TABLE OF
CONTENTS
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Our Product Categories |
-3- |
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Sourcing and Production |
-7- |
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Research and Development |
-7- |
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Geographic Sales Regions |
-8- |
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Intellectual Property |
-15- |
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Government Regulation |
-15- |
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Available Information |
-20- |
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ITEM 1A. |
RISK FACTORS |
-22- |
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ITEM 1B. |
UNRESOLVED STAFF COMMENTS |
-36- |
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ITEM 3. |
LEGAL PROCEEDINGS |
-37- |
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ITEM 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
-38- |
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ITEM 5. |
MARKET FOR REGISTRANTS COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
-38- |
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ITEM 6. |
SELECTED FINANCIAL DATA |
-41- |
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ITEM 7. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |
-42- |
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ITEM 7A. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK |
-68- |
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ITEM 8. |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
-68- |
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ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE |
-100- |
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ITEM 9A. |
CONTROLS AND PROCEDURES |
-100- |
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ITEM 9B. |
OTHER INFORMATION |
-101- |
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ITEM 10. |
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE ACCOUNTING AND FINANCIAL DISCLOSURE |
-101- |
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ITEM 11. |
EXECUTIVE COMPENSATION |
-101- |
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ITEM 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
-101- |
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ITEM 13. |
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE |
-101- |
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ITEM 14. |
PRINCIPAL ACCOUNTANT FEES AND SERVICES |
-101- |
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ITEM 15. |
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
-101- |
-i-
FORWARD-LOOKING
STATEMENTS
THIS
ANNUAL REPORT ON FORM 10-K, IN PARTICULAR ITEM 7. MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION, AND ITEM 1.
BUSINESS, INCLUDE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE STATEMENTS REPRESENT
OUR EXPECTATIONS OR BELIEFS CONCERNING, AMONG OTHER THINGS, FUTURE REVENUE, EARNINGS,
GROWTH STRATEGIES, NEW PRODUCTS AND INITIATIVES, FUTURE OPERATIONS AND OPERATING RESULTS,
AND FUTURE BUSINESS AND MARKET OPPORTUNITIES. WE UNDERTAKE NO OBLIGATION TO PUBLICLY
UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENT, WHETHER AS A RESULT OF NEW INFORMATION,
FUTURE EVENTS OR OTHERWISE, EXCEPT AS REQUIRED BY LAW. WE WISH TO CAUTION AND ADVISE
READERS THAT THESE STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THE EXPECTATIONS AND BELIEFS CONTAINED HEREIN. FOR A
SUMMARY OF CERTAIN RISKS RELATED TO OUR BUSINESS, SEE ITEM 1A RISK
FACTORS BEGINNING ON PAGE 22.
In this Annual Report on Form
10-K, references to dollars and $ are to United States dollars. Nu
Skin and Pharmanex are our trademarks. The italicized product names used in this Annual
Report on Form 10-K are product names and also, in certain cases, our trademarks.
PART I
Overview
Nu
Skin Enterprises is a leading, global direct selling company with operations in 48 markets
worldwide. We develop and distribute innovative, premium-quality personal care products
and nutritional supplements that are sold under the Nu Skin and Pharmanex brands. We conduct business
using a direct selling model in all of our markets with the exception of Mainland China
(hereinafter China) where we operate through a modified business model.
In
2008, we posted revenue of $1.2 billion. As of December 31, 2008, we had a global
network of approximately 761,000 active independent distributors, sales representatives,
and preferred customers, approximately 31,000 of whom were executive level distributors
(including sales representatives in China). Our executive level distributors play an
important leadership role in our distribution network and are critical to the growth and
profitability of our business.
Approximately
85% of our 2008 revenue came from markets outside the United States. Japan accounted for
approximately 36% of our 2008 total revenue and is our largest revenue market. Due to the
size of our foreign operations, our results are often impacted positively or negatively by
foreign currency fluctuations, particularly fluctuations in the Japanese yen. In addition,
our results are impacted by global economic, political and general business conditions.
-1-
We
develop and market branded consumer products that we believe are well suited for direct
selling. Our distributors sell our products by educating consumers about the benefits and
distinguishing characteristics of our products and by offering personalized customer
service. Leveraging our research and development efforts, we continually develop and
introduce new products that enhance our product portfolio. We attempt to attract and
motivate high-caliber, independent distributors because of our focus on product
innovation, our generous global compensation plan, and our distributor support programs.
Our
business is subject to various laws and regulations globally, in particular with respect
to network marketing activities, cosmetics, and nutritional supplements. This creates
certain risks for our business, including improper activities by our distributors or our
inability to obtain or maintain necessary product registrations.
Strategies
As
we work to grow our business, we are focused on the following three key strategies:
|
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introducing
unique tools and initiatives; |
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|
|
developing
compelling and innovative products under distinct brands; and |
|
|
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offering
motivating and rewarding distributor incentives. |
Unique
Tools. We remain committed to providing unique tools and initiatives that help
demonstrate our difference, motivate distributors, and aid in recruiting and product
sales. We are focused on tools and initiatives that provide demonstrable results or
evidence of our product efficacy. Throughout 2008, we benefited from strong interest in
our Galvanic Spa System II, a handheld spa unit that uses galvanic current. Our
distributors can easily demonstrate the benefits of the Galvanic Spa System II
through product demonstrations. Our distributors typically introduce the Galvanic
Spa System II by having them use the Galvanic Spa System II on half of their
face as a demonstration. Consumers can see immediate benefits to the appearance of their
skin following this demonstration. Our distributors also utilize our Pharmanex
BioPhotonic Scanner, a portable unit based on patented technologies that allows
distributors to non-invasively measure the impact of our nutritional products,
particularly our LifePak line of nutritional products.
Innovative
Products. Compelling and innovative products are vital to our success as they
help attract distributors and customers. Our distributors use the innovative features of
our products to build successful sales organizations and attract new customers. Our
product philosophy is largely based on anti-aging and we believe we have a competitive
advantage in this area through our product offerings. We believe we are one of only a few
direct selling companies that has successfully built brand equity in both skin care and
nutrition, both key anti-aging categories. Key anti-aging products include:
|
|
|
Galvanic
Spa Gels with ageLOC, our newestanti-aging product that is used with
our Galvanic Spa System II and incorporates our innovative ageLOC technology;
|
|
|
|
Tru
Face Essence and Tru Face Essence Ultra, anti-aging products featuring the
ingredient Ethocyn which helps to minimize the natural loss of skin elastin and improve
skin tone; |
|
|
|
LifePak,
a family of anti-aging nutritional supplement products aimed at providing optimal
levels of antioxidants, phytonutrients, vitamins, minerals and other vital ingredients
that help promote general wellness; |
-2-
|
|
|
g3,
a nutrient-rich juice blend containing a highly bioavailable mix of carotenoid
antioxidants and micronutrients with a natural delivery system called lipocarotenes; |
|
|
|
Nu
Skin 180° Anti-aging Skin Therapy System, designed to combat the visible signs of
aging, specifically facial lines and wrinkles; and |
|
|
|
MyVictory!
and The Right Approach (TRA), weight management systems focus on controlling
cravings while boosting metabolism. |
Distributor
Incentives. We are committed to providing generous compensation and incentives to our
distributors in order to motivate them and reward them for distributing our products. We
believe our global sales compensation plan is one of our competitive advantages and we
often refine our plan and add enhancements to help our distributors grow their businesses.
For example, during the year ended December 31, 2008, we launched enhancements to our
compensation plan in select markets. These enhancements are targeted at providing
additional commissions and early income for new distributors who are interested in
building their sales organizations and rewards positive business building behavior. We
also offer incentive trips and recognition events for distributors that reach key levels
in our compensation plan. In addition, we have continued to expand and promote product
subscription and loyalty programs in many of our markets that provide incentives for
customers who commit to purchase a set amount of products on a recurring basis. We believe
that these programs, along with a concerted focus on global compensation plan alignment
and an increased level of distributor recognition, goal setting and accountability, will
help motivate our distributors to drive revenue growth.
Our Product Categories
We
have multiple product categories, each operating under its own brand. We market our
premium-quality personal care products under the Nu Skin brand and our science-based
nutritional supplements under the Pharmanex brand. We also offer technology-based products
and services under different brands.
Presented
below are the U.S. dollar amounts and associated revenue percentages from the sale of Nu
Skin, Pharmanex, and other products and services for the years ended December 31, 2006,
2007, and 2008. This table should be read in conjunction with the information presented in
Item 7. Managements Discussion and Analysis of Financial Condition
and Results of Operation, which discusses the costs associated with generating
the aggregate revenue presented.
Revenue by Product
Category
(U.S. dollars in
millions)(1)
|
Year Ended December 31, |
|
Product Category | |
2006 | |
2007 | |
2008 | |
| |
| |
| |
| |
Nu Skin |
|
$ 454.5 |
|
40.8% |
|
$ 498.5 |
|
43.0% |
|
$ 633.4 |
|
50.8% |
|
| |
| |
| |
| |
Pharmanex | |
632.7 |
|
56.7 |
|
634.2 |
|
54.8 |
|
597.7 |
|
47.9 |
|
| |
| |
| |
| |
Other | |
28.2 |
|
2.5 |
|
25.0 |
|
2.2 |
|
16.5 |
|
1.3 |
|
| |
| |
| |
| |
| |
$ 1,115.4 |
|
100.0% |
|
$ 1,157.7 |
|
100.0% |
|
$ 1,247.6 |
|
100.0% |
|
(1) |
|
In 2008, 85% of our sales were transacted in foreign currencies that were then
converted to U.S. dollars for financial reporting purposes at weighted-average
exchange rates. Foreign currency fluctuations negatively impacted reported
revenue by approximately 3% in 2008 compared to 2007, and positively impacted
reported revenue by approximately 1% in 2007 compared to 2006. |
-3-
Nu
Skin. Nu Skin is our original product line and offers premium-quality personal
care products in the areas of core systems, targeted treatments, total care, cosmetics and
our specialty botanical-based Epoch line. Our strategy is to leverage our network
marketing distribution model to establish Nu Skin as an innovative leader in the personal
care market. We are committed to continuously improving and evolving our product
formulations to develop and incorporate innovative and proven ingredients. In 2008, we
launched Galvanic Spa Gels with ageLOC, the first products that incorporate
our innovative ageLOC technology. The products that incorporate this technology
have been developed to address not only the outward signs of aging, but also the sources
of aging in the skin. We plan a global rollout of ageLOC later this year at our
global convention in a new daily skin care system.
In
addition to marketing premium-quality personal care products, we are committed to
developing tools to help distributors market our products more effectively. The
Galvanic Spa System II, which was first introduced in 2002, is a great direct
selling product because our distributors can easily demonstrate the benefits of this tool.
This helps them to recruit new customers and distributors. The Galvanic Spa System
II has experienced strong growth during the last 24 months as sales have risen from
$7.5 million in the first quarter of 2007 to $52.0 million in the fourth quarter of 2008.
In 2008, revenue from the sales of the Galvanic Spa System II and Galvanic Spa
Gels accounted for 13% of our total revenue and 26% of Nu Skin revenue.
The
following table summarizes our Nu Skin product line by category:
Category | |
Description | |
Selected Products | |
|
|
|
Core Systems | |
Regardless of skin type, our core systems provide a
solid foundation for our customers' individual skin care needs.
Our systems are developed to target specific skin
concerns and are made from ingredients
scientifically proven to provide visible results for
concerns ranging from aging to acne. | |
Nu Skin 180° Anti-Aging Skin Therapy System
Nu Skin Tri-Phasic White
Nutricentials
Nu Skin Clear Action Acne Medication System | |
|
|
|
Targeted Treatments |
|
Our customized skin care line allows a
customer to tailor product regimens that help
deliver younger looking skin at any age. The
products are developed using cutting-edge ingredient
technologies that target specific skin care needs. |
|
Nu Skin Galvanic Spa System II
Galvanic Spa Gels with ageLOC
Tru Face Essence Ultra
Tru Face Line Corrector
Enhancer Skin Conditioning Gel
Celltrex Ultra Recovery Fluid
Celltrex CoQ10 Complete
NAPCA Moisturizer
Polishing Peel Skin Refinisher |
|
-4-
Category | |
Description | |
Selected Products | |
|
|
|
Total Care |
|
Our total care line addresses body, hair and oral care. The total
care line can be used by families and the products
are designed to deliver superior benefits from head
to toe for the ultimate sense of total body
wellness. |
|
Body Bar
Liquid Body Lufra
Perennial Intense Body Moisturizer
Dividends Men's Care
AP-24 Dental Care
Nu Skin Renu Hair Mask |
|
|
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|
Cosmetic |
|
The Nu Colour cosmetic line products are targeted to define and
highlight your natural beauty.
|
|
Tinted Moisturizer SPF 15
Finishing Powder
Contouring Lip Gloss
Defining Effects Mascara |
|
|
|
|
Epoch |
|
Our Epoch line is distinguished by utilizing
traditional knowledge of indigenous cultures for
skin care. Each Epoch product is formulated with
botanical ingredients derived from renewable
resources found in nature. In addition, we
contribute a percentage of our proceeds from Epoch
sales to charitable causes.
|
|
Baobab Body Butter
Sole Solution Foot Treatment
Calming Touch Soothing Skin Cream
Glacial Marine Mud
IceDancer Invigorating Leg Gel
Everglide Foaming Shave Gel
Ava puhi moni Shampoo
Epoch Baby Hibiscus Hair & Body Wash |
|
| |
| |
| |
Pharmanex.
We market a variety of nutritional products comprised of comprehensive
nutritional products, targeted solution supplements and weight management
products under the Pharmanex brand. We also sell a nutritious meal product
called Vitameal that can be purchased and donated through our Nourish the
Children initiative to feed starving children in various locations throughout
the world or purchased for personal food storage. LifePak, our flagship
line of micronutrient supplements, accounted for 20% of our total revenue and
41% of Pharmanex revenue in 2008.
Direct
selling has proven to be an extremely effective method of marketing our high-quality
nutritional supplements because our distributors can personally educate consumers on the
quality and benefits of our products, differentiating them from our competitors
offerings. Our strategy for expanding the nutritional supplement business is to introduce
innovative, substantiated products based on extensive research and development and quality
manufacturing. Our product development efforts focus in the areas of anti-aging, weight
management, and general nutrition.
In
2003, we launched the Pharmanex BioPhotonic Scanner, a cutting edge tool that
safely measures carotenoid antioxidant levels in the skin, serving as a general indicator
of a persons overall antioxidant status. This tool is used globally in our business,
and is utilized by our distributors. Several improvements and enhancements have been made
to the unit since its introduction.
-5-
The
following table summarizes our Pharmanex product line by category:
Category | |
Description | |
Selected Products | |
|
|
|
Nutritionals |
|
Pharmanex nutritional products supply a broad spectrum of micronutrients that our bodies need as a foundation for a
lifetime of
optimal health. Our LifePak family of products along with our g3
superfruit juice are the top-selling products in our nutritionals line.
|
|
LifePak family of products
g3 juice |
|
|
|
|
Solutions | |
Our targeted solutions supplements contain
standardized levels of botanical and other active
ingredients that are formulated for consumers to meet the demands of everyday life.
| |
Tegreen 97
ReishiMax GLp
MarineOmega
Cholestin
CordyMax Cs-4
Cortitrol
Detox Formula
Eye Formula | |
|
|
|
Weight Management | |
Our weight loss management products include supplements as well
as meal replacement shakes.
| |
The Right Approach (TRA) weight management system
MyVictory! weight management program
| |
|
|
|
Vitameal | |
A highly nutritious meal that can be purchased and donated through our Nourish the Children initiative to feed starving children or purchased for personal food storage.
| |
Vitameal
| |
| |
| |
| |
Other. We also offer simple and innovative technology products and services under the Big Planet and other
brands. These products include digital content, storage and related services we market under the Maxvault name, digital
video services we market under the Maxcast name, and other technology related products. We also have integrated technology into our other areas of our business
and offer other advanced tools and services that help distributors establish an online presence and
manage their business.
We
also market a small line of home care products under the Ecosphere brand, designed to
clean and protect the home environment, which include water purifiers, filtering
showerheads and surface wipes. These products are primarily distributed in our Asian
markets.
-6-
Sourcing and Production
Nu
Skin. In order to maintain high product quality, we acquire our ingredients and
contract production of our proprietary products from suppliers and manufacturers that we
believe are reliable, reputable and deliver high quality materials and service. Our
Galvanic Spa System II is procured from a single vendor who owns certain patent rights
associated with such product. In the event our relationship with this vendor were
terminated, we would be required to develop a new galvanic unit and source it from another
supplier. We also acquire ingredients and products from one other supplier that currently
manufactures products that represent approximately 21% of our Nu Skin personal care
revenue in 2008. We maintain a good relationship with our suppliers and do not anticipate
that either party will terminate the relationship in the near term. We also have ongoing
relationships with secondary and tertiary suppliers. Please refer to Item 1A.
Risk Factors for a discussion of risks and uncertainties associated with our
supplier relationships and with the sourcing of raw materials and ingredients.
We
also established a production facility in Shanghai, where we currently manufacture our
personal care products sold through our retail stores in China, as well as a small portion
of product exported to select other markets. We believe that if the need arose, this plant
could be expanded or other facilities could be built in China to produce larger
amounts of inventory for export or as a back up to our existing supply chain.
Pharmanex.
Substantially all of our Pharmanex nutritional supplements and ingredients,
including LifePak, are produced or provided by third-party suppliers and
manufacturers. We rely on two partners for the majority of our Pharmanex
products, one of which supplies products that represent approximately 40% of our
nutritional supplement revenue while the other supplier manufactures products
that represent approximately 18% of our nutritional supplement revenue in 2008.
In the event we become unable to source any products or ingredients from these
suppliers or from other current vendors, we believe that we would be able to
produce or replace those products or substitute ingredients without great
difficulty or significant increases to our cost of goods sold. Please refer
to Item 1A. Risk Factors for a discussion of certain risks
and uncertainties associated with our supplier relationships, as well as with
the sourcing of raw materials and ingredients.
We
also maintain a facility in Zhejiang Province, China, where we produce some of our
Pharmanex nutritional supplements for sale in China and herbal extracts used to produce
Tegreen 97, ReishiMax GLp and other products sold globally.
Research and Development
We
continually invest in our research and development capabilities. Our research and
development expenditures were $8.7 million, $10.0 million and $9.6 million in 2006, 2007
and 2008, respectively. Because of our commitment to product innovation, we will continue
to commit resources to research and development in the future.
Our
primary research and testing laboratory, adjacent to our office complex in Provo, Utah,
houses both Pharmanex and Nu Skin research facilities and professional and technical
personnel. We also maintain research facilities in China. Much of our Pharmanex research
to date is conducted in China, where we benefit from a well-educated, low-cost, scientific
labor pool that enables us to conduct research and clinical trials at a much lower cost
than would be possible in the United States.
We
have joint research projects with numerous independent scientists, including scientific
advisory boards comprised of recognized authorities in related disciplines for each of our
nutritional and personal care product categories. We also enter into joint research
projects with prominent universities and research institutions in the United States,
Europe and Asia, whose staffs include scientists with expertise in natural product
chemistry, biochemistry, dermatology, pharmacology and clinical studies. Some of the
university research centers include Purdue University, Stanford University, Vanderbilt
University, and Tufts University.
-7-
In
addition, we evaluate a significant number of product ideas for our Nu Skin and Pharmanex
categories presented by outside sources. We utilize strategic licensing and other
relationships with vendors for access to directed research and development work for
innovative and proprietary offerings.
Geographic Sales Regions
We
currently sell and distribute our products in 48 markets. We have segregated our markets
into five geographic regions: North Asia, Americas, Greater China, Europe, and South
Asia/Pacific. The following table sets forth the revenue for each of the geographic
regions for the years ended December 31, 2006, 2007 and 2008:
|
Year Ended December 31, | |
|
(U.S. dollars in millions) | |
2006 | |
2007 | |
2008 | |
North Asia |
|
$ 593.8 | |
53% |
|
$ 585.8 |
|
50% |
|
$ 594.5 |
|
48% |
|
Americas | |
165.9 |
|
15 |
|
188.3 |
|
16 |
|
223.9 |
|
18 |
|
Greater China | |
208.2 |
|
19 |
|
205.0 |
|
18 |
|
210.0 |
|
17 |
|
Europe | |
59.5 |
|
5 |
|
77.2 |
|
7 |
|
111.6 |
|
9 |
|
South Asia/Pacific | |
88.0 |
|
8 |
|
101.4 |
|
9 |
|
107.6 |
|
8 |
|
| |
$ 1,115.4 |
|
100% |
|
$ 1,157.7
|
|
100% |
|
$ 1,247.6 |
|
100% |
|
Additional
comparative revenue and related financial information is presented in the tables captioned
Segment Information in Note 17 to our Consolidated Financial Statements. The
information from these tables is incorporated by reference in this Report.
North
Asia. The following table provides information on each of the markets in the North
Asia region, including the year it opened, 2008 revenue, and the percentage of our total
2008 revenue for each market:
(U.S. dollars in millions) | |
Year Opened | |
2008 Revenue | |
Percentage of
2008 Revenue | |
|
|
|
|
Japan |
|
1993 |
|
$ 443.7 |
|
36% |
|
South Korea | |
1996 | |
$ 150.8 |
|
12% |
|
| |
| |
| |
| |
Japan
is our largest market and accounted for approximately 36% of total revenue in 2008. We
market most of our Nu Skin and Pharmanex products in Japan, along with a limited number of
other offerings. In addition, all product categories offer a limited number of locally
developed products sold exclusively in our Japanese market. In 2008, we introduced
LifePak Nano EX and Tru Face Essence Ultra, which have proven
successful in other markets. In addition, we developed marketing programs surrounding
the Galvanic Spa System II. In 2009, we have plans to introduce our new ageLOC
technology anti-aging brand into the market with the launch of several new anti-aging
products.
-8-
The
direct selling environment in Japan continues to be difficult as the industry has been on
the decline for several years and regulatory and media scrutiny have increased. Please
refer to Government Regulation and Item 1A. Risk Factors
for a discussion of risks and uncertainties associated with challenges in the Japan
market.
In
South Korea, we offer most of our Nu Skin and Pharmanex products, along with a limited
number of other offerings. Product introductions for 2008 included the launch of Estera
and Tru Face Essence Ultra. In 2009, we plan to introduce Prostate
Formula and New Hair Care.
Americas.
The following table provides information on each of the markets in the Americas
region, including the year opened, 2008 revenue, and the percentage of our total
2008 revenue for each market:
(U.S. dollars in millions) | |
Year Opened | |
2008 Revenue | |
Percentage of
2008 Revenue | |
|
|
|
|
United States |
|
1984 |
|
$ 192.1 |
|
15% |
|
Canada | |
1990 | |
$ 16.2 |
|
1% |
|
Latin America(1) | |
1994 | |
$ 15.6 |
|
1% |
|
| |
| |
| |
| |
(1) |
|
Latin America includes Brazil, Costa Rica, El Salvador, Guatemala, Honduras,
Mexico and Venezuela. |
Substantially
all of our Nu Skin and Pharmanex products, as well as limited other products and services,
are available for sale in the United States. In 2008, we introduced the ageLOC
technology anti-aging brand with the introduction of Galvanic Spa Gels. In
2009, we will begin company authorized business activity in Colombia to assess the
potential of this market for future opening and business infrastructure.
Greater
China. The following table provides information on each of the markets in
the Greater China region, including the year opened, 2008 revenue, and the percentage of
our total 2008 revenue for each market:
(U.S. dollars in millions) | |
Year Opened | |
2008 Revenue | |
Percentage of
2008 Revenue | |
|
|
|
|
Taiwan |
|
1992 |
|
$ 92.3 |
|
7% |
|
China | |
2003 | |
$ 65.3 |
|
5% |
|
Hong Kong | |
1991 | |
$ 52.4 |
|
4% |
|
| |
| |
| |
| |
Our
Hong Kong and Taiwan markets operate using our global direct selling business model and
global compensation plan. We offer a robust product offering of the majority of our Nu
Skin and Pharmanex products and limited other products and services in Hong Kong and
Taiwan. Approximately half of our revenue in these markets comes from orders through our
monthly product subscription program, which has led to improved retention of customers and
distributors and has helped streamline the ordering process.
In
China, we sell many of our Nu Skin products and a locally produced value line of personal
care products under the Scion brand name. We also sell a select number of Pharmanex
products, including our number one nutritional product, LifePak.
-9-
We
currently are unable to fully operate under our global direct selling business model in
China as a result of regulatory restrictions on direct selling activities in this market.
Consequently, we have developed a retail sales model that utilizes an employed sales force
and service contractors to sell products through fixed locations that we are supplementing
with a single level direct sales opportunity in those locations where we have obtained a
direct sales license. In addition, we have recently begun engaging contracted sales
promoters to sell products through our retail stores. We rely on our sales force to market
and sell products at the various retail locations supported by only minimal advertising
and traditional promotional efforts. Our retail model in China is largely based upon our
ability to attract customers to our retail stores through our sales force, to educate them
about our products through frequent training meetings, and to obtain repeat purchases.
While our distributor leaders from other markets are able to introduce customers and sales
people to our stores, their promotional efforts are limited due to the restrictions on
direct selling in this market.
We also continue to implement a direct sales opportunity that allows us to engage
independent distributors who can sell products away from our retail stores. We have
received licenses and approvals to engage in direct selling activities in the
municipalities of Shanghai, Beijing and in four cities in the Guangdong province, and we
continue to work to obtain the necessary approvals in other locations in China. The direct
selling licenses allow us to engage an entry-level, non-employee sales force that can sell
products away from fixed retail locations. Our current direct sales model is structured in
a manner that we believe is complementary to our existing retail sales model. Our
independent direct sellers, for example, can transition into our retail model and become
sales promoters or employees, which can provide them with a more rewarding income
opportunity.
Beginning
in early 2008, we made significant changes to our China business and infrastructure as we
decided to change our strategy for operating retail stores in order to operate more
effectively and efficiently by focusing our business around plaza stores in major cities.
As part of this plan, we closed down approximately 70 retail stores scattered throughout
the country and terminated approximately 650 corporate employees.
Europe.
The following table provides information on our Europe region, including the
year opened, revenue for 2008, and the percentage of our total 2008 revenue for
the region.
(U.S. dollars in millions) | |
Year Opened | |
2008 Revenue | |
Percentage of
2008 Revenue | |
|
|
|
|
Europe(1) |
|
1995 |
|
$ 111.6 |
|
9% |
|
| |
| |
| |
| |
(1) |
|
Europe includes Austria, Belgium, Czech Republic, Denmark, Finland,
France, Germany, Hungary, Ireland, Iceland, Israel, Italy, Luxembourg, the
Netherlands, Norway, Poland, Portugal, Romania, Russia, Slovakia, South Africa,
Spain, Sweden, Switzerland, and the United Kingdom. |
We
currently operate and offer a full range of Nu Skin and Pharmanex products in 25 countries
throughout Northern, Eastern, and Central Europe as well as in Israel and South Africa.
Various products and distributor tools have contributed to Europes recent success,
including the Galvanic Spa System II, the Pharmanex BioPhotonic Scanner, and
g3. We have been experiencing strong growth in Central and Eastern European
markets. In 2008, we opened operations in South Africa and the Czech Republic. In 2009, we
will begin company authorized business activity in Turkey and Ukraine to assess the
potential of these markets for future opening and business infrastructure.
-10-
South
Asia/Pacific. The following table provides information on each of the
markets in the South Asia/Pacific region, including the year opened, 2008 revenue, and the
percentage of our total 2008 revenue for each market:
(U.S. dollars in millions) | |
Year Opened | |
2008 Revenue | |
Percentage of
2008 Revenue | |
|
|
|
|
Singapore/Malaysia/Brunei |
|
2000/2001/2004 |
|
$ 43.8 |
|
3% |
|
Thailand | |
1997 | |
$ 34.6 |
|
3% |
|
Australia/New Zealand | |
1993 | |
$ 13.3 |
|
1% |
|
Indonesia | |
2005 | |
$ 8.9 |
|
1% |
|
Philippines | |
1998 | |
$ 7.0 |
|
1% |
|
| |
| |
| |
| |
We
offer a majority of our Pharmanex and Nu Skin products in the South Asia/Pacific region.
Marketing initiatives in South Asia/Pacific have centered on monthly product subscription
orders and the Galvanic Spa System II.
Distribution
Overview.
The foundation of our sales philosophy and distribution system is network
marketing. We sell our products through independent distributors who are not
employees, except in China where we sell our products through employed retail
sales representatives, contractual sales promoters and direct sellers. Our
distributors generally purchase products from us for resale to consumers and for
personal consumption. We also enjoy a large base of subscription customers who
purchase directly from the company and in doing so receive a product discount.
Network
marketing is an effective vehicle to distribute our products because:
|
|
|
distributors
can educate consumers about our products in person, which we believe is more effective
for premium-quality, differentiated products than using traditional advertising; |
|
|
|
direct
sales allow for actual product testing by potential customers; |
|
|
|
there
is greater opportunity for distributor and customer testimonials; and |
|
|
|
as
compared to other distribution methods, our distributors can provide customers higher
levels of service and encourage repeat purchases. |
Active
distributors under our global compensation plan are defined as those distributors
who have purchased products for resale or personal consumption during the previous three
months. In addition, we have implemented preferred customer programs in many
of our markets, which allow customers to purchase products directly from us, generally on a recurring
monthly product subscription basis. We include preferred customers
who have purchased products during the previous three months in our active
distributor numbers. While preferred customers are legally very different from
distributors, both are considered customers of our products.
Executive-level
distributors under our global compensation plan are those distributors who are most
seriously pursuing the direct selling opportunity and must achieve and maintain specified
personal and group sales volumes each month. Once an individual becomes an executive-level
distributor, he or she can begin to take advantage of the benefits of commission payments
on personal and group sales volume. As a result of direct selling restrictions in China,
we have implemented a modified business model utilizing retail stores and an employed
sales force. (See the discussion on China in Geographic Sales Regions.)
Full-time sales representatives are those sales representatives that have completed a
qualification process. Throughout this annual report, we include full-time sales
representatives in China in our executive-level distributor numbers in order
to provide some level of comparison between our China model and our global direct selling
model.
-11-
Our
revenue is highly dependent upon the number and productivity of our distributors. Growth
in sales volume requires an increase in the productivity and/or growth in the total number
of distributors. As of December 31, 2008, we had approximately 761,000 active distributors
of our products and services. Approximately 31,000 of these distributors were
executive-level distributors. As of each of the dates indicated below, we had the
following number of executive distributors in the referenced regions:
Total Number of Active
and Executive Distributors by Region
|
As of December 31, 2006 | |
As of December 31, 2007 | |
As of December 31, 2008 | |
|
Active | |
Executive | |
Active | |
Executive | |
Active | |
Executive | |
|
|
|
|
|
|
|
North Asia |
|
333,000 |
|
15,354 |
|
335,000 |
|
14,845 |
|
326,000 |
|
13,937 |
|
Americas | |
150,000 |
|
4,141 |
|
158,000 |
|
4,588 |
|
171,000 |
|
4,876 |
|
Greater China | |
155,000 |
|
6,492 |
|
138,000 |
|
6,389 |
|
115,000 |
|
6,323 |
|
Europe | |
50,000 |
|
1,600 |
|
59,000 |
|
1,957 |
|
83,000 |
|
2,911 |
|
South Asia/Pacific | |
73,000 |
|
2,169 |
|
65,000 |
|
2,223 |
|
66,000 |
|
2,541 |
|
Total | |
761,000 |
|
29,756 |
|
755,000 |
|
30,002 |
|
761,000 |
|
30,588 |
|
Sponsoring.
We rely on our distributors to recruit and sponsor new distributors of our
products. While we provide internet support, product samples, brochures,
magazines, and other sales and marketing materials at cost, distributors are
primarily responsible for recruiting and educating new distributors with respect
to products, our global compensation plan, and how to build a successful
distributorship.
The
sponsoring of new distributors creates multiple levels in a network marketing structure.
Individuals that a distributor sponsors are referred to as downline or
sponsored distributors. If downline distributors also sponsor new
distributors, they create additional levels in the structure, but their downline
distributors remain in the same downline network as their original sponsoring distributor.
Sponsoring
activities are not required of distributors and we do not pay any commissions for
sponsoring new distributors. However, because of the financial incentives provided to
those who succeed in building and mentoring a distributor network that resells and
consumes products, many of our distributors attempt, with varying degrees of effort and
success, to sponsor additional distributors. People often become distributors after using
our products as regular customers. Once a person becomes a distributor, he or she is able
to purchase products directly from us at wholesale prices. The distributor is also
entitled to sponsor other distributors in order to build a network of distributors and
product users. A potential distributor must enter into a standard distributor agreement,
which among other things, obligates the distributor to abide by our policies and
procedures.
Global
Compensation Plan. One of our competitive advantages is our global sales
compensation plan. Under our global compensation plan, a distributor is paid consolidated
monthly commissions in the distributors home country, in local currency, for the
distributors own product sales and for product sales in that distributors
downline distributor network across all geographic markets. Because of restrictions on
direct selling in China, our contractual and employed sales representatives there do not
participate in the global compensation plan, but are instead compensated according to a
compensation model established for that market.
-12-
Commissions
on the sale of an individual Nu Skin or Pharmanex product can exceed 50% of the wholesale
price, except in a limited number of markets where commissions are limited by law.
The actual commission payout percentage, however, varies depending on the number of
distributors at each payout level within our global compensation plan. On a global basis,
the overall payout on these products has typically averaged approximately 41% to 44%. We
believe that our commission payout as a percentage of total sales is among the most
generous paid by major direct selling companies.
From
time to time, we make modifications and enhancements to our global compensation plan to
help motivate distributors. In 2008, we successfully launched modifications to our
compensation plan in the Americas and Europe regions designed to improve commission
payments early in the distributor lifecycle. In 2009, we plan to modify our compensation
plans in most of our Asian markets to conform to the revised plan implements in the
Americas and Europe regions. In addition, we evaluate a limited number of distributor
requests on a monthly basis for exceptions to the terms and conditions of the global
compensation plan, including volume requirements. While our general policy is to
discourage exceptions, we believe that the flexibility to grant exceptions is critical in
retaining distributor loyalty and dedication and we make exceptions in limited cases as
necessary.
High
Level of Distributor Incentives. Based upon managements knowledge of our
competitors distributor compensation plans, we believe our global compensation plan
is among the most financially rewarding plans offered by leading direct selling companies.
There are two fundamental ways in which our distributors can earn money:
|
|
|
through
retail markups on sales of products purchased by distributors at wholesale; and |
|
|
|
through
a series of commissions on product sales. |
Each
of our products carries a specified number of sales volume points. Commissions are based
on total personal and group sales volume points per month. Sales volume points are
generally based upon a products wholesale cost, net of any point-of-sale taxes. As a
distributors business expands to successfully sponsoring other distributors into the
business, who in turn expand their own businesses, a distributor receives a higher
percentage of commissions. An executives commissions can increase substantially as
multiple downline distributors achieve executive status. In determining commissions, the
number of levels of downline distributors included in an executives commissionable
group increases as the number of executive distributorships directly below the executive
increases.
Distributor
Support. We are committed to providing high-level support services tailored to the
needs of our distributors in each market. We attempt to meet the needs and build the
loyalty of distributors by providing personalized distributor services and by maintaining
a generous product return policy. Because the majority of our distributors are part time
and have only a limited number of hours each week to concentrate on their business, we
believe that maximizing a distributors efforts by providing effective distributor
support has been, and will continue to be, important to our success.
Through
training meetings, distributor conventions, web-based messages, distributor focus groups,
regular telephone conference calls, and other personal contacts with distributors, we seek
to understand and satisfy the needs of our distributors. We provide walk-in, telephonic,
and Web-based product fulfillment and tracking services that result in user-friendly,
timely product distribution. Several of our walk-in retail centers maintain meeting rooms,
which our distributors may utilize for training and sponsoring activities. Because of our
efficient distribution system, we believe that most of our distributors do not maintain a
significant inventory of our products.
-13-
Rules
Affecting Distributors. We monitor regulations and distributor activity in each
market to ensure our distributors comply with local laws. Our published distributor
policies and procedures establish the rules that distributors must follow in each market.
We also monitor distributor activity to maintain a level playing field for our
distributors, ensuring that some are not disadvantaged by the activities of others. We
require our distributors to present products and business opportunities ethically and
professionally. Distributors further agree that their presentations to customers must be
consistent with, and limited to, the product claims and representations made in our
literature.
Distributors
must represent to us that their receipt of commissions is based on retail sales and
substantial personal sales efforts. We must produce or pre-approve all sales aids used by
distributors such as videotapes, audiotapes, brochures and promotional clothing.
Distributors may not use any form of media advertising to promote products. Products may
be promoted only by personal contact or by literature produced or approved by the company.
Distributors may not use our trademarks or other intellectual property without our
consent.
Our
products may not be sold, and our business opportunities may not be promoted, in
traditional, non-Company owned retail environments. We have made an exception to this rule
by allowing some of our Pharmanex products to be sold in independently owned pharmacies
and drug stores meeting specified requirements. Distributors who own or are employed by a
service-related business, such as a doctors office, hair salon or health
club, may make products available to regular customers as long as products are not
displayed visibly to the general public in a manner to attract the general public into the
establishment to purchase products.
In
order to qualify for commission bonuses, our distributors generally must satisfy specific
requirements including achieving at least 100 points, which is approximately $100 in
personal sales volume per month. In addition, individual markets may have requirements
specific to that country based on regulatory factors. For example, in the United States,
distributors must also:
|
|
|
document
retail sales or customer connections to established numbers of retail customers; and
|
|
|
|
sell
and/or consume at least 80% of personal sales volume. |
We
systematically review reports of alleged distributor misbehavior. If we determine one of
our distributors has violated any of our policies or procedures, we may terminate the
distributors rights completely. Alternatively, we may impose sanctions, such as
warnings, probation, withdrawal or denial of an award, suspension of privileges of a
distributorship, fines and/or withholding of commissions until specified conditions are
satisfied, or other appropriate injunctive relief.
Product
Returns. We believe we are among the most consumer-protective companies in the
direct selling industry. While the regulations and our operations vary somewhat from
country to country, we generally follow a similar procedure for product returns. For 30
days from the date of purchase, our product return policy generally allows a retail
customer to return any Nu Skin or Pharmanex product to us directly or to the distributor
through whom the product was purchased for a full refund. After 30 days from the date of
purchase, the end users return privilege is at the discretion of the distributor.
Our distributors can generally return unused products directly to us for a 90% refund for
one year. Through 2008, our experience with actual product returns averaged less than 5%
of annual revenue.
Payment.
Distributors generally pay for products prior to shipment. Accordingly, we carry
minimal accounts receivable. Distributors typically pay for products in cash, by
wire transfer or by credit card.
-14-
Competition
Direct
Selling Companies. We compete with other direct selling organizations, some of
which have a longer operating history and higher visibility, name recognition and
financial resources than we do. The leading direct selling companies in our existing
markets are Avon and Alticor (Amway). We compete for new distributors on the strength of
our multiple business opportunities, product offerings, global compensation plan,
management, and our international operations. In order to successfully compete in this
market and attract and retain distributors, we must maintain the attractiveness of our
business opportunities to our distributors.
Nu
Skin and Pharmanex Products. The markets for our Nu Skin and Pharmanex products
are highly competitive. Our competitors include manufacturers and marketers of personal
care and nutritional products, pharmaceutical companies and other direct selling
organizations, many of which have longer operating histories and greater name recognition
and financial resources than we do. We compete in these markets by emphasizing the
innovation, value and premium quality of our products and the convenience of our
distribution system. We focus on delivering a product whose value can be measured and
provide our distributors with powerful tools that allow them to demonstrate this
effectiveness.
Intellectual Property
Our
major trademarks are registered in the United States and in each country where we operate
or have plans to operate, and we consider trademark protection to be very important to our
business. Our major trademarks include Nu Skin, Pharmanex, LifePak and Galvanic
Spa. In addition, a number of our products and tools, including the Pharmanex
BioPhotonic Scanner, are based on proprietary technologies and formulations, some of
which are patented or licensed from third parties. We also rely on trade secret protection
to protect our proprietary formulas and know-how.
Government Regulation
Direct
Selling Activities. Direct selling activities are regulated by various federal,
state and local governmental agencies in the United States and foreign countries. These
laws and regulations are generally intended to prevent fraudulent or deceptive schemes,
often referred to as pyramid schemes, that compensate participants for
recruiting additional participants irrespective of product sales, use high-pressure
recruiting methods and/or do not involve legitimate products. The laws and regulations in
our current markets often:
|
|
|
impose
cancellation/product return, inventory buy-backs and cooling-off rights for consumers and
distributors; |
|
|
|
require
us or our distributors to register with governmental agencies; |
|
|
|
impose
caps on the amount of commission we can pay; |
|
|
|
impose
reporting requirements; and |
|
|
|
impose
upon us requirements, such as requiring distributors to maintain levels of retail sales
to qualify to receive commissions, to ensure that distributors are being compensated for
sales of products and not for recruiting new distributors. |
-15-
The
laws and regulations governing direct selling are modified from time to time, and, like
other direct selling companies, we are subject from time to time to government
investigations in our various markets related to our direct selling activities. This can
require us to make changes to our business model and aspects of our global compensation
plan in the markets impacted by such changes and investigations.
Regulators
in Japan have recently increased their scrutiny of our industry. Several direct sellers in
Japan have been penalized for actions of their distributors that violated applicable
regulations, including one prominent international direct selling company that was
suspended from sponsoring activities for three months in 2008, and another large Japanese
direct selling company that was suspended from sponsoring activities for six months in
2009. In addition, Japanese media has reported on increased political pressure on
lawmakers supporting our industry.
We
have also experienced an increase in complaints and inquiries to consumer protection
centers in Japan and have taken steps to try to resolve these issues including providing
additional training and restructuring our compliance group in Japan. We have been in
contact with consumer protection centers in Japan, one of which recently sent us a written
warning that we needed to reduce the number of complaints and inquiries being filed with
that consumer protection center. If consumer complaints escalate to a government review or
if the current level of complaints does not improve, there is an increased likelihood that
regulators could take action against us or we could receive negative media attention,
either of which could harm our business.
As
a result of restrictions in China on direct selling activities, we have implemented a
retail store model utilizing an employed sales force and contractual sales promoters, and
we are currently integrating direct selling in our business model in this market pursuant
to direct selling regulations in this market. The regulatory environment in China remains
complex. Chinas direct selling and anti-pyramiding regulations are restrictive and
contain various limitations, including a restriction on the ability to pay multi-level
compensation to independent distributors. Our operations in China have attracted
significant regulatory and media scrutiny since we expanded our operations there in
January 2003. Regulations are subject to discretionary interpretation by municipal and
provincial level regulators as well as local customs and practices. Interpretations of
what constitutes permissible activities by regulators can vary from province to province
and can change from time to time because of the lack of clarity in the rules regarding
direct selling activities and differences in customs and practices in each location.
Because
of the Chinese governments significant concerns about direct selling activities, it
scrutinizes very closely activities of direct selling companies. At times, investigations
and related actions by government regulators have impeded our ability to conduct business
in certain locations, and have resulted in a few cases in fines being paid by our company.
In each of these cases, we have been allowed to recommence operations after the
governments investigation, and no material changes to our business model were
required in connection with these fines and impediments. Please refer to Item 1A.
Risk Factors for more information on the regulatory risks associated with our
business in China.
The
regulatory environment with respect to direct selling in China remains fluid and the
process for obtaining the necessary governmental approvals to conduct direct selling
continues to evolve. The regulations and processes in some circumstances have been
interpreted differently by different governmental authorities. In order to expand our
direct selling model into additional provinces we currently must obtain a series of
approvals from the Departments of Commerce in such provinces, the Shanghai Department of
Commerce (Nu Skin Chinas supervisory authority), as well as the Departments of
Commerce in each city and district in which we plan to operate. We also are required to
obtain the approval of the State Ministry of Commerce, which is the national governmental
authority overseeing direct selling. In addition, regulators are acting cautiously as they
monitor the roll-out of direct selling, which has made the approval process take longer
than we anticipated. Please refer to Item 1A. Risk Factors for more
information on the risks associated with our planned expansion of direct selling in China.
-16-
Regulation
of Our Products. Our Nu Skin and Pharmanex products and related promotional and
marketing activities are subject to extensive governmental regulation by numerous domestic
and foreign governmental agencies and authorities, including the FDA, the FTC, the
Consumer Product Safety Commission, the Department of Agriculture, State Attorneys General
and other state regulatory agencies in the United States, and the Ministry of Health,
Labor and Welfare in Japan and similar government agencies in each market in which we
operate.
Our
personal care products are subject to various laws and regulations that regulate cosmetic
products and set forth regulations for determining whether a product can be marketed as a
cosmetic or requires further approval as an over-the-counter (OTC) drug. In
the United States, regulation of cosmetics are under the jurisdiction of the FDA. The
Food, Drug and Cosmetic Act defines cosmetics by their intended use, as articles
intended to be rubbed, poured, sprinkled, or sprayed on, introduced into, or otherwise
applied to the human body . . . for cleansing, beautifying, promoting attractiveness, or
altering the appearance. Among the products included in this definition are skin
moisturizers, perfumes, lipsticks, fingernail polishes, eye and facial makeup
preparations, shampoos, permanent waves, hair colors, toothpastes and deodorants, as well
as any material intended for use as a component of a cosmetic product. Conversely, a
product will not be considered a cosmetic, but may be considered an (OTC) drug if it is
intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease,
or is intended to affect the structure or any function of the body. The other markets we
operate in have similar regulations. In Japan, the Ministry of Health, Labor and Welfare
regulates the sale and distribution of cosmetics and requires us to have an import
business license and to register each personal care product imported into Japan. In
Taiwan, all medicated cosmetic products require registration. In China,
personal care products are placed into one of two categories, general and
drug. Products in both categories require submission of formulas and other
information with the health authorities, and drug products require human clinical studies.
The product registration process in China for these products can take from nine to more
than 18 months. Such regulations in any given market can limit our ability to import
products and can delay product launches as we go through the registration and approval
process for those products. The sale of cosmetic products is regulated in the European
Union under the European Union Cosmetics Directive, which requires a uniform application
for foreign companies making personal care product sales.
Our
Pharmanex products are subject to various regulations promulgated by government agencies
in the markets in which we operate. In the United States, we generally market our
nutritional products as foods or dietary supplements. The FDA has jurisdiction over this
regulatory area. Because these products are regulated under the Dietary Supplement and
Health Education Act, we are generally not required to obtain regulatory approval prior to
introducing a product into the United States market. None of this infringes, however, upon
the FDAs power to remove from the market any product it determines to be unsafe or
an unapproved drug. In our foreign markets, the products are generally regulated by
similar government agencies, such as the Ministry of Health, Labor and Welfare in Japan,
the KFDA in South Korea, and the Department of Health in Taiwan. We typically market our
Pharmanex products in international markets as foods or health foods under applicable
regulatory regimes. In the event a product, or an ingredient in a product, is classified
as a drug or pharmaceutical product in any market, we will generally not be able to
distribute that product in that market through our distribution channel because of strict
restrictions applicable to drug and pharmaceutical products. China has some of the most
restrictive nutritional supplement product regulations. Products marketed as health
foods are subject to extensive laboratory and clinical analysis by governmental
authorities, and the product registration process for these products takes approximately
two years. We market both health foods and general foods in China.
Our flagship product, LifePak, is currently marketed as a general food with only
one of the three main capsules having received health food classification.
Currently, general foods is not an approved category for direct selling;
therefore, we will only market LifePak through our retail stores until final health
food classification for LifePak is obtained for the other two capsules.
Additionally, there is some risk associated with the common practice in China of marketing
a product as a general food while seeking health food
classification. If government officials feel our categorization of our products is
inconsistent with product claims, ingredients or function, this could limit our ability to
market such products in China in their current form.
-17-
The
markets in which we operate all have varied regulations that distinguish foods and
nutritional health supplements from drugs or pharmaceutical
products. Because of the varied regulations, some products or ingredients that are
recognized as a food in certain markets may be treated as a
pharmaceutical in other markets. In Japan, for example, if a specified
ingredient is not listed as a food by the Ministry of Health and Welfare, we
must either modify the product to eliminate or substitute that ingredient, or petition the
government to treat such ingredient as a food. We experience similar issues in our other
markets. This is particularly a problem in Europe where the regulations differ from
country to country. As a result, we must often modify the ingredients and/or the levels of
ingredients in our products for certain markets. In some circumstances, the regulations in
foreign markets may require us to obtain regulatory approval prior to introduction of a
new product or limit our uses of certain ingredients altogether. Because of negative
publicity associated with some supplements, such as ephedra or human growth
hormones (HGH) (which we have never marketed) and other potentially harmful ingredients,
there has been an increased movement in the United States and other markets to expand the
regulation of dietary supplements, which could impose additional restrictions or
requirements in the future. In general, the regulatory environment is becoming more
complex with increasingly strict regulations each year.
In
June 2007, the U.S. Food and Drug Administration announced a final rule establishing
regulations to require current good manufacturing practices (cGMP) for dietary
supplements. The rule ensures that dietary supplements are produced in a quality manner,
do not contain contaminants or impurities, and are accurately labeled. The final rule
includes requirements for establishing quality control procedures, designing and
constructing manufacturing plants, and testing ingredients and the finished products. It
also includes requirements for record keeping and handling consumer product complaints. If
dietary supplements contain contaminants or do not contain the dietary ingredient they are
represented to contain, the FDA would consider those products to be adulterated or
misbranded. We were required to comply with the new rule by June 2008. Our business is
subject to additional regulations, such as those implementing an adverse event reporting
system (AERs) effective December 2007, which requires us to document and
track adverse events and report serious adverse events associated with consumers use
of our products.
We
are aware that, in some of our international markets, there has been adverse publicity
concerning products that contain ingredients that have been genetically modified,
(GM) or irradiated. In some markets, the possibility of health risks or
perceived consumer preference thought to be associated with GM or irradiated ingredients
has prompted proposed or actual governmental regulation. We cannot anticipate the extent
to which these or other future regulations in our markets will restrict the use of
ingredients in our products or the impact of any regulations on our business in those
markets. We believe, based upon currently available information, that compliance with
regulatory requirements in this area should not have a material adverse effect on us or
our business. Compliance with GM, irradiation regulations or the like could be expected to
increase the cost of manufacturing certain of our products.
-18-
Most
of our major markets also regulate advertising and product claims regarding the efficacy
of products. This is particularly true with respect to our dietary supplements because we
typically market them as foods or health foods. Accordingly, these regulations can limit
our ability to inform consumers of the full benefits of our products. For example, in the
United States, we are unable to claim that any of our nutritional supplements will
diagnose, cure, mitigate, treat or prevent disease. In most of our foreign markets, we are
not able to make any medicinal claims with respect to our Pharmanex products.
In the United States, the Dietary Supplement Health and Education Act, however, permits
substantiated, truthful and non-misleading statements of nutritional support to be made in
labeling, such as statements describing general well-being resulting from consumption of a
dietary ingredient or the role of a nutrient or dietary ingredient in affecting or
maintaining a structure or a function of the body. Most of the other markets in which we
operate have not adopted similar legislation and we may be subject to more restrictive
limitations on the claims we can make about our products in these markets. For example, in
Japan, our nutritional supplements are marketed as food products, which significantly
limits our ability to make any claims regarding these products.
To
date, we have not experienced any difficulty maintaining our import licenses. However, due
to the varied regulations governing the manufacture and sale of nutritional products in
the various markets, we have found it necessary to reformulate many of our products or
develop new products in order to comply with such local requirements. In the United
States, we are also subject to a consent decree with the FTC and various state regulatory
agencies arising out of investigations that occurred in the early 1990s of certain alleged
unsubstantiated product and earnings claims made by our distributors. The consent decree
requires us to, among other things, supplement our procedures to enforce our policies, not
allow our distributors to make earnings representations without making certain average
earnings disclosures, and not allow our distributors to make unsubstantiated product
claims. Compliance with the anti terrorism regulations of the US has caused some delays in
customs but these situations have been resolved by working with the US customs officials
and training our vendors and market staff in the guidelines.
Regulation
of Our Business Tools. One of our strategies is to develop
technologically-advanced business tools designed to help our distributors effectively
market our Nu Skin and Pharmanex products. For example, during the last several years we
have introduced the Pharmanex BioPhotonic Scanner (the "Scanner") in many of our markets around the world as well as the
Galvanic Spa System II and the ProDerm Skin Analyzer. These tools are
subject to the regulations of various health, consumer protection and other governmental
authorities around the world. These regulations vary from market to market and affect
whether our business tools are required to be registered as medical devices, the claims
that can be made with respect to these tools, who can use them, and where they can be
used. We have been subject to regulatory inquiries in the United States, Japan, and other
countries with respect to the status of the Scanner as a non-medical device. Any
determination that medical device clearance is required for one of our tools could require
us to expend significant time and resources in order to meet the stringent standards
imposed on medical device companies or prevent us from marketing the product. For example,
we are not able to market the Galavanic Spa System II in Taiwan as a result of the
regulatory restrictions in this market. We are also subject to regulatory constraints on
the claims that can be made with respect to the use of our business tools. In Japan, for
example, we are limited in our ability to tie the Scanner measurement directly to the
consumption of our nutrition products.
Other
Regulatory Issues. As a United States entity operating through subsidiaries in
foreign jurisdictions, we are subject to foreign exchange control, transfer pricing and
custom laws that regulate the flow of funds between us and our subsidiaries and for
product purchases, management services and contractual obligations, such as the payment of
distributor commissions.
As
is the case with most companies that operate in our product categories, we receive from
time to time inquiries from government regulatory authorities regarding the nature of our
business and other issues, such as compliance with local direct selling, transfer pricing,
customs, taxation, foreign exchange control, securities and other laws. Negative publicity
resulting from inquiries into our operations by United States and state government
agencies in the early 1990s, stemming in part from alleged inappropriate product and
earnings claims by distributors, and in the late 1990s resulting from adverse media
attention in South Korea, harmed our business.
-19-
Employees
As
of December 31, 2008, we had approximately 9,185 full- and part-time employees worldwide,
approximately 2,670 of whom are employed as sales representatives in our China operations.
We also had labor contracts with approximately 2,949 potential new sales representatives
in China. None of our employees are represented by a union or other collective bargaining
group, except in China and a small number of employees in Japan. We believe that our
relationship with our employees is good, and we do not foresee a shortage in qualified
personnel necessary to operate our business.
Available Information
Our
Internet address is www.nuskinenterprises.com. We make available free of charge on
or through our Internet Website our annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after we electronically file such material with, or furnish it to,
the Securities and Exchange Commission.
Executive Officers
Our
executive officers as of February 27, 2009, are as follows:
Name |
|
|
|
Age |
|
Position |
| |
Blake Roney |
|
|
|
50 |
|
Executive Chairman of the Board |
|
|
Truman Hunt | | |
| 49 |
|
President and Chief Executive Officer | | |
Ritch Wood | | |
| 43 |
|
Chief Financial Officer | | |
Joe Chang | | |
| 56 |
|
Chief Scientific Officer and Executive Vice President, Product Development | | |
Dan Chard | | |
| 44 |
|
Executive Vice President, Distributor Success | | |
Scott Schwerdt | | |
| 51 |
|
President, Americas and Europe | | |
Matthew Dorny | | |
| 45 |
|
General Counsel and Secretary | | |
Ashok Pahwa | | |
| 54 |
|
Chief Marketing Officer | | |
Set forth
below is the business background of each of our executive officers.
Blake Roney
founded our company in 1984 and served as its president through 1996. Mr. Roney
currently serves as the executive Chairman of the Board, a position he has held since our
company went public in 1996. Mr. Roney is also a trustee of the Force for Good
Foundation, a charitable organization that was established in 1996 by Mr. Roney and the
other founders of our company to help encourage and drive the philanthropic efforts of our
company, its employees, its distributors and its customers to enrich the lives of others.
He received a B.S. degree from Brigham Young University.
Truman
Hunt has served as our President since January 2003 and our Chief Executive Officer
since May 2003. He has also served as a director of our company since May 2003.
Mr. Hunt joined our company in 1994 and has served in various positions, including
Vice President and General Counsel from 1996 to January 2003 and Executive Vice President
from January 2001 until January 2003. He received a B.S. degree from Brigham Young
University and a J.D. degree from the University of Utah.
-20-
Ritch Wood
has served as our Chief Financial Officer since November 2002. Prior to this appointment,
Mr. Wood served as Vice President, Finance from July 2002 to November 2002 and Vice
President, New Market Development from June 2001 to July 2002. Mr. Wood joined our
company in 1993 and has served in various capacities. Prior to joining us, he worked for
the accounting firm of Grant Thornton LLP. Mr. Wood earned a B.S. and a Master of
Accountancy degree from Brigham Young University.
Joe
Chang has served as Chief Scientific Officer and Executive Vice President of Product
Development since February 2006. Dr. Chang served as President of our Pharmanex division
from April 2000 to February 2006. Dr. Chang served as Vice President of Clinical Studies
and Pharmacology of Pharmanex from 1997 until April 2000. Dr. Chang has nearly 20 years of
pharmaceutical experience. He received a B.S. degree from Portsmouth University and a
Ph.D. degree from the University of London.
Daniel
Chard has served as Executive Vice President of Distributor Success since
February 2006. Prior to serving in this position, Mr. Chard served as President
of Nu Skin Europe from April 2004 to February 2006. Mr. Chard also served as Vice
President of Marketing and Product Management of Big Planet, our technology products and
services division, from September 2002 to March 2004 and as Senior Director of Marketing
and Product Development at Pharmanex. Prior to joining us in 1998, Mr. Chard worked
in a variety of strategic marketing positions in the consumer products industry.
Mr. Chard holds a B.A. degree in Economics from Brigham Young University and an
M.B.A. from the University of Minnesota.
Scott Schwerdt
has served as President, Americas and Europe since February 2006. Mr. Schwerdt served
as Regional Vice President of North America and President of Nu Skin Enterprises United
States, Inc. from May 2004 to February 2006. Mr. Schwerdt previously served as the
General Manager of our U.S. operations from May 2001 to May 2004. Mr. Schwerdt joined
our company in 1988 and has held various positions, including Vice President of North
America/South Pacific Operations and Vice President of Europe. Mr. Schwerdt received
a B.A. degree in International Relations from Brigham Young University.
Matthew
Dorny has served as our General Counsel and Secretary since January 2003.
Mr. Dorny previously served as Assistant General Counsel from May 1998 to January
2003. Prior to joining us, Mr. Dorny was a securities and business attorney in
private practice in Salt Lake City, Utah. Mr. Dorny received B.A., M.B.A. and J.D.
degrees from the University of Utah.
Ashok
Pahwa has served as Chief Marketing Officer since June 2008. Mr. Pahwa has over
25 years of marketing experience in the direct selling and consumer products
industries. Prior to joining us, Mr. Pahwa was Vice President of Global Marketing
and Sales at Wall Street Institute, a global English language training company, from
February 2006 to January 2008. Mr. Pahwa served as Vice President of New Businesses
at Avon Products, Inc., a global direct seller of personal care products, from 2003 to
2006. He also served in various positions at Mary Kay Cosmetics, a global direct
seller of personal care products, from 1993 until 2003. He spent more than ten years
with Publicis/Bloom and Ogilvy & Mather, global advertising agencies. Mr. Pahwa
holds a bachelors degree in economics from the University of Delhi, a masters
degree in management studies from the University of Bombay and a masters degree in
business administration from Texas Tech University.
Note
Regarding Forward-Looking Statements. Certain statements made in this
filing under the caption Item 1- Business are forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of 1934,
as amended (the Exchange Act). In addition, when used in this Report the words
or phrases will likely result, expect, intend,
will continue, anticipate, estimate,
project, believe and similar expressions are intended to identify
forward-looking statements within the meaning of the Exchange Act.
-21-
Forward-looking
statements include plans and objectives of management for future operations, including
plans and objectives relating to our products and future economic performance in countries
where we operate. These forward-looking statements involve risks and uncertainties and are
based on certain assumptions that may not be realized. Actual results and outcomes may
differ materially from those discussed or anticipated. We assume no responsibility or
obligation to update these statements to reflect any changes. The forward-looking
statements and associated risks set forth herein relate to, among other things:
|
|
|
our
plans to launch or continue to roll-out or promote various products, tools, and
initiatives; |
|
|
|
our
plans regarding new markets; |
|
|
|
the
expectation that our relationship with our current primary suppliers will not end in the
near term, and the belief that we could replace our primary suppliers of Pharmanex
products without great difficulty or increased cost; |
|
|
|
our
plans to continue to develop and introduce new, innovative products and to improve and
evolve our existing product formulations; |
|
|
|
our
belief that our global sales compensation plan will continue to motivate our distributors
to drive revenue growth; |
|
|
|
our
plans to modify our compensation plans in most of our Asian markets in 2009; |
|
|
|
our
belief that compliance with certain regulatory requirements will not have a material
adverse effect on our business; |
|
|
|
our
belief that if the need arises, our production facility in Shanghai could be expanded or
other facilities built in China to increase production for export or as a backup to our
existing supply chain; |
|
|
|
our
plans to commit resources to research and development in the future; |
|
|
|
our
belief that providing effective distributor support will be important to our success; and |
|
|
|
our
belief that we do not currently foresee a shortage in qualified personnel necessary to
operate our business. |
These
and other forward-looking statements are subject to various risks and uncertainties
including those described below under Risk Factors and in Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operation.
ITEM 1A. |
|
1A.
RISK FACTORS |
We
face a number of substantial risks. Our business, financial condition or results of
operations could be harmed by any of these risks. The trading price of our common stock
could decline due to any of these risks, and they should be considered in connection with
the other information contained in this Annual Report on Form 10-K. These risk factors
should be read together with the other items in this Annual Report on Form 10-K, including
Item 1. Business and Item 7. Managements Discussion and Analysis
of Financial Condition and Results of Operation.
-22-
Deteriorating economic conditions
globally, including the current financial crisis and declining consumer confidence and
spending could harm our business.
Global
economic conditions have deteriorated significantly over the past year. Consumer
confidence and spending have declined drastically and the global credit crisis has limited
access to capital for many companies. Although we have continued to see growth in many of
our markets during this period, the economic downturn could adversely impact our business
in the future by causing a decline in demand for our products, particularly if the
economic conditions are prolonged or continue to worsen. In South Korea, for example, we
believe that our growth has started to slow due in part to prolonged difficult economic
conditions in this market. In addition, such economic conditions may adversely impact
access to capital for us and our suppliers, may decrease our distributors ability to
obtain or maintain credit cards, and may otherwise adversely impact our operations and
overall financial condition. Although we have historically met our funding needs utilizing
cash flow from operations, no assurances can be given that we will not need to obtain
additional equity or debt financing and that such financing will be available to us on
terms that are favorable.
Currency exchange rate
fluctuations could lower our revenue and net income.
In
2008, we recognized approximately 85% of our revenue in markets outside of the United
States in each markets respective local currency. We purchase inventory primarily in
the United States in U.S. dollars. In preparing our financial statements, we translate
revenue and expenses in foreign countries from their local currencies into U.S. dollars
using weighted-average exchange rates. If the U.S. dollar strengthens relative to local
currencies, particularly the Japanese yen inasmuch as we generated approximately 36% of
our 2008 revenue in Japan, our reported revenue, gross profit and net income will likely
be reduced. Foreign currency fluctuations can also result in losses and gains resulting
from translation of foreign currency denominated balances on our balance sheet. In 2008,
significant fluctuations in foreign currencies resulted in an $18.4 million loss. During
the last couple of years the Japanese yen has strengthened considerably, which has
improved our results. However, in prior years our results have been negatively impacted by
weakening of the yen. Given the complex global political and economic dynamics that affect
exchange rate fluctuations, it is difficult to predict future fluctuations and the effect these
fluctuations may have upon future reported results or our overall financial condition. In
the event the Japanese yen or other foreign currencies weaken, our results in 2009 would
be negatively impacted. In addition, fluctuations in foreign currencies could also result
in additional losses related to our foreign currency denominated balances on our balance
sheet. Although we attempt to reduce our exposure to short-term exchange rate fluctuations
by using foreign currency exchange rate contracts for Japanese yen and through
yen-denominated debt, we cannot be certain these contracts or any other hedging activity
will effectively reduce exchange rate exposure.
Because our Japanese operations
account for a significant part of our business, continued weakness in our business
operations in Japan would harm our business.
Approximately
36% of our 2008 revenue was generated in Japan. We have experienced a significant revenue
decline in Japan over the last several years and continue to face challenges in this
market. Factors that could impact our results in the market include:
|
|
|
continued
or increased levels of regulatory and media scrutiny, or any adoption of more restrictive
regulations in response to such scrutiny; |
|
|
|
any
weakening of the Japanese yen; |
-23-
|
|
|
regulatory
constraints with respect to the claims we can make regarding the efficacy of products and
tools, which could limit our ability to introduce or effectively market them; |
|
|
|
risks
that the new initiatives we are implementing in Japan, which are patterned after
successful initiatives implemented in other markets, will not have the same level of
success in Japan, may not generate renewed growth or increased productivity among our
distributors, and may cost more or require more time to implement than we have
anticipated; |
|
|
|
inappropriate
activities by our distributors and any resulting regulatory actions against us or our
distributors; |
|
|
|
any
negative distributor reaction to our efforts to increase distributor compliance efforts
in this market; |
|
|
|
any
weakness in the economy or consumer confidence; and |
|
|
|
increased
competitive pressures from other direct selling companies and their distributors who
actively seek to solicit our distributors to join their businesses. |
Regulators in Japan have
increased their scrutiny of the direct selling industry.
Regulators
in Japan have recently increased their scrutiny of our industry. Several direct sellers in
Japan have been penalized for actions of distributors that violated applicable
regualtions, including one prominent international direct selling company that was
suspended from sponsoring activities for three months in 2008, and another large Japanese
direct selling company that was suspended from sponsoring activities for six months in
2009. In addition, Japanese media has reported on increased political pressure on
lawmakers supporting our industry.
We
have also experienced an increase in complaints and inquiries to consumer protection
centers in Japan and have taken steps to try to resolve these issues including providing
additional training and restructuring our compliance group in Japan. We have been in
contact with consumer protection centers in Japan, one of which recently sent us a written
warning that we needed to reduce the number of complaints and inquiries being filed with
that consumer protection center. If consumer complaints escalate to a government review or
if the current level of complaints does not improve, there is an increased likelihood that
regulators could take action against us or we could receive negative media attention,
either of which could harm our business.
If we are unable to retain our
existing independent distributors and recruit additional distributors, our revenue will
not increase and may even decline.
We
distribute almost all of our products through our independent distributors (and China
sales representatives) and we depend on them to generate virtually all of our revenue. Our
distributors may terminate their services at any time, and, like most direct selling
companies, we experience high turnover among distributors from year to year. Distributors
who join to purchase our products for personal consumption or for short-term income goals
frequently only stay with us for a short time. Executive distributors who have committed
time and effort to build a sales organization will generally stay for longer periods.
Distributors have highly variable levels of training, skills and capabilities. As a
result, in order to maintain sales and increase sales in the future, we need to continue
to retain existing distributors and recruit additional distributors. To increase our
revenue, we must increase the number of and/or the productivity of our distributors.
-24-
We
have experienced periodic declines in both active distributors and executive distributors
in the past. The number of our active and executive distributors may not increase and
could decline again in the future. While we take many steps to help train, motivate, and
retain distributors, we cannot accurately predict how the number and productivity of
distributors may fluctuate because we rely primarily upon our distributor leaders to
recruit, train, and motivate new distributors. Our operating results could be harmed if we
and our distributor leaders do not generate sufficient interest in our business to retain
existing distributors and attract new distributors.
The
number and productivity of our distributors also depends on several additional factors,
including:
|
|
|
any
adverse publicity regarding us, our products, our distribution channel, or our
competitors; |
|
|
|
lack
of interest in, or the technical failure of, existing or new products; |
|
|
|
lack
of a sponsoring story that generates interest for potential new distributors and
effectively draws them into the business; |
|
|
|
the
public's perception of our products and their ingredients; |
|
|
|
the
public's perception of our distributors and direct selling businesses in general; |
|
|
|
our
actions to enforce our policies and procedures; |
|
|
|
any
regulatory actions of charges against us or others in our industry; |
|
|
|
general
economic and business conditions; and |
|
|
|
potential
saturation or maturity levels in a given country or market which could negatively impact
our ability to attract and retain distributors in such market. |
Because
our products are distributed exclusively through our distributors and we compete with
other direct selling companies in attracting distributors, our operating results could be
adversely affected if our existing and new business opportunities and incentives,
products, business tools and other initiatives do not generate sufficient enthusiasm and
economic incentive to retain our existing distributors or to sponsor new distributors on a
sustained basis. In addition, in our mature markets, one of the challenges we face is
keeping distributor leaders with established businesses and high income levels motivated
and actively engaged in business building activities and developing new distributor
leaders. There can be no assurance that our initiatives will continue to generate
excitement among our distributors in the long-term or that planned initiatives will be
successful in maintaining distributor activity and productivity or in motivating
distributor leaders to remain engaged in business building and developing new distributor
leaders. In addition, some initiatives may have unanticipated negative impacts on our
distributors, particularly changes to our compensation plan. The introduction of a new
product or key initiative can also negatively impact other product lines to the extent our
distributor leaders focus their efforts on the new product or initiative.
-25-
Our business transformation
initiatives may not achieve reduced overhead and growth, and may have unintended negative
consequences.
We
continue to implement our business transformation initiatives to improve operational
efficiencies in our corporate offices and reduce investments in unprofitable markets. In
2009, we plan to significantly reduce our workforce in Japan. There could be unintended
negative consequences, including business disruptions, and any negative impact on our
ability to effectively manage our business with reduced employee levels and corporate
facilities. Further, we may not realize the cost improvements and greater efficiencies we
hope for as a result of our realignment. In addition, as we continually evaluate strategic
reinvestment of any savings generated as a result of our transformation initiative, we may
not ultimately achieve the amount of savings that we anticipate.
Although our distributors are
independent contractors, improper distributor actions that violate laws or regulations
could harm our business.
Distributor
activities in our existing markets that violate governmental laws or regulations could
result in governmental actions against us in markets where we operate, which would harm
our business. Except in China, our distributors are not employees and act independently of
us. We implement strict policies and procedures to ensure our distributors will comply
with legal requirements. However, given the size of our distributor force, we experience
problems with distributors from time to time. For example, product claims made by some of
our distributors in 1990 and 1991 led to an investigation by the FTC in the United States,
which resulted in our entering into a consent decree with the FTC. In addition, recent
rulings by the Korean FTC and by judicial authorities against us and other companies in
Korea indicate that vicarious liability may be imposed on us for the criminal activity of
our independent distributors. As we expand internationally, our distributors may attempt
to anticipate which markets we will open in the future and may begin marketing and
sponsoring activities in markets where we are not qualified to conduct business. If we are
unable to address this issue, we could face fines or other legal action.
Government inquiries,
investigations, and actions could harm our business.
There
has been an increase in governmental scrutiny of our industry in various markets,
including Japan, China, Europe, and the United Kingdom. Any adverse results in these cases
could spur further reviews and actions with respect to others in the industry. From time
to time, we receive formal and informal inquiries from various government regulatory
authorities about our business and our compliance with local laws and regulations. Any
determination that we or our distributors are not in compliance with existing laws or
regulations could potentially harm our business. Even if governmental actions do not
result in rulings or orders, they potentially could create negative publicity which could
detrimentally affect our efforts to recruit or motivate distributors and attract customers
and, consequently, reduce revenue and net income.
In
the early 1990s, we entered into voluntary consent agreements with the FTC and a few state
regulatory agencies relating to investigations of our distributors product claims
and practices. These investigations centered on alleged unsubstantiated product and
earnings claims made by some of our distributors. We believe that the negative publicity
generated by this FTC action, as well as a subsequent action in the mid-1990s related to
unsubstantiated product claims, harmed our business and results of operation in the United
States. Pursuant to the consent decrees, we agreed, among other things, to supplement our
procedures to enforce our policies, to not allow distributors to make earnings
representations without making additional disclosures relating to average earnings and to
not make, or allow our distributors to make, product claims that were not substantiated.
We have taken various actions, including implementing a more generous inventory buy-back
policy, publishing average distributor earnings information, supplementing our procedures
for enforcing our policies, and reviewing distributor product sales aids, to address the
issues raised by the FTC and state agencies in these investigations. As a result of the
previous investigations, the FTC makes inquiries from time to time regarding our
compliance with applicable laws and regulations and our consent decree. Any further
actions by the FTC or other comparable state or federal regulatory agencies, in the United
States or abroad, could have a further negative impact on us in the future.
-26-
Challenges by private parties to
the form of our network marketing system or other regulatory compliance issues could harm
our business.
We
may be subject to challenges by private parties, including our distributors, to the form
of our network marketing system or elements of our business. For example, lawsuits have
recently been brought or threatened against some of our competitors that include
allegations that the businesses involve unlawful pyramid schemes as well as other
allegations. Adverse rulings in any of the cases that have been filed or that may be filed
in the future could negatively impact our business if they create adverse publicity,
modify current regulatory requirements in a manner that is inconsistent with our current
business practices, or impose fines or other penalties. In the United States, the network
marketing industry and regulatory authorities have generally relied on the implementation
of distributor rules and policies designed to promote retail sales to protect consumers
and to prevent inappropriate activities and to distinguish between legitimate network
marketing distribution plans and unlawful pyramid schemes. We have adopted rules and
policies based on case law, rulings of the FTC, discussions with regulatory authorities in
several states and domestic and global industry standards. Legal and regulatory
requirements concerning network marketing systems, however, involve a high level of
subjectivity, are inherently fact-based and are subject to judicial interpretation.
Because of the foregoing, we can provide no assurance that we would not be harmed by the
application or interpretation of statutes or regulations governing network marketing,
particularly in any civil challenge by a current or former distributor.
Current or future governmental
regulations relating to the marketing and advertising of our products and services, in
particular our nutritional supplements, may restrict, inhibit or delay our ability to sell
these products and harm our business.
Our
products and our related marketing and advertising efforts are subject to numerous
domestic and foreign governmental agencies and authorities laws and extensive
regulations, which govern the ingredients and products that may be marketed without
registration as a drug and the claims that may be made regarding such products. Many of
these laws and regulations involve a high level of subjectivity and are inherently
fact-based and subject to interpretation. If these laws and regulations restrict, inhibit
or delay our ability to introduce or market our products or limit the claims we are able
to make regarding our products, our business may be harmed.
There
has been an increasing movement in the United States and other markets to increase the
regulation of dietary supplements, which could impose additional restrictions or
requirements in the future. In several of our markets, including Europe, South Korea and
Hong Kong, new regulations have been adopted or are likely to be adopted in the near-term
that could impose new requirements, make changes in some classifications of supplements
under the regulations, or limit the levels of ingredients we can include and claims we can
make. In addition, there has been increased regulatory scrutiny of nutritional supplements
and marketing claims under existing and new regulations. In Europe for example, we are
unable to market supplements that contain ingredients that were not marketed prior to May
1997 in Europe (novel foods) without going through an extensive registration
and pre-market approval process. Europe is also expected to adopt additional regulations
setting new limits on acceptable maximum levels of vitamins and minerals. In addition, the
FDA recently finalized new regulations on Good Manufacturing Practices and Adverse Event
Reporting requirements for the nutritional supplement industry. These regulations require
good manufacturing processes for us and our vendors and reporting of serious adverse
events associated with consumer use of our products. Our operations could be harmed if new
regulations require us to reformulate products or effect new registrations, if regulatory
authorities make determinations that any of our products do not comply with applicable
good manufacturing practices and regulatory requirements, or if we are not able to effect
necessary changes to our products in a timely and efficient manner in order to respond or
comply to new regulations. In addition, our operations could be harmed if governmental
laws or regulations are enacted that restrict the ability of companies to market or
distribute nutritional supplements or impose additional burdens or requirements on
nutritional supplement companies.
-27-
Our operations in China are
subject to significant governmental scrutiny and may be harmed by the results of such
scrutiny.
Because
of the governments significant concerns about direct selling activities, government
regulators in China closely scrutinize activities of direct selling companies or
activities that resemble direct selling. The regulatory environment in China with regards
to direct selling is evolving, and officials in multiple national and local levels in the
Chinese government often exercise broad discretion in deciding how to interpret and apply
applicable regulations. In the past, the government has taken significant actions against
companies that the government found were engaging in direct selling activities in
violation of applicable law, including shutting down their businesses and imposing
substantial fines.
Our
operations in China are subject to significant regulatory scrutiny, and we have
experienced challenges in the past, including interruption of sales activities at certain
stores and fines being paid in some cases. Although we have now obtained a direct selling
license for certain locations, government regulators continue to scrutinize our activities
and the activities of our direct sellers, sales promoters and sales employees to monitor
our compliance with the new regulations and other applicable regulations as we integrate
direct selling into our business model. We continue to be subject to current governmental
reviews and investigations. At times, complaints made by our sales representatives to the
government have resulted in increased scrutiny by the government. Any determination that
our operations or activities, or the activities of our employed sales representatives,
contractual sales promoters or approved direct sellers, are not in compliance with
applicable regulations, could result in the imposition of substantial fines, extended
interruptions of business, termination of necessary licenses and permits, including our
direct selling licenses, or restrictions on our ability to open new stores or obtain
approvals for service centers or expand into new locations, all of which could harm our
business.
If direct selling regulations in
China are interpreted or enforced by governmental authorities in a manner that negatively
impacts our retail business model or our dual business model there, our business in China
could be harmed.
Chinese
regulators have adopted anti-pyramiding and direct selling regulations that contain
significant restrictions and limitations, including a restriction on multi-level
compensation for independent distributors selling away from a fixed location. The
regulations also impose various requirements on individuals before they can become direct
sellers, including the passage of an examination, which are more burdensome than in our
other markets and which could negatively impact the willingness of some people to sign up
to become direct sellers. There continues to be some confusion and uncertainty as to the
interpretation and enforcement of the regulations and their scope, and the specific types
of restrictions and requirements imposed under them. Our business and our growth prospects
would be harmed if Chinese regulators interpret the anti-pyramiding regulations or direct
selling regulations as applying to our business model of retail stores with employed sales
representatives and contractual sales promoters, or if regulations are interpreted in such
a manner that our current method of conducting business through the use of employed sales
representatives and contractual sales promoters or our implementation of direct selling
that is currently underway is found to violate applicable regulations. In particular, our
business would be harmed by any determination that our current method of compensating our
sales employees and promoters, including our use of the sales productivity of a sales
employee and the group of sales employees whom he or she trains and supervises as one of
the factors in establishing such sales employees salary and compensation, violates
the restriction on multi-level compensation in the new regulations. Our business could
also be harmed if regulators inhibit our ability to concurrently operate our business
model of retail stores with employed sales representatives and contractual sales promoters
and our direct selling business.
-28-
If we are unable to obtain
additional necessary national and local governmental approvals in China as quickly as we would
like, our ability to expand our direct selling business and grow our business there could
be negatively impacted.
We
have completed the required national and local licensing process and commenced direct
selling activities in Beijing and Shanghai, Shenzhen City and four cities in the Guangdong
province. In order to expand our direct selling model into additional provinces, we
currently must obtain a series of approvals from district, city, provincial and national
governmental agencies with respect to each province in which we wish to expand. The
process for obtaining the necessary governmental approvals to conduct direct selling
continues to evolve. As we are being required to work with such a large number of
provincial, city, district and national governmental authorities, we have found that it is
taking more time than anticipated to work through the approval process with these
authorities. The complexity of the approval process as well as the governments
continued cautious approach as direct selling develops in China makes it difficult to
predict the timeline for obtaining these approvals. If the results of the
governments evaluation of our direct selling activities result in further delays in
obtaining licenses elsewhere, or if the current processes for obtaining approvals are
delayed further for any reason or are changed or are interpreted differently than
currently understood, our ability to expand direct selling in China and our growth
prospects in this market, could be negatively impacted.
Implementing a compensation plan
and business model for our independent distributors in China that is different from other
markets could harm our ability to grow our business in China.
The
direct selling regulations in China impose various limitations and requirements, including
a prohibition on multi-level compensation and a requirement that all distributors pass a
required examination before becoming a distributor. The regulations also impose other
restrictions on direct selling activities that differ from the regulations in our other
markets. As a result, we are implementing a direct selling compensation plan and business
model for the direct sales component of our business that differs from the model we use in
other markets. There can be no assurance that these restrictions will not negatively
impact our ability to provide an attractive business opportunity to distributors in this
market and limit our ability to grow our business in this market. In addition, the
regulations do not allow the sale of general foods through a direct selling business
model. Because some of our supplements, including LifePak, are being marketed as
general foods until we obtain health food status for these products, we will only be able
to sell these products at our stores and not away from the stores until they receive
health food status, which could have a negative impact on our direct selling business.
Product diversion to certain
markets, including China, may have a negative impact on our business.
From time to time, we see our product
being sold through online or other distribution channels in certain markets. This has
become a more significant problem in China. Product diversion causes confusion regarding
our distribution channels and negatively impacts our distributors ability to retail
our products. It also creates a negative impression regarding the viability of the business
opportunity for our distributors and sales representatives, which can harm our ability to recruit new
distributors and sales representatives. In addition, in some cases, product diversion schemes may also involve
illegal importation, investment or other activities. If we are unable to effectively
address this issue or if diversion increases, our business could be harmed.
-29-
Intellectual property
rights are difficult to enforce in China.
Chinese
commercial law is relatively undeveloped compared to most of our other major markets, and,
as a result, we may have limited legal recourse in the event we encounter significant
difficulties with patent or trademark infringers. Limited protection of intellectual
property is available under Chinese law, and the local manufacturing of our products may
subject us to an increased risk that unauthorized parties may attempt to copy or otherwise
obtain or use our product formulations. As a result, we cannot assure that we will be able
to adequately protect our product formulations.
If one of our tools is determined
to be a medical device in a particular geographic market or if our distributors use it for
medical purposes, our ability to continue to market and distribute such tool could be
harmed.
One of our strategies is to market unique tools that allow our distributors to distinguish
our products, including the Pharmanex BioPhotonic Scanner and the
Galvanic Spa System II. We do not believe these tools are medical devices and do
not market them to our distributors as medical devices. In March 2003, the FDA questioned
whether the Pharmanex BioPhotonic Scanner was a non-medical device. We subsequently
filed an application with the FDA to have it affirmatively classified as a non-medical
device. The FDA has not yet acted on our application. There are various factors that could
determine whether a product is a medical device including the claims that we or our
distributors make about it. We have faced similar uncertainties and regulatory issues in
other markets with respect to the status of one or more of our tools as a non-medical
device and the claims that can be made in using it. For example, we have faced regulatory
inquiries in Japan, Korea, Singapore and Thailand regarding distributor claims with
respect to the Pharmanex BioPhotonic Scanner. We are not able to market the
Galvanic Spa System II in Taiwan due to similar regulatory restrictions. There have
also been recent legislative proposals in Singapore and Malaysia relating to the
regulation of medical devices which could have an impact on some or all of our tools. A
determination in any of these markets that any of our tools are medical devices or that
distributors are using it to make medical claims or perform medical diagnoses or other
activities limited to licensed professionals or approved medical devices could negatively
impact our ability to use these tools in a market. Regulatory scrutiny of a tool could
also dampen distributor enthusiasm and hinder the ability of distributors to effectively
utilize such tool. In the event medical device clearance is required in any market,
obtaining clearance could require us to provide documentation concerning its clinical
utility and to make some modifications to its design, specifications and manufacturing
process in order to meet stringent standards imposed on medical device companies. If we
obtained such medical device approval in order to sell a tool in one market, such approval
may be used as precedent to a claim in another market that such approval should likewise
be required in such market. There can be no assurance we would be able to provide the
required medical device documentation, prove clinical utility in a manner sufficient to
obtain medical device approval or make such changes promptly or in a manner that is
satisfactory to regulatory authorities.
Changes to our compensation
arrangements with our distributors could be viewed negatively by some distributors and
could harm our operating results if such changes impact distributor productivity.
We
have implemented a global compensation plan that has some components that differ from
market to market. We modify components of our compensation plan from time to time in an
attempt to keep our compensation plan competitive and attractive to existing and potential
distributors, to address changing market dynamics, to provide incentives to distributors
that we believe will help grow our business, and to address other business needs. Because
of the size of our distributor force and the complexity of our compensation plans, it is
difficult to predict whether such changes will achieve their desired results. For example,
in 2005, we made changes to our compensation plan in Japan that had been successful in
other markets, but did not have the impact in Japan that we anticipated and negatively
impacted our business. China and certain markets in Southeast Asia similarly were
negatively impacted by compensation plan changes in 2005. In 2008, we implemented
modifications to our compensation plan in the Americas and Europe regions. We are
currently planning to implement the same compensation plan features in most of our Asian
markets in 2009. Because of unique features of existing plans in these markets,
particularly in our Southeast Asia and Japan markets, implementation of these features
will involve a more significant transition. There are risks that the compensation plan
modifications we make will not be well received or achieve desired results in each of
these markets and that the transition could have a negative impact on revenue. If our
distributors fail to adapt to these changes or find them unattractive, our business could
be harmed.
-30-
If we are unable to successfully
expand and grow operations within our recently opened and developing markets, we may have
difficulty achieving our long-term objectives.
A
significant percentage of our revenue growth over the past decade has been attributable to
our expansion into new markets. Our growth over the next several years depends in part on
our ability to successfully introduce products and tools, and to successfully implement
initiatives in our new and developing markets, including China, Russia, Latin America and
Eastern Europe that will help generate growth. In addition to the regulatory difficulties
we may face in introducing our products, tools, and initiatives in these markets, we could
face difficulties in achieving acceptance of our premium-priced products in developing
markets. In the past, we have struggled to operate profitably in developing markets, such
as Latin America. This may also be the case in Eastern Europe and the other new markets
into which we have recently expanded. If we are unable to successfully expand our
operations within these new markets, our opportunities to grow our business may be
limited, and, as a result, we may not be able to achieve our long-term objectives.
Adverse publicity concerning our
business, marketing plan or products could harm our business and reputation.
The
size of our distribution force and the results of our operations can be particularly
impacted by adverse publicity regarding us, the nature of our distributor network, our
products or the actions of our distributors. Specifically, we are susceptible to adverse
publicity concerning:
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suspicions
about the legality and ethics of network marketing; |
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the
ingredients or safety of our or our competitors' products; |
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regulatory
investigations of us, our competitors and our respective products; |
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the
actions of our current or former distributors; and |
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public
perceptions of direct selling generally. |
In the past we have experienced negative publicity that has harmed our business in
connection with regulatory investigations and inquiries. We may receive negative publicity
in the future, and it may harm our business and reputation.
-31-
Inability of new products to gain
distributor and market acceptance could harm our business.
A
critical component of our business is our ability to develop new products that create
enthusiasm among our distributor force. If we are unable to introduce new products, our
distributor productivity could be harmed. In addition, if any new products fail to gain
market acceptance, are restricted by regulatory requirements or have quality problems,
this would harm our results of operations. Factors that could affect our ability to
continue to introduce new products include, among others, government regulations, the
inability to attract and retain qualified research and development staff, the termination
of third-party research and collaborative arrangements, proprietary protections of
competitors that may limit our ability to offer comparable products and the difficulties
in anticipating changes in consumer tastes and buying preferences.
The loss of key high-level
distributors could negatively impact our distributor growth and our revenue.
As
of December 31, 2008, we had approximately 761,000 active independent distributors,
sales representatives and preferred customers, including approximately 31,000
executive level distributors or full-time sales representatives. Approximately
480 distributors occupied the highest distributor level under our global
compensation plan as of that date. These distributors, together with their extensive
networks of downline distributors, account for substantially all of our revenue. As a
result, the loss of a high-level distributor or a group of leading distributors in the
distributors network of downline distributors, whether by their own choice or
through disciplinary actions by us for violations of our policies and procedures, could
negatively impact our distributor growth and our revenue.
Laws and regulations may prohibit
or severely restrict our direct sales efforts and cause our revenue and profitability to
decline, and regulators could adopt new regulations that harm our business.
Various
government agencies throughout the world regulate direct sales practices. These laws and
regulations are generally intended to prevent fraudulent or deceptive schemes, often
referred to as pyramid schemes, that compensate participants for recruiting
additional participants irrespective of product sales, use high pressure recruiting
methods and/or do not involve legitimate products. The laws and regulations in our current
markets often:
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impose
order cancellations, product returns, inventory buy-backs and cooling-off rights for
consumers and distributors; |
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require
us or our distributors to register with governmental agencies; |
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impose
caps on the amount of commissions we can pay; and/or |
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require
us to ensure that distributors are not being compensated based upon the recruitment of
new distributors. |
Complying
with these widely varying and sometimes inconsistent rules and regulations can be
difficult and require the devotion of significant resources on our part. If we are unable
to continue business in existing markets or commence operations in new markets because of
these laws, our revenue and profitability will decline. Countries where we currently do
business could change their laws or regulations to negatively affect or completely
prohibit direct sales efforts.
-32-
Increases in duties on our
imported products in our markets outside of the United States or adverse results of tax
audits in our various markets could reduce our revenue, negatively impact our operating
results and harm our competitive position.
Historically,
we have imported most of our products into the countries in which they are ultimately
sold. These countries impose various legal restrictions on imports and typically impose
duties on our products. We are subject from time to time to reviews and audits by the
foreign taxing authorities of the various jurisdictions in which we conduct business
throughout the world. These audits sometimes result in challenges by such taxing
authorities as to our methodologies used in determining our income tax, duties, customs,
and other amounts owed in connection with the importation and distribution of our
products. Currently, customs audits are underway in a number of our markets. We have been
assessed by the Japan customs authorities approximately yen 2.7 billion (or approximately
$29.7 million as of December 31, 2008) for additional duties on products imported into
Japan, and we are currently contesting this assessment. Effective July 1, 2005, the
Company is operating under a new structure in Japan and we are in the process of
negotiating a new advanced pricing agreement with the income tax authorities in Japan
related to our transfer pricing for products being imported into Japan. In connection with
these negotiations, they have requested that we explain our position in the customs
appeal and the difference in our treatment of the transaction for customs purposes
compared to our income tax treatment under the prior structures. In the event the income
tax authorities disagree with our position or explanation, there is a risk that they could
attempt to challenge our income tax position, which could negatively impact our ability to
successfully prosecute our customs appeal or result in additional income tax
assessments. To the extent that we are unsuccessful in recovering the amounts assessed and
paid, we will be required to take a corresponding charge to our earnings.
Governmental authorities may
question our tax positions or transfer pricing policies or change their laws in a manner
that could increase our effective tax rate or otherwise harm our business.
As
a U.S. company doing business in international markets through subsidiaries, we are
subject to various tax and intercompany pricing laws, including those relating to the flow
of funds between our company and our subsidiaries. From time to time, we are audited by
tax regulators in the United States and in our foreign markets. If regulators challenge
our tax positions, corporate structure, transfer pricing mechanisms or intercompany
transfers, we may be subject to fines and payment of back taxes, our effective tax rate
may increase and our operations may be harmed. Tax rates vary from country to country,
and, if regulators determine that our profits in one jurisdiction may need to be
increased, we may not be able to fully utilize all foreign tax credits that are generated,
which will increase our effective tax rate. For example, our corporate income tax rate in
the United States is 35%. If our profitability in a higher tax jurisdiction, such as Japan
where the corporate tax rate is currently set at 45%, increases disproportionately to the
rest of our business, our effective tax rate may increase. The various customs, exchange
control and transfer pricing laws are continually changing and are subject to the
interpretation of governmental agencies. Despite our efforts to be aware of and comply
with such laws and changes to and interpretations thereof, there is a risk that we may not
continue to operate in compliance with such laws. We may need to adjust our operating
procedures in response to such changes, and as a result, our business may suffer.
The loss of suppliers or shortages
in ingredients could harm our business.
We acquire ingredients and products from two suppliers that each currently manufactures a
significant portion of our Nu Skin personal care products. In addition, we currently rely
on two suppliers for a majority of Pharmanex nutritional supplement products. In the event
we were to lose any of these suppliers and experience any difficulties in finding or
transitioning to alternative suppliers, this could harm our business. In addition, we
obtain some of our products from sole suppliers that own or control the product
formulations, ingredients, or other intellectual property rights associated with such
products. These products include our Galvanic Spa System II and True Face
Essence products, two products that have contributed significantly to our growth over
the past year. We also license the right to distribute some of our products from third
parties. In the event we are unable to renew these contracts, we may need to discontinue
some products or develop substitute products, which could harm our revenue. In addition,
if we experience supply shortages or regulatory impediments with respect to the raw
materials and ingredients we use in our products, we may need to seek alternative supplies
or suppliers. Some of our nutritional products, including g3 juice, incorporate
natural products that are only harvested once a year and may have limited supplies. If
demand exceeds forecasts, we may have difficulties in obtaining additional supplies to
meet the excess demand until the next growing season. If we are unable to successfully
respond to such issues, our business could be harmed.
-33-
Production difficulties and
quality control problems could harm our business.
Production
difficulties and quality control problems and our reliance on third party suppliers to
deliver quality products in a timely manner could harm our business. Occasionally, we have
experienced production difficulties with respect to our products, including the delivery
of products that do not meet our quality control standards. These quality problems have
resulted in the past, and could result in the future, in stock outages or shortages in our
markets with respect to such products, harming our sales and creating inventory write-offs
for unusable products. In addition, these issues can negatively impact distributor
confidence as well as potentially invite additional governmental scrutiny in our various
markets.
We depend on our key personnel,
and the loss of the services provided by any of our executive officers or other key
employees could harm our business and results of operations.
Our
success depends to a significant degree upon the continued contributions of our senior
management, many of whom would be difficult to replace. In addition, expatriates serve in
key management positions in several of our foreign markets, including Japan and China.
These employees may voluntarily terminate their employment with us at any time. We may not
be able to successfully retain existing personnel or identify, hire and integrate new
personnel. We do not carry key person insurance for any of our personnel. Although we have
signed offer letters or written agreements summarizing the compensation terms for some of
our senior executives, we have generally not entered into formal employment agreements
with our executive officers. If we lose the services of our executive officers or key
employees for any reason, our business, financial condition and results of operations
could be harmed.
Our markets are intensely
competitive, and market conditions and the strengths of competitors may harm our business.
The
markets for our products are intensely competitive. Our results of operations may be
harmed by market conditions and competition in the future. Many competitors have much
greater name recognition and financial resources than we have, which may give them a
competitive advantage. For example, our Nu Skin products compete directly with branded,
premium retail products. We also compete with other direct selling organizations. The
leading direct selling companies in our existing markets are Herbalife, Mary Kay,
Oriflame, Melaleuca, Avon and Amway. We currently do not have significant patent or other
proprietary protection, and our competitors may introduce products with the same
ingredients that we use in our products. Because of regulatory restrictions concerning
claims about the efficacy of dietary supplements, we may have difficulty differentiating
our products from our competitors products, and competing products entering the
nutritional market could harm our nutritional supplement revenue.
-34-
We
also compete with other network marketing companies for distributors. Some of these
competitors have a longer operating history and greater visibility, name recognition and
financial resources than we do. Some of our competitors have also adopted and could
continue to adopt some of our successful business strategies, including our global
compensation plan for distributors. Consequently, to successfully compete in this market
and attract and retain distributors, we must ensure that our business opportunities and
compensation plans are financially rewarding. We are beginning our 25th year in
this industry and believe we have significant competitive advantages, but we cannot assure
you that we will be able to successfully compete in every endeavor in this market.
Product liability claims
could harm our business.
We may be required to pay for losses or injuries purportedly or actually caused by our
products. Although historically we have had a very limited number and relatively low
financial exposure from product claims, we have experienced difficulty in finding insurers
that are willing to provide product liability coverage at reasonable rates due to
insurance industry trends and the rising cost of insurance generally. As a result, we have
elected to self-insure our product liability risks for our product lines. Until we elect
and are able at reasonable rates to obtain product liability insurance, if any of our
products are found to cause any injury or damage, we will be subject to the full amount of
liability associated with any injuries or damages. This liability could be substantial and
may exceed our reserves. We cannot predict if and when product liability insurance will be
available to us on reasonable terms.
System failures could
harm our business.
Because
of our diverse geographic operations and our complex distributor compensation plan, our
business is highly dependent on efficiently functioning information technology systems.
These systems and operations are vulnerable to damage or interruption from fires,
earthquakes, telecommunications failures and other events. They are also subject to
break-ins, sabotage, intentional acts of vandalism and similar misconduct. We have adopted
and implemented a Business Continuity/Disaster Recovery Plan. Our primary data sets are
archived and stored at third-party secure sites, but we have not contracted for a
third-party recovery site. Despite any precautions, the occurrence of a natural disaster
or other unanticipated problems could result in interruptions in services and reduce our
revenue and profits.
There is a risk that a SARS like
epidemic could negatively impact our business, particularly in those Asian markets most
affected by such epidemics in recent years.
Our
revenue was negatively impacted in 2003 by the SARS epidemic that hit Asia during that
year. It is difficult to predict the impact on our business, if any, of a recurrence of
SARS, or the emergence of new epidemics. Although such events could generate increased
sales of health/immune supplements and certain personal care products, our direct selling
and retail activities and results of operations could be harmed if the fear of the Avian
Flu, SARS or other communicable diseases that spread rapidly in densely populated areas
causes people to avoid public places and interaction with one another.
The market price of our common
stock is subject to significant fluctuations due to a number of factors that are beyond
our control.
Our
common stock closed at $17.72 per share on February 16, 2007 and closed at $10.83 per
share on February 17, 2009. During this two-year period, our common stock traded as low as
$8.42 per share and as high as $19.99 per share. Many factors could cause the market price
of our common stock to fall. Some of these factors include:
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fluctuations
in our quarterly operating results; |
-35-
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the
sale of shares of Class A common stock by our original or significant stockholders; |
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general
trends in the market for our products; |
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acquisitions
by us or our competitors; |
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economic
and/or currency exchange issues in markets in which we operate; |
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changes
in estimates of our operating performance or changes in recommendations by securities
analysts; and |
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general
business and political conditions. |
Broad
market fluctuations could also lower the market price of our common stock regardless of
our actual operating performance.
As of December 31,2008, our
original stockholders, together with their family members, estate planning entities and
affiliates, controlled approximately 30% of the combined stockholder voting power, and
their interests may be different from yours.
The
original stockholders of our company, together with their family members and affiliates,
have the ability to influence the election and removal of the board of directors and, as a
result, our future direction and operations. As of December 31, 2008, these stockholders
owned approximately 30% of the voting power of the outstanding shares of common
stock. Accordingly, they may influence decisions concerning business opportunities,
declaring dividends, issuing additional shares of common stock or other securities and the
approval of any merger, consolidation or sale of all or substantially all of our assets.
They may make decisions that are adverse to your interests.
If our stockholders sell a
substantial number of shares of our common stock in the public market, the market price of
our common stock could fall.
Several
of our principal stockholders hold a large number of shares of the outstanding common
stock. A decision by any of our principal stockholders to aggressively sell their shares
could depress the market price of our common stock. As of December 31, 2008, we had
approximately 63.4 million shares of common stock outstanding. All of these shares are
freely tradable, except for approximately 17.3 million shares held by certain
founding stockholders who entered into lock-up agreements with us in connection
with the repurchase of shares in 2003. Under the terms of these lock-up agreements, they
are subject to certain volume limitations with respect to open market transactions. We have
the discretion to waive or terminate these restrictions. In the event these
lock-up restrictions were terminated, our stock price could be harmed if these
stockholders sold large amounts of stock over a short period of time.
ITEM 1B. |
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UNRESOLVED STAFF COMMENTS |
None.
Our
principal properties consist of the following:
-36-
Operational
Facilities. These facilities include administrative offices, walk-in centers, and
warehouse/distribution centers. Our operational facilities measuring 50,000 square feet or
more include the following:
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our
worldwide headquarters in Provo, Utah; |
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our
worldwide distribution center/warehouse in Provo, Utah; and |
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our
distribution center in Tokyo, Japan. |
Manufacturing Facilities. Each of
our manufacturing facilities measure 50,000 square feet or more, and include the
following:
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our
nutritional supplement manufacturing facility in Zhejiang Province, China; |
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our
personal care manufacturing facility in Shanghai, China; |
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our
Vitameal manufacturing facility in Jixi, Heilongjiang Province. |
Retail Stores. As of December 31,
2008, we operated approximately 45 stores throughout China.
Research
and Development Centers. We operate three research and development centers, one in
Provo, Utah, one in Shanghai, China, and one in Beijing, China.
With
the exception of our research and development center in Utah, our nutritional supplement
plant in China, and a few other minor facilities, which we own, we lease the properties
described above. Our headquarters and distribution center in Utah are leased from related
parties. We believe that our existing and planned facilities are adequate for our current
operations in each of our existing markets.
ITEM 3. |
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LEGAL PROCEEDINGS |
Due
to the international nature of our business, we are subject from time to time to reviews
and audits by the foreign taxing authorities of the various jurisdictions in which we
conduct business throughout the world. In 1999, we implemented a duty valuation
methodology with respect to the importation of certain products into Japan. For purposes
of the import transactions at issue, we had taken the position that, under applicable
customs law, there was a sale between the manufacturer and our Japan subsidiary, and that
customs duties should be assessed on the manufacturers invoice. The Valuation
Department of the Yokohama customs authorities reviewed and approved this methodology at
that time, and it had been reviewed on several occasions by the audit division of the
Japan customs authorities since then. In connection with subsequent audits in 2004, the
Yokohama customs authorities assessed us additional duties and penalties on these products
imported into Japan from October 2002 to October 2004, based on a different valuation
methodology than what was previously approved. With respect to the periods under audit,
the customs authorities took the position that the relevant import transaction involved a
sale between our U.S. affiliate and our Japan subsidiary and that duties should be
assessed on the value of that transaction. We disputed this assessment. We also disputed
the amount of duties we were required to pay on products imported from November of 2004 to
June of 2005 for similar reasons. The total amount assessed or in dispute was
approximately yen 2.7 billion (or approximately $29.7 million as of December 31, 2008),
net of any recovery of consumption taxes. Effective July 1, 2005, we implemented some
modifications to our business structure in Japan and in the United States that we believe
will eliminate any further customs valuation disputes with respect to product imports in
Japan after that time.
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Because
we believe the documentation and legal analysis supports our position and the valuation
methodology we used with respect to the products in dispute had been reviewed and approved
by the customs authorities in Japan, we believe the assessments are improper and we filed
letters of protest with Yokohama customs with respect to this entire amount. Yokohama
customs rejected our letters of protest, and to follow proper administrative procedures we
filed appeals with the Japan Ministry of Finance. In order to appeal, we were required to
pay the approximately yen 2.7 billion in custom duties and assessments related to all of
the amounts at issue, which we recorded in Other Assets in our Consolidated
Balance Sheet. On June 26, 2006, we were advised that the Ministry of Finance had rejected
the appeals filed with their office relating to the imports from October 2002 to October
2004. We decided to appeal this issue through the judicial court system in Japan, and on
December 22, 2006, we filed a complaint with the Tokyo District Court Civil Action Section
with respect to this period. In January 2007, we were advised that the Ministry of Finance
also rejected our appeal with them for the imports from November 2004 to June 2005. We
appealed this decision with the court system in July 2007. Currently, all appeals are
pending with the Tokyo District Court Civil Action Section. One of the findings cited by
the Ministry of Finance in its decisions was that we had treated the transactions as sales
between our U.S. affiliate and our Japan subsidiary on our corporate income tax return
under applicable income tax and transfer pricing laws. To the extent that we are
unsuccessful in recovering the amounts assessed and paid, we will be required to take a
corresponding charge to our earnings.
ITEM 4. |
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SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
There
were no matters submitted to a vote of the security holders during the fourth quarter of
the fiscal year ended December 31, 2008.
PART II
ITEM 5. |
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MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES |
Our
Class A common stock is listed on the New York Stock Exchange (NYSE) and
trades under the symbol NUS. The following table is based upon the information
available to us and sets forth the range of the high and low sales prices for our Class A
common stock for the quarterly periods during 2007 and 2008 based upon quotations on the
NYSE.
Quarter Ended | |
High | |
Low | |
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March 31, 2007 |
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$ 19.15 |
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$ 15.59 |
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June 30, 2007 | |
18.11 |
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15.67 |
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September 30, 2007 | |
17.37 |
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13.85 |
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December 31, 2007 | |
18.21 |
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13.91 |
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Quarter Ended | |
High | |
Low | |
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March 31, 2008 |
|
$ 19.99 |
|
$ 14.51 |
|
June 30, 2008 | |
19.12 |
|
14.91 |
|
September 30, 2008 | |
17.83 |
|
14.51 |
|
December 31, 2008 | |
16.34 |
|
8.42 |
|
-38-
The
market price of our Class A common stock is subject to significant fluctuations in
response to variations in our quarterly operating results, general trends in the market
for our products and product candidates, economic and currency exchange issues in the
foreign markets in which we operate and other factors, many of which are not within our
control. In addition, broad market fluctuations, as well as general economic, business,
regulatory and political conditions may adversely affect the market for our Class A common
stock, regardless of our actual or projected performance.
The
closing price of our Class A common stock on February 17, 2009, was $10.83. The
approximate number of holders of record of our Class A common stock as of February 17,
2009 was 518. This number of holders of record does not represent the actual number of
beneficial owners of shares of our Class A common stock because shares are frequently held
in street name by securities dealers and others for the benefit of individual
owners who have the right to vote their shares.
Dividends
We
declared and paid a $0.105 per share dividend for Class A common stock in March, June,
September and December of 2007, and a $0.11 per share quarterly dividend for Class A
common stock in March, June, September and December of 2008. The board of directors
approved an increase to the quarterly cash dividend to $0.115 per share of Class A common
stock on February 2, 2009. This quarterly cash dividend will be paid on March 18, 2009, to
stockholders of record on February 27, 2009. Management believes that cash flows from
operations will be sufficient to fund this and future dividend payments, if any.
We
expect to continue to pay dividends on our common stock. However, the declaration of
dividends is subject to the discretion of our board of directors and will depend upon
various factors, including our net earnings, financial condition, cash requirements,
future prospects and other factors deemed relevant by our board of directors.
Purchases of Equity
Securities by the Issuer
|
(a) | |
(b) | |
(c) | |
(d) | |
Period | |
Total Number of Shares Purchased | |
Average Price Paid per Share | |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | |
Approximate Dollar Value of Shares that may yet be Purchased Under
the Plans or Programs (in millions)(1) | |
October 1 - 31, 2008 |
|
|
|
$ |
|
|
|
$ 86.1 |
|
November 1 - 30, 2008 |
|
171,000 | |
11.04 |
|
171,000 |
|
84.2 |
| |
December 1 - 31, 2008 |
|
62,400 |
|
9.69 |
|
62,400 |
|
83.6 | |
|
Total |
|
233,400 |
|
10.68 |
|
233,400 |
(1) |
|
In
August 1998, our board of directors approved a plan to repurchase $10.0 million
of our Class A common stock on the open market or in private transactions. Our
board has from time to time increased the amount authorized under the plan and
a total amount of approximately $335.0 million is currently authorized. As of
December 31, 2008, we had repurchased approximately $251.4 million of shares
under the plan. There has been no termination or expiration of the plan since
the initial date of approval. |
-39-
Stock Performance Graph
Set
forth below is a line graph comparing the cumulative total stockholder return (stock price
appreciation plus dividends) on the Class A Common Stock with the cumulative total return
of the S&P 500 Index and a market-weighted index of publicly traded peers for the
period from December 31, 2003 through December 31, 2008. The graph assumes that $100 is
invested in each of the Class A Common Stock, the S&P 500 Index, and each of the
indexes of publicly traded peers on December 31, 2003 and that all dividends were
reinvested. The peer group consists of all of the following companies that compete in our
industry and product categories: Avon Products, Inc., Estee Lauder, Natures Sunshine
Products, Inc., Tupperware Corporation, Herbalife LTD., USANA Health Sciences, Inc. and
Alberto Culver Co.
Measured Period
|
Company
|
S&P 500 Index
|
Peer Group Index
|
December 31, 2003 |
|
$ 100 |
.00 |
100 |
.00 |
100 |
.00 |
December 31, 2004 | |
150 |
.57 |
110 |
.88 |
110 |
.87 |
December 31, 2005 | |
106 |
.12 |
116 |
.33 |
116 |
.32 |
December 31, 2006 | |
112 |
.53 |
134 |
.70 |
134 |
.70 |
December 31, 2007 | |
104 |
.02 |
142 |
.10 |
155 |
.28 |
December 31, 2008 | |
68 |
.09 |
89 |
.53 |
102 |
.58 |
-40-
ITEM 6. |
|
SELECTED FINANCIAL DATA |
The
following selected consolidated financial data as of and for the years ended December 31,
2004, 2005, 2006, 2007 and 2008 have been derived from the audited consolidated financial
statements.
|
Year Ended December 31, |
|
|
2004 | |
2005 | |
2006 | |
2007 | |
2008 | |
|
(U.S. dollars in thousands, except per share data and cash dividends) |
|
Income Statement Data: |
|
|
|
|
|
|
|
|
|
|
|
Revenue | |
$ 1,137,864 |
|
$ 1,180,930 |
|
$ 1,115,409 |
|
$ 1,157,667 |
|
$ 1,247,646 |
|
Cost of sales | |
191,211 |
|
206,163 |
|
195,203 |
|
209,283 |
|
228,597 |
|
Gross profit | |
946,653 |
|
974,767 |
|
920,206 |
|
948,384 |
|
1,019,049 |
|
Operating expenses: | |
Selling expenses | |
487,631 |
|
497,421 |
|
480,136 |
|
496,454 |
|
529,368 |
|
General and administrative expenses(1) | |
333,263 |
|
354,223 |
|
353,412 |
|
361,242 |
|
364,253 |
|
Restructuring charges | |
|
|
|
|
11,115 |
|
19,775 |
|
|
|
Impairment of assets and other | |
|
|
|
|
20,840 |
|
|
|
|
|
Total operating expenses | |
820,894 |
|
851,644 |
|
865,503 |
|
877,471 |
|
893,621 |
|
Operating income | |
125,759 |
|
123,123 |
|
54,703 |
|
70,913 |
|
125,428 |
|
Other income (expense), net | |
(3,618 |
) |
(4,172 |
) |
(2,027 |
) |
(2,435 |
) |
(24,775 |
) |
Income before provision for income taxes | |
122,141 |
|
118,951 |
|
52,676 |
|
68,478 |
|
100,653 |
|
Provision for income taxes | |
44,467 |
|
44,918 |
|
19,859 |
|
24,606 |
|
35,306 |
|
Net income | |
$ 77,674 |
|
$ 74,033 |
|
$ 32,817 |
|
$ 43,872 |
|
$ 65,347 |
|
Net income per share: | |
Basic | |
$ 1.10 |
|
$ 1.06 |
|
$ 0.47 |
|
$ 0.68 |
|
$ 1.03 |
|
Diluted | |
$ 1.07 |
|
$ 1.04 |
|
$ 0.47 |
|
$ 0.67 |
|
$ 1.02 |
|
Weighted-average common shares outstanding (000s): | |
Basic | |
70,734 |
|
70,047 |
|
69,418 |
|
64,783 |
|
63,510 |
|
Diluted | |
72,627 |
|
71,356 |
|
70,506 |
|
65,584 |
|
64,132 |
|
|
|
|
Balance Sheet Data (at end of period): | |
Cash and cash equivalents and current investments | |
$ 120,095 |
|
$ 155,409 |
|
$ 121,353 |
|
$ 92,552 |
|
$ 114,586 |
|
Working capital | |
117,401 |
|
149,098 |
|
109,418 |
|
95,175 |
|
124,036 |
|
Total assets | |
609,737 |
|
678,866 |
|
664,849 |
|
683,243 |
|
709,772 |
|
Current portion of long-term debt | |
18,540 |
|
26,757 |
|
26,652 |
|
31,441 |
|
30,196 |
|
Long-term debt | |
132,701 |
|
123,483 |
|
136,173 |
|
169,229 |
|
158,760 |
|
Stockholders' equity | |
296,233 |
|
354,628 |
|
318,980 |
|
275,009 |
|
316,180 |
|
Cash dividends declared | |
0.32 |
|
0.36 |
|
0.40 |
|
0.42 |
|
0.44 |
|
|
|
|
Supplemental Operating Data (at end of period): | |
Approximate number of active distributors(2) | |
820,000 |
|
803,000 |
|
761,000 |
|
755,000 |
|
761,000 |
|
Number of executive distributors(2) | |
32,016 |
|
30,471 |
|
29,756 |
|
30,002 |
|
30,588 |
|
(1) |
|
Beginning
in 2006 the Company adopted FAS 123R which resulted in stock-based
compensation expense of $9.3 million, 8.1 million and $7.3 million in
2006, 2007 and 2008, respectively. |
(2) |
|
Active
distributors include preferred customers and distributors purchasing products
directly from us during the three months ended as of the date indicated. An
executive distributor is an active distributor who has achieved required
personal and group sales volumes. |
-41-
ITEM 7. |
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION |
The
following discussion of our financial condition and results of operation should be read in
conjunction with the Consolidated Financial Statements and related Notes thereto, which
are included in this Annual Report on Form 10-K.
Overview
We
are a leading, global direct selling company with 2008 revenue of $1.2 billion and a
global network of approximately 761,000 active independent distributors and preferred
customers who purchase our products for resale and for personal use. Approximately 31,000
of these distributors are executive level distributors, who play an important leadership
role in our distribution network and are critical to the growth of our business. We
develop and distribute premium-quality, innovative personal care products and nutritional
supplements that are sold under the Nu Skin and Pharmanex brands. We also market a limited
number of other products and services. We currently operate in 48 countries worldwide.
Our
revenue depends on the number and productivity of our active independent distributors and
executive distributor leaders. We have been successful in attracting and motivating
distributors by:
|
|
|
developing
and marketing innovative, technologically and scientifically advanced products; |
|
|
|
providing
compelling initiatives, advanced technological tools and strong distributor support; and |
|
|
|
offering
attractive incentives that motivate distributors to build sales organizations. |
Our
distributors market and sell our products and recruit new distributors based on the
distinguishing benefits and innovative characteristics of our products. As a result, it is
vital to our business that we continuously leverage our research and development resources
to develop and introduce innovative products and provide our distributors with an
attractive portfolio of products. We also offer unique initiatives, products, and business
tools, such as our Galvanic Spa System II and technologically-advanced Pharmanex
BioPhotonic Scanner (the Scanner), to help distributors effectively
differentiate our earnings opportunity and product offering. If we experience delays or
difficulties in introducing compelling products or attractive initiatives or tools into a
market, this can have a negative impact on revenue and distributor recruiting.
We
have developed a global distributor compensation plan and other incentives designed to
motivate our distributors to market and sell our products and to build sales organizations
around the world and across product lines. In 2008, we implemented modifications to our
compensation plan in the Americas and Europe regions designed to improve commission
payments early in the distributor lifecycle. The initial results from these modifications
have been positive and we plan to introduce the same compensation plan features in most of
our Asian markets in 2009. While we anticipate that the changes will help support
distributor growth in our Asia markets, the implementation of these modifications in these
markets, particularly Southeast Asia and Japan, involve a more significant transition than
the transition in the Americas and Europe because of the unique features of our existing
compensation plans in these markets.
Our
extensive global distributor network helps us to rapidly introduce products and penetrate
our markets with little up-front promotional expense. Similar to other companies in our
industry, we experience a high level of turnover among our distributors. As a result, it
is important that we regularly introduce innovative and compelling products and
initiatives in order to maintain a compelling business opportunity that will attract new
distributors. We have also developed and continue to promote in many of our markets
product subscription and loyalty programs that provide incentives for customers to commit
to purchase a specific amount of products on a monthly basis. We believe these
subscription programs have improved customer retention, have had a stabilizing impact on
revenue, and have helped generate recurring sales for our distributors. Subscription
orders represented 50% of our revenue in 2008.
-42-
In
2008, we generated approximately 73% of our revenue from our Asian markets, with sales in
Japan representing approximately 36% of revenue. Because of the size of our foreign
operations, operating results can be impacted negatively or positively by factors such as
foreign currency fluctuations, in particular, fluctuations between the Japanese yen and
the U.S. dollar, and economic, political and business conditions around the world. In
addition, our business is subject to various laws and regulations related to network
marketing activities and nutritional supplements that create certain risks for our
business, including improper claims or activities by our distributors and the potential
inability to obtain necessary product registrations. For more information about these
risks and challenges we face, please refer to the Note Regarding Forward-Looking
Statements.
Over
the last few years, we have also taken steps to transform and align our business and
operate more efficiently. These steps have helped improve our operating efficiencies as
evidenced by our improved operating margin in 2008. We are taking additional steps in
Japan in the beginning of 2009 to further align our operations in this market and to
improve operating efficiencies.
Global
economic conditions have deteriorated significantly over the last year. Consumer
confidence and spending have declined drastically and the global credit crisis has limited
access to capital for many companies. There is significant concern that such conditions
may not improve in the near future and may get worse. To date, we have been fortunate that
these economic conditions have not negatively impacted our operations significantly.
Despite difficult economic conditions in the United States, South Korea and Europe, we
experienced strong growth in these markets in 2008. While we are not immune to
contractions in consumer spending, we believe we have benefited from the nature of our
distribution model and strong execution around a demonstrative product/opportunity
initiative, which has helped offset to some degree the impact of the decline in consumer
spending. As a direct selling company, we offer a direct selling opportunity that allows
an individual to supplement his/her income by selling our products and building a sales
organization to market and sell our products. As the economy and the labor market decline,
we find that there can be an increase in the number of people interested in becoming
distributors in order to supplement their income. We believe that this increase in
interest in our direct selling opportunity coupled with the strong marketing position of
our Galvanic Spa System II, a product that shows immediate results in facial
demonstrations, has helped us to continue growing our business in these difficult economic
conditions. However, if the economic problems continue for an extended period of time, or
if they continue to worsen, we expect that we could see a negative impact on our business
as distributors may have a more difficult time selling products and finding new customers.
For example, we have seen a slowing in the growth of our business in South Korea during
the latter part of 2008, which we believe is due in part to the prolonged economic
challenges in this market.
As
a company, we have not experienced negative impact from the credit crisis, as we generally
do not rely on debt or lines of credit to finance our operations or capital expenditures.
In 2008, we generated $103.3 million in cash from operations. In the event capital needs
require borrowings in the future, we have a $25 million revolving credit facility
available to us through May 2010. In addition, $58 million is available under our shelf
facility, which currently expires in August of this year.
-43-
Our
financial results, however, have been negatively impacted during the past year by
significant foreign currency fluctuations resulting from the global economic crisis.
During 2008, we recorded an $18.4 million expense as a result of foreign currency
transaction losses related to our yen-denominated debt as the Japanese yen strengthened
from 111.45 at December 31, 2007 to 90.73 at December 31, 2008. In addition, we recorded
foreign currency transaction losses with respect to our intercompany receivables and
payables with certain of our international affiliates, including markets that are newly
opened or have remained in a loss position since inception. Generally, foreign currency
transaction losses with these affiliates would be offset by gains related to the foreign
currency transactions of our yen-based bank debt. However, during 2008, the Japanese yen
strengthened against the U.S. dollar while most foreign currencies weakened against the
U.S. dollar. Other income (expense), net also includes approximately $7.8 million in
interest expense during 2008. Because it is impossible to predict foreign currency
fluctuations we cannot estimate the degree to which our operations will be impacted in the
future, but we remain subject to these currency risks. However, the majority of these
transaction losses are non-cash, non-operating losses.
Income Statement
Presentation
We
recognize revenue in five geographic regions and we translate revenue from each
markets local currency into U.S. dollars using weighted-average exchange rates. The
following table sets forth revenue information by region for the periods indicated. This
table should be reviewed in connection with the tables presented under Results of
Operations, which disclose selling expenses and other costs associated with
generating the aggregate revenue presented.
Revenue by Region
|
Year Ended December 31, | |
|
(U.S. dollars in millions) | |
2006 | |
2007 | |
2008 | |
North Asia |
|
$ 593.8 | |
53% |
|
$ 585.8 |
|
50% |
|
$ 594.5 |
|
48% |
|
Americas | |
165.9 |
|
15 |
|
188.3 |
|
16 |
|
223.9 |
|
18 |
|
Greater China | |
208.2 |
|
19 |
|
205.0 |
|
18 |
|
210.0 |
|
17 |
|
Europe | |
59.5 |
|
5 |
|
77.2 |
|
7 |
|
111.6 |
|
9 |
|
South Asia/Pacific | |
88.0 |
|
8 |
|
101.4 |
|
9 |
|
107.6 |
|
8 |
|
| |
$ 1,115.4 |
|
100% |
|
$ 1,157.7
|
|
100% |
|
$ 1,247.6 |
|
100% |
|
Cost
of sales primarily consists of:
|
|
|
cost
of products purchased from third-party vendors, generally in U.S. dollars; |
|
|
|
costs
of self-manufactured products; |
|
|
|
cost
of sales materials which we sell to distributors at or near cost; |
|
|
|
amortization
expenses associated with certain products and services such as the Scanners that are
leased to distributors; |
|
|
|
freight
cost of shipping products to distributors and import duties for the products; and |
|
|
|
royalties
and related expenses for licensed technologies. |
We
source the majority of our products from third-party manufacturers located in the United
States. Due to Chinese government restrictions on the importation of finished goods
applicable to the current scope of our business in China, we are required to manufacture
the bulk of our own products for distribution in China. Cost of sales and gross profit may
fluctuate as a result of changes in the ratio between self-manufactured products and
products sourced from third-party suppliers. In addition, because we purchase a
significant majority of our goods in U.S. dollars and recognize revenue in local
currencies, we are subject to exchange rate risks in our gross margins. Because our gross
margins vary from product to product and are higher in some markets such as Japan, changes
in product mix and geographic revenue mix can impact our gross margins.
-44-
Selling
expenses are our most significant expense and are classified as operating expenses.
Selling expenses include distributor commissions as well as wages, benefits, bonuses and
other labor and unemployment expenses we pay to employed sales representatives in China.
Our global compensation plan, which we employ in all of our markets except China, is an
important factor in our ability to attract and retain distributors. We pay monthly
commissions to several levels of distributors on each product sale based upon a
distributors personal and group product volumes, as well as the group product
volumes of up to six levels of executive distributors in such distributors downline
sales organization. We do not pay commissions on sales materials, which are sold to
distributors at or near cost. Small fluctuations occur in the amount of commissions paid
as the network of distributors actively purchasing products changes from month to month.
However, due to the size of our distributor force of approximately 761,000 active
distributors, the fluctuation in the overall payout is relatively small. The overall
payout has typically averaged from 41% to 44% of global product sales. From time to time,
we make modifications and enhancements to our global compensation plan in an effort to
help motivate distributors and develop leadership characteristics, which can have an
impact on selling expenses.
Distributors
also have the opportunity to make retail profits by purchasing products from us at
wholesale and selling them to customers with a retail mark-up. We do not account for nor
pay additional commissions on these retail mark-ups received by distributors. In many
markets, we also allow individuals who are not distributors, whom we refer to as
preferred customers, to buy products directly from us at wholesale or
discounted prices. We pay commissions on preferred customer purchases to the referring
distributors.
General
and administrative expenses include:
|
|
|
depreciation
and amortization; |
|
|
|
promotion
and advertising; |
|
|
|
research
and development; and |
|
|
|
other
operating expenses. |
Labor
expenses are the most significant portion of our general and administrative expenses.
Promotion and advertising expenses include costs of distributor conventions held in
various markets worldwide, which we expense in the period in which they are incurred.
Because our various distributor conventions are not always held during each fiscal year,
or in the same period each year, their impact on our general and administrative expenses
may vary from year to year and from quarter to quarter. For example, we held our global
distributor convention in September 2007 and will not have another global convention until
the fall of 2009 as we currently plan to hold a global convention every other year. In
addition, we hold regional conventions and conventions in our major markets at different
times during the year. These conventions have significant expenses associated with them.
Because we have not incurred expenses for these conventions during every fiscal year or in
comparable interim periods, year-over-year comparisons have been impacted accordingly.
-45-
Provision
for income taxes depends on the statutory tax rates in each of the jurisdictions in which
we operate. For example, statutory tax rates in 2008 were approximately 17.5% in Hong
Kong, 25% in Taiwan, 27.5% in South Korea (effective January 1, 2009 South Koreas
tax rate is reduced to 24.2%), 45% in Japan and 25% in China. For the years 2006 through
2008 we were subject to a reduced tax rate of 13.5% in China, after which time we will be
subject to the full statutory rate. We are subject to taxation in the United States at the
statutory corporate federal tax rate of 35% and we pay taxes in multiple states within the
United States at various tax rates. Our overall effective tax rate was 35.1% for the year
ended December 31, 2008.
Critical Accounting
Policies
The
following critical accounting policies and estimates should be read in conjunction with
our audited Consolidated Financial Statements and related Notes thereto. Management
considers our critical accounting policies to be the recognition of revenue, accounting
for income taxes, accounting for intangible assets and accounting for stock-based
compensation. In each of these areas, management makes estimates based on historical
results, current trends and future projections.
Revenue.
We recognize revenue when products are shipped, which is when title and risk
of loss pass to our independent distributors. With some exceptions in various
countries, we offer a return policy whereby distributors can return unopened and
unused product for up to 12 months subject to a 10% restocking fee. Reported
revenue is net of returns, which have historically been less than 5% of gross
sales. A reserve for product returns is accrued based on historical experience.
We classify selling discounts as a reduction of revenue. Our selling expenses
are computed pursuant to our global compensation plan for our distributors,
which is focused on remunerating distributors based primarily upon the selling
efforts of the distributors and the volume of products purchased by their
downlines, and not their personal purchases.
Income
Taxes. We account for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. This statement establishes financial accounting
and reporting standards for the effects of income taxes that result from an
enterprises activities during the current and preceding years. It requires an asset
and liability approach for financial accounting and reporting of income taxes. We pay
income taxes in many foreign jurisdictions based on the profits realized in those
jurisdictions, which can be significantly impacted by terms of intercompany transactions
among our affiliates around the world. Deferred tax assets and liabilities are created in
this process. As of December 31, 2008, we had net deferred tax assets of $76.3 million.
These net deferred tax assets assume sufficient future earnings will exist for their
realization, as well as the continued application of current tax rates. In certain foreign
jurisdictions, valuation allowances have been recorded against the deferred tax assets
specifically related to use of net operating losses. When we determine that there is
sufficient taxable income to utilize the net operating losses, the valuation allowances
will be released. In the event we were to determine that we would not be able to realize
all or part of our net deferred tax assets in the future, an adjustment to the deferred
tax assets would be charged to earnings in the period such determination was made.
In
June 2006, the FASB issued FASB Interpretation Number 48, Accounting for Uncertainty
in Income Taxes an Interpretation of SFAS 109 (FIN 48). We
adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of
FIN 48, we recognized a $2.6 million increase in the liability for unrecognized tax
benefits, which was accounted for as a reduction to the January 1, 2007 balances of
retained earnings and additional paid in capital.
-46-
We
file income tax returns in the U.S. federal jurisdiction, and various states and foreign
jurisdictions. We are currently under examination by the United States Internal Revenue
Service (the IRS) for the 2006 and 2007 tax years. With a few exceptions, we
are no longer subject to state and local income tax examination by tax authorities for
years before 2005. In major foreign jurisdictions, we are no longer subject to income tax
examinations for years before 2002. Along with the IRS examination, we are currently under
examination in certain foreign jurisdictions; however, the outcomes of those reviews are
not yet determinable.
At
December 31, 2008, we had $30.9 million in unrecognized tax benefits of which $5.8
million, if recognized, would affect the effective tax rate. In comparison, at December
31, 2007 we had $31.9 million in unrecognized tax benefits of which $9.1 million, if
recognized, would affect the effective tax rate. During each of the years ended December
31, 2008 and December 31, 2007, we recognized approximately $0.5 million in interest and
penalties. We had approximately $3.2 million and $2.7 million of accrued interest and
penalties related to uncertain tax positions at December 31, 2008 and December 31, 2007.
Interest and penalties related to uncertain tax positions are recognized as a component of
income tax expense.
We
are subject to regular audits by federal, state and foreign tax authorities. These audits
may result in additional tax liabilities. We account for such contingent liabilities in
accordance with FIN 48, and believe we have appropriately provided for income taxes for
all years. Several factors drive the calculation of our tax reserves. Some of these
factors include: (i) the expiration of various statutes of limitations; (ii) changes in
tax law and regulations; (iii) issuance of tax rulings; and (iv) settlements with tax
authorities. Changes in any of these factors may result in adjustments to our reserves,
which would impact our reported financial results.
Intangible
Assets. Under the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS 142), our goodwill and intangible assets with
indefinite useful lives are not amortized. All of our goodwill is based in the U.S. Our
intangible assets with finite lives are recorded at cost and are amortized over their
respective estimated useful lives and are reviewed for impairment in accordance with SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (see
Note 5 to the Consolidated Financial Statements).
We
are required to make judgments regarding the useful lives of our intangible assets. With
the implementation of SFAS 142, we determined certain intangible assets to have indefinite
lives based upon our analysis of the requirements of SFAS No. 141, Business
Combinations (SFAS 141) and SFAS 142. Under the provisions of SFAS 142,
we are required to test these assets for impairment at least annually. The annual
impairment tests were completed and did not result in an impairment charge. To the extent
an impairment is identified in the future, we will record the amount of the impairment as
an operating expense in the period in which it is identified.
Stock-Based
Compensation. Effective January 1, 2006, we adopted the fair value
recognition provisions of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment (SFAS 123R), using the modified prospective
transition method. Under this method we recognize compensation expense for all share-based
payments granted after January 1, 2006 and prior to but not yet vested as of January 1,
2006, in accordance with SFAS 123R. Under the fair value recognition provisions of SFAS
123R, we recognize stock-based compensation net of any estimated forfeitures on a
straight-line basis over the requisite service period of the award. The fair value of our
stock-based compensation expense is based on estimates using the Black-Scholes
option-pricing model. This option-pricing model requires the input of highly subjective
assumptions including the options expected life, risk-free interest rate, expected
dividends and price volatility of the underlying stock. The stock price volatility
assumption was determined using the historical volatility of our common stock.
-47-
Results of Operations
The
following table sets forth our operating results as a percentage of revenue for the
periods indicated:
|
Year Ended December 31, | |
|
2006 | |
2007 | |
2008 | |
|
|
|
|
Revenue |
|
100.0 |
% |
100.0 |
% |
100.0 |
% |
Cost of sales | |
17.5 |
|
18.1 |
|
18.3 |
|
|
|
|
|
Gross profit | |
82.5 |
|
81.9 |
|
81.7 |
|
| |
Operating expenses: | |
Selling expenses | |
43.1 |
|
42.9 |
|
42.4 |
|
General and administrative expenses | |
31.7 |
|
31.2 |
|
29.2 |
|
Restructuring charges |
|
.9 |
|
1.7 |
|
|
|
Impairment of assets and other | |
1.9 |
|
|
|
|
|
|
|
|
|
Total operating expenses | |
77.6 |
|
75.8 |
|
71.6 |
|
|
|
|
|
Operating income | |
4.9 |
|
6.1 |
|
10.1 |
|
Other income (expense), net | |
(.2 |
) |
(.2 |
) |
(2.0 |
) |
|
|
|
|
Income before provision for income taxes | |
4.7 |
|
5.9 |
|
8.1 |
|
Provision for income taxes | |
1.8 |
|
2.1 |
|
2.9 |
|
|
|
|
|
Net income | |
2.9 |
% |
3.8 |
% |
5.2 |
% |
2008 Compared to 2007
Overview
Revenue
in 2008 increased 8% to $1.25 billion from $1.16 billion in 2007, with foreign currency
exchange fluctuations positively impacting revenue by 3% in 2008 compared to 2007. Revenue
in 2008 was positively impacted by growth in South Korea, Europe, the United States, and
our South Asia markets. We also continued to see declines in our business in Japan and
China, which negatively impacted financial results.
Earnings
per share in 2008 increased to $1.02 compared to $0.67 in 2007 on a diluted basis. The
increase in earnings is primarily a result of our transformation initiatives to improve
operational efficiencies as evidenced by the improvements in selling expenses and general
and administrative expenses as a percentage of revenue and the increase in revenue.
Earnings per share in 2008 and 2007 were also impacted by:
|
|
|
foreign
currency transaction losses in 2008 of approximately $11.9 million (net of taxes of $6.5
million), or $.19 per share, as foreign currencies shifted dramatically during the year;
|
-48-
|
|
|
restructuring
charges in 2007 totaling $12.6 million (net of taxes of $7.2 million), or $0.20 per
share, relating to our business transformation initiative to reduce overhead expenses and
streamline operations; and |
|
|
|
the
repurchase of approximately 4.1 million shares of our Class A common stock in 2007. |
Revenue
North
Asia. The following table sets forth revenue for the North Asia region and its
principal markets (U.S. dollars in millions):
|
2007 | |
2008 | |
Change | |
|
|
|
|
|
|
|
|
Japan |
|
$ 443.7 |
|
$ 443.7 |
|
|
|
South Korea | |
142.1 |
|
150.8 |
|
6% |
|
North Asia total | |
$ 585.8 |
|
$ 594.5 |
|
1% |
|
Foreign
currency fluctuations positively impacted revenue by 5% in this region compared to the
prior-year period. Currency fluctuations were most significant during the last quarter of
the year when the average Japanese yen rate strengthened 11% and the average Korean won
rate weakened by 28% during the fourth quarter of 2008. Our active and executive
distributor counts decreased 10% and 12%, respectively, in Japan in 2008 compared to 2007.
In South Korea, our active and executive distributor counts increased 19% and 13%,
respectively, comparing 2008 to 2007.
Local
currency revenue in Japan declined 12% in 2008 compared to 2007. We continue to experience
weakness in our distributor numbers in this market as evidenced by the declines in both
active and executive distributors. The direct selling environment in Japan continues to be
very difficult as the industry has been in a decline for several years and, according to
industry sources, the decline appears to have steepened. Most direct selling companies are
seeing their businesses contract in this market. Increased regulatory and media scrutiny
of the industry continues to negatively impact the industry and our business. In response
to this regulatory environment and, as a result of increases in the number of complaints
to consumer centers regarding the activities of some of our distributors, we have
increased our focus on distributor compliance and training. We believe that some of the
actions we have taken to address activities of distributor groups that were having higher
levels of complaints have contributed to the declines in our revenue. We also engaged in
less aggressive product promotions in 2008 than we had in 2007. In the last half of 2008,
we implemented additional management changes in this market and are currently in the
process of restructuring our operations to improve operational efficiencies and align more
closely with our global operating structure. Given the difficult direct selling
environment, we believe that it will take some time for us to generate growth in this
market.
South
Korea posted strong year-over-year local currency revenue growth of 24%. This growth was
fueled by strong distributor alignment behind our product and distributor initiatives,
maintaining a vibrant sponsoring environment for our distributors. During the latter part
of 2008 and the first part of 2009, we have seen some slowing of our growth in this
market, which we believe is due in part to the prolonged economic challenges in this
market.
-49-
Americas.
The following table sets forth revenue for the Americas region and its principal
markets (U.S. dollars in millions):
|
2007 | |
2008 | |
Change | |
|
|
|
|
|
|
|
|
United States |
|
$ 167.8 |
|
$ 192.1 |
|
14% |
|
Canada | |
11.5 |
|
16.2 |
|
41% |
|
Latin America | |
9.0 |
|
15.6 |
|
73% |
|
Americas total | |
$ 188.3 |
|
$ 223.9 |
|
19% |
|
We
experienced strong growth in the United States particularly in the personal care brand.
The revenue growth is being driven by interest in our Galvanic Spa System II as
well as complementary products such as Galvanic Spa Facial Gels, Tru Face
Essence Ultra and Tru Face Line Corrector. These products provide highly
demonstrable results and are generating significant consumer interest. In the fourth
quarter, we launched our Galvanic Facial Gels that incorporate innovative new
ageLoc anti-aging technology. Revenue in 2007 was positively impacted by approximately $5.0 million as a result
of product and convention fee revenue from foreign distributors attending our global convention in 2007,
which convention is only held every two years. Active distributors in the United States increased 4%
and executive distributors increased 8% compared to the prior-year period.
Revenue
increased by 41% in Canada and by 73% in Latin America in 2008 compared to 2007,
respectively. The growth in Latin America can be attributed to our opening of operations
in Venezuela and strength in our Mexico market. Similar to the United States, revenue
growth in Canada and Latin America is also being driven by the strong sales in our Nu Skin
brand personal care products.
Greater
China. The following table sets forth revenue for the Greater China region and its
principal markets (U.S. dollars in millions):
|
2007 | |
2008 | |
Change | |
|
|
|
|
|
|
|
|
Taiwan |
|
$ 93.0 | |
$ 92.3 |
|
(1%) |
|
China |
|
66.5 |
|
65.3 |
|
(2%) |
|
Hong Kong | |
45.5 |
|
52.4 |
|
15% |
|
Greater China total | |
$ 205.0 |
|
$ 210.0 |
|
2% |
|
Foreign
currency exchange rate fluctuations positivley impacted revenue in the Greater China region by 5% in 2008. On
a local currency basis, revenue in Mainland China decreased 10% in 2008 compared to
2007. Our revenue decline in Mainland China was primarily the result of a 25%
decline in our preferred customers compared to the prior-year period and a 3% decline in
the number of employed sales representatives. Given the regulatory environment in
China, we have continued to be cautious in our promotions and the sales activities of our
sales representatives. At the end of 2007, we also adjusted our store strategy to
focus our business around plaza stores in major cities, which resulted in the closure of
nearly 70 of our smaller stores in this market. In 2008, we opened new plaza stores
in Shanghai and Guangzhou as part of this strategy. We also plan to open new plaza
stores in Beijing and Xian in 2009 and in Shenzen in early 2010.
Additionally, we modified our business model to engage sales promoters under a
service contract as well as offer part-time employment. These business model changes
were made in order to allow us to provide a supplemental income opportunity to individuals
who may not be interested in working full-time in this business as well as reduce our
selling expenses, as the amount of social benefits, taxes and unemployment charges under
this model will be lower. While we believe that these adjustments to our store
strategy and business model may have had a small negative impact on our revenue during the
first part of the year as our sales representatives and preferred customers adapted to
them, they significantly improved our profitability in this market during the year.
In
the fourth quarter of 2008, we introduced the Galvanic Spa System II to a limited
number of sales leaders in Mainland China. The launch has generated excitement among our
sales force and helped contribute to an improvement in revenue trends, with revenue
declining only 1% in the fourth quarter. We fully launched the Galvanic Spa System
II in the first quarter of 2009, which we expect will have a positive impact on
revenue given its success in other markets. In January 2009, we also received approvals to
engage in direct selling in four cities in Guandong Province as well as Shenzhen City.
-50-
Local
currency revenue in Taiwan was down 5% in 2008 compared to 2007. We believe that the
decline in Taiwan is primarily attributed to regulatory restrictions that currently
prevent us from marketing the Galvanic Spa System II in this market and a softening
of sales of our weight loss products. The executive distributor count in Taiwan was up 3%
compared to the prior-year period, while the number of active distributors was down 13%
when compared to the prior-year period. Hong Kong local currency revenue was up 15% in
2008 compared to 2007, primarily as a result of the strength of our personal care
initiatives. Executive distributors in Hong Kong were down 5% and the active distributors
in Hong Kong were up 1% compared to 2007.
Europe.
The following table sets forth revenue for our Europe region (U.S. dollars in
millions):
|
2007 | |
2008 | |
Change | |
|
|
|
|
|
|
|
|
Europe |
|
$ 77.2 |
|
$ 111.6 |
|
45% |
|
Foreign
currency exchange rate fluctuations positively impacted revenue in Europe by 9% in 2008
compared to the prior year. On a local currency basis, revenue in Europe grew by 36% in
2008 compared to 2007. The strong growth in Europe was primarily a result of distributor
enthusiasm and strong interest in our Galvanic Spa System II and personal care
business, as well as strong growth in our newer Eastern European markets. We believe that
strong alignment of distributor leaders behind our key initiatives, including the
Galvanic Spa System II, has helped contribute to the distributor excitement and
revenue growth. In 2008, we also expanded our operations into the Czech Republic and South
Africa. We are looking to expand into additional markets in this region in 2009 including
Turkey and Ukraine. Our active and executive distributor counts increased by 43% and 49%,
respectively, in 2008 compared to 2007.
South
Asia/Pacific. The following table sets forth revenue for the South Asia/Pacific region
and its principal markets (U.S. dollars in millions):
|
2007 | |
2008 | |
Change | |
|
|
|
|
|
|
|
|
Singapore/Malaysia/Brunei |
|
$ 39.3 |
|
$ 43.8 |
|
11% |
|
Thailand | |
32.3 |
|
34.6 |
|
7% |
|
Australia/New Zealand | |
15.8 |
|
13.3 |
|
(16%) |
|
Indonesia | |
8.8 |
|
8.9 |
|
1% |
|
Philippines | |
5.2 |
|
7.0 |
|
35% |
|
South Asia/Pacific total | |
$ 101.4 |
|
$ 107.6 | |
6% |
|
Foreign
currency exchange rate fluctuations positively impacted revenue in South Asia/Pacific by
1% in 2008 compared to the same prior-year period. All of the markets in this region
experienced growth except for Australia/New Zealand. The growth was fueled in part by
continued success of our TRA family of weight loss products during the first part
of the year and success of our Galvanic Spa System II. The decline in Australia/New
Zealand is largely related to a transition away from Photomax, which has not proven
to be a strong, long-term business initiative for our distributors. Executive
distributors in the region increased 14% while active distributors increased 1% compared
to the prior year.
-51-
Gross profit
Gross
profit as a percentage of revenue in 2008 decreased to 81.7% from 81.9% in 2007. The
decrease is due in part to a shift in our product mix as our Japan business, which
historically has our strongest gross margins, now represents a smaller percentage of our
overall business. Gross margins have also been impacted by the increase in sales of the
Galvanic Spa System II, which has a slightly lower margin.
Selling expenses
Selling
expenses decreased as a percentage of revenue to 42.4% in 2008 from 42.9% in 2007. The
slight decrease as a percentage of revenue was due primarily to enhancements to our
compensation plan to improve alignment between distributor and corporate growth objectives
and encourage and reward targeted distributor activity.
General and administrative expenses
General
and administrative expenses decreased as a percentage of revenue to 29.2% in 2008 from
31.2% in 2007. The improvement relates to restructuring efforts to reduce general and
administrative levels and improve efficiencies.
Restructuring
charges
During
2007, we recorded restructuring charges of $19.8 million relating to our efforts to
simplify our operations in China and improve operational efficiencies in our corporate
offices and reduce investments in unprofitable markets. Approximately $13.9 million of
these charges related to severance payments to terminated employees and approximately $5.9
million related to leasehold terminations and expenses related to the closure of our
operations in Brazil in 2007.
In
2009, we expect to incur approximately $14 million in restructuring charges primarily
related to transformation efforts in Japan designed to improve operational efficiencies
and align organizationally in Japan with how we are organized globally in our other
markets. We estimate that approximately $7 million of the charges will relate to severance
payments to employees who voluntarily elect to retire early, and $7 million will relate to
converting to smaller more-efficient walk-in centers. Most of these expenses will be
incurred in the first-half of 2009.
Other
income (expense), net
Other
income (expense), net was $24.8 million of expense in 2008 compared
to $2.4 million of expense in 2007. Of this amount, approximately $18.4 million relates to
foreign currency transaction losses related to our yen-denominated debt as the Japanese
yen strengthened from 111.45 at December 31, 2007 to 90.73 at December 31, 2008. In
addition, we recorded foreign currency transaction losses with respect to our intercompany
receivables and payables with certain of our international affiliates, including markets
that are newly opened or have remained in a loss position since inception. Generally,
foreign currency transaction losses with these affiliates would be offset by gains related
to the foreign currency transactions of our yen-based bank debt. However, during 2008, the
Japanese yen strengthened against the U.S. dollar while most foreign currencies weakened
against the U.S. dollar. Other income (expense), net also includes approximately $7.8
million in interest expense during 2008. It is impossible to predict foreign currency
fluctuations. We cannot estimate the degree to which our operations will be impacted in
the future, but we remain subject to these currency risks. However, the majority of these
transaction losses are non-cash, non-operating losses.
-52-
Provision
for income taxes
Provision
for income taxes increased to $35.3 million in 2008 from $24.6 million in 2007. The
effective tax rate decreased to 35.1% from 35.9% of pre-tax income in 2007. The lower tax
rate is due primarily to the expiration of the statute of limitations in certain tax
jurisdictions. In connection with our reconciliation of deferred tax asset and liability
accounts at year end, we identified accounting adjustments related to prior periods. These
adjustments were included in our provision for income taxes at 2007 year end and totaled
approximately $0.1 million.
Net
income
As
a result of the foregoing factors, net income increased to $65.3 million in 2008 from
$43.9 million in 2007.
2007 Compared to 2006
Overview
Revenue
in 2007 increased 4% to $1.16 billion from $1.12 billion in 2006, with foreign currency
exchange fluctuations positively impacting revenue by 1% in 2007 compared to 2006. Revenue
in 2007 was positively impacted by growth in South Korea, Europe, the United States, and
our South Asia markets. The revenue growth from these markets was offset partially by
revenue declines in Japan and China.
Earnings
per share in 2007 were $0.67 compared to $0.47 in 2006 on a diluted basis. Earnings per
share in 2007 and 2006 were impacted by:
|
|
|
restructuring
and impairment charges in the first quarter of 2006 totaling $20.0 million (net of taxes
of $12.0 million), or $0.28 per share, relating to a business transformation initiative
that we implemented during the first quarter; |
|
|
|
restructuring
charges in the second quarter of 2007 totaling $1.8 million (net of taxes of $1.0
million), or $0.03 per share, relating to a business transformation initiative that we
implemented during the first quarter; |
|
|
|
restructuring
and impairment charges in the fourth quarter of 2007 totaling $10.8 million (net of taxes
of $6.2 million), or $0.17 per share, relating to an additional step in our business
transformation initiative to reduce overhead expenses and streamline operations; |
|
|
|
a
decrease in our gross margin as a result of changing product and geographic sales mix;
and |
|
|
|
the
repurchase of approximately 4.1 million shares of our Class A common stock in 2007. |
In
the fourth quarter of 2007, we took additional steps in connection with our transformation
efforts to further reduce our overhead and improve our earnings per share. These steps
included simplifying our operations in China and identifying additional areas for improved
operational efficiencies globally. As a result of these steps, we reduced our headcount
globally by approximately 1,000 employees.
-53-
Revenue
North
Asia. The following table sets forth revenue for the North Asia region and its
principal markets (U.S. dollars in millions):
|
2006 | |
2007 | |
Change | |
|
|
|
|
|
|
|
|
Japan |
|
$ 476.5 |
|
$ 443.7 |
|
(7%) |
|
South Korea | |
117.3 |
|
142.1 |
|
21% |
|
North Asia total | |
$ 593.8 |
|
$ 585.8 |
|
(1%) |
|
Foreign
currency fluctuations did not significantly impact revenue in this region compared to the
prior-year period. The decline in this region is related to the decline in revenue in
Japan, which was offset partially by the increase in revenue in South Korea. Our active
and executive distributor counts decreased 6% and 8%, respectively, in Japan in 2007
compared to 2006. In South Korea, our active and executive distributor counts increased
30% and 17%, respectively, comparing 2007 to 2006.
In
Japan, the weakness in sponsoring activity and the resulting declines in active and
executive distributors contributed to the local currency revenue decline of 5% in 2007
compared to 2006. During 2007, we implemented a variety of strategic initiatives and
product promotions, effected a change in management, and continued efforts to improve our
corporate image and took steps to improve distributor recruitment and leadership
development.
South
Korea posted strong year-over-year local currency revenue growth of 18%. This growth was
fueled by strong distributor alignment behind our product and distributor initiatives that
have helped maintain a vibrant sponsoring environment for our distributors in this market.
The Galvanic Spa System II and our Nu Skin 180° Anti-Aging Skin Therapy
System helped contribute to growth in our personal care business, while continued
focus on nutrition products including LifePak and g3 positively impacted our
nutrition revenue in this market. We also launched TriPhasic White, a global
top-selling personal care product for us, in 2007.
Americas.
The following table sets forth revenue for the Americas region and its principal
markets (U.S. dollars in millions):
|
2006 | |
2007 | |
Change | |
|
|
|
|
|
|
|
|
United States |
|
$ 147.1 |
|
$ 167.8 |
|
14% |
|
Canada | |
10.0 |
|
11.5 |
|
15% |
|
Latin America | |
8.8 |
|
9.0 |
|
2% |
|
Americas total | |
$ 165.9 |
|
$ 188.3 |
|
14% |
|
Revenue
in the United States was positively impacted by several key initiatives implemented in
each of our product categories during the past year. In particular, the Galvanic Spa
System II has been a primary focus of many of our distributor leaders and has helped
drive significant growth in our personal care revenue, with personal care sales up 42%
compared to 2006. We have implemented distributor incentives around the Galvanic Spa
System II to increase the initial earnings opportunity for new distributors, which we
believe also contributed to the revenue growth. The United States also hosted our
global convention in 2007, which positively impacted revenue in the market by
approximately $5.0 million as a result of product and convention fee revenue from foreign
distributors attending the convention. We also introduced a new weight management product
system in this market in the fourth quarter.
-54-
Revenue
in our other markets in this region also saw improvements with Canada having local
currency growth of 9% and Latin America growing 2%. During the year, we elected to close
our offices and facilities in Brazil because of continued operating losses in this market.
While we continue to allow customers to purchase products from the United States for
personal use consumption, we are not engaged in any operations or product promotions in
this market.
Greater
China. The following table sets forth revenue for the Greater China region and its
principal markets (U.S. dollars in millions):
|
2006 | |
2007 | |
Change | |
|
|
|
|
|
|
|
|
Taiwan |
|
$ 93.1 | |
$ 93.0 |
|
|
|
China |
|
70.5 |
|
66.5 |
|
(6%) |
|
Hong Kong | |
44.6 |
|
45.5 |
|
2% |
|
Greater China total | |
$ 208.2 |
|
$ 205.0 |
|
(2%) |
|
Foreign
currency exchange rate fluctuations positively impacted revenue in the Greater China
region by 1% in 2007. In China, revenue declined 10%, on a local currency
basis, compared to the prior year as we continue to transition our business model in this
market. The decrease is primarily attributed to a 17% decline in preferred customers
and a 6% decline in our sales force as we were cautious in our promotions and the sales
activities of our sales representatives given the regulatory environment. As discussed
above, we took steps at the end of 2007 to allow us to operate more efficiently and
effectively in this market, including a significant modification to our store strategy.
Local
currency revenue in Taiwan was relatively flat and Hong Kong local currency revenue was up
3% when compared with 2006. Revenue comparisons for Hong Kong are impacted by
approximately $1.6 million in sales to non-Hong Kong distributors attending a regional
convention in this market in 2006. A similar convention was not held in 2007.
Europe.
The following table sets forth revenue for our Europe region (U.S. dollars in
millions):
|
2006 | |
2007 | |
Change | |
|
|
|
|
|
|
|
|
Europe |
|
$ 59.5 |
|
$ 77.2 |
|
30% |
|
Foreign
currency exchange rate fluctuations positively impacted revenue in Europe by 2% in 2007
compared to the prior year. On a local currency basis, revenue grew by 27% in 2007
compared to 2006. The strong growth in Europe was primarily a result of distributor
enthusiasm and strong interest in our Galvanic Spa System II and personal care
business, as well as strong growth in our newer Eastern European markets. We believe that
strong alignment of distributor leaders behind our key initiatives, including the
Galvanic Spa System II, has helped contribute to the distributor excitement and
revenue growth. In 2007, we also expanded our operations into Switzerland and Slovakia.
Our active and executive distributor counts increased by 16% and 22%, respectively, in
2007 compared to 2006.
-55-
South
Asia/Pacific. The following table sets forth revenue for the South Asia/Pacific region
and its principal markets (U.S. dollars in millions):
|
2006 | |
2007 | |
Change | |
|
|
|
|
|
|
|
|
Singapore/Malaysia/Brunei |
|
$ 33.2 |
|
$ 39.3 |
|
18% |
|
Thailand | |
26.5 |
|
32.3 |
|
22% |
|
Australia/New Zealand | |
14.2 |
|
15.8 |
|
11% |
|
Indonesia | |
10.3 |
|
8.8 |
|
(15%) |
|
Philippines | |
3.8 |
|
5.2 |
|
37% |
|
South Asia/Pacific total | |
$ 88.0 |
|
$ 101.4 | |
15% |
|
Foreign
currency exchange rate fluctuations positively impacted revenue in South Asia/Pacific by
10% in 2007 compared to the same prior-year period. All of the markets in this region
experienced growth except for Indonesia. The growth was fueled in part by continued
success of our TRA family of weight loss products and success of our Galvanic
Spa System II. We believe the decrease in Indonesia is largely attributed to the
limited base of distributor leaders in this new market. We often see declines in new
markets after the initial opening as we work to strengthen our base of leaders in a new
market. Active distributors in the region decreased 11% while executive distributors
increased 3% compared to the prior year.
Gross
profit
Gross
profit as a percentage of revenue in 2007 decreased to 81.9% from 82.5% in 2006. The
decrease is due in part to a shift in our product mix as our Japan business, which
historically has our strongest gross margins, now represents a smaller percentage of our
overall business. Gross margins have also been impacted by the increase in sales of tools
that have lower margins such as the Galvanic Spa System II and the Scanner, as well
as increased air-freight costs during the year.
Selling
expenses
Selling
expenses decreased as a percentage of revenue to 42.9% in 2007 from 43.1% in 2006. The
slight decrease as a percentage of revenue was due primarily to a reduction in special
incentives in various markets, particularly Japan.
General
and administrative expenses
General
and administrative expenses increased to $361.2 million in 2007 from $353.4 million in
2006, but decreased as a percentage of revenue to 31.2% in 2007 from 31.7% in 2006. In the
fourth quarter we took additional steps under our transformation initiative to further
reduce our general and administrative expenses. These steps included the closing of
approximately 70 stores in China, and a reduction in headcount of 1,000 employees
globally.
Restructuring
charges
During
2007, we recorded restructuring charges of $19.8 million relating to our efforts to
simplify our operations in China and improve operational efficiencies in our corporate
offices and reduce investments in unprofitable markets. Approximately $13.9 million of
these charges related to severance payments to terminated employees and approximately $5.9
million related to leasehold terminations and tax payments related to the closure of our
operations in Brazil in 2007.
-56-
During
the first quarter of 2006, we recorded restructuring charges of $11.1 million, primarily
relating to our business transformation initiative designed to (i) eliminate
organizational redundancies, (ii) revamp administrative support functions, (iii)
prioritize investments to favor profitable initiatives and markets, and (iv) increase
efficiencies in the supply chain process. As a result, our overall headcount was reduced
by approximately 225 employees, the majority of which related to the elimination of
positions at our U.S. headquarters. These expenses consisted primarily of severance and
other compensation charges.
Other
income (expense), net
Other
income (expense), net was $2.4 million of expense in 2007 compared to
$2.0 million of expense in 2006. The increase in expense was primarily a result of an
increase in interest expense.
Provision
for income taxes
Provision
for income taxes increased to $24.6 million in 2007 from $19.9 million in 2006. The
effective tax rate decreased to 35.9% from 37.7% of pre-tax income in 2006, the lower rate
is due primarily to the expiration of the statute of limitations in certain tax
jurisdictions. In connection with our reconciliation of deferred tax asset and liability
accounts at year end, we identified accounting adjustments related to prior periods. These
adjustments were included in our provision for income taxes at year end and totaled
approximately $0.1 million.
Net
income
As
a result of the foregoing factors, net income increased to $43.9 million in 2007 from
$32.8 million in 2006.
Liquidity and Capital
Resources
Historically,
our principal uses of cash have included operating expenses, particularly selling
expenses, and working capital (principally inventory purchases), as well as capital
expenditures, stock repurchases, dividends, debt repayment, and the development of
operations in new markets. We have generally relied on cash flow from operations to fund
operating activities, and we have at times incurred long-term debt in order to fund
strategic transactions and stock repurchases.
We
typically generate positive cash flow from operations due to favorable gross margins and
the variable nature of selling expenses, which constitute a significant percentage of
operating expenses. We generated $103.3 million in cash from operations in 2008, compared
to $48.7 million in 2007. This increase in cash generated from operations is primarily due
to the increase in profitability from our restructuring efforts, the timing of payments of
taxes and a reduction in our accounts receivable.
As
of December 31, 2008, working capital was $124.0 million compared to $95.2 million as of
December 31, 2007. Our working capital increased primarily due to an increase in cash and
cash equivalents. Cash and cash equivalents, plus current investments, at December 31,
2008 were $114.6 million compared to $92.6 million at December 31, 2007. The increase in
cash was primarily the result of the increase in our cash generated from operations in
2008.
Capital
expenditures in 2008 totaled $16.0 million, and we anticipate capital expenditures of
approximately $20 million to $25 million for 2009. These capital expenditures are
primarily related to:
|
|
|
purchases
of computer systems and software, including equipment and development costs; and |
-57-
|
|
|
build-out and upgrade of leasehold improvements in our various markets, including retail
stores in China. |
We
currently have debt pursuant to various credit facilities and other borrowings. The
following table summarizes these debt arrangements as of December 31, 2008:
Facility or Arrangement(1) | |
Original Principal Amount | |
Balance as of December 31, 2008(2) | |
Interest Rate | |
Repayment terms | |
|
|
|
|
|
|
|
|
|
|
2000 Japanese yen-denominated notes |
|
9.7 billion yen |
|
2.8 billion yen ($30.6 million as of December 31, 2008) |
|
3.0% |
|
Notes due October 2010, with annual principal payments that began in October 2004. |
|
|
|
|
|
|
| |
| |
| |
| |
| |
| |
2003 $205.0 million multi-currency uncommitted shelf facility: | |
| |
| |
| |
| |
| |
U.S. dollar denominated: | |
$50.0 million | |
$20.0 million | |
4.5% | |
Notes due April 2010 with annual principal payments that began in April 2006. | |
|
|
|
|
|
| |
$40.0 million | |
$40.0 million | |
6.2% | |
Notes due July 2016 with annual principal payments beginning July 2010 | |
|
|
|
|
|
| |
$20.0 million(3) | |
$20.0 million | |
6.2% | |
Notes due January 2017 with annual principal payments beginning January 2011. |
|
| |
| |
| |
| |
| |
Japanese yen denominated: | |
3.1 billion yen | |
2.7 billion yen ($29.5 million as of December 31, 2008) | |
1.7% | |
Notes due April 2014 with annual principal payments that began April 2008. | |
|
|
|
|
|
| |
2.3 billion yen | |
2.3 billion yen ($25.0 million as of December 31, 2008) | |
2.6% | |
Notes due September 2017, with annual principal payments beginning September 2011. | |
|
|
|
|
|
| |
2.2 billion yen | |
2.2 billion yen ($23.9 million as of December 31, 2008) | |
3.3% | |
Notes due January 2017, with annual principal payments beginning January 2011. | |
|
|
|
|
|
| |
| |
| |
| |
| |
2004 $25.0 million revolving credit facility | |
N/A | |
None | |
N/A | |
Credit facility expires May 2010. | |
-58-
(1) |
|
Each
of the credit facilities and arrangements listed in the table are secured by
guarantees issued by our material domestic subsidiaries and by pledges of 65%
of the outstanding stock of our material foreign subsidiaries. |
(2) |
|
The
current portion of our long-term debt (i.e. becoming due in the next 12 months)
includes $15.3 million of the balance on our 2000 Japanese yen-denominated
notes, $4.9 million of the balance of our 2005 Japanese yen-denominated notes
and $10.0 million of the balance on our U.S. dollar denominated debt under the
2003 multi-currency shelf facility. |
(3) |
|
In
January 2008, $20.0 million of this loan was converted from U.S. dollar to
Japanese yen at an exchange rate of 108.5. The terms of the loan remain the
same, except for the interest rate lowers from 6.2% to 3.3%. |
Our
board of directors has approved a stock repurchase program authorizing us to repurchase
our outstanding shares of Class A common stock on the open market or in private
transactions. The repurchases are used primarily for our equity incentive plans and
strategic initiatives. On November 2, 2007, our board of directors authorized an increase
of $100 million to our ongoing share repurchase authorization. During the year ended
December 31, 2008, we repurchased approximately 0.4 million shares of Class A common stock
under this program for an aggregate amount of approximately $6.1 million. At December 31,
2008, approximately $83.6 million was still available under the stock repurchase program.
During
each quarter of 2008, our board of directors declared cash dividends of $0.11 per share on
our Class A common stock. These quarterly cash dividends totaled approximately $27.9
million and were paid during 2008 to stockholders of record in 2008. In February 2009, the
board of directors declared a dividend to be paid in March 2009 of $0.115 per share for
Class A common stock. Currently, we anticipate that our board of directors will continue
to declare quarterly cash dividends and that the cash flows from operations will be
sufficient to fund our future dividend payments. However, the continued declaration of
dividends is subject to the discretion of our board of directors and will depend upon
various factors, including our net earnings, financial condition, cash requirements,
future prospects and other factors deemed relevant by our board of directors.
We
believe we have sufficient liquidity to be able to meet our obligations on both a short-
and long-term basis. We currently believe that existing cash balances, future cash flows
from operations and existing lines of credit will be adequate to fund our cash needs on
both a short- and long-term basis. The majority of our historical expenses have been
variable in nature and as such, a potential reduction in the level of revenue would reduce
our cash flow needs. In the event that our current cash balances, future cash flow from
operations and current lines of credit are not sufficient to meet our obligations or
strategic needs, we would consider raising additional funds in the debt or equity markets
or restructuring our current debt obligations. Additionally, we would consider realigning
our strategic plans, including a reduction in capital spending, stock repurchases or
dividend payments.
-59-
Contractual Obligations
and Contingencies
The
following table sets forth payments due by period for fixed contractual obligations as of
December 31, 2008 (U.S. dollars in thousands):
|
Total | |
2009 | |
2010-2011 | |
2012-2013 | |
Thereafter | |
|
| |
| |
| |
| |
| |
Long-term debt obligations |
|
$ 188,956 |
|
$ 30,196 |
|
$ 56,382 |
|
$ 40,944 |
|
$ 61,434 |
|
Capital lease obligations | |
|
|
|
|
|
|
|
|
|
|
Operating lease obligations(1) | |
50,745 |
|
14,689 |
|
21,807 |
|
13,653 |
|
596 |
|
Purchase obligations | |
85,424 |
|
49,769 |
|
25,411 |
|
9,468 |
|
776 |
|
Other long-term liabilities reflected
on the balance sheet(2) | |
|
|
|
|
|
|
|
|
|
|
Total | |
$ 325,125 |
|
$ 94,654 |
|
$ 103,600 |
|
$ 64,065 |
|
$ 62,806 |
|
(1) |
|
Operating leases include corporate office and warehouse space with
two entities that are owned by certain officers and directors of our company who
are also founding shareholders. Total payments under these leases were $3.8
million for the year ended December 31, 2008 with remaining long-term
obligations under these leases of $10.5 million. |
(2) |
|
Other
long-term liabilities reflected on the balance sheet of $68.5 million primarily
consisting of long-term tax related balances, in which the timing of the
commitments is uncertain. |
Due
to the international nature of our business, we are subject from time to time to reviews
and audits by the foreign taxing authorities of the various jurisdictions in which we
conduct business throughout the world. In 1999, we implemented a duty valuation
methodology with respect to the importation of certain products into Japan. For purposes
of the import transactions at issue, we had taken the position that, under applicable
customs law, there was a sale between the manufacturer and our Japan subsidiary, and that
customs duties should be assessed on the manufacturers invoice. The Valuation
Department of the Yokohama customs authorities reviewed and approved this methodology at
that time, and it had been reviewed on several occasions by the audit division of the
Japan customs authorities since then. In connection with subsequent audits in 2004, the
Yokohama customs authorities assessed us additional duties and penalties on these products
imported into Japan from October 2002 to October 2004, based on a different valuation
methodology than what was previously approved. With respect to the periods under audit,
the customs authorities took the position that the relevant import transaction involved a
sale between our U.S. affiliate and our Japan subsidiary and that duties should be
assessed on the value of that transaction. We disputed this assessment. We also disputed
the amount of duties we were required to pay on products imported from November of 2004 to
June of 2005 for similar reasons. The total amount assessed or in dispute was
approximately yen 2.7 billion (or approximately $29.7 million as of December 31, 2008),
net of any recovery of consumption taxes. Effective July 1, 2005, we implemented some
modifications to our business structure in Japan and in the United States that we believe
will eliminate any further customs valuation disputes with respect to product imports in
Japan after that time.
Because
we believe the documentation and legal analysis supports our position and the valuation
methodology we used with respect to the products in dispute had been reviewed and approved
by the customs authorities in Japan, we believe the assessments are improper and we filed
letters of protest with Yokohama customs with respect to this entire amount. Yokohama
customs rejected our letters of protest, and to follow proper administrative procedures we
filed appeals with the Japan Ministry of Finance. In order to appeal, we were required to
pay the approximately yen 2.7 billion in custom duties and assessments related to all of
the amounts at issue, which we recorded in Other Assets in our Consolidated
Balance Sheet. On June 26, 2006, we were advised that the Ministry of Finance had rejected
the appeals filed with their office relating to the imports from October 2002 to October
2004. We decided to appeal this issue through the judicial court system in Japan, and on
December 22, 2006, we filed a complaint with the Tokyo District Court Civil Action Section
with respect to this period. In January 2007, we were advised that the Ministry of Finance
also rejected our appeal with them for the imports from November 2004 to June 2005. We
appealed this decision with the court system in July 2007. Currently, all appeals are
pending with the Tokyo District Court Civil Action Section. One of the findings cited by
the Ministry of Finance in its decisions was that we had treated the transactions as sales
between our U.S. affiliate and our Japan subsidiary on our corporate income tax return
under applicable income tax and transfer pricing laws. To the extent that we are
unsuccessful in recovering the amounts assessed and paid, we will be required to take a
corresponding charge to our earnings.
-60-
Seasonality and
Cyclicality
In
addition to general economic factors, we are impacted by seasonal factors and trends such
as major cultural events and vacation patterns. For example, most Asian markets celebrate
their respective local New Year in the first quarter, which generally has a negative
impact on that quarter. We believe that direct selling in Japan, the United States and
Europe is also generally negatively impacted during the third quarter, when many
individuals, including our distributors, traditionally take vacations.
We
have experienced rapid revenue growth in certain new markets following commencement of
operations. This initial rapid growth has often been followed by a short period of stable
or declining revenue, then followed by renewed growth fueled by product introductions, an
increase in the number of active distributors and increased distributor productivity. The
contraction following initial rapid growth has been more pronounced in certain new
markets, due to other factors such as business or economic conditions or distributor
distractions outside the market.
Distributor Information
The
following table provides information concerning the number of active and executive
distributors as of the dates indicated. Active distributors are those distributors and
preferred customers who were resident in the countries in which we operated and purchased
products for resale or personal consumption directly from us during the three months ended
as of the date indicated. Executive distributors are active distributors who have achieved
required monthly personal and group sales volumes as well as sales representatives in
China who have completed a qualification process.
|
As of December 31, 2006 | |
As of December 31, 2007 | |
As of December 31, 2008 | |
|
Active | |
Executive | |
Active | |
Executive | |
Active | |
Executive | |
|
|
|
|
|
|
|
North Asia |
|
333,000 |
|
15,354 |
|
335,000 |
|
14,845 |
|
326,000 |
|
13,937 |
|
Americas | |
150,000 |
|
4,141 |
|
158,000 |
|
4,588 |
|
171,000 |
|
4,876 |
|
Greater China | |
155,000 |
|
6,492 |
|
138,000 |
|
6,389 |
|
115,000 |
|
6,323 |
|
Europe | |
50,000 |
|
1,600 |
|
59,000 |
|
1,957 |
|
83,000 |
|
2,911 |
|
South Asia/Pacific | |
73,000 |
|
2,169 |
|
65,000 |
|
2,223 |
|
66,000 |
|
2,541 |
|
Total | |
761,000 |
|
29,756 |
|
755,000 |
|
30,002 |
|
761,000 |
|
30,588 |
|
-61-
Quarterly Results
The
following table sets forth selected unaudited quarterly data for the periods shown (U.S.
dollars in millions, except per share amounts):
|
2007 | |
2008 | |
|
1st
Quarter | |
2nd
Quarter | |
3rd
Quarter | |
4th
Quarter | |
1st
Quarter | |
2nd
Quarter | |
3rd
Quarter
| |
4th Quarter |
|
|
|
|
|
|
|
|
|
Revenue |
|
$ 273.6 |
|
$ 287.2 |
|
$ 290.7 |
|
$ 306.1 |
|
$ 298.1 |
|
$ 321.7 |
|
$ 310.3 |
|
$ 317.6 |
|
Gross profit | |
223.0 |
|
236.2 |
|
238.5 |
|
250.8 |
|
243.9 |
|
262.4 |
|
253.3 |
|
259.4 |
|
Operating income | |
17.6 |
|
21.0 |
|
19.2 |
|
13.1 |
|
27.4 |
|
28.9 |
|
30.3 |
|
38.8 |
|
Net income | |
10.5 |
|
13.8 |
|
13.5 |
|
6.0 |
|
13.5 |
|
20.6 |
|
16.8 |
|
14.5 |
|
Net income per share: | |
Basic | |
0.16 |
|
0.21 |
|
0.21 |
|
0.09 |
|
0.21 |
|
0.32 |
|
0.26 |
|
0.23 |
|
Diluted | |
0.16 |
|
0.21 |
|
0.21 |
|
0.09 |
|
0.21 |
|
0.32 |
|
0.26 |
|
0.23 |
|
Recent Accounting
Pronouncements
In
September 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements (SFAS 157), which defines fair value, establishes a framework
for measuring fair value in accordance with generally accepted accounting principles, and
expands disclosures about fair value measurements. In February 2008, the FASB issued Staff
Position 157-2, Effective Date of FASB Statement No. 158, which delays the
effective date of SFAS No. 157 for nonfinancial assets and liabilities, except for
those that are recognized or disclosed at fair value in the financial statements on a
recurring basis, until January 1, 2009. We adopted SFAS 157 as of January 1, 2008,
with the exception of the application of the statement to non-recurring, nonfinancial
assets and liabilities. The adoption of SFAS 157 did not have a material impact on our
consolidated financial statements. See Note 2, Fair Value of Financial Instruments, for
additional information.
In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities (SFAS 159). Under SFAS 159, companies may elect
to measure certain financial instruments and certain other items at fair value. The
standard requires that unrealized gains and losses on items for which the fair value
option has been elected be reported in earnings. SFAS 159 is effective for fiscal years
beginning after November 15, 2007. We adopted SFAS 159 for fiscal 2008; however, we did
not elect to apply the fair value option to any financial instruments or other items upon
adoption of SFAS 159. Therefore, the adoption of SFAS 159 did not impact our consolidated
financial position, results of operations or cash flows.
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations,
(SFAS 141R), which changes how business combinations are accounted for and
will impact financial statements both on the acquisition date and in subsequent periods.
SFAS 141R is effective January 1, 2009, and will be applied prospectively. The impact of
adopting SFAS 141R will depend on the nature and terms of future acquisitions.
In
June 2007, the FASBs Emerging Issues Task Force reached a consensus on EITF No.
07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in
Future Research and Development Activities, that would require nonrefundable advance
payments made by us for future research and development activities to be capitalized and
recognized as an expense as the goods or services are received by us. EITF Issue No. 07-3
is effective with respect to new arrangements entered into beginning January 1, 2008. We
have implemented this standard and it did not have a material impact on our consolidated
results of operations or financial condition.
-62-
In
December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue
No. 07-1, Accounting for Collaborative Arrangements, that discusses how parties to
a collaborative arrangement (which does not establish a legal entity within such
arrangement) should account for various activities. The consensus indicated that costs
incurred and revenues generated from transactions with third parties (i.e. parties outside
of the collaborative arrangement) should be reported by the collaborators on the
respective line items in their income statements pursuant to EITF Issue No. 99-19,
Reporting Revenue Gross as a Principal Versus Net as an Agent. Additionally, the
consensus provides that income statement characterization of payments between the
participants in a collaborative arrangement should be based upon existing authoritative
pronouncements; analogy to such pronouncements if not within their scope; or reasonable,
rational, and consistently applied accounting policy election. EITF Issue 07-1 is
effective for us beginning January 1, 2009 and is to be applied retrospectively to all
periods presented for collaborative arrangements existing as of the date of adoption. We
have evaluated the impact and required disclosures of this standard and do not expect EITF
Issue No. 07-1 to have a material impact on our consolidated results of operations or
financial condition.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements (SFAS 160), which changes the accounting and
reporting standards for the noncontrolling interests in a subsidiary in consolidated
financial statements. SFAS 160 recharacterizes minority interests as noncontrolling
interests and requires noncontrolling interests to be classified as a component of
shareholders equity. SFAS 160 is effective January 1, 2009 and requires retroactive
adoption of the presentation and disclosure requirements for existing minority interests.
We have evaluated the impact of SFAS 160 on our consolidated financial statements and do
not expect SFAS 160 to have a material impact on our consolidated results of operations or
financial condition.
In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities an amendment of SFAS No. 133 (SFAS 161). This
Standard requires enhanced disclosures regarding derivatives and hedging activities,
including: (a) the manner in which an entity uses derivative instruments; (b) the manner
in which derivative instruments and related hedged items are accounted for under SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities; and (c) the effect of
derivative instruments and related hedged items on an entitys financial position,
financial performance, and cash flows. The Standard is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008. As SFAS 161
relates specifically to disclosures, the Standard will have no impact on our financial
condition, results of operations or cash flows.
In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles (SFAS 162). This Standard identifies the sources of accounting
principles and the framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles. SFAS 162 directs the hierarchy to the entity,
rather than the independent auditors, as the entity is responsible for selecting
accounting principles for financial statements that are presented in conformity with
generally accepted accounting principles. The Standard is effective 60 days following SEC
approval of the Public Company Accounting Oversight Board amendments to remove the
hierarchy of generally accepted accounting principles from the auditing standards. SFAS
162 is not expected to have an impact on our financial condition, results of operations or
cash flows.
-63-
Currency Risk and
Exchange Rate Information
A
majority of our revenue and many of our expenses are recognized outside of the United
States, except for inventory purchases, which are primarily transacted in U.S. dollars
from vendors in the United States. The local currency of each of our Subsidiaries
primary markets is considered the functional currency. All revenue and expenses are
translated at weighted-average exchange rates for the periods reported. Therefore, our
reported revenue and earnings will be positively impacted by a weakening of the U.S.
dollar and will be negatively impacted by a strengthening of the U.S. dollar. Given the
large portion of our business derived from Japan, any weakening of the yen negatively
impacts reported revenue and profits, whereas a strengthening of the yen positively
impacts our reported revenue and profits. Given the uncertainty of exchange rate
fluctuations, it is difficult to predict the effect of these fluctuations on our future business,
product pricing and results of operation or financial condition. However, based on current exchange rate levels, we currently anticipate
that foreign currency fluctuations will have a negative impact on reported revenue in 2009.
We
may seek to reduce our exposure to fluctuations in foreign currency exchange rates through
the use of foreign currency exchange contracts, through intercompany loans of foreign
currency and through our Japanese yen-denominated debt. We do not use derivative financial
instruments for trading or speculative purposes. We regularly monitor our foreign currency
risks and periodically take measures to reduce the impact of foreign exchange fluctuations
on our operating results. At December 31, 2007 and 2008, we did not hold any forward
contracts designated as foreign currency cash flow hedges. At September 30, 2008, we held
forward contracts to purchase yen 1.4 billion ($13.2 million as of September 30, 2008). We
applied mark to market accounting for this forward contract and the loss was not material
to our results in the quarter. These forward contracts were fulfilled as of October 14,
2008 which generated a small gain overall.
Following
are the weighted-average currency exchange rates of U.S. $1 into local currency for each
of our international or foreign markets in which revenue exceeded U.S. $5.0 million for at
least one of the quarters listed:
|
2007 | |
2008 | |
|
1st
Quarter | |
2nd
Quarter | |
3rd
Quarter | |
4th
Quarter | |
1st
Quarter | |
2nd
Quarter | |
3rd
Quarter
| |
4th Quarter |
|
|
|
|
|
|
|
|
|
Japan(1) |
|
119.3 |
|
120.8 |
|
117.7 |
|
113.0 |
|
105.0 |
|
104.6 |
|
107.6 |
|
95.7 |
|
Taiwan | |
32.9 |
|
33.1 |
|
32.9 |
|
32.4 |
|
31.5 |
|
30.4 |
|
31.2 |
|
33.0 |
|
Hong Kong | |
7.8 |
|
7.8 |
|
7.8 |
|
7.8 |
|
7.8 |
|
7.8 |
|
7.8 |
|
7.8 |
|
South Korea | |
939.4 |
|
928.9 |
|
927.5 |
|
921.4 |
|
956.4 |
|
1,017.3 |
|
1,063.1 |
|
1,360.6 |
|
Malaysia | |
3.5 |
|
3.4 |
|
3.5 |
|
3.4 |
|
3.2 |
|
3.2 |
|
3.3 |
|
3.6 |
|
Thailand | |
33.9 |
|
32.6 |
|
31.5 |
|
31.2 |
|
31.0 |
|
32.3 |
|
33.9 |
|
34.9 |
|
China | |
7.8 |
|
7.7 |
|
7.6 |
|
7.4 |
|
7.2 |
|
7.0 |
|
6.8 |
|
6.8 |
|
Singapore | |
1.5 |
|
1.5 |
|
1.5 |
|
1.5 |
|
1.4 |
|
1.4 |
|
1.4 |
|
1.5 |
|
(1) |
|
As
of February 17, 2009, the exchange rate of U.S. $1 into the Japanese yen was
approximately 92.30. |
Note Regarding
Forward-Looking Statements
With
the exception of historical facts, the statements contained in Managements
Discussion and Analysis of Financial Condition and Results of Operations, are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 which reflect our current expectations and beliefs regarding
our future results of operations, performance and achievements. These statements are
subject to risks and uncertainties and are based upon assumptions and beliefs that may not
materialize. These forward-looking statements include, but are not limited to, statements
concerning:
|
|
|
our
transformation efforts in Japan and other countries; |
-64-
|
|
|
our
plans regarding new markets; |
|
|
|
our
plans to launch or to continue to roll out certain products, tools and other initiatives
in our various markets, and our belief that these initiatives and other recent product
launches and initiatives will positively impact our business going forward; |
|
|
|
our
plans to modify our compensation plans in most of our Asian markets in 2009; |
|
|
|
our
expectation that we will spend approximately $20 million to $25 million for capital
expenditures during 2009; |
|
|
|
our
plans to open new stores in China; |
|
|
|
our
belief that our recent business transformation initiative will provide continued savings
going forward; |
|
|
|
our
anticipation that our board of directors will continue to declare quarterly cash
dividends and that the cash flows from operations will be sufficient to fund our future
dividend payments; |
|
|
|
our
belief that we have appropriately provided for income taxes for all years; |
|
|
|
our
belief that we have sufficient liquidity to be able to meet our obligations on both a
short- and long-term basis and that existing cash balances together with future cash
flows from operations and existing lines of credit will be adequate to fund our cash
needs; and |
|
|
|
our
belief that recent modifications to our business structure in Japan and in the United
States should eliminate any further customs valuation disputes with respect to product
imports in Japan. |
In
addition, when used in this report, the words or phrases will likely result,
expect, anticipate, will continue, intend,
plan, believe and similar expressions are intended to help
identify forward-looking statements.
We
wish to caution readers that our operating results are subject to various risks and
uncertainties that could cause our actual results and outcomes to differ materially from
those discussed or anticipated. Reference is made to the risks and uncertainties described
below and factors described herein in Item 1A. Risk Factors
(which contain a more detailed discussion of the risks and uncertainties related to
our business). We also wish to advise readers not to place any undue reliance on the
forward-looking statements contained in this report, which reflect our beliefs and
expectations only as of the date of this report. We assume no obligation to update or
revise these forward-looking statements to reflect new events or circumstances or any
changes in our beliefs or expectations, except as required by law. Some of the risks and
uncertainties that might cause actual results to differ from those anticipated include,
but are not limited to, the following:
(a) Global
economic conditions have deteriorated significantly over the past year. Consumer
confidence and spending have declined drastically and the global credit crisis has limited
access to capital for many companies. Although we have continued to see growth in
many of our markets during this period, the economic downturn could adversely impact our
business in the future by causing a decline in demand for our products, particularly if
the economic conditions are prolonged or continue to worsen. In South Korea, for example,
we believe that our growth has started to slow due in part to prolonged difficult economic
conditions in this market. In addition, such economic conditions may adversely
impact access to capital for us and our suppliers, may decrease our distributors
ability to obtain or maintain credit cards, and may otherwise adversely impact our
operations and overall financial condition. Although we have historically met our funding
needs utilizing cash flow from operations, no assurances can be given that we will not
need to obtain additional equity or debt financing and that such financing will be
available to us on terms that are favorable.
-65-
(b) Recently, numerous foreign currencies have weakened against the U.S. dollar,
including substantial devaluations of the South Korean won and the euro. If these
currencies continue at present levels or weaken further, our results could be negatively
impacted.
(c) We have experienced revenue declines in Japan over the last several years and continue
to face challenges in this market. If we are unable to renew growth in this market our
results could be harmed. Factors that could impact our results in the market include:
|
|
|
continued
or increased levels of regulatory and media scrutiny and any regulatory actions taken by
regulators, or any adoption of more restrictive regulations, in response to such
scrutiny; |
|
|
|
any
weakening of the Japanese yen; |
|
|
|
regulatory
constraints with respect to the claims we can make regarding the efficacy of products and
tools, which could limit our ability to effectively market them; |
|
|
|
risks
that the new initiatives we are implementing in Japan, which are patterned after
successful initiatives implemented in other markets, will not have the same level of
success in Japan, may not generate renewed growth or increased productivity among our
distributors, and may cost more or require more time to implement than we have
anticipated; |
|
|
|
inappropriate
activities by our distributors and any resulting regulatory actions; |
|
|
|
any
weakness in the economy or consumer confidence; and |
|
|
|
increased
competitive pressures from other direct selling companies and their distributors who
actively seek to solicit our distributors to join their businesses. |
(d)
Distributor activities that violate applicable laws or regulations could result
in government or third party actions against us. We have experienced an increase
in complaints and inquiries to consumer protection centers in Japan and have
taken steps to try to resolve these issues including providing additional
training and restructuring our compliance group in Japan. We have also been in
contact with general consumer centers in Japan, one of which recently sent us a
written warning that we needed to reduce the number of complaints and inquiries
being filed with that consumer protection center. If consumer complaints
escalate to a government review or, if the current level of complaints does not
improve, regulators could take action against us.
(e)
Our operations in China are subject to significant regulatory scrutiny, and we
have experienced challenges in the past, including interruption of sales
activities at certain stores and fines being paid in some cases. Even though we
have now obtained a direct selling license, government regulators continue to
scrutinize our activities and the activities of our distributors and sales
employees to monitor our compliance with the regulations and other applicable
regulations as we integrate direct selling into our business model. Any
determination that our operations or activities, or the activities of our
employed sales representatives or distributors, are not in compliance with
applicable regulations, could result in the imposition of substantial fines,
extended interruptions of business, termination of necessary licenses and
permits, including our direct selling licenses, or restrictions on our ability
to open new stores or obtain approvals for service centers or expand into new
locations, all of which could harm our business.
-66-
(f)
The direct selling regulations in China are restrictive and there continues to be some
confusion and uncertainty as to the meaning of the regulations and the specific types of
restrictions and requirements imposed under them. It is also difficult to predict how
regulators will interpret and enforce these regulations. Our business and our growth
prospects may be harmed if Chinese regulators interpret the anti-pyramiding regulations or
direct selling regulations in such a manner that our current method of conducting business
through the use of employed sales representatives violates these regulations. In
particular, our business would be harmed by any determination that our current method of
compensating our sales employees, including our use of the sales productivity of a sales
employee and the group of sales employees whom he or she trains and supervises as one of
the factors in establishing such sales employees salary and compensation, violates
the restriction on multi-level compensation under the rules. Our business could also be
harmed if regulators inhibit our ability to concurrently operate our retail store/employed
sales representative business model and our direct selling business.
(g)
Our ability to retain key and executive level distributors or to sponsor new
executive distributors is critical to our success. Because our products are
distributed exclusively through our distributors and we compete with other
direct selling companies in attracting distributors, our operating results could
be adversely affected if our existing and new business opportunities and
incentives, products, business tools and other initiatives do not generate
sufficient enthusiasm and economic incentive to retain our existing distributors
or to sponsor new distributors on a sustained basis. In addition, in our more
mature markets, one of the challenges we face is keeping distributor leaders
with established businesses and high income levels motivated and actively
engaged in business building activities and in developing new distributor
leaders. There can be no assurance that our initiatives will continue to
generate excitement among our distributors in the long-term or that planned
initiatives will be successful in maintaining distributor activity and
productivity or in motivating distributor leaders to remain engaged in business
building and developing new distributor leaders.
(h)
There have been a series of third party actions and governmental actions
involving some of our competitors in the direct selling industry as well. These
actions have generated negative publicity for the industry and likely have
resulted in increased regulatory scrutiny of other companies in the industry.
There can be no assurance that similar allegations will not be made against us.
In addition, adverse rulings in these cases could harm our business if they
create adverse publicity or interpret laws in a manner inconsistent with our
current business practices.
(i)
We plan to implement some compensation plan modifications in most of our Asian
markets in 2009, similar to those we implemented in the Americas and Europe
regions in 2008. Because of the size of our distributor force and the
complexity of our compensation plans, it is difficult to predict whether such
changes will achieve their desired results. Because of unique features of
existing plans in these markets, particularly in our Southeast Asia and Japan
markets, implementation of these features will involve a more significant
transition. There are risks that the compensation plan modifications we
make will not be well received or achieve desired results in each of these
markets and that the transition could have a negative impact on revenue. If our
distributors fail to adapt to these changes or find them unattractive, our
business could be harmed.
(j)
As we continue to implement our business transformation initiative, there could
be unintended negative consequences, including business disruptions and/or a
loss of employees. Further, we may not realize the cost improvements and greater
efficiencies we hope for as a result of this realignment. In addition, as we
continually evaluate strategic reinvestment of any savings generated as a result
of our transformation initiative, we may not ultimately achieve the amount of
savings that we currently anticipate.
(k)
The network marketing and nutritional supplement industries are subject to
various laws and regulations throughout our markets, many of which involve a
high level of subjectivity and are inherently fact-based and subject to
interpretation. Negative publicity concerning supplements with controversial
ingredients has spurred efforts to change existing regulations or adopt new
regulations in order to impose further restrictions and regulatory control over
the nutritional supplement industry. If our existing business practices or
products, or any new initiatives or products, are challenged or found to
contravene any of these laws by any governmental agency or other third party, or
if there are any new regulations applicable to our business that limit our
ability to market such products or impose additional requirements on us, our
revenue and profitability may be harmed.
-67-
(l)
Production difficulties and quality control problems could harm our business, in
particular our reliance on third party suppliers to deliver quality products in
a timely manner. Occasionally, we have experienced production
difficulties with respect to our products, including the delivery of products
that do not meet our quality control standards. These quality problems have
resulted in the past, and could result in the future, in stock outages or
shortages in our markets with respect to such products, harming our sales and
creating inventory write-offs for unusable products.
ITEM 7A. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The
information required by Item 7A of Form 10-K is incorporated herein by reference from the
information contained in Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operation Currency Risk and Exchange Rate
Information and Note 15 to the Consolidated Financial Statements.
ITEM 8. |
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
1. |
|
Financial
Statements. Set forth below is the index to the Financial Statements
included in this Item 8: |
|
Page | |
|
|
|
Consolidated Balance Sheets at December 31, 2007 and 2008 |
69 |
|
|
|
|
Consolidated Statements of Income for the years
ended December 31, 2006, 2007 and 2008 |
70 |
|
|
|
|
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the years ended December 31, 2006, 2007 and 2008 |
71 |
|
|
|
|
Consolidated Statements of Cash Flows for the years
ended December 31, 2006, 2007 and 2008 |
72 |
|
|
|
|
Notes to Consolidated Financial Statements |
73 |
|
|
|
|
Report of Independent Registered Public Accounting Firm |
98 |
|
2. |
|
Financial
Statement Schedules: Financial statement schedules have been omitted
because they are not required or are not applicable, or because the
required information is shown in the financial statements or notes
thereto. |
-68-
Nu Skin Enterprises, Inc.
Consolidated Balance Sheets
(U.S. dollars in thousands)
|
December 31, | |
|
2007 | |
2008 | |
ASSETS |
|
|
|
|
|
Current assets | |
Cash and cash equivalents | |
$ 87,327 |
|
$ 114,586 |
|
Current investments | |
5,225 |
|
|
|
Accounts receivable | |
23,424 |
|
16,496 |
|
Inventories, net | |
100,792 |
|
114,378 |
|
Prepaid expenses and other | |
49,576 |
|
44,944 |
|
| |
266,344 |
|
290,404 |
|
| |
|
|
|
|
Property and equipment, net | |
88,529 |
|
82,336 |
|
Goodwill | |
112,446 |
|
112,446 |
|
Other intangible assets, net | |
86,163 |
|
87,888 |
|
Other assets | |
129,761 |
|
136,698 |
|
Total assets | |
$ 683,243 |
|
$ 709,772 |
|
LIABILITIES AND STOCKHOLDERS' EQUITY | |
Current liabilities | |
Accounts payable | |
$ 24,108 |
|
$ 20,378 |
|
Accrued expenses | |
115,620 |
|
115,794 |
|
Current portion of long-term debt | |
31,441 |
|
30,196 |
|
| |
171,169 |
|
166,368 |
|
| |
|
|
|
|
Long-term debt | |
169,229 |
|
158,760 |
|
Other liabilities | |
67,836 |
|
68,464 |
|
Total liabilities | |
408,234 |
|
393,592 |
|
| |
|
|
|
|
Commitments and contingencies (Notes 9 and 20) | |
| |
|
|
|
|
Stockholders' equity | |
Class A common stock - 500 million shares authorized,
$.001 par value, 90.6 million shares issued; | |
91 |
|
91 |
|
Additional paid-in capital | |
209,821 |
|
218,928 |
|
Treasury stock, at cost - 27.2 million shares | |
(413,976 |
) |
(417,017 |
) |
Accumulated other comprehensive loss | |
(67,759 |
) |
(70,061 |
) |
Retained earnings | |
546,832 |
|
584,239 |
|
| |
275,009 |
|
316,180 |
|
Total liabilities and stockholders' equity | |
$ 683,243 |
|
$ 709,772 |
|
The accompanying notes are an integral part of these
consolidated financial statements.
-69-
Nu Skin Enterprises, Inc.
Consolidated Statements of Income
(U.S. dollars in thousands, except per share amounts)
|
Year Ended December 31, |
|
|
2006 | |
2007 | |
2008 | |
|
|
|
Revenue |
|
$ 1,115,409 |
|
$ 1,157,667 |
|
$ 1,247,646 |
|
Cost of sales | |
195,203 |
|
209,283 |
|
228,597 |
|
|
|
|
Gross profit | |
920,206 |
|
948,384 |
|
1,019,049 |
|
|
|
|
Operating expenses: | |
Selling expenses | |
480,136 |
|
496,454 |
|
529,368 |
|
General and administrative expenses | |
353,412 |
|
361,242 |
|
364,253 |
|
Restructuring charges | |
11,115 |
|
19,775 |
|
|
|
Impairment of assets and other | |
20,840 |
|
|
|
|
|
|
|
|
Total operating expenses | |
865,503 |
|
877,471 |
|
893,621 |
|
|
|
|
Operating income | |
54,703 |
|
70,913 |
|
125,428 |
|
Other income (expense), net (Note 23) | |
(2,027 |
) |
(2,435 |
) |
(24,775 |
) |
|
|
|
Income before provision for income taxes | |
52,676 |
|
68,478 |
|
100,653 |
|
Provision for income taxes | |
19,859 |
|
24,606 |
|
35,306 |
|
|
|
|
Net income | |
$ 32,817 |
|
$ 43,872 |
|
$ 65,347 |
|
|
|
|
Net income per share: | |
Basic | |
$ 0.47 |
|
$ 0.68 |
|
$ 1.03 |
|
Diluted | |
$ 0.47 |
|
$ 0.67 |
|
$ 1.02 |
|
|
|
|
Weighted-average common shares outstanding (000s): | |
Basic | |
69,418 |
|
64,783 |
|
63,510 |
|
Diluted | |
70,506 |
|
65,584 |
|
64,132 |
|
The
accompanying notes are an integral part of these consolidated financial statements.
-70-
Nu Skin Enterprises, Inc.
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(U.S. dollars in thousands)
|
Class A
Common Stock | |
Additional
Paid-in Capital | |
Treasury Stock | |
Accumulated Other
Comprehensive Loss | |
Retained
Earnings | |
Total | |
Balance at January 1, 2006 |
|
$ 91 |
|
$ 179,335 |
|
$ (284,138 |
) |
$ (67,197 |
) |
$ 526,537 |
|
$ 354,628 |
|
| |
Comprehensive income: | |
Net income | |
|
|
|
|
|
|
|
|
32,817 |
|
32,817 |
|
Foreign currency translation adjustment | |
|
|
|
|
|
|
3,736 |
|
|
|
3,736 |
|
Net unrealized gains on foreign currency cash flow hedges | |
|
|
|
|
|
|
218 |
|
|
|
218 |
|
Less: Reclassification adjustment for realized gains in current earnings | |
|
|
|
|
|
|
(1,864 |
) |
|
|
(1,864 |
) |
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
34,907 |
|
Repurchase of Class A common stock (Note 10) | |
|
|
|
|
(67,452 |
) |
|
|
|
|
(67,452 |
) |
Adjustment related to prior common control merger | |
|
|
8,151 |
|
|
|
|
|
|
|
8,151 |
|
Exercise of employee stock options (519,000 shares) | |
|
|
870 |
|
4,530 |
|
|
|
|
|
5,400 |
|
Excess tax benefit from equity awards | |
|
|
1,836 |
|
|
|
|
|
|
|
1,836 |
|
Stock-based compensation | |
|
|
9,130 |
|
171 |
|
|
|
|
|
9,301 |
|
Cash dividends | |
|
|
|
|
|
|
|
|
(27,791 |
) |
(27,791 |
) |
Balance at December 31, 2006 | |
91 |
|
199,322 |
|
(346,889 |
) |
(65,107 |
) |
531,563 |
|
318,980 |
|
|
|
|
|
|
|
|
|
|
Comprehensive income: | |
Net income | |
|
|
|
|
|
|
|
|
43,872 |
|
43,872 |
|
Foreign currency translation adjustment | |
|
|
|
|
|
|
(2,236 |
) |
|
|
(2,236 |
) |
Net unrealized losses on foreign currency cash flow hedges | |
|
|
|
|
|
|
(152 |
) |
|
|
(152 |
) |
Less: Reclassification adjustment for realized gains in current earnings | |
|
|
|
|
|
|
(264 |
) |
|
|
(264 |
) |
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
41,220 |
|
Repurchase of Class A common stock (Note 10) | |
|
|
|
|
(71,100 |
) |
|
|
|
|
(71,100 |
) |
Exercise of employee stock options (593,000 shares) | |
|
|
1,734 |
|
3,996 |
|
|
|
|
|
5,730 |
|
Excess tax benefit from equity awards | |
|
|
1,770 |
|
|
|
|
|
|
|
1,770 |
|
Stock-based compensation | |
|
|
8,129 |
|
|
|
|
|
|
|
8,129 |
|
Adoption of FIN 48 | |
|
|
(1,117 |
) |
|
|
|
|
(1,458 |
) |
(2,575 |
) |
Vesting of stock awards | |
|
|
(17 |
) |
17 |
|
|
|
|
|
|
|
Cash dividends | |
|
|
|
|
|
|
|
|
(27,145 |
) |
(27,145 |
) |
Balance at December 31, 2007 | |
91 |
|
209,821 |
|
(413,976 |
) |
(67,759 |
) |
546,832 |
|
275,009 |
|
|
|
|
|
|
|
|
|
|
Comprehensive income: | |
Net income | |
|
|
|
|
|
|
|
|
65,347 |
|
65,347 |
|
Foreign currency translation adjustment | |
|
|
|
|
|
|
(2,302 |
) |
|
|
(2,302 |
) |
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
63,045 |
|
Repurchase of Class A common stock (Note 10) | |
|
|
|
|
(6,093 |
) |
|
|
|
|
(6,093 |
) |
Exercise of employee stock options (401,000 shares) | |
|
|
772 |
|
3,052 |
|
|
|
|
|
3,824 |
|
Excess tax benefit from equity awards | |
|
|
1,062 |
|
|
|
|
|
|
|
1,062 |
|
Stock-based compensation | |
|
|
7,273 |
|
|
|
|
|
|
|
7,273 |
|
Cash dividends | |
|
|
|
|
|
|
|
|
(27,940 |
) |
(27,940 |
) |
Balance at December 31, 2008 | |
$ 91 |
|
$ 218,928 |
|
$ (417,017 |
) |
$ (70,061 |
) |
$ 584,239 |
|
$ 316,180 |
|
The accompanying notes are an
integral part of these consolidated financial statements.
-71-
Nu Skin Enterprises, Inc.
Consolidated Statements of Cash Flows
(U.S. dollars in thousands)
|
Year Ended December 31, |
|
|
2006 | |
2007 | |
2008 | |
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
Net income | |
$ 32,817 |
|
$ 43,872 |
|
$ 65,347 |
|
Adjustments to reconcile net income to net cash provided | |
by operating activities: | |
Depreciation and amortization | |
29,132 |
|
32,967 |
|
30,393 |
|
Foreign currency (gains)/losses | |
(947 |
) |
(4,471 |
) |
18,409 |
|
Stock-based compensation | |
9,301 |
|
8,129 |
|
7,273 |
|
Impairment of Scanner asset | |
18,984 |
|
|
|
|
|
Changes in operating assets and liabilities: | |
Accounts receivable | |
(2,786 |
) |
(2,647 |
) |
7,069 |
|
Inventories, net | |
163 |
|
(12,312 |
) |
(14,910 |
) |
Prepaid expenses and other | |
(8,289 |
) |
(4,623 |
) |
5,084 |
|
Other assets | |
(9,382 |
) |
(31,662 |
) |
(4,671 |
) |
Accounts payable | |
118 |
|
2,956 |
|
(6,139 |
) |
Accrued expenses | |
7,181 |
|
(8,641 |
) |
(3,250 |
) |
Other liabilities | |
(497 |
) |
25,085 |
|
(1,298 |
) |
| |
Net cash provided by operating activities | |
75,795 |
|
48,653 |
|
103,307 |
|
| |
Cash flows from investing activities: | |
Purchase of property and equipment | |
(35,680 |
) |
(22,736 |
) |
(16,007 |
) |
Proceeds on investment sales | |
173,925 |
|
131,525 |
|
19,135 |
|
Purchases of investments | |
(173,925 |
) |
(136,750 |
) |
(13,910 |
) |
Purchase of long-term assets | |
(1,981 |
) |
|
|
|
|
| |
Net cash used in investing activities | |
(37,661 |
) |
(27,961 |
) |
(10,782 |
) |
| |
Cash flows from financing activities: | |
Payment of cash dividends | |
(27,791 |
) |
(27,145 |
) |
(27,940 |
) |
Repurchase of shares of common stock | |
(67,452 |
) |
(71,100 |
) |
(6,094 |
) |
Exercise of distributor and employee stock options | |
5,400 |
|
5,731 |
|
3,824 |
|
Income tax benefit of options exercised | |
1,836 |
|
1,770 |
|
227 |
|
Payments on long-term debt | |
(31,611 |
) |
(31,733 |
) |
(32,711 |
) |
Proceeds from long-term debt | |
45,000 |
|
64,845 |
|
|
|
| |
Net cash used in financing activities | |
(74,618 |
) |
(57,632 |
) |
(62,694 |
) |
| |
Effect of exchange rate changes on cash | |
2,428 |
|
2,914 |
|
(2,572 |
) |
| |
Net increase (decrease) in cash and cash equivalents | |
(34,056 |
) |
(34,026 |
) |
27,259 |
|
| |
Cash and cash equivalents, beginning of period | |
155,409 |
|
121,353 |
|
87,327 |
|
| |
Cash and cash equivalents, end of period | |
$ 121,353 |
|
$ 87,327 |
|
$ 114,586 |
|
The
accompanying notes are an integral part of these consolidated financial statements.
-72-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Nu
Skin Enterprises, Inc. (the Company) is a leading, global direct selling
company that develops and distributes premium-quality, innovative personal care products
and nutritional supplements that are sold worldwide under the Nu Skin and Pharmanex brands
and a small number of other products and services. The Company reports revenue from five
geographic regions: North Asia, which consists of Japan and South Korea; Americas, which
consists of the United States, Canada and Latin America; Greater China, which consists of
Mainland China, Hong Kong, Macau and Taiwan; Europe, which consists of several markets in
Europe as well as Israel, Russia and South Africa; and South Asia/Pacific, which consists
of Australia, Brunei, Indonesia, Malaysia, New Zealand, the Philippines, Singapore and
Thailand (the Companys subsidiaries operating in these countries are collectively
referred to as the Subsidiaries).
2. |
|
Summary
of Significant Accounting Policies |
Consolidation
The
consolidated financial statements include the accounts of the Company and the
Subsidiaries. All significant intercompany accounts and transactions are eliminated in
consolidation.
Use of estimates
The
preparation of these financial statements, in conformity with accounting principles
generally accepted in the United States of America, required management to make estimates
and assumptions that affected the reported amounts of assets and liabilities, and
disclosure of contingent assets and liabilities, at the date of the financial statements
and the reported amounts of revenue and expenses during the reporting period.
Cash and cash equivalents
Cash
equivalents are short-term, highly liquid instruments with original maturities of 90 days
or less.
Inventories
Inventories
consist primarily of merchandise purchased for resale and are stated at the lower of cost
or market, using the first-in, first-out method. The Company had reserves for obsolete
inventory totaling $5.0 million and $5.8 million as of December 31, 2007 and 2008,
respectively.
-73-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Inventories
consist of the following (U.S. dollars in thousands):
|
December 31, |
|
|
2007 | |
2008 | |
|
|
|
Raw materials |
|
$ 25,605 |
|
$ 33,182 |
|
Finished goods | |
75,187 |
|
81,196 |
|
| |
$ 100,792 |
|
$ 114,378 |
|
Property and equipment
Property
and equipment are recorded at cost and depreciated using the straight-line method over the
following estimated useful lives:
|
|
|
|
|
|
Furniture and fixtures |
|
5 - 7 years |
|
Computers and equipment | |
3 - 5 years | |
Leasehold improvements | |
Shorter of estimated useful life or lease term | |
Scanners | |
3 years | |
Vehicles | |
3 - 5 years | |
Expenditures
for maintenance and repairs are charged to expense as incurred. When an asset is sold or
otherwise disposed of, the cost and associated accumulated depreciation are removed from
the accounts and the resulting gain or loss is recognized in the statement of income.
Property and equipment are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets may not be recoverable. An
impairment loss is recognized if the carrying amount of the asset exceeds its fair value.
Goodwill and other
intangible assets
Under
the provisions of Statements of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS
142), the Companys goodwill and intangible assets with indefinite useful lives
are not amortized, but instead are tested for impairment at least annually. The
Companys intangible assets with finite lives are recorded at cost and are amortized
over their respective estimated useful lives using the straight-line method to their
estimated residual values and are reviewed for impairment in accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. In addition, the
Company is required to make judgments regarding and periodically assesses the useful life
of its intangible assets.
Revenue recognition
Revenue
is recognized when products are shipped, which is when title and risk of loss pass to
independent distributors and preferred customers who are the Companys customers. A
reserve for product returns is accrued based on historical experience totaling $1.9
million and $2.1 million as of December 31, 2007 and 2008, respectively. The Company
generally requires cash or credit card payment at the point of sale. The Company has
determined that no allowance for doubtful accounts is necessary. Amounts received prior to
shipment and title passage to distributors are recorded as deferred revenue. The global
compensation plan for the Companys distributors generally does not provide rebates
or selling discounts to distributors who purchase its products and services. The Company
classifies selling discounts and rebates, if any, as a reduction of revenue.
-74-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Advertising expenses
Advertising
costs are expensed as incurred. Advertising expense incurred for the years ended December
31, 2006, 2007 and 2008 totaled approximately $3.9 million, $2.1 million and $1.7 million,
respectively.
Selling expenses
Selling
expenses are the Companys most significant expense and are classified as operating
expenses. Selling expenses include distributor commissions as well as wages, benefits,
bonuses and other labor and unemployment expenses the Company pays to employed sales
representatives in China. The Company pays monthly commissions to several levels of
distributors on each product sale based upon a distributors personal and group
product volumes, as well as the group product volumes of up to six levels of executive
distributors in such distributors downline sales organization. The Company does not
pay commissions on sales materials.
The
Companys distributors may make retail profits by purchasing the products from the
Company at wholesale and selling them to customers with a retail mark-up. The Company does
not account for nor pay additional commissions on these retail mark-ups received by
distributors. In many markets, the Company also allows individuals who are not
distributors, referred to as preferred customers, to buy products directly
from the Company at wholesale or discounted prices. The Company pays commissions on
preferred customer purchases to the referring distributors.
Research and development
The
Companys research and development activities are conducted primarily through its
Pharmanex division. Research and development costs are included in general and
administrative expenses in the accompanying consolidated statements of income and are
expensed as incurred and totaled $8.7 million, $10.0 million and $9.6 million in 2006,
2007 and 2008, respectively.
Deferred tax assets and
liabilities
The
Company accounts for income taxes in accordance with SFAS 109. This statement establishes
financial accounting and reporting standards for the effects of income taxes that result
from an enterprises activities during the current and preceding years. It requires
an asset and liability approach for financial accounting and reporting of income taxes.
The Company pays income taxes in many foreign jurisdictions based on the profits realized
in those jurisdictions, which can be significantly impacted by terms of intercompany
transactions between the Company and its foreign affiliates. Deferred tax assets and
liabilities are created in this process. As of December 31, 2008, the Company has net
deferred tax assets of $76.3 million. The Company has netted these deferred tax assets and
deferred tax liabilities by jurisdiction. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be ultimately realized.
Uncertain Tax Positions
In
June 2006, the FASB issued FASB Interpretation Number 48, Accounting for Uncertainty
in Income Taxes an Interpretation of SFAS 109 (FIN 48). The
Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the
implementation of FIN 48, the Company recognized a $2.6 million increase in the liability
for unrecognized tax benefits, which was accounted for as a reduction to the January 1,
2007 balances of retained earnings and additional paid-in capital.
-75-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
Company files income tax returns in the U.S. federal jurisdiction, and various states and
foreign jurisdictions. The Company is currently under examination by the United States
Internal Revenue Service (the IRS) for the 2006 and 2007 tax years. With a few
exceptions, the Company is no longer subject to state and local income tax examination by
tax authorities for years before 2005. In major foreign jurisdictions, the Company is no
longer subject to income tax examinations for years before 2002. Along with the IRS
examination, the Company is currently under examination in certain foreign jurisdictions;
however, the outcomes of those reviews are not yet determinable.
A
reconciliation of the beginning and ending amount of unrecognized tax benefits is as
follows (U.S. dollars in thousands):
|
|
Gross Balance at January 1, 2007 |
|
|
$ | 31,875 |
|
Increases related to prior year tax positions | | |
| 1,254 |
|
Decreases related to prior year tax positions | | |
| (6,060 |
) |
Increases related to current year tax positions | | |
| 1,431 |
|
Decreases due to lapse of statutes of limitations | | |
|
(2,880 |
) |
Gross Balance at December 31, 2007 | | |
$ |
31,875 |
|
|
|
Gross Balance at January 1, 2008 |
|
|
$ | 38,130 |
|
Increases related to current year tax positions | | |
| 1,494 |
|
Settlements | | |
| (14 |
) |
Decreases due to lapse of statutes of limitations | | |
| (5,977 |
) |
Currency adjustments | | |
|
3,537 |
|
Gross Balance at December 31, 2008 | | |
$ |
30,915 |
|
At
December 31, 2008, the Company had $30.9 million in unrecognized tax benefits of which
$5.8 million, if recognized, would affect the effective tax rate. In comparison, at
December 31, 2007 the Company had $31.9 million in unrecognized tax benefits of which $9.1
million, if recognized, would affect the effective tax rate. The Companys
unrecognized tax benefits relate to multiple foreign and domestic jurisdictions. Due to
potential increases in unrecognized tax benefits from the multiple jurisdictions in which
the Company operates, as well as the expiration of various statutes of limitation, it is
reasonably possible that our gross unrecognized tax benefits, net of foreign currency
adjustments, may change within the next 12 months by a range of approximately zero to $5
million.
During
each of the years ended December 31, 2008 and December 31, 2007, the Company recognized
approximately $0.5 million in interest and penalties. The Company had approximately $3.2
million and $2.7 million of accrued interest and penalties related to uncertain tax
positions at December 31, 2008 and December 31, 2007, respectively. Interest and penalties
related to uncertain tax positions are recognized as a component of income tax expense.
Net income per share
Net
income per share is computed based on the weighted-average number of common shares
outstanding during the periods presented. Additionally, diluted earnings per share data
gives effect to all potentially dilutive common shares that were outstanding during the
periods presented (Note 10).
-76-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Foreign currency
translation
Most
of the Companys business operations occur outside the United States. The local
currency of each of the Companys subsidiaries is considered its functional currency.
All assets and liabilities are translated into U.S. dollars at exchange rates existing at
the balance sheet dates, revenue and expenses are translated at weighted-average exchange
rates and stockholders equity is recorded at historical exchange rates. The
resulting foreign currency translation adjustments are recorded as a separate component of
stockholders equity in the consolidated balance sheets and transaction gains and
losses are included in other income and expense in the consolidated financial statements.
Fair value of financial
instruments
The
carrying value of financial instruments including cash and cash equivalents, accounts
receivable and accounts payable approximate fair values due to the short-term nature of
these instruments. The carrying amount of long-term debt approximates fair value because
the applicable interest rates approximate current market rates. Fair value estimates are
made at a specific point in time, based on relevant market information.
The
Company adopted SFAS No. 157, Fair Value Measurements (SFAS 157), and
the related FASB Staff Position FAS No. 157-2. The adoption of these pronouncements did
not have a material impact on the Companys fair value measurements. SFAS 157 defines
fair value as the price that would be received to sell an asset or paid to transfer a
liability in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants at the measurement date. On a quarterly
basis, the Company measures at fair value certain financial assets, including cash
equivalents and available-for-sale securities. SFAS 157 specifies a hierarchy of valuation
techniques based on whether the inputs to those valuation techniques are observable or
unobservable. Observable inputs reflect data obtained from independent sources, while
unobservable inputs reflect the Companys market assumptions. These two types of
inputs have created the following fair-value hierarchy:
|
|
|
Level
1 - quoted prices in active markets for identical assets or liabilities; |
|
|
|
Level
2 inputs, other than the quoted prices in active markets, that are observable
either directly or indirectly; |
|
|
|
Level
3 unobservable inputs based on the Companys own assumptions. |
The following table presents the fair
value hierarchy for those assets and liabilities measured at fair value on a recurring
basis as of December 31, 2008 (U.S. dollars in millions):
|
Fair Value at December 31, 2008 | |
| |
Level 1 | |
Level 2 | |
Level 3 | |
Total | |
|
| |
| |
Assets: |
|
|
|
|
|
|
|
|
|
Auction Rate Securities | |
$ |
|
$ |
|
$ |
|
$ |
|
| |
|
|
|
|
|
|
|
|
Liabilities: | |
$ |
|
$ |
|
$ |
|
$ |
|
-77-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The following table provides a
summary of changes in fair value of the Companys Level 3 marketable securities (U.S.
dollars in millions):
Balance at January 31, 2008: |
|
$ 5.2 |
|
|
|
|
|
|
|
|
| |
| |
Purchases | |
13.9 |
|
|
|
|
|
|
|
Sales | |
(19.1 |
) |
|
|
|
|
|
|
|
| |
| |
Balance at December 31, 2008: | |
$ |
|
|
|
|
|
|
|
Also,
effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS 159). This standard
permits companies, at their option, to choose to measure many financial instruments and
certain other items at fair value. The Company has elected to not fair value existing
eligible items.
Stock-based compensation
Effective
January 1, 2006, the Company adopted the fair value recognition provisions of Financial
Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment
(SFAS 123R), using the modified prospective transition method and therefore
has not restated results for prior periods. Under this transition method, stock-based
compensation expense includes all stock-based compensation awards granted prior to, but
not yet vested as of January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123). Stock-based compensation expense for all
stock-based compensation awards granted after January 1, 2006 is based on the grant-dated
fair value estimated in accordance with the provisions of SFAS 123R. The Company
recognizes these compensation costs, net of an estimated forfeiture rate, on a
straight-line basis over the requisite service period of the award, which is generally the
option vesting term of four years. The Company estimated the forfeiture rate based on its
historical experience.
In
March 2005, the Securities and Exchange Commission (the SEC) issued Staff
Accounting Bulletin No. 107 (SAB 107) regarding the SECs interpretation
of SFAS 123R and the valuation of share-based payments for public companies. The Company
applied the provisions of SAB 107 in its adoption of SFAS 123R.
Prior
to the adoption of SFAS 123R the Company recognized stock based compensation expense in
accordance with Accounting Principles Board Opinion No. 25. Accounting for Stock Issued
to Employees (APB 25). Accordingly, the Company generally recognized
compensation expense only when it granted options with an exercise price less than the
market value of the underlying shares. Any resulting compensation expense was recognized
ratably over the associated service period, which was generally the option vesting term.
The
total compensation expense related to these plans was approximately $9.3 million, $8.1
million and $7.3 million for the years ended December 31, 2006, 2007 and 2008. Prior to
the adoption of SFAS 123R, the Company presented the tax benefit of stock option exercises
as a component of operating cash flows. Upon the adoption of SFAS 123R, tax benefits
resulting from tax deductions in excess of the compensation cost recognized for those
options are classified as financing cash flows. For the years ended December 31, 2007 and
2008, all stock-based compensation expense was recorded within general and administrative
expenses.
-78-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
Company has elected to follow the transition guidance indicated in Paragraph 81 of FASB
Statement No. 123 (revised 2004) for purposes of calculating the pool of excess tax
benefits available to absorb possible future tax deficiencies. As such, the Company has
calculated its historical APIC pool of windfall tax benefits using the
long-form method. Furthermore, the Company has elected to use a single-pool approach when
accounting for the pool of windfall tax benefits.
Reporting comprehensive
income
Comprehensive
income is defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources, and it includes
all changes in equity during a period except those resulting from investments by owners
and distributions to owners.
Accounting for derivative
instruments and hedging activities
The
Company recognizes all derivatives as either assets or liabilities, with the instruments
measured at fair value as required by SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133).
The
Companys Subsidiaries enter into significant transactions with each other and third
parties that may not be denominated in the respective Subsidiaries functional
currencies. The Company regularly monitors its foreign currency risks and seeks to reduce
its exposure to fluctuations in foreign exchange rates using foreign currency exchange
contracts and through certain intercompany loans of foreign currency.
The
Company hedges its exposure to future cash flows from forecasted transactions over a
maximum period of 12 months. Hedge effectiveness is assessed at inception and throughout
the life of the hedge to ensure the hedge qualifies for hedge accounting treatment.
Changes in fair value associated with hedge ineffectiveness, if any, are recorded in the
results of operations currently. In the event that an anticipated transaction is no longer
likely to occur, the Company recognizes the change in fair value of the derivative in its
results of operations currently.
Changes
in the fair value of derivatives are recorded in current earnings or accumulated other
comprehensive loss, depending on the intended use of the derivative and its resulting
designation. The gains and losses in accumulated other comprehensive loss stemming from
these derivatives will be reclassified into earnings in the period during which the hedged
forecasted transaction affects earnings. The fair value of the receivable and payable
amounts related to these unrealized gains and losses is classified as other current assets
and liabilities. The Company does not use such derivative financial instruments for
trading or speculative purposes. Gains and losses on certain intercompany loans of foreign
currency are recorded as other income and expense in the consolidated statements of
income.
Recent accounting
pronouncements
In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations,
(SFAS 141R), which changes how business combinations are accounted for and
will impact financial statements both on the acquisition date and in subsequent periods.
SFAS 141R is effective January 1, 2009, and will be applied prospectively. The impact of
adopting SFAS 141R will depend on the nature and terms of future acquisitions.
-79-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
In
June 2007, the FASBs Emerging Issues Task Force reached a consensus on EITF No.
07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in
Future Research and Development Activities, that would require nonrefundable advance
payments made by the Company for future research and development activities to be
capitalized and recognized as an expense as the goods or services are received by the
Company. EITF Issue No. 07-3 is effective with respect to new arrangements entered into
beginning January 1, 2008. The Company has implemented this standard and it did not have a
material impact on its consolidated results of operations or financial condition.
In
December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue
No. 07-1, Accounting for Collaborative Arrangements, that discusses how parties to
a collaborative arrangement (which does not establish a legal entity within such
arrangement) should account for various activities. The consensus indicated that costs
incurred and revenues generated from transactions with third parties (i.e. parties outside
of the collaborative arrangement) should be reported by the collaborators on the
respective line items in their income statements pursuant to EITF Issue No. 99-19,
Reporting Revenue Gross as a Principal Versus Net as an Agent. Additionally, the
consensus provides that income statement characterization of payments between the
participants in a collaborative arrangement should be based upon existing authoritative
pronouncements; analogy to such pronouncements if not within their scope; or reasonable,
rational, and consistently applied accounting policy election. EITF Issue 07-1 is
effective for the Company beginning January 1, 2009 and is to be applied retrospectively
to all periods presented for collaborative arrangements existing as of the date of
adoption. The Company has evaluated the impact and required disclosures of this standard
and does not expect EITF Issue No. 07-1 to have a material impact on its consolidated
results of operations or financial condition.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements (SFAS 160), which changes the accounting and
reporting standards for the noncontrolling interests in a subsidiary in consolidated
financial statements. SFAS 160 recharacterizes minority interests as noncontrolling
interests and requires noncontrolling interests to be classified as a component of
shareholders equity. SFAS 160 is effective January 1, 2009 and requires retroactive
adoption of the presentation and disclosure requirements for existing minority interests.
The Company has evaluated the impact of SFAS 160 on its consolidated financial statements
and does not expect SFAS 160 to have a material impact on its consolidated results of
operations or financial condition.
In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities an amendment of SFAS No. 133 (SFAS 161). This
Standard requires enhanced disclosures regarding derivatives and hedging activities,
including: (a) the manner in which an entity uses derivative instruments; (b) the manner
in which derivative instruments and related hedged items are accounted for under SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities; and (c) the effect of
derivative instruments and related hedged items on an entitys financial position,
financial performance, and cash flows. The Standard is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008. As SFAS 161
relates specifically to disclosures, the Standard will have no impact on the
Companys financial condition, results of operations or cash flows.
In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles (SFAS 162). This Standard identifies the sources of accounting
principles and the framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles. SFAS 162 directs the hierarchy to the entity,
rather than the independent auditors, as the entity is responsible for selecting
accounting principles for financial statements that are presented in conformity with
generally accepted accounting principles. The Standard is effective 60 days following SEC
approval of the Public Company Accounting Oversight Board amendments to remove the
hierarchy of generally accepted accounting principles from the auditing standards. SFAS
162 is not expected to have an impact on the Companys financial condition, results
of operations or cash flows.
-80-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
3. |
|
Related
Party Transactions |
The
Company leases corporate office and warehouse space from two entities that are owned by
certain officers and directors of the Company. Total lease payments to these two
affiliated entities were $3.7 million, $3.8 million and $3.8 million for the years ended
December 31, 2006, 2007 and 2008 with remaining long-term minimum lease payment
obligations under these operating leases of $13.7 million and $10.5 million at December
31, 2007 and 2008, respectively.
4. |
|
Property
and Equipment |
Property
and equipment are comprised of the following (U.S. dollars in thousands):
|
December 31, |
|
|
2007 | |
2008 | |
|
|
|
Furniture and fixtures |
|
$ 53,517 |
|
$ 51,783 |
|
Computers and equipment | |
98,107 |
|
101,592 |
|
Leasehold improvements | |
58,584 |
|
64,885 |
|
Scanners | |
28,462 |
|
22,444 |
|
Vehicles | |
2,096 |
|
1,682 |
|
| |
240,766 |
|
242,386 |
|
Less: accumulated depreciation | |
(152,237 |
) |
(160,050 |
) |
| |
$ 88,529 |
|
$ 82,336 |
|
Depreciation
of property and equipment totaled $23.7 million, $27.1 million and $24.4 million for the
years ended December 31, 2006, 2007 and 2008, respectively, which includes amortization
expense relating to the Scanners of approximately $7.3 million, $7.8 million and $6.7
million for the years ended December 31, 2006, 2007 and 2008, respectively.
5. |
|
Goodwill
and Other Intangible Assets |
Goodwill
and other intangible assets consist of the following (U.S. dollars in thousands):
|
Carrying Amount at
December 31, |
|
Goodwill and indefinite life intangible assets: | |
2007 | |
2008 | |
|
|
|
Goodwill |
|
$ 112,446 |
|
$ 112,446 |
|
Trademarks and trade names | |
24,599 |
|
24,599 |
|
| |
$ 137,045 |
|
$ 137,045 |
|
-81-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
|
December 31, 2007 | |
December 31, 2008 | |
|
Finite life intangible assets: |
Gross Carrying
Amount | |
Accumulated
Amortization | |
Gross Carrying
Amount | |
Accumulated
Amortization | |
Weighted-average
Amortization Period | |
|
|
|
|
|
|
Scanner technology |
|
$ 46,482 |
|
$ 9,323 |
|
$ 46,482 |
|
$ 12,356 |
|
18 years |
|
Developed technology |
|
22,500 |
|
10,963 |
|
22,500 |
|
11,788 |
|
20 years |
|
Distributor network | |
11,598 |
|
7,082 |
|
11,598 |
|
7,583 |
|
15 years | |
Trademarks | |
12,558 |
|
7,510 |
|
13,016 |
|
8,160 |
|
15 years | |
Other | |
21,938 |
|
18,634 |
|
29,216 |
|
19,636 |
|
5 years | |
| |
$ 115,076 |
|
$ 53,512 |
|
$ 122,812 |
|
$ 59,523 |
|
15 years | |
Amortization
of finite-life intangible assets totaled $5.4 million, $5.9 million and $6.0 million for
the years ended December 31, 2006, 2007 and 2008, respectively. Annual estimated
amortization expense is expected to approximate $6.0 million for each of the five
succeeding fiscal years.
All
of the Companys goodwill is based in the U.S. Goodwill and indefinite life
intangible assets are not amortized, rather they are subject to annual impairment tests.
Annual impairment tests were completed resulting in no impairment charges for any of the
periods shown. Finite life intangibles are amortized over their useful lives unless
circumstances occur that cause the Company to revise such lives or review such assets for
impairment.
Other
assets consist of the following (U.S. dollars in thousands):
|
December 31, |
|
|
2007 | |
2008 | |
|
|
|
Deferred taxes |
|
$ 60,057 |
|
$ 66,427 |
|
Deposits for noncancelable operating leases | |
25,023 |
|
24,184 |
|
Deposit for customs assessment (Note 20) | |
24,184 |
|
29,707 |
|
Other | |
20,497 |
|
16,380 |
|
| |
$ 129,761 |
|
$ 136,698 |
|
Accrued
expenses consist of the following (U.S. dollars in thousands):
|
December 31, |
|
|
2007 | |
2008 | |
|
|
|
Accrued commissions and other payments to distributors |
|
$ 43,064 |
|
$ 47,819 |
|
Income taxes payable | |
3,138 |
|
4,067 |
|
Other taxes payable | |
11,923 |
|
9,682 |
|
Accrued payroll and payroll taxes | |
9,742 |
|
14,432 |
|
Accrued payable to vendors | |
9,641 |
|
9,494 |
|
Accrued severance | |
5,455 |
|
482 |
|
Other accrued employee expenses | |
10,780 |
|
7,722 |
|
Other | |
21,877 |
|
22,096 |
|
| |
$ 115,620 |
|
$ 115,794 |
|
-82-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
following tables summaries the Companys long-term debt arrangements as of December
31, 2008:
Facility or Arrangement(1) | |
Original Principal Amount | |
Balance as of December 31, 2008(2) | |
Interest Rate | |
Repayment terms | |
|
|
|
|
|
|
|
|
|
|
2000 Japanese yen-denominated notes |
|
9.7 billion yen |
|
2.8 billion yen ($30.6 million as of December 31, 2008) |
|
3.0% |
|
Notes due October 2010, with annual principal payments that began in October 2004. |
|
|
|
|
|
|
| |
| |
| |
| |
| |
| |
2003 $205.0 million multi-currency uncommitted shelf facility: | |
| |
| |
| |
| |
| |
U.S. dollar denominated: | |
$50.0 million | |
$20.0 million | |
4.5% | |
Notes due April 2010 with annual principal payments that began in April 2006. | |
|
|
|
|
|
| |
$40.0 million | |
$40.0 million | |
6.2% | |
Notes due July 2016 with annual principal payments beginning July 2010 | |
|
|
|
|
|
| |
$20.0 million(3) | |
$20.0 million | |
6.2% | |
Notes due January 2017 with annual principal payments beginning January 2011. |
|
| |
| |
| |
| |
| |
Japanese yen denominated: | |
3.1 billion yen | |
2.7 billion yen ($29.5 million as of December 31, 2008) | |
1.7% | |
Notes due April 2014 with annual principal payments that began April 2008. | |
|
|
|
|
|
| |
2.3 billion yen | |
2.3 billion yen ($25.0 million as of December 31, 2008) | |
2.6% | |
Notes due September 2017, with annual principal payments beginning September 2011. | |
|
|
|
|
|
| |
2.2 billion yen | |
2.2 billion yen ($23.9 million as of December 31, 2008) | |
3.3% | |
Notes due January 2017, with annual principal payments beginning January 2011. | |
|
|
|
|
|
| |
| |
| |
| |
| |
2004 $25.0 million revolving credit facility | |
N/A | |
None | |
N/A | |
Credit facility expires May 2010. | |
-83-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
(1) |
Each of the credit facilities and arrangements listed in the table are
secured by guarantees issued by our material domestic subsidiaries and by
pledges of 65% of the outstanding stock of our material foreign subsidiaries. |
(2) |
The current portion of our long-term debt (i.e. becoming due in the next 12
months) includes $15.3 million of the balance on our 2000 Japanese
yen-denominated notes, $4.9 million of the balance of our 2005 Japanese
yen-denominated notes and $10.0 million of the balance on our U.S. dollar
denominated debt under the 2003 multi-currency shelf facility. |
(3) |
In January 2008, $20.0 million of this loan was converted from U.S. dollar to
Japanese yen at an exchange rate of 108.5. The terms of the loan remain the
same, except for the interest rate lowers from 6.2% to 3.3%. |
Interest
expense relating to debt totaled $5.1 million, $8.3 million and $7.7 million for the years
ended December 31, 2006, 2007 and 2008, respectively.
The
notes and shelf facility contain other terms and conditions and affirmative and negative
financial covenants customary for credit facilities of this type, including a requirement
to maintain a minimum cash balance of $65.0 million. As of December 31, 2008, the Company
is in compliance with all financial covenants under the notes and shelf facility.
Maturities
of all long-term debt at December 31, 2008, based on the year-end exchange rate, are as
follows (U.S. dollars in thousands):
Year Ending December 31, |
|
|
|
|
|
2009 |
|
$ 30,196 |
|
2010 | |
35,910 |
|
2011 | |
20,472 |
|
2012 | |
20,472 |
|
2013 | |
20,472 |
|
Thereafter | |
61,434 |
|
Total | |
$ 188,956 |
|
-84-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Year Ending December 31, |
|
|
|
|
|
2009 |
|
$ 14,689 |
|
2010 | |
12,596 |
|
2011 | |
9,211 |
|
2012 | |
7,137 |
|
2013 | |
6,516 |
|
Thereafter | |
596 |
|
Total | |
$ 50,745 |
|
Rental
expense for operating leases totaled $31.4 million, $32.2 million and $33.5 million for
the years ended December 31, 2006, 2007 and 2008, respectively.
The
Companys authorized capital stock consists of 25 million shares of preferred stock,
par value $.001 per share, 500 million shares of Class A common stock, par value $.001 per
share and 100 million shares of Class B common stock, par value $.001 per share. The
shares of Class A common stock and Class B common stock are identical in all respects,
except for voting rights and certain conversion rights and transfer restrictions, as
follows: (1) each share of Class A common stock entitles the holder to one vote on matters
submitted to a vote of the Companys stockholders and each share of Class B common
stock entitles the holder to ten votes on each such matter; (2) stock dividends of Class A
common stock may be paid only to holders of Class A common stock and stock dividends of
Class B common stock may be paid only to holders of Class B common stock; (3) if a holder
of Class B common stock transfers such shares to a person other than a permitted
transferee, as defined in the Companys Certificate of Incorporation, such shares
will be converted automatically into shares of Class A common stock; and (4) Class A
common stock has no conversion rights; however, each share of Class B common stock is
convertible into one share of Class A common stock, in whole or in part, at any time at
the option of the holder. All outstanding Class B shares have been converted to Class A
shares. As of December 31, 2008 and 2007, there were no preferred or Class B common shares
outstanding.
Weighted-average common
shares outstanding
The
following is a reconciliation of the weighted-average common shares outstanding for
purposes of computing basic and diluted net income per share (in thousands):
|
Year Ended December 31, |
|
|
2006 | |
2007 | |
2008 | |
|
|
|
|
Basic weighted-average common shares outstanding |
|
69,418 |
|
64,783 |
|
63,510 |
|
Effect of dilutive securities: | |
Stock awards and options | |
1,088 |
|
801 |
|
622 |
|
Diluted weighted-average common shares outstanding | |
70,506 |
|
65,584 |
|
64,132 |
|
-85-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
For
the years ended December 31, 2006, 2007 and 2008, other stock options totaling 2.8
million, 3.3 million and 5.0 million, respectively, were excluded from the calculation of
diluted earnings per share because they were anti-dilutive.
Repurchases of common
stock
Since
August 1998, the board of directors has authorized the Company to repurchase up to $335.0
million of the Companys outstanding shares of Class A common stock on the open
market or in private transactions. The repurchases are used primarily for the
Companys equity incentive plans and strategic initiatives. During the years ended
December 31, 2006, 2007 and 2008, the Company repurchased approximately 3.8 million, 4.1
million and 0.4 million shares of Class A common stock for an aggregate price of
approximately $67.5 million, $71.1 million and $6.1 million, respectively, under these
repurchase programs. Included in the 4.1 million shares repurchased in 2007, are 1.5
million shares that we repurchased under a $25.0 million accelerated repurchase
transaction during the fourth quarter of 2007. Between August 1998 and December 31, 2008,
the Company repurchased a total of approximately 18.4 million shares of Class A common
stock under this repurchase program for an aggregate price of approximately $251.4
million.
11. |
|
StockBased
Compensation |
At
December 31, 2008, the Company had the following stock-based employee compensation plans:
Equity Incentive Plans
During
the year ended December 31, 1996, the Companys board of directors adopted the Nu
Skin Enterprises, Inc., 1996 Stock Incentive Plan (the 1996 Stock Incentive
Plan). In April 2006, the Companys Board of Directors approved the Nu Skin
Enterprises, Inc. 2006 Stock Incentive Plan (the 2006 Stock Incentive Plan).
This plan was approved by the Companys stockholders at the Companys 2006
Annual Meeting of Stockholders held in May of 2006. The 1996 Stock Incentive Plan and the
2006 Stock Incentive Plan provide for granting of stock awards and options to purchase
common stock to executives, other employees, independent consultants and directors of the
Company and its Subsidiaries. Options granted under the equity incentive plans are
generally non-qualified stock options, but the plans permit some options granted to
qualify as incentive stock options under the U.S. Internal Revenue Code. The
exercise price of a stock option generally is equal to the fair market value of the
Companys common stock on the option grant date. The contractual term of options
granted since 1996 is generally ten years. However, for options granted beginning in the
second quarter of 2006, the contractual term has been shortened to seven years. Currently,
all shares issued upon the exercise of options are from the Companys treasury
shares. With the adoption of the 2006 Stock Incentive Plan, no further grants will be made
under the 1996 Stock Incentive Plan. Under the 2006 Stock Incentive Plan 6.0 million
shares were authorized for issuance.
In
the fourth quarter of 2007, the compensation committee of the board of directors approved
the grant of performance stock options to certain senior level executives. Vesting for the
options is performance based, with the options vesting in two installments if the
Companys earnings per share equal or exceed the two established performance levels,
measured in terms of diluted earnings per share. Fifty percent of the options will vest
upon earnings per share meeting or exceeding the first performance level and fifty percent
of the options will vest upon earnings per share meeting or exceeding the second
performance level. If the performance levels have not been met on or prior to the 2nd
business day following the filing of the Companys Annual Report on Form 10-K for the
year ended December 31, 2012, then any unvested options shall terminate at such time. As
of December 31, 2008, none of these performance levels have been met.
-86-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
fair value of stock option awards was estimated using the Black-Scholes option-pricing
model with the following assumptions and weighted-average fair values as follows:
|
December 31, | |
Stock Options: |
2006 | |
2007 | |
2008 | |
|
|
|
|
Weighted average grant date fair value of grants |
|
$ 6.52 |
|
$ 5.51 |
|
$ 4.69 |
|
Risk-free interest rate(1) |
|
4.9% |
|
3.8% |
|
3.0% |
|
Dividend yield(2) | |
2.1% |
|
2.5% |
|
2.6% |
|
Expected volatility(3) | |
44.3% |
|
40.4% |
|
36.1% |
|
Expected life in months(4) | |
58 months |
|
59 months |
|
58 months |
|
(1) |
The risk-free interest rate is based upon the rate on a zero coupon U.S.
Treasury bill, for periods within the contractual life of the option, in effect
at the time of the grant. |
(2) |
The dividend yield is based on the rolling average of annual stock prices and
the actual dividends paid in the corresponding 12 months. |
(3) |
Expected volatility is based on the historical volatility of our stock price,
over a period similar to the expected life of the option. |
(4) |
The expected term of the option is based on the historical employee exercise
behavior, the vesting terms of the respective option, and a contractual life of
either seven or ten years. |
-87-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Options
under the plans as of December 31, 2008 and changes during the year ended December 31,
2008 were as follows:
|
Shares
(in thousands) | |
Weighted-average
Exercise Price | |
Weighted-average
Remaining Contractual Term
(in years) | |
Aggregate Intrinsic
Value
(in thousands) | |
Options activity - service based Outstanding at December 31, 2007 |
|
5,266.4 |
|
$ 16.74 |
|
|
|
|
|
Granted | |
515.8 |
|
16.87 |
|
Exercised | |
(334.1 |
) |
11.60 |
|
Forfeited/cancelled/expired | |
(580.1 |
) |
18.71 |
|
Outstanding at December 31, 2008 | |
4,868.0 |
|
16.87 |
|
4.89 |
|
$ 1,320 |
|
Exercisable at December 31, 2008 | |
3,603.3 |
|
16.50 |
|
4.53 |
|
1,320 |
|
| |
|
|
|
|
Options activity - performance based Outstanding at December 31, 2007 | |
1,435.0 |
|
$ 17.10 |
|
Granted | |
425.0 |
|
17.12 |
|
Exercised | |
|
|
|
|
Forfeited/cancelled/expired | |
(55.0 |
) |
18.03 |
|
Outstanding at December 31, 2008 | |
1,805.0 |
|
17.08 |
|
6.04 |
|
$ |
|
Exercisable at December 31, 2008 | |
|
|
|
|
|
|
|
|
| |
|
|
|
|
Options activity - all options Outstanding at December 31, 2007 | |
6,701.4 |
|
$ 16.82 |
|
Granted | |
940.8 |
|
16.98 |
|
Exercised | |
(334.1 |
) |
11.60 |
|
Forfeited/cancelled/expired | |
(635.1 |
) |
18.65 |
|
|
|
|
Outstanding at December 31, 2008 | |
6,673.0 |
|
16.93 |
|
5.20 |
|
$ 1,320 |
|
Exercisable at December 31, 2008 | |
3,603.3 |
|
16.50 |
|
4.53 |
|
1,320 |
The
aggregate intrinsic value in the table above represents the total pretax intrinsic value
(the difference between the Companys closing stock price on the last trading day of
the respective years and the exercise price, multiplied by the number of in-the-money
options) that would have been received by the option holders had all option holders
exercised their options on December 31, 2008. This amount varies based on the fair market
value of the Companys stock. The total fair value of options vested and expensed was
$3.0 million, net of tax, for the year ended December 31, 2008.
Cash
proceeds, tax benefits, and intrinsic value related to total stock options exercised
during 2006, 2007 and 2008, were as follows (in millions):
|
December 31, | |
|
2006 | |
2007 | |
2008 | |
|
|
|
|
|
|
|
|
Cash proceeds from stock options exercised |
|
$ 5.4 |
|
$ 5.7 |
|
$ 3.8 |
|
Tax benefit realized for stock options exercised | |
1.8 |
|
1.8 |
|
1.2 |
|
Intrinsic value of stock options exercised | |
3.7 |
|
3.4 |
|
0.2 |
|
-88-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
Nonvested
restricted stock awards as of December 31, 2008 and changes during the year ended December
31, 2008 were as follows:
|
Number of Shares
(in thousands) | |
Weighted-average Grant
Date Fair Value | |
Nonvested at December 31, 2007 |
|
352.0 |
|
$ 17.42 |
|
| |
|
|
|
|
Granted | |
155.6 |
|
16.88 |
|
Vested | |
(104.8 |
) |
17.00 |
|
Forfeited |
|
(37.0 |
) |
16.74 |
|
|
|
|
|
|
|
Nonvested at December 31, 2008 | |
365.8 |
|
17.27 |
|
As
of December 31, 2008, there was $4.4 million of unrecognized stock-based compensation
expense related to nonvested restricted stock awards. That cost is expected to be
recognized over a weighted-average period of 2.5 years. As of December 31, 2008, there was
$12.9 million of unrecognized stock-based compensation expense related to
nonvested stock option awards. That cost is expected to be recognized over a
weighted-average period of 2.7 years.
Consolidated
income before provision for income taxes consists of the following for the years ended
December 31, 2006, 2007 and 2008 (U.S. dollars in thousands):
|
2006 | |
2007 | |
2008 | |
|
|
|
|
|
|
|
|
U.S. |
|
$ 32,907 |
|
$ 45,235 |
|
$ 52,756 |
|
Foreign | |
19,769 |
|
23,243 |
|
47,897 |
|
Total | |
$ 52,676 |
|
$ 68,478 |
|
$ 100,653 |
|
The
provision for current and deferred taxes for the years ended December 31, 2006, 2007 and
2008 consists of the following (U.S. dollars in thousands):
|
2006 | |
2007 | |
2008 | |
|
|
|
|
|
|
|
|
Current |
|
|
|
|
|
|
|
Federal | |
$ |
|
$ |
|
$ 10,524 |
|
State | |
2,121 |
|
(94 |
) |
2,620 |
|
Foreign | |
24,207 |
|
22,090 |
|
22,408 |
|
| |
26,328 |
|
21,996 |
|
35,552 |
|
| |
Deferred | |
Federal | |
4,115 |
|
(298 |
) |
713 |
|
State | |
(1,767 |
) |
2,181 |
|
(345 |
) |
Foreign | |
(8,817 |
) |
727 |
|
(614 |
) |
| |
(6,469 |
) |
2,610 |
|
(246 |
) |
Provision for income taxes | |
$ 19,859 |
|
$ 24,606 |
|
$ 35,306 |
|
-89-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
Companys foreign taxes paid are high relative to foreign operating income and the
Companys U.S. taxes paid are low relative to U.S. operating income due largely to
the flow of funds among the Companys Subsidiaries around the world. As payments for
services, management fees, license arrangements and royalties are made from the
Companys foreign affiliates to its U.S. corporate headquarters, these payments often
incur withholding and other forms of tax that are generally creditable for U.S. tax
purposes. Therefore, these payments lead to increased foreign effective tax rates and
lower U.S. effective tax rates. Variations (or shifts) occur in the Companys foreign
and U.S. effective tax rates from year to year depending on several factors. These factors
include the impact of global transfer prices, the timing and level of remittances from
foreign affiliates, profits and losses in various markets, in the valuation of deferred
tax assets or liabilities, or changes in tax laws, regulations, accounting principles, or
interpretations thereof.
The
principal components of deferred taxes are as follows (U.S. dollars in thousands):
|
Year Ended December 31, | |
|
2007 | |
2008 | |
|
|
|
Deferred tax assets: |
|
|
|
|
|
Inventory differences | |
$ 3,481 |
|
$ 4,335 |
|
Stock-based compensation | |
5,470 |
|
6,127 |
|
Accrued expenses not deductible until paid | |
23,711 |
|
24,025 |
|
Minimum tax credit | |
7,611 |
|
|
|
Net operating losses | |
18,190 |
|
14,752 |
|
Capitalized research and development | |
18,779 |
|
21,481 |
|
Asian marketing rights | |
2,321 |
|
1,710 |
|
Exchange gains and losses | |
|
|
2,513 |
|
Other | |
44,455 |
|
53,614 |
|
Gross deferred tax assets | |
124,018 |
|
128,557 |
|
Deferred tax liabilities: | |
Exchange gains and losses | |
3,719 |
|
|
|
Pharmanex intangibles step-up | |
14,696 |
|
14,105 |
|
Amortization of intangibles | |
8,155 |
|
5,911 |
|
Foreign outside basis in controlled foreign corporation | |
599 |
|
10,465 |
|
Prepaid expenses | |
11,812 |
|
11,239 |
|
Other | |
1,012 |
|
1,262 |
|
Gross deferred tax liabilities | |
39,993 |
|
42,982 |
|
Valuation allowance | |
(11,303 |
) |
(9,254 |
) |
Deferred taxes, net | |
$ 72,722 |
|
$ 76,321 |
|
At
December 31, 2008, the Company had foreign operating loss carryforwards of approximately
$76.0 million for tax purposes, which will be available to offset future taxable
income. If not used, $39.3 million of carryforwards will expire between 2009 and
2018, while $36.7 million do not expire.
The
valuation allowance primarily represents amounts for foreign operating loss carryforwards
for which it is more likely than not some portion or all of the deferred tax asset will
not be realized. In making such determination, the Company considers all available
positive and negative evidence, including future reversals of existing taxable temporary
difference, projected future taxable income, tax planning strategies and recent financial
operations. When the Company determines that there is sufficient taxable income to utilize
the net operating losses, the valuation will be released which would reduce the provision
for income taxes.
-90-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
The
components of deferred taxes, net on a jurisdiction basis are as follows (U.S. dollars in
thousands):
|
Year Ended December 31, |
|
|
2007 | |
2008 | |
|
|
|
Net current deferred tax assets |
|
$ 23,929 |
|
$ 23,105 |
|
Net noncurrent deferred tax assets | |
60,057 |
|
66,426 |
|
Total net deferred tax assets | |
83,986 |
|
89,531 |
|
|
|
|
|
Net current deferred tax liabilities | |
| |
|
Net noncurrent deferred tax liabilities | |
11,264 |
|
13,210 |
|
Total net deferred tax liabilities | |
11,264 |
|
13,210 |
|
Deferred taxes, net | |
$ 72,722 |
|
$ 76,321 |
|
The
Companys deferred tax assets as of December 31, 2008 and 2007 were increased due to
the implementation of FIN 48.
The
Company is subject to regular audits by federal, state and foreign tax authorities. These
audits may result in proposed assessments that may result in additional tax liabilities.
The
actual tax rate for the years ended December 31, 2006, 2007 and 2008 compared to the
statutory U.S. Federal tax rate is as follows:
|
Year Ended December 31, |
|
|
2006 | |
2007 | |
2008 | |
|
|
|
|
Income taxes at statutory rate |
|
35.00 |
% |
35.00 |
% |
35.00 |
% |
Non-deductible expenses | |
.86 |
|
.27 |
|
.23 |
|
Other | |
1.84 |
|
.66 |
|
(.15 |
) |
| |
37.70 |
% |
35.93 |
% |
35.08 |
% |
The
decrease in the effective tax rate in 2007 compared to 2006 and from 2008 compared to 2007
was due primarily to the expiration of the statute of limitations in certain tax
jurisdictions.
13. |
|
Employee
Benefit Plan |
The
Company has a 401(k) defined contribution plan which permits participating employees to
defer up to a maximum of 100% of their compensation, subject to limitations established by
the Internal Revenue Service. Employees
age 18 and older are eligible to contribute to the plan starting the first of the month
following their date of hire. After completing at least one year of service,
employees age 21 and older are eligible to receive the Companys matching
funds. The Company matches 100% of the first 2% and 50% of the next 2% of each
participants contributions to the plan. Participant contributions are
immediately vested. Company contributions vest based on the participants years
of service at 25% per year over four years. Therefore, matching funds for employees
with four or more years of service are 100% vested immediately upon contribution. The
Company recorded compensation expense of $1.4 million, $1.5 million and $1.3 million for
the years ended December 31, 2006, 2007 and 2008, respectively, related to its
contributions to the plan. Beginning January 1, 2009, the following changes were
made to the 401(k) defined contribution plan:
-91-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
|
|
|
all
employees age 18 and older are eligible to contribute to the plan and receive the Companys
matching funds starting the first of the month following their date of hire; |
|
|
|
the
Company matches 100% of the first 1% and 50% of the next 5% of each participant's
contributions to the plan; and |
|
|
|
the
Company's match is 100% vested after the completion of 2 years of service. |
The
Company has a defined benefit pension plan for its employees in Japan. All employees of Nu
Skin Japan, after certain years of service, are entitled to pension plan benefits when
they terminate employment with Nu Skin Japan. The accrued pension liability was $5.0
million, $5.2 million and $6.9 million as of December 31, 2006, 2007 and 2008,
respectively. Although Nu Skin Japan has not specifically funded this obligation, Nu Skin
Japan believes it maintains adequate cash balances for this defined benefit pension plan.
The Company recorded pension expense of $1.0 million, $1.4 million and $0.9 million for
the years ended December 31, 2006, 2007 and 2008, respectively. Beginning in 2006, this
plan is accounted for in accordance with Financial Accounting Standards Board
(FASB) Statement No. 158 Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88,
106, and 132(R) (SFAS 158). The adoption of SFAS 158 did not have a
material impact on the Companys consolidated financial statements.
14. |
|
Executive
Deferred Compensation Plan |
The
Company has an executive deferred compensation plan for select management personnel. Under
this plan, the Company currently makes a contribution of up to 10% of each
participants salary. In addition, each participant has the option to defer a portion
of their compensation up to a maximum of 100% of their compensation. Participant
contributions are immediately vested. Company contributions vest based on the earlier of:
(a) attaining 60 years of age; (b) continuous employment of 20 years; or (c) death or
disability. The Company recorded compensation expense of $0.7 million, $0.7 million and
$0.8 million for the years ended December 31, 2006, 2007 and 2008, respectively, related
to its contributions to the plan. The Company had accrued $8.4 million and $6.2 million as
of December 31, 2007 and 2008, respectively, related to the Executive Deferred
Compensation Plan. Effective January 1, 2009, the plan was amended to revise the vesting schedule. Company contributions
now vest on the earlier of:
(a) attaining 60 years of age; (b) 50% after ten years of service and 5% each year of service thereafter; and (c) death or
disability.
15. |
|
Derivative
Financial Instruments |
At
December 31, 2007 and 2008, the Company held no forward contracts designated as foreign
currency cash flow hedges to hedge forecasted foreign-currency-denominated intercompany
transactions. As of December 31, 2007, $(0.2) million of net unrealized loss, net of
related taxes, was recorded in accumulated other comprehensive loss and none was recorded
as of December 31, 2008. The contracts held at December 31, 2008 have maturities through
December 2009, and accordingly, all unrealized gains and losses on foreign currency cash
flow hedges included in accumulated other comprehensive loss will be recognized in current
earnings over the next 12 months. The pre-tax net (losses)/gains on foreign currency cash
flow hedges recorded in current earnings were $3.3 million, $0.4 million and none for the
years ended December 31, 2006, 2007 and 2008, respectively.
During
2006, 2007 and 2008, the Company did not have any gains or losses related to hedging
ineffectiveness. Additionally, no component of gains and losses was excluded from the
assessment of hedging effectiveness. During 2006, 2007 and 2008, the Company did not have
any gains or losses reclassified into earnings as a result of the discontinuance of cash
flow hedges.
-92-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
16. |
|
Supplemental
Cash Flow Information |
Cash
paid for interest totaled $5.6 million, $7.4 million and $7.9 million for the years ended
December 31, 2006, 2007 and 2008, respectively. Cash paid for income taxes totaled $19.4
million, $21.9 million and $27.2 million for the years ended December 31, 2006, 2007 and
2008, respectively.
The
Company operates in a single operating segment by selling products to a global network of
independent distributors that operates in a seamless manner from market to market, except
for its operations in Mainland China. In Mainland China, the Company utilizes an employed
sales force, contractual sales promoters and direct sellers to sell its products through
fixed retail locations. Selling expenses are the Companys largest expense comprised
of the commissions paid to its worldwide independent distributors as well as remuneration
to its Mainland China sales employees, promoters and direct sellers paid on product sales.
The Company manages its business primarily by managing its global sales force. The Company
does not use profitability reports on a regional or divisional basis for making business
decisions. However, the Company does recognize revenue in five geographic regions: North
Asia, Americas, Greater China, Europe and South Asia/Pacific.
Revenue
generated in each of these regions is set forth below (U.S. dollars in thousands):
|
Year Ended December 31, |
|
Revenue: |
2006 | |
2007 | |
2008 | |
|
|
|
|
North Asia |
|
$ 593,789 |
|
$ 585,805 |
|
$ 594,548 |
|
Americas | |
165,908 |
|
188,256 |
|
223,902 |
|
Greater China | |
208,226 |
|
205,026 |
|
209,968 |
|
Europe | |
59,469 |
|
77,163 |
|
111,572 |
|
South Asia/Pacific | |
88,017 |
|
101,417 |
|
107,656 |
|
Total | |
$ 1,115,409 |
|
$ 1,157,667 |
|
$ 1,247,646 |
|
Revenue generated
by each of the Companys product lines is set forth below (U.S. dollars in
thousands):
|
Year Ended December 31, |
|
Revenue: |
2006 | |
2007 | |
2008 | |
|
|
|
|
Nu Skin |
|
$ 454,480 |
|
$ 498,500 |
|
$ 633,411 |
|
Pharmanex | |
632,705 |
|
634,191 |
|
597,714 |
|
Other | |
28,224 |
|
24,976 |
|
16,521 |
|
Total | |
$ 1,115,409 |
|
$ 1,157,667 |
|
|