resolved June 25, 1998 by the filing of a Stipulation of Voluntary
Dismissal. The terms of the settlement are subject to a confidentiality
agreement.
On March 13, 1998, the Securities and Exchange Commission ("SEC") suspended
trading of the Company's common stock until March 26, 1998, because of
questions regarding the accuracy of statements concerning, among other things,
the return investors could expect to make on their investment and the
regulatory background of the Company and its President. On March 16, 1998, the
SEC filed a Complaint for Injunctive and Other Relief against the Company, the
Company's three founders individually, and Incorporated (the "Defendants").
The SEC alleges that the Defendants engaged in the sale of unregistered
securities; made misrepresentations and material omissions in connection with
the sale of securities; and, knowingly misrepresented the Company's financial
condition and concealed that it was operating a pyramid scheme. The Court
entered, ex parte, an Order to Show Cause, Temporary Restraining Order, Order
Freezing Assets, Order Prohibiting Destruction of Documents and Order
Expediting Discovery as well as an Order Appointing a Receiver for the
Company. On March 17, 1998 the Court amended the above Orders to allow the
Company to accept new product sales orders from existing IRSRs for the
Company's new nutritional and skin care products and telecommunication
services. On March 24, 1998, the Defendants filed a Memorandum in Opposition
to the SEC's Motion for Preliminary Injunction and Other Equitable Relief. On
April 3, 1998, the Court entered a Memorandum Opinion and Order setting forth
that the Company, its officers, agents, servants, employees, attorneys and
persons in active concert or participation with them be restrained from, among
other things: securities law violations; appointing a Monitor; requiring the
posting of a $5 million bond upon which the receivership would be dissolved
and management reinstated; a 50% reduction in the President's compensation;
and certain other things. On April 9, 1998, the $5 million bond was posted by
the President and the Receiver was relieved of his responsibilities.
Subsequently, pursuant to an Order dated July 1, 1998, the Company secured and
posted a 70% collateralized surety bond freeing up $1,500,000 previously
loaned by the Company's President for the posting of the aforementioned bond.
The Company's President, upon repayment of the $1.5 million plus interest of
$47,484, from the replacement of the cash bond, executed options at a per
share price of $1.33 for 1,163,522 shares of Company common stock. On April
22, 1998, the Court reviewed the Company's revised IRSR compensation plan and
authorized the Company to conduct business consistent with the revised plan
and under the scrutiny of the Monitor. Management of the Company intends to
vigorously defend this action. The ultimate outcome of this matter cannot
presently be determined and no adjustments have been made to the consolidated
financial statements. The SEC action has had and continues to have an
extremely negative impact on the day-to-day operations and the depleting
operating capital. Tangible costs directly attributable to the SEC action for
the period ending June 30, 1998 are;
Additional Cash Out and refund requests over and above
historical amounts $ 3,753,000
Legal costs, Receiver costs and Court-appointed Monitor
costs associated with the SEC action and class action
lawsuits $ 1,041,305
Business material write-offs $ 2,000,000
Total SEC related costs for the six month period ending
June 30, 1998 $ 6,794,305
Costs to secure additional financing needed
to bridge the operating cash flow deficiency resulting
from the SEC action $ 364,372
On April 3, 1998, the Montana Securities Commissioner issued a Cease and
Desist Order in the matter of International Heritage, Inc., Stanley H. Van
Etten, Claude W. Savage, Larry G. Smith and International Heritage,
Incorporated, a Nevada corporation, and their agents and representatives, Case
No. I-04-02-98-04. The Order concluded that the Company's marketing program
is a security within the meaning of the Montana Securities Act and that such
has been and is offered and sold in violation of the Montana securities laws.
On April 20, 1998, the Montana Securities Commissioner amended the Order,
finding among other things, that the President made inaccurate statements to
Montana IRSRs regarding the terms and status of the original Order. Under
both Orders, the Montana Securities Commissioner ordered the Defendants to
cease and desist violations of the Montana securities laws and sought fines up
to $250,000 and restitution to Montana residents. A hearing was set for May
26, 1998. On May 1, 1998, the Company signed a Consent Agreement with the
Montana Securities Commissioner allowing the Company to do business in the
State under its new compensation plan. In accordance with the Consent
Agreement, the Company must pay: $21,000 to reimburse the State's
investigative costs; must allow refunds to any Montana resident Independent
Retail Sales Representative ("IRSR") who executed a Retail Business Agreement
("RBA") with the Company and requests a refund within 45 days of written
notice from the Company (refunds shall be less any commissions or refunds
previously paid, as well as the retail value of any products received); offer
the right to rescind the sale of any notes purchased by citizens of the State
of Montana between July 17, 1997 and October 31, 1997; contribute to youth
activities and consumer protection efforts in the State of Montana; and
provide documents upon the reasonable request of the Commissioner to monitor
compliance with the Order. No adjustments have been made to the consolidated
financial statements as a result of this matter.
On March 24, 1998, a class action complaint was filed in the U.S. District
Court for the Eastern District of North Carolina on behalf of Sharon A.
Meckenstock, Dan H. Meckenstock, Custodian FBO Jean Carol Meckenstock and
Wilber E. Meckenstock, on their own behalf and on behalf of a class of all
persons similarly situated v. International Heritage, Inc., Stanley H. Van
Etten, Claude W. Savage, Larry G. Smith, International Heritage, Incorporated,
Civil Action No. 5:98-CV-237-BR-2 ("Meckenstock"). On March 27, 1998, a class
action complaint was filed in the District Court of Dallas County, Texas,
101st Judicial District, by Denise Marsh, Felix Glen Ortega, Lupe Ortega,
individually and on behalf of all others similarly situated v. International
Heritage, Inc., Stanley H. Van Etten, Claude W. Savage and Larry Smith, Case
No. 98-2332-E. On March 18, 1998, a class action complaint was filed in the
Circuit Court of Dallas County, Texas, F-116th Judicial District by Craig T.
Liebendorfer, individually, and on behalf of all others similarly situated v.
International Heritage, Inc., Case No. DV98-2241. On April 1, 1998, a class
action complaint was filed in the Circuit Court of Barbour County, Alabama, by
Randall L. Greene, Andy Clark, Jackson Wayne Murphy, Donnie Kenneth Broderway,
James H. Thomas, individually and on behalf of all others similarly situated
v. International Heritage, Incorporated, a foreign corporation, et. al., Case
No. CV-98-42. On April 7, 1998, a class action complaint was filed in the
General Court of Justice, Superior Court Division, Wake County, North
Carolina, by William Swinney and Marshall Reddy, individually and as
representatives of a class of all similarly situated sales representatives in
the Company v. Stanley H. Van Etten, Clyde [sic] Savage, Larry Smith,
International Heritage, Inc. and the remaining members of the Board of
Directors, File No. 98 CVS 04277 ("Swinney"). All of these class action
lawsuits, other than Meckenstock, allege the Defendants defrauded investors
used misrepresentations and omissions of material facts in an unlawful and
fraudulent scheme to offer and sell securities of the Company through
recruiting people to buy interests in business centers, among other things.
Plaintiffs in all of these class actions, collectively seek relief, through
class action status in the form of actual damages, punitive damages, legal
fees and other relief up to $300 million. However, many of the potential
class members would include the same persons as those for which the SEC is
seeking relief in the SEC action and it is arguable that potential class
plaintiffs would be prohibited from receiving multiple recovery in more than
one legal action. In addition, there are an unidentifiable number of
potential unasserted claims in the form of class actions otherwise growing out
of the SEC action. Swinney settled pursuant to a settlement agreement,
wherein the parties neither admitted nor denied any wrongdoing, and the
Company paid plaintiffs a nominal amount to dismiss the action. The specific
terms of the settlement are subject to a confidentiality agreement. The
ultimate outcome of these actions and unasserted claims cannot be presently
determined; however, given the Court's April 22, 1998 authorization for the
Company to conduct business under its revised compensation plan as referred to
above, the Defendants intend to vigorously defend these actions.
NOTE 5: NOTES PAYABLE AND CONVERTIBLE DEBENTURES
During 1997, the Company issued $4,335,662 in convertible notes in a private
placement conducted pursuant to Rule 506 of Regulation D of the Securities Act
of 1933, as amended, ("Securities Act"). The notes bear interest at a rate of
ten percent per annum. Principal and interest are due August 1, 1999, with
interest payable quarterly. The notes are convertible into one share of
common stock for each $2.00 principal amount of the notes. The notes
automatically convert under the same terms upon: (1) an initial public
offering providing gross proceeds of a minimum of $10,000,000 at a per share
price of no less than $4.00, (2) a sale of all or substantially all of the
assets of the Company to a public company and the per share price of the
common stock of such company remains over $4.00 for any thirty-day period
thereafter, or (3) any recapitalization, reconsolidation, merger or
acquisition of or by the Company that results in the existing shareholders of
the Company owning less than 51% of the Company and the per share price of the
common stock of the Company remains over $4.00 for any 30-day period
thereafter. The notes contain covenants restricting dividend payments and
increase in executive compensation. The Company capitalized $553,120 in
deferred registration costs, of which $288,895 has been amortized as of June
30, 1998 and $90,380 as of December 31, 1997. Interest expense was $108,390
in the quarter ended June 30, 1998 and $-0- in the quarter ended June 30,
1997. As of June 30, 1998, approximately $4,114,696 in note principal and
accrued interest were converted to 2,057,348 shares of common stock in
accordance with the conversion terms, and $229,398 in related deferred
registration costs was charged to additional paid in capital.
During 1997 and 1998, the Company issued $10,537,000 in subordinated
convertible debentures in a private placement to non-US residents pursuant to
Regulation S of the Securities Act. The debentures bear interest at 8.5% per
annum and mature December 15, 1999. Interest is payable in semi-annual
payments on June 15 and December 15 of each year, commencing June 15, 1998.
The debentures are subordinate to the Regulation D convertible notes. The
debentures are convertible into 5,000 shares of common stock and warrants to
purchase 3,000 shares of common stock at $4.00 per share for each $10,000
debenture. The debentures automatically convert under the same terms upon the
same conditions as the Regulation D convertible notes described above. Upon
automatic conversion, the debenture holder shall receive a premium of 500
additional shares of common stock. The debenture holders shall receive a
premium for voluntary conversion per each $10,000 debenture as follows: 500
additional shares of common stock if redemption occurs prior to June 15, 1998;
400 additional shares if prior to December 15, 1998; 300 additional shares if
prior to June 15, 1999; and 100 additional shares if prior to December 15,
1999. The warrants are exercisable by the holder at an exercise price of
$4.00 per share on or before December 15, 1999. As of June 30, 1998,
$9,507,000 in debentures were converted into 5,228,850 shares of common stock
and 2,852,100 warrants and $772,182 in related deferred registration costs was
charged to additional paid in capital. The Company capitalized $1,375,596 in
deferred registration costs, of which $146,822 has been amortized as of June
30, 1998 and $13,405 as of December 31,1997.
Total Interest expense was $212,499 in the quarter ended June 30, 1998 and $0
in the quarter ended June 30, 1997.
NOTE 6: STOCK OPTIONS
During 1995, the Company granted the initial Board of Directors and founders
options for 5% of the issued and outstanding shares at $.02 per share.
Effective October 31, 1996, the Board of Directors approved, and the original
founders accepted, the cancellation of these options and the grant of new
options for 1,350,000 shares in exchange for the canceled options. These new
options are exercisable at $1.33 per share and expire October 31, 1999. These
options remain outstanding at June 30, 1998 and are not subject to the option
plan noted below.
In 1996, the Company issued Mayflower Holdings, Inc. 187,500 shares of common
stock (valued at $250,000) in exchange for consulting fees. The shares were
then canceled and options were granted for 375,000 shares effective October
31, 1996, at an exercise price of $1.33 per share. The options expire on
October 31, 1999, and are outstanding as of June 30, 1998. During 1997, all
shares and options issued to Mayflower Holdings, Inc. were reissued in the
President's name. These options are not subject to the option plan noted
below.
Under a 1995 employment contract and based on the Company's achievement of
certain revenue goals, the President of the Company is entitled to receive
stock incentives in the amount of 1% of issued and outstanding shares as of
December 31, 1995, 2% as of December 31, 1996, and 3% as of each year ended
December 31, 1997 through 2000. These stock incentives were granted to the
President as additional compensation and were at no cost to the President. In
1995, the Company did not meet the sales level noted in the President's
contract, but in March 1996, the Board granted the incentive stock to the
President based on accrued sales and deferred revenue combined. Effective
October 31, 1996, the President gave back the incentive stock and the Company
granted additional stock options of 151,300 shares of common stock at an
exercise price of $1.33 per share. Effective October 31, 1996, the President
voluntarily agreed to accept grants of stock options for 2,295,000 shares,
exercisable at $1.33 per share in exchange for the 1996, 1997, 1998, 1999 and
2000 incentive stock referred to above in order to eliminate the contingent
stock issuances. As a result of having been granted these options, the
President is no longer entitled to receive the stock incentives referred to
above and the options are not contingent on the Company's achievement of the
specified revenue goals. These options are outstanding as of June 30, 1998,
expire on October 31, 2001, and are not subject to the option plan noted
below. No compensation expense has been recorded since the options granted
have exercise prices that approximate fair market value.
In 1996, the Company formalized and consolidated all previously existing
options into a single option plan effective October 31, 1996, and reissued
options for 3,579,250 shares (previously 3,175,000 shares) to its Board of
Directors, management, advisory board members, consultants, named experts and
counsel, IRSRs and others. These options are exercisable at $1.33 per share
and expire on October 31, 1999. 3,495,000 of these options are outstanding as
of June 30, 1998.
In 1997, the Company granted the three Company founders options for 2,700,000
shares. These options are exercisable at $2.00 per share and expire October
31, 1999. The Company also granted the President options for 1,085,500
shares. These options are exercisable at $2.00 per share and expire December
19, 2000. The Company also granted options for 384,628 shares to others
during 1997. These options are exercisable at $2.00 per share and expire
December 19, 2000. All of these options are outstanding at June 30, 1998 and
are not subject to the option plan noted above.
In 1997, the Company granted options to its Board of Directors, management,
advisory board members, consultants, named experts and counsel, IRSRs and
others in the amount of 3,330,000 shares. 1,038,000 of these options are
exercisable at $1.33 per share and expire on various dates in 2000. 2,292,000
of these options are exercisable at $2.00 per share and expire on various
dates in 2000. 3,329,990 of these options are outstanding at June 30, 1998
and are subject to the option plan noted above.
During 1997, the Board of Directors approved the number of shares authorized
for grant as options under the option plan as 25% of authorized common stock.
As of December 31, 1997, the Company had issued 574,990 more options than was
authorized under the option plan, and the plan was closed. On February 27,
1998, but with a record date of December 31, 1997, the shareholders approved
an increase in authorized shares of common stock to 50,000,000 shares. As a
result of this increase, the number of options granted under the option plan
no longer exceeded the maximum authorized.
During the quarter ended June 30, 1998, no options were granted or exercised.
The weighted average exercise price for all outstanding options is $1.62 per
share. If all of the above options were exercised as of June 30, 1998, this
would result in approximately 15,000,000 shares of additional outstanding
common stock.
NOTE 7: ACQUISITION
On March 6, 1998, the Company entered into a share-for-share exchange with
Kara International, Inc. ("Kara"), a Nevada corporation whose common stock is
quoted and publicly traded on the Over-the-Counter Bulletin Board. The
transaction is viewed as a reverse acquisition and is treated as a
recapitalization of the Company for accounting purposes. Each outstanding
share of the Company was exchanged for three shares of Kara and each
outstanding option outside of the option plan described in Note 6 of the
Company was exchanged for one option to acquire one share of Kara on like
terms and conditions. Options subject to option plan described in Note 4
shall be exchanged for similar options, as not yet determined. 7,379,493
shares (97.73%) of the Company were exchanged for 22,138,479 shares of Kara,
and 8,341,428 options of the Company were exchanged for 8,341,428 options of
Kara. Effective March 3, 1998, Kara amended its articles of incorporation to
change its name to "International Heritage, Incorporated" and increase its
authorized capital from 50,000,000 shares to 100,000,000 shares of common
stock at $0.001 par value. The shares of Kara received in exchange by the
Company's stockholders are restricted and subject to Rule 144 of the
Securities Act and must be held for a period of one year (or two years, as
applicable) in order to comply with the rule.
The Company has convertible notes and debentures outstanding as of June 30,
1998 which are convertible into 481,500 shares of common stock plus warrants
to purchase 2,852,000 shares of common stock. These potentially dilutive
securities were not included in the computation of diluted earnings per share
since to do so would have an anti-dilutive effect.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with the Condensed
Consolidated Statements and the notes thereto.
FINANCIAL UPDATE
The Company has been operating under extremely adverse conditions as a result
of the SEC action and including SEC related costs the Company lost $8,258,128
for the second quarter and $7,920,648 for the 6 months ending June 30, 1998.
The operating loss for the 6 months ending June 30, 1998, excluding SEC
related costs of $6,794,305 and finance/interest expenses of $1,041,305 was
$85,038 as compared to a $7,375,349 operating loss for the 6 months ending
June 30, 1997. Considering the negative impact of external factors, management
believes the Company has performed well from an operational standpoint.
As a result of the SEC action and the other class actions management has
serious short-term and long-term liquidity concerns. If the SEC action had
not been brought and there were no restrictions with respect to capital
raising (as there currently are in place pursuant to the court's Order dated
April 3, 1998) the Company would have conducted a secondary offering after the
completion of its reverse merger, with the goal of raising $25 to 50 million
to fund further domestic growth and international expansion. Furthermore, if
the SEC action were not pending, holders of the 2,852,100 warrants have
indicated their intention to exercise the same, which would provide the
Company with $11,408,400 in additional working capital. Management is working
diligently to expedite a resolution to or a hearing of the SEC action so as to
enable the Company to pursue additional opportunities to satisfy its current
and future liquidity concerns.
SALES
Net Sales for the second quarter of Fiscal 1998 were $10,724,171 as compared
to sales for the first quarter of Fiscal 1998 of $19,718,732, or a 46%
decrease in revenues which management attributes directly to the SEC action
and the other class actions. New IRSRs recruited during the first quarter of
1998 were 17,618 or an average of 1,468 per week. Recruiting decreased
significantly in the second quarter of 1998 as a result of the SEC action to
8,515 or 709 per week. Prior to the SEC action, management had anticipated
doubling first quarter 1998 sales from new product launches and increased
momentum within the network of IRSRs. From March 16 to April 3, 1998 the
Company was ordered not to sign any new IRSRs into the Company. In addition,
the Company was allowed to ship only a limited select line of products to
existing IRSRs. Management considers sales generated in the second quarter of
Fiscal 1998 to be a strong indication of the belief and confidence its IRSRs
continue to have in the Company.
COST OF SALES
Gross profit margin for the period ending March 31, 1998 was 27.8% as compared
to 3% for the first quarter ending March 31, 1997. Gross profit margins for
periods ending June 30, 1998 and June 30, 1997 are 13.7% and 3% respectively.
The low profit margin for the period ending June 30, 1998 is related to write-
offs of business and marketing materials of $2,000,000 and additional cash
outs and refunds of $3,753,000 which management directly attributes to the SEC
action. Adding back these costs provides the Company with a 32.5% profit
margin. This increase in operational specific margins is from the addition of
the higher profit consumable products and the introduction of the Flex-Level
compensation program which caps commission payouts at 55% of commissionable
sales. Direct consumable product orders accounted for 34% in the second
quarter as compared with 7.8% in the first quarter. Management anticipates
consumable sales to contribute over 50% of its revenues in the third quarter,
thereby increasing profitability even further.
SALES AND ADMINISTRATIVE EXPENSES
Overheads were 39.7% of sales for the period ending June 30, 1998 as compared
with 14.3% for the period ending June 30, 1997. The increase is a direct
result of the large decrease in sales. During the second quarter ending June
30, 1998, management reduced staffing costs by $1,9280,000 on an annualized
basis. The Company has also implemented a cost justification program thereby
examining all facets of the business to ensure efficient use of working
capital. The Company's President voluntarily took a 50% pay decrease and
other senior managers volunteered reductions in their salaries in order to
reduce costs, increase operating profitability and preserve operating capital.
SEC RELATED COSTS
i) Tangible
Legal Fees - Legal Fees directly related to the SEC action and class action
law suits in the second quarter total $ 845,404.75. In addition to these
expenses $120,000 has been disbursed as retainer fees to various firms,
bringing the total use of working capital for SEC related legal fees to
$965,404.
Monitor and Receiver Fees - Court appointed Monitor fees (including monitor,
monitor's accountant and monitor's legal fees) total $131,000, plus an
additional $50,000 retainer requested by the monitor, for the three months
ending June 30, 1998. In addition, Receiver fees in March 1998 were
approximately $120,000. In the six months ending June 30,1998 Monitor and
Receiver fees have utilized over $300,000 of the Company's working capital.
Cash Outs/Refunds - Negative publicity and uncertainty within the IRSR network
resulting from the SEC action precipitated substantial refund and cash out
requests of $3,753,000, over and above historical levels. The requests are
being paid out over a six month period, as agreed with several State Attorneys
General.
Inventory Write-Offs - Business and marketing materials in the amount of
$2,000,000 became unusable and were written off as a direct result of the SEC
action, and more specifically the court's Order dated April 3, 1998.
Judgement Bond - As part of the conditions of the Court Order, the Company was
ordered to post a $5,000,000 bond with the court. The 100% collateralized
bond was personally funded by the Company's President. The Company
subsequently secured a 70% collateralized surety bond freeing up $1.5 million.
The President, upon repayment of the $1.5 million plus interest of
$47,484, exercised options at a per share price of $1.33 for 1,163,522 shares
of common stock.
SEC Settlement Reserve - The Company is currently in discussions with the SEC
aimed at resolving the SEC action taken against the Company. Management
anticipates reaching an amicable settlement at some time in the future and
therefore, the Company has reserved an amount equal to the court bond of
$5,000,000 for these purposes. Management believes that whatever amount is
necessary to settle the SEC action shall also serve as a settlement fund for
the various class actions since all of the claims are substantially similar
and potential class plaintiffs would be prohibited from recovery in more than
one legal action.
ii) Intangible
Sales decreased by 46% from second quarter of 1997 to second quarter 1998 as a
direct result of the SEC action. The Company cannot easily identify the
tangible negative impact the action has had, and continues to have, on sales
and new IRSR sign-ups. At the time the SEC action was commenced, the Company
had just launched its new consumable products in conjunction with the Flex-
Level Compensation plan. The weekend prior to the commencement of the SEC
action, the Company held its third annual convention in New Orleans which was
attended by over 12,000 IRSRs and guests. 1998 sales projections, prior to the
SEC action, were $150,000,000 and the revised forecast is approximately $55
million for fiscal year end December 31, 1998. It is difficult to quantify
those individuals who would otherwise join the Company as IRSRs if it were not
for the SEC action.
Vendors having a long-term association with IHI have been understanding of the
Company's situation but many have instituted COD payment terms. This exerts
extreme pressure on the Company's working capital and has a negative
cumulative effect on the Company's ability to meet current obligations.
The Company's previous credit card processor terminated its relationship with
the Company on June 4, 1998 in response to their strategic decision to focus
on industry segments other than direct sales and networking companies. The
Company secured a new credit card processor and is building a solid business
relationship with them. The Company's current monthly processing limit is $2
million and therefore the Company is attempting to increase the monthly
processing cap, as well as seek other processors and provide payment
alternatives such as check draft authorization.
Centura Bank ended its banking relationship with the Company during the second
quarter as a result of the pending litigation. Management has secured another
banking relationship.
WORKING CAPITAL
The SEC action has had a severe negative impact on the Company's working
capital, both in expense outlays and a material decrease in revenues.
Obtaining short-term working capital is an immediate priority of management
and they are pursuing several potential sources which do not violate the
capital raising restrictions imposed by the court's Order in the SEC action.
NEW PRODUCTS
The Company has introduced EarthPals TM, a new children's chewable vitamin to
be included in its proprietary nutritional product line as well as a new
Travel Pack for the Company's patented Skin Care product line, Tyra.
Management anticipates that these additional products will further increase
consumable product sales which generate higher profit margins than some of the
Company's product lines consisting primarily of durable goods.
The Company has also made its telecommunications products available for
commissions to be earned under the Flex-Level compensation plan. The
Company's telecommunications strategic partnership with Business
Telecommunications Inc. is competitive in rate and price structure with AT&T,
MCI and Sprint, and provides IRSRs with the ability to earn commissions on the
sale and usage of its telecommunications product. The Company has a similar
strategic partnership in Canada with Sprint Canada. Management anticipates
this program will contribute significantly to future sales.
ITEM 1 Legal Proceedings
Registrant incorporates by reference Current Form 8-K dated March
16, 1998, Current Form 8-KA No. 1 dated March 16, 1998, Current Form 8KA No. 2
dated March 16, 1998, and Current Form 8K dated July 17, 1998.
ITEM 2 Change in Securities
None
ITEM 3 Defaults on Senior Securities
As of the date of this filing, Registrant has not yet paid
$31,025.00 of accrued interest due June 15, 1998 on 8.5% Convertible
Debentures issued pursuant to a private placement to non-US residents
conducted pursuant to Regulation S of the Securities Act, due to the fact that
the escrow agent has failed to provide the Registrant with payment
instructions for the respective debenture holders. Registrant anticipates
paying all such accrued but unpaid interest prior to the filing of the Form
10-Q for the period ended September 30, 1998.
ITEM 4 Submission on Matters to a Vote of Security Holders
None
ITEM 5 Other Information
None
ITEM 6 Exhibits and Reports on Form 8-K
Exhibits
None
Reports on Form 8-K
None
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this Report to be singed on its behalf by the
undersigned hereunto duly authorized.
INTERNATIONAL HERITAGE, INCORPORATED
DATED: 08/14/1998 By /s/ Stanley H. Van Etten
______________________________________
President, CEO and Chairman
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from 10QSB and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 211,010
<SECURITIES> 667,186
<RECEIVABLES> 1,274,288
<ALLOWANCES> 86,126
<INVENTORY> 3,903,929
<CURRENT-ASSETS> 12,423,227
<PP&E> 2,942,045
<DEPRECIATION> 580,979
<TOTAL-ASSETS> 15,705,449
<CURRENT-LIABILITIES> 21,688,042
<BONDS> 1,030,000
0
0
<COMMON> 33,985
<OTHER-SE> (7,494,578)
<TOTAL-LIABILITY-AND-EQUITY> 15,705,449
<SALES> 30,442,903
<TOTAL-REVENUES> 30,442,903
<CGS> 26,251,204
<TOTAL-COSTS> 26,251,204
<OTHER-EXPENSES> 12,112,542
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 978,049
<INCOME-PRETAX> (7,920,843)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,920,843)
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,920,843)
<EPS-PRIMARY> (.265)
<EPS-DILUTED> (.265)
</TABLE>
