Nu Skin Enterprises Annual Report
IT'S IN THE BAG
[2003]
IT'S IN THE BAG
This saying is thought to have originated from a hunter's game bag -
victory was certain once the prize was bagged. At Nu Skin Enterprises, we have
certain strengths in our bag that create a solid foundation for growth.
Knowledge and innovation in product development. Expertise and capability in
creating sales tools that maximize product value. Potential and momentum in our
most important geographic markets. These characteristics are the cornerstones of
our success and the competitive advantages that will enhance your investment in
2004 and beyond.
Knowledge. Innovation. Expertise. Capability. Potential. Momentum. These
fundamental strengths are the cornerstones of our success.
[GRAPHIC OMITTED - Picture of bag in between books on shelf.]
Products
KNOWLEDGE
Understanding gained through experience and study for the purpose of developing
ingenious, exceptional products.
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Products
Leadership in utilizing expansive knowledge to create better, differentiated
products.
INNOVATION
Our Products DRIVE REVENUE
Compelling products are vital to our company. They foster consumer interest.
They empower our direct sales force. They drive revenue. That's why we are
committed to consistently refreshing our product portfolio with innovative,
differentiated products.
AN IMPRESSIVE INNOVATION NETWORK
Our innovation network enables us to create life enhancing products for millions
of people in 35 markets. This network includes in-house product development
capabilities, more than 150 scientists, and scientific collaborations with
Stanford University, the Pharmanex Center for Sports Medicine with Rippe
Lifestyle Institute, and the Nu Skin and Pharmanex Scientific Advisory Boards -
leaders in the fields of dermatology, chemistry, pharmacology, ethnobotany,
immunology, and cosmetic and nutritional sciences. This solid infrastructure for
innovation allows us to develop products that incorporate the most advanced
technologies available.
A PROGRESSIVE PRODUCT PORTFOLIO
We are constantly expanding and refreshing our product portfolio. Utilizing new
technologies. Leveraging in-house and third-party research. And formulating
products to deliver greater benefits to our customers. In fact, new and
significantly reformulated products introduced in the last three years -
including LifePak Anti-Aging Formula, Tru Face™ Essence Firming Serum, and
ReishiMax GLp Immune Defense - accounted for more than 50 percent of 2003
revenue. Because of our dedication to innovation, we will continue to see a
significant amount of annual revenue stemming from new or improved products,
including these scientifically advanced 2004 product introductions:
NU SKIN GALVANIC SPA™ SYSTEM II-featuring patented self-adjusting galvanic
currents and three interchangeable heads for the face, scalp, and body, this
system makes it possible for consumers to enjoy professional spa results at
home.
MARINEOMEGA™-this improved version of Pharmanex Optimum Omega features krill
oil,
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[GRAPHIC OMITTED - Picture of Pharmanex TRA complex, Nu Skin Galvanic Spa System
II and Epoch Glacial Marine Mud.]
an ultra-pure form of omega-3 fatty acids, and provides added flavonoid,
phospholipid, and carotenoid antioxidant benefits to promote overall wellness
and lifelong vitality.
TRA™ THE RIGHT APPROACH™-an approach to weight management that promotes a
healthy lifestyle through safe supplementation (our formulas contain no
stimulants and can be used with any diet regimen) and exercise.
POLISHING PEEL™-a convenient alternative to professional microdermabrasion
treatments that resurfaces, softens, and polishes the skin, delivering a fresh,
healthy looking complexion.
A QUALITY APPROACH TO PRODUCT DEVELOPMENT
Founded in 1984 with a commitment to provide products using only premium,
wholesome ingredients, Nu Skin Enterprises remains true to this heritage. For
example, the Pharmanex 6S Quality Process guarantees every supplement capsule
delivers safe, precise, standardized, clinically beneficial nutritional
ingredients. This focus on quality fosters demand for our products and is a
measurable difference that set us apart from our competitors.
A PHILANTHROPIC CONNECTION
In 1996, we became the first company to base a skin care line entirely on
ethnobotany. Utilizing ancient traditions of indigenous cultures on several
continents, our Epoch product line offers ethnobotanical solutions to personal
care concerns in a natural, comforting, and therapeutic way. In addition, Epoch
fosters long-lasting improvements in the world-$0.25 of every Epoch product sale
goes toward creating a better world for children by improving human life,
continuing indigenous cultures, and protecting fragile environments. For
example, sales of Epoch Glacial Marine Mud™ alone have raised more than $600,000
to help scientists at the Stanford University School of Medicine find a
treatment for Epidermolysis Bullosa-a deadly, genetic skin disease that
primarily affects children. By giving back to communities, we hope to make the
world a better place for the children of today-and tomorrow.
[7]
$100M
[8]
With KNOWLEDGE and INNOVATION in the bag, we expect to generate $100 million of
revenue in 2004 from products launched this year.
In 2003, new and reformulated products introduced in the past three years
accounted for more than 50 percent of revenue.
[9]
Tools
A fusion of skill and knowledge that produces advanced programs and tools to
increase the impact and value of innovation.
EXPERTISE
[10]
[GRAPHIC OMITTED - Picture of Book open to page with bag and Nu Skin
information]
Tools
CAPABILITY
The ability and judgement to apply expertise to maximize distributor success.
[GRAPHIC OMITTED - Picture of bag inside a computer.]
Our Tools PROVIDE A COMPETITIVE EDGE
Nu Skin. Pharmanex. Big Planet. With three distinctive brands, the Nu Skin
Enterprises portfolio provides a powerful opportunity. To ensure this
opportunity is effectively cultivated, we arm our distributors with unique,
proprietary tools that utilize cutting-edge technologies.
A TECHNOLOGICAL ADVANTAGE
Speed. Convenience. Access. The Internet has changed the way we do business-for
the better. With significant investments in IT initiatives, the Internet is an
integral part of our business. It is also a powerful distributor tool. Through
Big Planet, we offer distributors a technological edge that increases their
productivity. Our Internet tools help distributors build their businesses more
quickly and effectively-registering new distributors and customers immediately,
placing product orders online, monitoring global sales volumes in real time, and
communicating with sizeable sales organizations. For example, today in Japan,
our distributors utilize their Internet-enabled cell phones to check sales
volumes within their global business organizations and place product orders
online. In 2003, Japanese distributors registered approximately 600,000 cell
phone logins to our system.
AN AUTOMATIC PROGRAM FOR SUCCESS
Productivity. Retention. Revenue. The results of our monthly product
subscription initiatives are dramatic. In 2002, subscription orders accounted
for 19 percent of our annual revenue. In 2003, this number increased to 24
percent of revenue. This is largely due to offering compelling incentives and
educating executive distributor leaders on the significant advantages provided
by monthly product subscriptions. On average, our customer retention rate is
three times better with those who are enrolled in monthly subscription programs
than with nonsubscribers. And the higher the customer retention rate, the higher
the distributor retention rate. Automatic purchase programs foster a consistent
commission stream for our distributors and dramatically impact productivity and
retention.
[14]
[GRAPHIC OMITTED - Picture of cell phone, PDA, and computer]
A MEASURABLE DIFFERENCE
February 2003 marked the official launch of one of the most advanced tools ever
introduced in the direct selling industry-the Pharmanex BioPhotonic Scanner.
This revolutionary scanner offers a noninvasive measurement of the impact of
regular dietary supplementation. By simply placing the palm of the hand in front
of a safe, low-energy blue light laser, customers can quickly measure the level
of carotenoids-important antioxidants-in their skin. For the first time,
consumers can now determine how to improve their carotenoid levels through diet
and by taking our multivitamin/mineral supplement LifePak. The ability to
measure carotenoid antioxidants differentiates us from our competitors-thus the
Pharmanex slogan, "The Measurable Difference."
The scanner provides our distributors with tremendous competitive advantages: a
product guarantee and quantifiable proof that LifePak works to increase
carotenoid antioxidant levels-something no other nutrition company can
demonstrate. This is proving to be a powerful catalyst for growth as evidenced
by U.S. LifePak sales, which were up 70 percent in the fourth quarter of 2003.
With only 600 scanners deployed throughout the United States in 2003, we see
significant potential ahead as we further penetrate the U.S. market and abroad.
We are currently building a scanner manufacturing plant that will enable us to
have approximately 3,000 scanners in use by the end of 2004.
A BRILLIANT ASSORTMENT OF TOOLS
We seek to offer consumers an experience with our products that they cannot
duplicate elsewhere. Tools like the Pharmanex BioPhotonic Scanner provide a
compelling customer experience. Similarly, the VISIA Complexion Analysis System,
which we plan to use in our walk-in centers, offers a unique customer
experience. This highly advanced machine provides a quantitative evaluation of
the skin's wrinkles, texture, pores, and pigmentation. With this precise
information, our distributors can help customers plan the most effective
treatment regimens and demonstrate how Nu Skin products target specific needs
and improve skin health and appearance. Another innovative business tool is the
Nu Skin Regimen Optimizer. This PDA-based software program integrates decades of
skin care expertise into an easy-to-use distributor tool that customizes an
effective product regimen based on a customer's needs.
[15]
$450M
[16]
With EXPERTISE and CAPABILITY in the bag, we will provide our distributors the
tools to earn $450 million in commissions in 2004.
In 2003, our distributors earned $407 million in commissions.
[17]
[GRAPHIC OMITTED - Picture of bag.]
Markets
POTENTIAL
The opportunity to generate revenue in untapped markets.
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Markets
The generation of increasing energy that propels strong, profitable growth.
MOMENTUM
Our Markets Are POSITIONED FOR GROWTH
We have plenty of room to grow. And now, more than at any other time in the
company's history, we are positioned to do so. With a global distributor force
motivated by a compensation structure that enables them to generate commissions
in new markets, we have the ability to penetrate new markets rapidly.
A STRONG PRESENCE IN MAINLAND CHINA
In 2003, after years of preparation and investment, we launched a business in
China that contributed $38 million of revenue to our 2003 results. Unique
regulations require that we operate through retail stores and with an employed
sales force, so we have opened 113 retail stores in 26 cities in 8 provinces.
And at the end of the year, we had 3,100 sales representatives in our employ,
making us one of China's largest foreign-owned employers. In 2004, we look to at
least double China revenue through organic growth in current locations and by
opening at least one additional city each quarter. We will also expand the range
of Nu Skin's product offering, and prepare to launch Pharmanex products in 2005.
A TREMENDOUS GROWTH PROSPECT
By the end of 2004, it is anticipated that the Chinese government will present
new direct selling regulations. An ease on restrictions will positively impact
the direct selling industry in general, and our company specifically. We believe
that in 2004, the direct selling industry in China will grow to be $3 billion
strong. This is encouraging to us because of the great success we have achieved
in Chinese markets around the world. For example, in Hong Kong, we currently
command 19 percent of the direct selling market, and in Taiwan 6 percent. This
gives us confidence that China will become one of our strongest markets in the
future.
A FLEXIBLE BUSINESS MODEL
To generate success in emerging economies that historically have not performed
at the level we desire, we are customizing our business model to
[22]
address the specific needs of particular markets. As a result, we are seeing
progress in meaningful markets. Over the past three years, Thailand revenue has
more than tripled to $23 million and we now command approximately 5 percent of
Thailand's direct selling market. We are also experiencing notable success in
Brazil, where we launched a revised business model in September 2003. This
endeavor positively impacted fourth quarter revenue. Our initial success in
Brazil gives us confidence that we can gain market share in important developing
countries.
AN AGENDA FOR TOMORROW'S MARKETS
Since we currently have business operations in just 35 of the world's many
markets, we have a rich field of opportunity to cultivate. We are researching
new market opportunities in Russia, Indonesia, India, Israel, Vietnam, and
several Eastern European markets. With the notable potential of these
markets-Russia and India are among the world's fastest growing direct selling
markets-we are confident our development efforts will significantly increase
revenue over the coming years.
[GRAPHIC OMITTED - Graph showing China 2003 Revenue U.S. Dollars in Millions.
Q1-$3.9; Q2-$5.8 Q3-$10.7; Q4-$18.0]
[GRAPHIC OMITTED - Graph showing Thailand Revenue U.S. Dollars in Millions.
2001-$6.6; 2002-$13.0; 2003-$22.7]
[23]
$300M
[24]
With POTENTIAL and MOMENTUM in the bag, we will generate $300 million in annual
revenue over the next three years from markets opened since 2003.
In 2003, new markets opened in the past three years contributed $75 million to
our annual global revenue.
[25]
To Our SHAREHOLDERS
[GRAPHIC OMITTED - Picture of M. Truman Hunt holding bag and Blake M. Roney.]
Simply stated, OUR GOAL is to become the world's leading direct selling company.
We made good progress toward achieving this objective in 2003. Trends in nearly
all of our markets are moving in the right direction, with results in our key
geographic markets-Japan, the United States, and China-particularly encouraging.
[GRAPHIC OMITTED - Graph showing Revenue in U.S. Dollars in Millions -
2001-$885.6; 2002-$964.1; 2003-$986.5]
[GRAPHIC OMITTED - Graph showing Earnings Per Share in U.S. Dollars -
2001-$0.60; 2002=$0.78; 2003-$0.85]
We generated revenue for the year of $986 million, which was up 2 percent over
2002 results. Positive trends in the second half of the year in China, the
United States, and Japan were offset by declines in Singapore and Malaysia, as
well as by a third quarter restructuring of Big Planet services to improve
profitability and refocus Big Planet's direction.
Outpacing revenue growth, earnings per share increased 9 percent to $0.85.
Excluding a $5.6 million restructuring charge in the third quarter, earnings per
share would have been $0.90.1 Cash flow from operations in 2003 continued to be
healthy at $109 million. And we used our strong balance sheet to benefit our
shareholders by repurchasing 11 million shares of common stock and paying more
than $20 million in dividends.
In 2004, we will build upon the momentum created in 2003. We will continue to
attract and retain quality distributors. We will increase shareholder value by
reinvesting in the company's growth. And we will strive to leverage our unique
strengths to ensure long-term success.
WE ARE ATTRACTING LARGE NUMBERS OF DISTRIBUTORS
In 2003, our active distributor count increased 20 percent and our executive
distributor count grew by 4 percent. Nearly 680,000 people around the world
purchased products from the company in the fourth quarter. China is playing a
significant role, with 117,000 people in 2003 becoming preferred customers by
meeting a minimum purchase requirement. The Pharmanex BioPhotonic Scanner and
several new, innovative products from each of our divisions are also driving
growth in our distributor numbers. By the end of 2004, we look to increase our
active distributor count to 800,000.
WE ARE IMPROVING RETENTION
Improving distributor and customer retention is one of our key initiatives. We
are seeing significant retention improvement in markets emphasizing
[28]
[GRAPHIC OMITTED - Graph showing Active Distributor Count in thousands.
2001-558; 2002 - 566; 2003-678]
[GRAPHIC OMITTED - Graph showing Executive Distributor Count. 2001 - 24,839;
2002 - 27,915; 2003 - 29,131]
monthly product subscription programs and providing periodic purchase
incentives. In 2003, our global product subscription orders increased more than
32 percent to 230,000 orders processed in December. By focusing on this issue,
our retention rates are doubling. Over time, improved retention will
significantly impact revenue. As we further execute these programs globally in
2004, we anticipate increasing our monthly product subscriber base to 300,000 by
year end.
WE ARE INCREASING SHAREHOLDER VALUE
We take our responsibility to increase shareholder value seriously. In 2003, we
took several steps to augment shareholder value, including reducing our labor
expenses and eliminating or restructuring nonstrategic, low margin products and
services. We also increased our annual dividend payout by $0.04 per share for
the third consecutive year.
In October 2003, we completed a transaction that enabled our shareholders to
benefit from the success of our business initiatives. We repurchased 11 million
shares of common stock held by original shareholders. These shareholders also
sold an additional 6 million shares to institutional investors. As a result of
this transaction, 55 percent of our outstanding shares are publicly held,
generating a much higher level of daily trading volume and improving liquidity
for our shareholders. As part of this transaction, we also negotiated the
conversion of all of the supervoting Class B shares of common stock to our
publicly-traded Class A shares of common stock. This accretive transaction was
well received by the market-at year end, our share price had increased 94
percent from its low point in 2003, and has continued to increase since.
WE ARE LEVERAGING OUR STRENGTHS TO ENSURE CONTINUED GROWTH
Nu Skin Enterprises is perfectly positioned to capitalize on emerging and global
demographic and socio-economic trends. The facts are indisputable-modern
medicine is keeping people alive much longer. But there is a big difference
between living extra years and living those extra years to the fullest. Most
people do not have the financial resources to retire, and no one wants to live
an extra 25 years in poor health.
Experts agree that living better, longer requires a well-rounded, balanced
approach-a healthy lifestyle, responsible choices, and a positive, passionate
attitude. Nu Skin Enterprises is uniquely
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[GRAPHIC OMITTED - Graph showing Product Subscription Orders in thousands. 2001
- 1,304; 2002 - 1,663; 2003 - 2,175]
[GRAPHIC OMITTED - Graph showing Average Daily Trading Volume in thousands. Q4
2001 - 68; Q4 2002 - 180; Q4 2003 - 296]
positioned to become a leading resource for helping people live better, longer
by bringing together three key elements:
1. A GENEROUS, PROVEN BUSINESS OPPORTUNITY
Over its 20 year history, Nu Skin Enterprises has helped thousands of people
reach their financial and lifestyle goals. In fact, in 20 years, we have paid
out more than $4 billion in distributor commissions. In 2003, we paid $407
million to our distributor force. Our goal is to pay our distributors more
commissions than any other direct selling company. To accomplish this, we need
to be 2.5 times our current size.
2. THREE PRODUCT DIVISIONS OFFER TOTAL WELLNESS
Increasing numbers of scientists are recognizing that the road to long lasting
health and longevity incorporates knowledge from the fields of health,
nutrition, dermatology, and even psychology and lifestyle management. Nu Skin
Enterprises brings these worlds together with three distinct product divisions:
Nu Skin offers premium personal care products; Pharmanex is a leader in
science-based nutritional supplements; and Big Planet enables broad audiences to
enjoy the benefits of technology based products and services. Our product teams
work in harmony to develop a high quality portfolio that helps people achieve
overall health, wellness, and longevity. And we are confident that the resources
deployed in each of our product categories will continue to yield innovative,
differentiated products and services that enable people to live better, longer.
3. AN ENRICHING AND UPLIFTING CULTURE
Nu Skin Enterprises is guided by its mission to be a force for good in the
world. Living better requires that people be part of environmental and
humanitarian causes that are making a global difference. People want to leave a
legacy that goes beyond the size of their bank accounts. The Nu Skin Force for
Good Foundation™ and our recently launched Nourish the Children™ Initiative-both
fueled by our hundreds of thousands of distributors around the world-are making
a difference. Our objective is to make the world a better place for children.
And we're doing that by supporting research to find cures for insidious
diseases, preserving invaluable ecosystems, and providing nutritious meals to
save the lives of starving and malnourished children.
[30]
[GRAPHIC OMITTED - Graph showing Nourish the Children™ Meals Donated in
thousands. 2002 - 1,440; 2003 - 4,780]
WE ARE OPTIMISTIC ABOUT OUR FUTURE
As we pursue our goal to become the world's leading direct selling company, we
will focus on the following priorities in 2004:
•Build Japan momentum
•Achieve 20 percent U.S. Nu Skin and Pharmanex growth
•Double China revenue
•Continue positive trends in other markets
•Advance our emerging markets business model
•Focus on retention
We have a bright future. All of the resources we need to meet our objectives are
"in the bag"-a bag brimming with strong corporate qualities and a dedicated
distributor force and employee base that will enable us to successfully meet our
goals.
/s/Blake M. Roney /s/Truman Hunt
Blake M. Roney, Chairman M. Truman Hunt, President and CEO
1. This earnings per share measure adjusts GAAP earnings per share to remove
the impact of certain one-time third quarter restructuring charges that are
unusual in nature and unlikely to impact results of operations going
forward. See Reconciliation to GAAP Earnings Per Share table on p. 72.
[31]
[GRAPHIC OMITTED - Pie Chart showing Revenue by Region]
[GRAPHIC OMITTED - Pie Chart showing Revenue by division]
KEY MARKET OUTLOOK
"Our Japan business is strong and vibrant. We have launched programs promoting
healthy business growth and increased rewards to new executives. We are also
focused on using technology and sales tools to expand our already large consumer
base, making our products accessible to many more people."
[GRAPHIC OMITTED - Picture of Robert S. Conlee]
Robert S. Conlee, President, North Asia
"In the United States, we are enthusiastically driving automatic delivery
subscribers through all three divisions, setting our 2004 target at 100,000
subscribers-double our subscriber base at the beginning of 2004. By the end of
2004, automatic delivery orders should represent 50 percent of U.S. revenue."
[GRAPHIC OMITTED - Picture of Scott Schwerdt]
Scott E. Schwerdt, General Manager, United States
"Our robust growth in 2003 gives us confidence that China has the potential to
become the company's largest market. Adapting our growing business to the
changing dynamics of the Chinese market will be our top priority in 2004."
[GRAPHIC OMITTED - Picture of Corey Lindley]
Corey B. Lindley, President, Greater China
DIVISION OUTLOOK
"In 2004, Nu Skin will enable more people to benefit from advancements in skin
care science. Key treatment products promise to strengthen our share of the
lucrative anti-aging skin care market, while the mobile technology of the Nu
Skin Regimen Optimizer will allow distributors to customize our product
portfolio to every consumer."
[GRAPHIC OMITTED - Picture of Lori Bush]
Lori H. Bush, President, Nu Skin
"We plan to deploy more than 3,000 Pharmanex BioPhotonic Scanners throughout our
U.S. and global markets by December 2004. In addition, we will roll out our
recently announced products, including TRA™, which will enable Pharmanex to gain
greater share of the $7 billion weight management category."
[GRAPHIC OMITTED - Picture of Joseph Chang]
Joseph Y. Chang, President, Pharmanex
"We are investing in high profit margin software and services in high growth
consumer market segments, including digital imaging and Internet security. Big
Planet's mission is to enable mass markets to benefit from high technology
products and services."
[GRAPHIC OMITTED - Picture of Larry Macfarlane]
Larry V. Macfarlane, President, Big Planet
[32]
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of and for the years ended
December 31, 1999, 2000, 2001, 2002 and 2003 have been derived from the audited
consolidated financial statements.
Year Ended December 31,
1999 2000 2001 2002 2003
(U.S. dollars in thousands, except per share data)
Income Statement Data:
Revenue $ 894,249 $ 879,758 $ 885,621 $ 964,067 $ 986,457
Cost of sales 151,681 149,342 178,083 190,868 176,545
Gross profit 742,568 730,416 707,538 773,199 809,912
Operating expenses:
Selling expenses 346,951 345,259 347,452 382,159 407,088
General and administrative
expenses 265,770 294,744 288,605 285,229 289,925
Restructuring and other
charges -- -- -- -- 5,592
Total operating expenses 612,721 640,003 636,057 667,388 702,605
Operating income 129,847 90,413 71,481 105,811 107,307
Other income (expense), net (1,411 ) 5,993 8,380 (2,886 ) 432
Income before provision for income
taxes 128,436 96,406 79,861 102,925 107,739
Provision for income taxes 41,742 34,706 29,548 38,082 39,863
Net income(1) $ 86,694 $ 61,700 $ 50,313 $ 64,843 $ 67,876
Net income per share:
Basic $ 1.00 $ 0.72 $ 0.60 $ 0.79 $ 0.86
Diluted $ 0.99 $ 0.72 $ 0.60 $ 0.78 $ 0.85
Weighted average common shares
outstanding (000s):
Basic 87,081 85,401 83,472 81,731 78,637
Diluted 87,893 85,642 83,915 83,128 79,541
Balance Sheet Data (at end of
period):
Cash and cash equivalents $ 110,162 $ 63,996 $ 75,923 $ 120,341 $ 122,568
Working capital 74,561 122,835 152,513 180,639 143,568
Total assets 643,215 590,803 582,352 611,838 623,747
Current portion of long-term debt 55,889 -- -- -- 17,915
Long-term debt 89,419 84,884 73,718 81,732 147,488
Stockholders' equity 309,379 366,733 379,890 386,486 290,248
Supplemental Operating Data (at
end of period):
Approximate number of active
distributors(2) 510,000 497,000 558,000 566,000 678,000
Number of executive
distributors(2) 21,005 21,381 24,839 27,915 29,131
(1) In January 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." Assuming no amortization of goodwill and other indefinite-lived
intangibles for all periods presented prior to adoption, net income would
have been $93 million, $68 million and $57 million for each of the years
ended December 31, 1999, 2000, and 2001, respectively. For 2003, net income
includes a pre-tax non-recurring charge of $6 million due to restructuring
and other charges incurred during the third quarter.
(2) Active distributors are those distributors who were resident in the
countries in which we operated and who purchased products 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.
Following the opening for retail business in Mainland China during 2003,
active distributors includes 117,000 preferred customers and executive
distributors includes 3,100 employed, full-time sales representatives.
[33]
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of our financial condition and results of operations
should be read in conjunction with the Consolidated Financial Statements and
related Notes thereto, which are included in this Annual Report.
OVERVIEW
We are a leading, global direct selling company. We develop and distribute
premium-quality, innovative personal care products and nutritional supplements
that are sold worldwide under the Nu Skin and Pharmanex brands. We also market
technology products and services and a line of home care products under the Big
Planet brand. We had revenue of $986 million in 2003 and a global network of
approximately 678,000 active independent distributors. Approximately 29,000 of
our active distributors have achieved executive distributor status. Our
executive distributors play an important leadership role in our distribution
network and are critical to the growth and profitability of our business. We
develop and market branded consumer products that we believe are well suited for
direct selling. Our distributors market and sell our products by educating
consumers about the benefits and distinguishing characteristics of our products
and by providing personalized customer service. Through dedicated research and
development, we continually develop and introduce new products and enhance our
existing line of products to provide our distributors with a differentiated
portfolio of premium products. We are able to attract and motivate high-caliber
independent distributors because of our focus on developing innovative products,
our attractive global compensation system and our advanced technological
distributor support.
We currently operate in over 30 countries throughout Asia, North and South
America and Europe. In 2003, approximately 89% of our revenue was generated in
markets outside of the United States and is translated into U.S. dollars from
each market's local currency using quarterly weighted average exchange rates.
Approximately 84% of our revenue was generated from our Asia markets, with
revenue from Japan representing approximately 57% of our revenue. As a result,
our financial results can be negatively impacted by the weakening of foreign
currencies relative to the U.S. dollar and economic and business conditions in
Asia, particularly in Japan.
The following table sets forth revenue information by region for the time
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.
Year Ended December 31,
Revenue by Region 2001 2002 2003
(U.S. dollars in millions)
North Asia $ 553.9 63% $ 593.9 62% $ 617.7 63%
Greater China 93.4 10 104.9 11 135.5 14
North America 155.9 18 145.9 15 122.8 12
South Asia/Pacific 56.9 6 91.1 9 75.8 8
Other Markets 25.5 3 28.3 3 34.7 3
$ 885.6 100% $ 964.1 100% $ 986.5 100%
Our revenue depends upon the number and productivity of independent distributors
who purchase products and sales materials from us in their local currency for
resale to their customers or for personal use. Information concerning the number
of active and executive distributors for the past three years is provided below
under the heading "Distributor Information." Because we distribute almost all of
our products through our independent distributors, our failure to retain our
existing distributors and recruit additional distributors could have an adverse
effect on our revenue.
[34]
Our business and the direct selling and nutritional supplement industries are
subject to extensive governmental regulations throughout the world, which impose
some restrictions on our business and create certain business risks, including
the imposition of fines or suspension of our operations if we fail to comply
with such regulations. Some of the more significant regulatory risks facing our
business today include regulatory risks in Mainland China where we are not
allowed to operate using our direct selling model and we continue to be subject
to regulatory scrutiny, uncertainty regarding the status of our Pharmanex
BioPhotonic Scanner as a non-medical device in the United States and Japan, and
efforts to enact more stringent laws and regulations related to nutritional
supplements as a result of adverse publicity related to deaths associated with
ephedrine, a supplement we have never marketed.
We source the majority of our products from manufacturers located in the United
States. In connection with our operations in Mainland China, we acquired a
manufacturing facility in Mainland China and are manufacturing our own products
for distribution in Mainland China. Cost of sales primarily consists of the cost
of products purchased from third party vendors, generally in U.S. dollars, and
the freight cost of shipping these products to distributors, as well as import
duties for the products. Cost of sales also includes the cost of sales materials
sold to distributors at or near cost. Sales materials sold to distributors at or
near cost are generally purchased in local currencies. As the sales mix changes
between product categories and sales materials, cost of sales and gross profit
may fluctuate to some degree due primarily to the margin on each product line.
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.
Selling expenses (previously referred to as distributor incentives), classified
as operating expenses, are our most significant expense. Our global sales
compensation plan is an important factor in our ability to attract and retain
distributors. Selling expenses are paid to several levels of distributors on
each product sale. The amount of the incentive paid varies depending on the
purchaser's position within our Global Compensation Plan. Selling expenses are
paid monthly and are based upon a distributor's personal and group product
volumes, as well as the group product volumes of up to six levels of executive
distributors in their downline sales organizations. Distributors also have the
opportunity to make retail profits by selling the products they purchase from us
at wholesale to retail customers with a retail mark-up. We do not pay
commissions on these retail sales by distributors to their customers and do not
recognize any revenue or commission expense from these retail sales by
distributors to their retail customers. In some markets, we allow individuals
who are not distributors to buy products directly from us at preferred prices.
We pay commissions to the referring distributors and sales employees on these
sales made directly by us to the "preferred customers." Small fluctuations occur
in the amount of incentives 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 678,000 active distributors, the fluctuation
in the overall payout is relatively small. The overall payout has typically
averaged from 41% to 43% of global product sales. We also make modifications and
enhancements to our compensation plan to help motivate distributors and develop
leadership characteristics, which can have an impact on selling expenses. Sales
materials and starter kits are not subject to selling expenses. We previously
referred to "selling expenses" as "distributor incentives" in our financial
statements. The reason for the change in title is because the sales
representatives in Mainland China are employees, as opposed to independent
distributors.
General and administrative expenses (previously referred to as selling, general
and administrative expenses) include wages and benefits, depreciation and
amortization, rents and utilities, travel, promotion and advertising including
costs of distributor conventions, which are expensed in the period in which they
are incurred, research and development, professional fees and other operating
expenses. The most significant portion of our general and administrative
expenses is labor expenses.
Provision for income taxes depends on the statutory tax rates in each of the
jurisdictions in which we operate. For example, statutory tax rates are 16% in
Hong Kong, 25% in Taiwan, 30% in South Korea, 46% in Japan and 33% in Mainland
China; however, we are currently benefiting from a tax holiday in Mainland
China. We are subject to taxation in the United States at a statutory corporate
federal tax rate of 35% and we also pay taxes in various states. However, we
receive foreign tax credits in the United States for the amount of foreign taxes
actually paid in a given period, which are utilized to reduce taxes in the
United States to the extent allowed. We have historically
[35]
experienced high effective foreign tax rates in comparison to the overall
effective tax rate, which is due to the impact of: (1) foreign activities with
pre-tax losses that provide a tax benefit in the United States, but not in the
foreign jurisdictions; (2) higher tax rates in certain foreign jurisdictions,
particularly Japan, which accounts for a significant portion of the foreign
pre-tax income each year; and (3) the effect of foreign withholding taxes, which
factor into the total tax provision, but are not based on income. We experienced
a higher foreign tax rate in 2003 compared to 2002 and 2001 due to reduced
taxable foreign income, coupled with consistent foreign withholding taxes, which
are non-income based taxes. Our effective U.S. tax rates in comparison to our
overall effective tax rate are lower due to the impact of applicable foreign tax
credits in the U.S. income tax expense breakdown.
From September 1999 to August 2003, we operated a professional employer
organization that outsourced personnel and benefit services to small businesses
in the United States. We sold the professional employer organization during the
third quarter of 2003. Revenue for the professional employer organization
consisted of service fees paid by its clients. For our professional employer
organization, cost of sales included the direct costs, such as salaries, wages
and other benefits, associated with the worksite employees.
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 the most critical accounting policies to be the
recognition of revenue, accounting for income taxes and accounting for
intangible assets. 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
passes 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 all selling discounts as a reduction of revenue. Our Global
Compensation Plan for our distributors is focused on remunerating distributors
based upon the selling efforts of the distributors and their downline, 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
enterprise's 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 between us and our foreign affiliates. Deferred tax
assets and liabilities are created in this process. As of December 31, 2003, we
have net deferred tax assets of $74.1 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. We have considered projected
future taxable income and ongoing tax planning strategies in determining that no
valuation allowance is required. 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.
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 SFAS No. 5, "Accounting for
Contingencies" and believe that 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 Statements of Financial Accounting
Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," our
goodwill and intangible assets with indefinite useful lives are no longer
amortized, but instead are tested for impairment at least annually. In addition,
our intangible assets with definite lives are recorded at cost and are amortized
over their
[36]
respective estimated useful lives to their estimated residual values, and are
reviewed for impairment in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lives Assets" (see Note 5 to our consolidated
financial statements).
We are required to make judgments regarding the useful lives of our intangible
assets. With the implementation of SFAS No. 142, we determined certain
intangible assets to have indefinite lives based upon our analysis of the
requirements of SFAS 141 and 142 as well as an independent third party
evaluation of such lives, which was conducted in 2001. These intangible assets
include our trademarks and trade names, our distributor network, and our
marketing rights to operate the Nu Skin business in various foreign markets. In
connection with a registration statement we filed in October 2003, the Staff of
the Securities and Exchange Commission has commented on and sought additional
support for the indefinite life designation of these assets. This review is
on-going and if it is determined that any of these assets has a finite life, we
would amortize the value of that asset over the remainder of such finite life,
which annual amortization expense we do not believe would be material to our
operating results. The amortization expense would be a non-cash expense that
would not impact the Company's cash flow from operations.
RESULTS OF OPERATIONS
The following table sets forth our operating results as a percentage of revenue
for the periods indicated:
Year Ended December 31,
2001 2002 2003
Revenue 100.0 % 100.0 % 100.0 %
Cost of sales 20.1 19.8 17.9
Gross profit 79.9 80.2 82.1
Operating expenses:
Selling expenses 39.2 39.6 41.3
General and administrative expenses 32.6 29.6 29.4
Restructuring and other charges -- -- 0.5
Total operating expenses 71.8 69.2 71.2
Operating income 8.1 11.0 10.9
Other income (expense), net .9 (.3 ) --
Income before provision for income taxes 9.0 10.7 10.9
Provision for income taxes 3.3 4.0 4.0
Net income 5.7 % 6.7 % 6.9 %
2003 COMPARED TO 2002
REVENUE
OVERVIEW. Revenue in 2003 increased 2% to $986.5 million from $964.1 million
in 2002. Excluding the impact of changes in foreign currency exchange rates, we
experienced a revenue decline of 2% for 2003 compared to 2002. This resulted
from the sale of our professional employer organization in the United States in
August 2003 and our transition away from certain Big Planet offerings, both of
which were eliminated as part of our continued efforts to eliminate low-margin
products and services. Although these actions negatively impacted 2003 to 2002
revenue comparisons by $22.0 million, we believe that they positively impacted
gross and operating margins in the fourth quarter of 2003 and will continue to
have a positive impact on gross and operating margins going forward.
Revenue in 2003 was positively impacted by significant revenue growth from our
expanded operations in Mainland China. In addition, growth in our U.S. nutrition
business also positively impacted 2003 results. These improvements were largely
offset by declines in local currency revenue in South Korea, Singapore and
Malaysia, and in Japan for the year ended December 31, 2003. The negative
year-over-
[37]
year comparisons were related in part to the shift of attention of distributor
leaders away from their home markets during the first quarter of 2003 to focus
on Mainland China, the positive impact on revenue results in 2002 from
distributor enthusiasm surrounding and incentives related to our planned
expansion of operations in Mainland China, and geo-political conflicts and weak
economic conditions. After two consecutive quarters of year-over-year declines
in Japan, revenue stabilized in this market during the last half of 2003.
In late December 2003, the Company received notification that Japanese and South
Korean regulators had suspended the importation of nutritional supplements in
bovine-based capsules, which includes many of our Pharmanex products. A few
weeks later, Japanese regulators also determined they would no longer allow
these same products to be sold by nutrition companies after February 16, 2004.
As a result, we have transitioned our production to non-bovine capsules and
tablets and expect all of our key Pharmanex products to remain in stock.
Although we expect these measures to result in some additional expenses for
production costs, inventory write-offs and expedited shipping fees during the
first quarter of 2004, we do not believe that these expenses will have a
material impact on our overall projected 2004 financial results.
NORTH ASIA. The following table sets forth revenue for the North Asia region and
its principal markets (U.S. dollars in millions):
2002 2003 Change
Japan $ 529.8 $ 558.7 5 %
South Korea 64.1 59.0 (8 )
North Asia total $ 593.9 $ 617.7 4
Excluding the impact of changes in foreign currency exchange rates, revenue in
North Asia decreased 3% in 2003 compared to 2002. In local currency, revenue in
Japan decreased 2% in 2003 compared to 2002. Local currency revenue in Japan
during 2003 was negatively impacted by the factors noted in "Revenue - Overview"
above. In local currency, revenue in South Korea decreased 12%. The decrease in
revenue in South Korea was primarily a result of the factors discussed in
"Revenue - Overview" above, as well as regulatory changes requiring a
modification to our sales incentive plan towards the end of 2002, which was
disconcerting to our distributor leaders 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):
2002 2003 Change
Taiwan $ 78.9 $ 73.1 (7 %)
Mainland China 2.0 38.5 1,825
Hong Kong 24.0 23.9 --
Greater China total $ 104.9 $ 135.5 29
Revenue in Greater China increased primarily as a result of the expansion of
operations in Mainland China. Foreign currency fluctuations from 2002 to 2003
did not have a notable impact on this region. Revenue in Mainland China was
$38.5 million in 2003, following our expansion of retail operations and the
introduction of Nu Skin branded products in Mainland China in January 2003. On a
sequential basis, revenue in Mainland China increased 67% from the third quarter
to the fourth quarter. This growth is attributed to an increased number of
preferred customers and employed sales representatives in Mainland China. The
success of our product launches and product promotions as well as our employment
opportunities provide an attraction to many unemployed or underemployed sales
people in Mainland China. As our business expands in Mainland China, we continue
to experience government scrutiny due to our international reputation as a
direct selling company. Although we conduct retail operations and not direct
selling operations in Mainland China, we expect the government scrutiny to
continue throughout 2004 when new direct selling laws and regulations are
anticipated. For a more detailed discussion of the risks and challenges we face
in Mainland China, please refer to "Note Regarding Forward-Looking Statements".
We currently operate in a total of 23 cities in 8 provinces in Mainland China.
[38]
The increase in revenue in Mainland China was somewhat offset by the decline in
revenue in Taiwan. We believe that the SARS epidemic negatively impacted revenue
in Taiwan and Hong Kong during the first half of 2003. In addition, revenue in
Taiwan and Hong Kong during the second, third and fourth quarters of 2002 was
positively impacted by distributor enthusiasm surrounding our planned expansion
of operations in Mainland China in 2003.
NORTH AMERICA. The following table sets forth revenue for the North America
region and its principal markets (U.S. dollars in millions):
2002 2003 Change
United States $ 136.6 $ 113.4 (17 %)
Canada 9.4 9.4 --
North America total $ 146.0 $ 122.8 (16 )
The decline in revenue in the United States is principally a result of a $22.0
million revenue decline in Big Planet in 2003 compared to the prior year. This
decline was due primarily to the sale of our professional employer organization
and the restructuring of Big Planet telecommunication products, both of which
transitions are part of our continued efforts to eliminate or modify low-margin
products. The North America region was also negatively impacted by
year-over-year hedging losses of approximately $5.3 million in 2003 compared to
hedging gains of $4.5 million in 2002 related to foreign currency forward
contracts. In addition, revenue in 2002 in the United States included $6.0
million of sales to foreign distributors during the third quarter of 2002 at the
global distributor convention held in the United States, which did not recur in
2003.
Increasing distributor activity tied to the Pharmanex BioPhotonic Scanner
program, a focus on signing up more consumers on monthly reorder programs, the
introduction of new weight-management products and implementation of distributor
leadership incentives, however, resulted in 36% growth in our Pharmanex revenue
in the United States from $48.3 million in 2002 to $65.6 million in 2003,
excluding sales to foreign distributors at the 2002 global convention held in
the United States. Nu Skin revenue held relatively constant in 2003 compared to
2002, excluding sales to foreign distributors at the same 2002 global
convention. Moreover, we experienced an 18% increase in our 2003 executive
distributors in the United States and a 20% increase during 2003 of automatic
delivery orders compared to 2002. Early in 2003, the FDA questioned the status
of the Pharmanex BioPhotonic Scanner as a non-medical device. We believe the
scanner can be marketed as a non-medical device, but the FDA has not responded
yet to our request to classify the scanner as a non-medical device. In the event
the FDA concludes that the scanner requires medical device clearance, this could
delay or inhibit our ability to market the scanner. We currently intend to
contest any conclusion by the FDA that the scanner is a medical device.
SOUTH ASIA/PACIFIC. The following table sets forth revenue for the South
Asia/Pacific region and its principal markets (U.S. dollars in millions):
2002 2003 Change
Singapore/Malaysia $ 64.3 $ 36.7 (43 %)
Thailand 13.0 22.7 75
Australia/New Zealand 11.0 13.5 23
Philippines 2.8 2.9 4
South Asia/Pacific total $ 91.1 $ 75.8 (17 )
Excluding the impact of changes in foreign currency exchange rates, revenue in
South Asia/Pacific decreased 21% in 2003 compared to 2002. The decrease in
revenue in this region was due primarily to the combined decrease in Singapore
and Malaysia. Both Singapore and Malaysia were opened in the last two years. We
often experience a revenue contraction after an initial period of rapid revenue
growth following the opening of the market. This revenue contraction occurred
later than usual in Singapore and Malaysia and was more pronounced
[39]
than anticipated. We believe that this was due in part to distributor enthusiasm
related to the planned opening of expanded operations in Mainland China in
January 2003, which drove revenue growth throughout 2002. This decrease was
somewhat offset by an increase in revenue in both Thailand and combined
Australia/New Zealand.
OTHER MARKETS. The following table sets forth revenue for our Other Markets
(U.S. dollars in millions):
2002 2003 Change
Europe $ 25.6 $ 31.9 25 %
Latin America 2.7 2.8 4
Other Markets total $ 28.3 $ 34.7 23
This increase was primarily due to a 25% increase in revenue in Europe, which
included the 17% favorable impact of currency fluctuations in 2003 compared to
2002.
GROSS PROFIT
Gross profit as a percentage of revenue increased to 82.1% in 2003 compared to
80.2% in 2002. Our gross profit was positively impacted by the divestiture of
our professional employer organization, the decline in low-margin revenue from
Big Planet, a new personal care manufacturing plant in Mainland China and the
positive impact of fluctuations in foreign currency in 2003 compared to 2002. We
anticipate these factors will continue to positively impact gross profit
throughout 2004 with gross margins expected to range from 83.0% to 84.0% in 2004
consistent with our reported gross margin of 83.4% during the fourth quarter of
2003.
SELLING EXPENSES
Selling expenses as a percentage of revenue increased to 41.3% in 2003 from
39.6% in 2002. In U.S. dollars, selling expenses increased to $407.1 million in
2003 from $382.2 million in 2002. The increase in selling expenses was due to
the increase of sales employee labor and commission expenses in Mainland China.
In addition, selling expenses as a percent of revenue increased due to the
divestiture of our professional employer organization, which paid no
commissions, and by the introduction of leadership incentives in Japan and in
the United States. We anticipate these factors will continue to impact our
selling expenses throughout 2004 with selling expenses expected to range from
42.0% to 43.0% similar to reported results during the fourth quarter of 2003,
which were 42.2%.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses as a percentage of revenue remained nearly
level at 29.4% in 2003 from 29.6% in 2002. In U.S. dollars, general and
administrative expenses increased to $289.9 million in 2003 from $285.2 million
in 2002. The U.S. dollar increase during 2003 in general and administrative
expenses was primarily due to the incremental costs associated with the
expansion of retail operations in Mainland China in 2003, as well as the
negative impact of foreign currency fluctuations on operating expenses in 2003.
These increases were somewhat offset by the reduction in labor expenses
resulting from our restructuring that occurred in the third quarter of 2003. We
anticipate incurring distributor convention expenses of approximately $6.5
million in 2004 relating to our global distributor convention in the United
States in the first quarter and approximately $4.0 million relating to our 2004
Japan distributor convention in the fourth quarter, which represents an overall
increase in 2004 of approximately $6.5 million in convention expenses compared
to 2003.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges of $5.6 million recorded in the third quarter of
2003 include $5.1 million of expenses resulting from an early retirement program
and other employee separation charges. As a result of these employee
terminations, our overall headcount was reduced by approximately 130 employees,
the majority of which were employees at our U.S. headquarters. These
restructuring expenses consisted primarily of severance and other compensation
charges. The savings associated with these reductions in force have been refo-
[40]
cused on revenue growth initiatives throughout the company. In connection with
these restructuring charges, we also completed the divestiture of our
professional employer organization operated through Big Planet resulting in a
charge of approximately $0.5 million.
OTHER INCOME (EXPENSE), NET
Other income (expense), net was $0.4 million of income in 2003 compared to $2.9
million of expense in 2002. This increase in other income (expense), net of $3.3
million is primarily related to the foreign exchange fluctuations to the U.S.
dollar on the translation of yen-based bank debt and other foreign denominated
intercompany balances into U.S. dollars for financial reporting purposes. We
anticipate interest expense increasing to approximately $6.0 million in 2004
from approximately $3.0 million in 2003 resulting from additional debt incurred
in October 2003.
PROVISION FOR INCOME TAXES
Provision for income taxes increased to $39.9 million in 2003 from $38.1 million
in 2002. This increase was largely due to the increase in operating income as
compared to the prior year. The effective tax rate remained at 37.0% of pre-tax
income for 2003 and 2002.
NET INCOME
As a result of the foregoing factors, net income increased to $67.9 million in
2003 from $64.8 million in 2002. Earnings per share were positively impacted by
the repurchase of 10.8 million shares of our Class A common stock, which
occurred in October 2003.
2002 COMPARED TO 2001
REVENUE
OVERVIEW. Revenue in 2002 increased 9% to $964.1 million from $885.6 million
in 2001 primarily due to the growth in the North and South Asia/Pacific regions
as discussed below, which was somewhat offset by the decline in the North
America region. Excluding the impact of changes in exchange rates, we
experienced growth of 10% for 2002 compared to the prior year. Successful new
product introductions, the addition of Singapore and Malaysia in the last two
years and distributor interest surrounding our expansion of retail operations in
Mainland China contributed to revenue growth in 2002.
NORTH ASIA. The following table sets forth revenue for the North Asia region and
its principal markets (U.S. dollars in millions):
2001 2002 Change
Japan $ 508.1 $ 529.8 4 %
South Korea 45.8 64.1 40
North Asia total $ 553.9 $ 593.9 7
In local currency, revenue in Japan increased 7%. Revenue growth in Japan was
driven by continued leveraging of technology tools for distributors as well as
by successful product introductions and growth in automated orders. Reported
U.S. dollar results reflect the negative impact of currency fluctuations. In
local currency, revenue in South Korea increased 35%. Revenue growth in South
Korea was driven by a 22% increase in executive distributors as well as
successful product introductions. Our revenue growth in South Korea, which grew
67% in local currency in 2001, slowed in the second half of 2002 as a result of
increased government regulations and political changes as well as weakening in
the overall direct selling industry and the economy.
[41]
GREATER CHINA. The following table sets forth revenue for the Greater China
region and its principal markets (U.S. dollars in millions):
2001 2002 Change
Taiwan $ 70.2 $ 78.9 12 %
Hong Kong 21.7 24.0 11
Mainland China 1.5 2.0 33
Greater China total $ 93.4 $ 104.9 12
Distributor interest surrounding our expansion of retail operations in Mainland
China, which commenced in January 2003, spurred the growth in this region. In
local currency, revenue in Taiwan increased 15%. Revenue growth in Taiwan was
driven by a 27% increase in executive distributors primarily related to
distributor enthusiasm throughout the Greater China region resulting from the
planned retail expansion of operations in Mainland China.
NORTH AMERICA. The following table sets forth revenue for the North America
region and its principal markets (U.S. dollars in millions):
2001 2002 Change
United States $ 149.0 $ 136.6 (8 %)
Canada 6.9 9.4 36
North America total $ 155.9 $ 146.0 (6 )
This decrease in the North America region is due to the decline in revenue in
the United States. The decrease in the United States is due to declines in Big
Planet, including a decline of $8.9 million in 2002 in our core Big Planet
revenue and a $2.7 million decline from our professional employer organization
as we implemented initiatives centered on the more profitable personal care and
nutritional supplement product categories. For the year, Nu Skin and Pharmanex
revenue was flat, although revenue increased 19% in the fourth quarter of 2002
compared to the same period in 2001. These decreases were somewhat offset by the
increase in revenue in Canada.
SOUTH ASIA/PACIFIC. The following table sets forth revenue for the South
Asia/Pacific region and its principal markets (U.S. dollars in millions):
2001 2002 Change
Singapore/Malaysia $ 39.6 $ 64.3 62 %
Thailand 6.6 13.0 97
Australia/New Zealand 7.2 11.0 53
Philippines 3.5 2.8 (20 )
South Asia/Pacific total $ 56.9 $ 91.1 60
Excluding the impact of changes in exchange rates, our revenue in South
Asia/Pacific increased 58% in 2002 compared to the prior year. Distributor
interest surrounding our expansion of retail operations in Mainland China, which
commenced in January 2003 and the opening of the Malaysian market in November
2001 spurred the growth in this region. The combined revenue of Singapore and
Malaysia increased primarily as a result of the inclusion of a full year of
operations in Malaysia in our 2002 results and distributor activity spurred over
our plans to expand in Mainland China.
[42]
OTHER MARKETS. The following table sets forth revenue for our Other Markets
(U.S. dollars in millions):
2001 2002 Change
Europe $ 22.7 $ 25.6 13 %
Latin America 2.8 2.7 (4 )
Other Markets total $ 25.5 $ 28.3 11
This increase in revenue is primarily due to a 13% increase in revenue in Europe
in U.S. dollars compared to the prior year. Excluding the impact of changes in
exchange rates, our revenue in Europe increased approximately 4% compared to
2001 and in Latin America revenue increased 5% compared to 2001.
GROSS PROFIT
Gross profit as a percentage of revenue remained nearly constant at 80.2% in
2002 compared to 79.9% in 2001. The slight negative impact of fluctuations in
foreign currency in 2002 was offset by a decrease of revenue related to low
margin Big Planet products and services in 2002. We purchase a significant
majority of our goods in U.S. dollars and recognize revenue in local currencies.
Consequently, we are subject to exchange rate risks in our gross margins.
SELLING EXPENSES
Selling expenses (previously referred to as distributor incentives) as a
percentage of revenue increased to 39.6% in 2002 from 39.2% in 2001. In U.S.
dollars, selling expenses increased to $382.2 million in 2002 from $347.5
million in 2001. The decline in revenue from Big Planet products and services,
which pay lower commissions than our personal care and nutritional supplement
product categories, contributed to the increase in selling expenses during 2002.
General and administrative
General and administrative expenses (previously referred to as selling, general
and administrative expenses) as a percentage of revenue decreased to 29.6% in
2002 from 32.6% in 2001. Without the impact of $10.5 million of amortization of
intangibles recorded in 2001, which was not recorded in 2002 due to the
implementation of SFAS No. 142, general and administrative expenses as a
percentage of revenue would have been 31.4% in 2001. In 2002, we generated
higher revenue while maintaining operating expenses primarily due to improved
efficiencies from our cost-saving technology and automated reordering
initiatives which allowed us to reduce labor expense as a percentage of revenue.
These efficiencies in 2002, combined with the additional general and
administrative expenses of approximately $4.0 million we incurred in 2001 for a
distributor convention held in Japan, which was not held in 2002, contributed to
the remaining decrease in general and administrative expenses as a percentage of
revenue. In U.S. dollar terms, general and administrative expenses decreased to
$285.2 million in 2002 from $288.6 million in 2001.
Other income (expense), net
Other income (expense), net was $2.9 million of expense in 2002 compared to $8.4
million of income in 2001. The decrease in other income (expense), net is
primarily related to the foreign exchange fluctuations to the U.S. dollar on the
translation of yen-based bank debt and other foreign denominated intercompany
balances into U.S. dollars for financial reporting purposes. In 2001, the net
$8.4 million of income primarily included foreign exchange gains due to a
weakened Japanese yen relative to the U.S. dollar over 2000, while the net $2.9
million of expense in 2002 was due to a strengthened Japanese yen relative to
the U.S. dollar over 2001.
Provision for income taxes
Provision for income taxes increased to $38.1 million in 2002 from $29.5 million
in 2001. This increase was largely due to the increases in operating income as
compared to the prior year. The effective tax rate remained at 37.0% of pre-tax
income for 2002 and 2001.
Net income
As a result of the foregoing factors, net income increased to $64.8 million in
2002 from $50.3 million in 2001.
[43]
LIQUIDITY AND CAPITAL RESOURCES
Historically, our principal needs for funds have been for operating expenses
including selling expenses, working capital (principally inventory purchases),
capital expenditures and the development of operations in new markets. We have
generally relied on cash flow from operations to meet our cash needs and
business objectives without incurring long-term debt to fund operating
activities.
We typically generate positive cash flow from operations due to favorable gross
margins, the variable nature of selling expenses, which constitute a significant
percentage of operating expenses, and minimal capital requirements. We generated
$109.0 million in cash from operations in 2003 compared to $111.1 million in
2002. This decrease in cash generated from operations in 2003 compared to the
prior-year period is largely related to the timing of payments of a higher
amount of accrued expenses, including income taxes and commissions to
distributors, during the year ended December 31, 2003, compared to the same
prior-year period. These accrued expenses were substantially higher at December
31, 2002 than the amounts accrued at December 31, 2001 because revenue and
profitability were significantly higher in 2002 compared to 2001. The negative
impact of these timing differences was somewhat offset by our improved cash flow
from inventory efficiencies.
As of December 31, 2003, working capital was $143.6 million compared to $180.6
million as of December 31, 2002. Cash and cash equivalents at December 31, 2003
were $122.6 million and were $120.3 million at December 31, 2002, following the
use of $45.0 million of our cash to repurchase shares of our common stock in
October 2003 and $20.0 million to pay off our revolving credit facility. This
decrease in working capital was primarily due to the increase in accrued
liabilities and in the current portion of long-term debt.
Capital expenditures, primarily for equipment, including the Pharmanex
BioPhotonic Scanner, computer systems and software, office furniture and
leasehold improvements, were $23.5 million for the year ended December 31, 2003.
In addition, we anticipate capital expenditures in 2004 of approximately $30
million to $35 million to further enhance our infrastructure, including
enhancements to computer systems and software, further expansion of our retail
stores, manufacturing and related infrastructure in Mainland China and
approximately $15 million to $20 million in purchases of additional Pharmanex
BioPhotonic Scanners, which we lease to our distributors.
We maintain a $30.0 million revolving credit facility with Bank of America, N.A.
and Bank One, N.A. for which Bank of America, N.A. acted as agent. Drawings on
this revolving credit facility may be used for working capital, capital
expenditures and other purposes including repurchases of our outstanding shares
of Class A common stock. The revolving credit facility is set to expire on May
10, 2004.
In August 2003, we entered into a $125.0 million multi-currency private
uncommitted shelf facility with Prudential Investment Management, Inc. We
utilized a portion of this shelf facility and a portion of the revolving credit
facility in a transaction in October 2003 involving the repurchase of our shares
of Class A common stock noted below. This portion of the long-term debt is U.S.
dollar denominated, bears interest of approximately 4.5% per annum and will be
amortized in two tranches over five and seven years. As of December 31, 2003,
there were no outstanding balances under our revolving credit facility. As of
December 31, 2003, we had $75.0 million outstanding under our shelf facility,
$5.0 million of which is included in the current portion of long-term debt.
In addition to the $75.0 million currently outstanding under our long-term shelf
facility, our long-term debt includes the long-term portion of Japanese
yen-denominated ten-year senior notes issued to the Prudential Insurance Company
of America in 2000. The notes bear interest at an effective rate of 3.03% per
annum and are due October 2010, with annual principal payments beginning in
October 2004. As of December 31, 2003, the outstanding balance on the notes was
9.7 billion Japanese yen, or $90.4 million, $12.9 million of which is included
in the current portion of long-term debt. The Japanese notes and the revolving
and shelf credit facilities are secured by guarantees issued by our material
subsidiaries and by a pledge of 65% to 100% of the outstanding stock of our
material foreign subsidiaries.
In October 2003, we repurchased approximately 10.8 million shares of Class A
common stock from certain members of our original stockholder group for
approximately $141.6 million, which includes $1.6 million of related expenses.
These stockholders also sold approximately 6.2 million additional shares of
Class A common stock to third party investors. The transaction also included the
agreement among all participants in the transaction to convert all of their
remaining shares of super-voting Class B common stock to Class A
[44]
common stock and their agreement not to sell shares on the open market for two
years subject to certain exceptions. We financed the repurchase with $45.0
million from existing cash balances, approximately $20.0 million from our
revolving credit facility, which was repaid prior to December 31, 2003, and
$75.0 million in new long-term debt drawn under the $125.0 million shelf
facility. The terms and conditions of the repurchase were approved by a special
committee of our board of directors comprised solely of independent directors.
The special committee engaged its own financial and legal advisors in connection
with the repurchase transaction.
Since August 1998, our board of directors has authorized us to repurchase up to
$90.0 million of our outstanding shares of Class A common stock. The repurchases
are used primarily to fund our equity incentive plans. During the year ended
December 31, 2003, in addition to the transaction referenced above, we
repurchased approximately 0.8 million shares of Class A common stock for an
aggregate amount of approximately $8.4 million. Between August 1998 and December
31, 2003, we had repurchased a total of approximately 8.7 million shares of
Class A common stock for an aggregate price of approximately $81.6 million.
During each quarter of 2003, our board of directors declared cash dividends of
$0.07 per share for all classes of common stock. These quarterly cash dividends
totaled approximately $21.9 million and were paid during 2003 to stockholders of
record in 2003. On January 28, 2004, the board of directors declared a dividend
to be paid in March 2004 of $0.08 per share for all classes of common stock. In
addition, 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. Assuming a quarterly dividend
declaration of $0.08 per share in 2004, dividends for the year will total
approximately $24.0 million. 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.
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 together with future cash flows from operations will be adequate to
fund our cash needs. 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. Within the past year, however, fixed costs
associated with our retail store expansion in Mainland China and our manufacture
of Pharmanex BioPhotonic Scanners have increased our capital needs beyond our
historical business model. 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 and a reduction in the level of stock repurchases
or dividend payments.
The following table sets forth payments due by period for fixed contractual
obligations as of December 31, 2003 (U.S. dollars in thousands):
Total 2004 2005-2006 2007-2008 Thereafter
Long-term debt obligations $ 165,403 $ 17,915 $ 45,830 $ 55,830 $ 45,828
Capital lease obligations -- -- -- -- --
Operating lease obligations(1) 60,358 11,088 21,080 18,861 9,329
Purchase obligations(2) 61,651 36,235 17,002 1,894 6,520
Other long-term liabilities
reflected on balance sheet(3) -- -- -- -- --
Total $ 287,412 $ 65,238 $ 83,912 $ 76,585 $ 61,677
(1) Operating leases includes 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 $3.3
million for the year ended December 31, 2003 with remaining long-term
obligations under these leases of $27.3 million.
(2) The Company is also party to acquisition agreements pursuant to which
contingent payments of up to $8.5 million and 1.2 million shares of the
Company's Class A common stock may be made if certain development and
revenue targets are met.
(3) Other long-term liabilities reflected on the balance sheet primarily consist
of long-term tax related balances, which totaled $52.8 million as of
December 31, 2003.
[45]
SEASONALITY
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 month of August, which is in our third quarter, when many
individuals, including our distributors, traditionally take vacations.
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 during the
three months ended as of the date indicated. An executive distributor is an
active distributor who has achieved required monthly personal and group sales
volumes.
As of December 31, As of December 31, As of December 31,
2001 2002 2003
Active Executive Active Executive Active Executive
North Asia 319,000 16,891 322,000 17,668 321,000 17,013
Greater China(1) 74,000 2,698 73,000 3,564 187,000 5,991
North America 76,000 2,419 73,000 2,693 70,000 2,861
South
Asia/Pacific 63,000 1,842 66,000 2,972 68,000 2,175
Other Markets 26,000 989 32,000 1,018 32,000 1,091
Total 558,000 24,839 566,000 27,915 678,000 29,131
(1) Following the opening of our retail business in Mainland China during 2003,
active distributors includes 117,000 preferred customers and executive
distributors includes 3,100 employed, full-time sales representatives.
QUARTERLY RESULTS
The following table sets forth selected unaudited quarterly data for the periods
shown:
2002 2003
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
(U.S. dollars in millions, except per share amounts)
Revenue $ 216.1 $ 244.9 $ 252.9 $ 250.2 $ 219.6 $ 240.7 $ 250.2 $ 275.9
Gross profit 172.0 196.3 203.2 201.7 178.0 195.4 206.5 230.0
Operating
income 20.5 30.4 25.9 29.0 19.7 25.7 24.5 37.4
Net income 12.9 18.0 15.9 18.0 12.8 16.8 15.1 23.1
Net income per
share:
Basic 0.16 0.22 0.20 0.22 0.16 0.21 0.19 0.32
Diluted 0.16 0.22 0.19 0.22 0.16 0.21 0.19 0.31
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." We have adopted this standard and it did not have a
significant effect on our financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which is effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. We have adopted this standard and it did not
have a significant effect on our financial statements.
[46]
In December 2003, the FASB issued Interpretation No. 46R, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51." This accounting
standard will become effective beginning with the first quarter of 2004. We do
not believe the adoption of this standard will have a significant effect on our
financial statements.
CURRENCY RISK AND EXCHANGE RATE INFORMATION
A majority of our revenue and many of our expenses are recognized primarily
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 subsidiary's 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. Media reports have
indicated that the Chinese government may begin to allow the RMB to float more
freely against the U.S. dollar and other major currencies. A strengthening of
the RMB would benefit our reported revenue and profits and a weakening of the
RMB would negatively impact reported revenue and profits. Given the uncertainty
of exchange rate fluctuations, we cannot estimate the effect of these
fluctuations on our future business, product pricing, and results of operations
or financial condition.
We 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.
Our foreign currency derivatives are comprised of over-the-counter forward
contracts with major international financial institutions. As of December 31,
2003, we had $64.3 million of these contracts with expiration dates through
December 2004. All of these contracts were denominated in Japanese yen. For the
year ended December 31, 2003, we recorded losses of $5.3 million in operating
income, and losses of $3.2 million, net of tax, in other comprehensive income
related to the fair market valuation of our outstanding forward contracts.
Because of our foreign exchange contracts at December 31, 2003, the impact of a
10% appreciation or 10% depreciation of the U.S. dollar against the Japanese yen
would not represent a material potential loss in fair value, earnings or cash
flows against these contracts. This potential loss does not consider the
underlying foreign currency transaction or translation exposures to which we are
subject.
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:
2002 2003
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Japan(1) 132.5 126.9 119.3 122.3 118.9 118.5 117.3 108.7
Taiwan 35.0 34.4 33.9 34.8 34.6 34.7 34.2 34.0
Hong Kong 7.8 7.8 7.8 7.8 7.8 7.8 7.8 7.8
South Korea 1,314.9 1,261.4 1,192.2 1,217.8 1,200.2 1,208.7 1,174.6 1,182.1
Singapore 1.8 1.8 1.8 1.8 1.7 1.8 1.8 1.7
Malaysia 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8
Thailand 43.7 42.7 42.1 43.4 42.8 42.2 41.3 39.8
China(2) -- -- -- -- 8.3 8.3 8.3 8.3
(1) As of February 27, 2004 the exchange rate of U.S. $1 into the Japanese yen
was approximately 109.0.
(2) We commenced retail operations in Mainland China in January 2003.
[47]
NOTE REGARDING FORWARD-LOOKING STATEMENTS
With the exception of historical facts, the statements contained in Management's
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 (the "Reform Act") 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 belief that existing cash and cash flow from operations will be
adequate to fund cash needs;
• the expectation that we will spend $30 million to $35 million for
capital expenditures during 2004 including approximately $15 million to
$20 million for purchases of additional scanners;
• the anticipation that we will continue to declare quarterly cash
dividends and that cash will be sufficient to pay future dividends;
• our belief that additional expenses related to the transition of some of
our nutritional supplements to tablet form in response to recent
Japanese regulatory actions will not have a material impact on our
overall projected 2004 financial results, and our expectation that all
of our key Pharmanex products will remain in stock in Japan;
• our belief that we can market the scanner as a non-medical device; and
• our belief that the sale of our PEO and other modifications to our Big
Planet strategy as well as our self-manufacturing in China will continue
to have a positive impact on gross and operating margins.
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 in our Annual Report on Form
10-K (which contains 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. 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) Our expansion of operations in Mainland China is subject to risks and
uncertainties. We have been subject to significant regulatory scrutiny and
have experienced challenges including interruption of sales activities at
certain stores and minor fines being paid in several cases. Because of
restrictions on direct selling activities, we have implemented a modified
business model for this market using retail stores and an employed sales
force. We have at times received guidance from local regulators on
conducting our operations including limiting the size of our training
meetings, controlling the activities of our sales employees, controlling the
distribution of product outside of our stores, keeping the number of sales
employees at reasonable levels and limiting the involvement of our overseas
distributors. While we continuously update our operating model to address
these concerns, we believe we could experience similar challenges in the
future as we expand operations in Mainland China and continue to work with
regulators to help them understand our business model. Our operations in
Mainland China may be modified or otherwise harmed by regulatory changes,
subjective interpretations of laws or an inability to work effectively with
national and local government agencies. In addition, actions by overseas
distributors or local sales employees in violation of local laws could harm
our efforts.
(b) As with any new technology, we have experienced technical, production
and cost issues in developing the Pharmanex BioPhotonic Scanner. In
addition, the FDA has questioned its status as a non-medical device, and
we are facing similar uncertainties and regulatory issues in other
markets, including Japan, with respect to the status of the scanner as a
non-medical device, which could delay
[48]
or negatively impact our plans for the scanner in these markets. If the
full launch or use of this tool is delayed or otherwise inhibited by
production or development issues, or if the FDA or other domestic or
foreign government agency takes formal action to prevent us from
distributing the scanner as a non-medical device, this could delay our
distribution of the scanner and harm our business.
(c) Because a substantial majority of our sales are generated in Asia,
particularly Japan, significant variations in operating results
including revenue, gross margin and earnings from those expected could
be caused by:
• renewed or sustained weakness of Asian economies or consumer confidence;
• weakening of foreign currencies, particularly the Japanese yen;
• political unrest or uncertainty;
• failure of planned initiatives to generate continued interest and
enthusiasm among distributors in these markets or to attract new
distributors; or
• any problems with our expansion of operations in Mainland China into
new cities, increasing product offerings and attracting additional
sales representatives.
(d) 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. Recent negative publicity concerning
stimulant-based supplements 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 changes in regulations applicable to our business, our revenue
and profitability may be harmed.
(e) There is uncertainty whether the SARS epidemic or other communicable
diseases could return this winter, particularly in those Asian markets
most affected by the epidemic earlier in 2003. It is difficult to
predict the impact, if any, of a recurrence of SARS on our business.
Although such an event could generate increased sales of health/immune
supplements and personal care products, our direct selling and retail
activities and results of operations could be harmed if the fear of SARS
causes people to avoid public places and interaction with one another.
(f) Many countries have banned the importation of products that contain
bovine materials sourced from locations where Bovine Spongiform
Encephalopathy (BSE), commonly referred to as "mad cow disease", has
been identified. The recent discovery of BSE in a single cow in the
United States prompted Japan and certain other countries to ban the
importation of bovine products, including supplements encapsulated in
bovine-sourced capsules. In the event we are unable to successfully
continue meeting product demand with non-bovine capsules or tablets in
these markets as a result of supply issues or production problems, or if
we experience quality problems, this could harm our 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 products do not generate sufficient
enthusiasm and economic incentive to retain our existing distributors or
to sponsor new distributors on a sustained basis.
[49]
NU SKIN ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share amounts)
December 31,
2002 2003
ASSETS
Current assets
Cash and cash equivalents $ 120,341 $ 122,568
Accounts receivable 18,914 15,054
Inventories, net 88,306 83,338
Prepaid expenses and other 48,878 53,777
276,439 276,737
Property and equipment, net 55,342 60,528
Goodwill 118,768 118,768
Other intangible assets, net 69,181 67,572
Other assets 92,108 100,142
Total assets $ 611,838 $ 623,747
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 17,992 $ 18,816
Accrued expenses 77,808 96,438
Current portion of long-term debt -- 17,915
95,800 133,169
Long-term debt 81,732 147,488
Other liabilities 47,820 52,842
Total liabilities 225,352 333,499
Stockholders' equity
Class A common stock - 500,000,000 shares
authorized, $.001 par
value, 35,707,785 and 70,700,497 shares
issued and outstanding 36 71
Class B common stock - 100,000,000 shares
authorized, $.001 par
value, 45,362,854 and 6,466 shares
issued and outstanding 45 --
Additional paid-in capital 69,803 (68,191 )
Accumulated other comprehensive loss (68,988 ) (70,849 )
Retained earnings 385,590 431,615
Deferred compensation -- (2,398 )
386,486 290,248
Total liabilities and
stockholders' equity $ 611,838 $ 623,747
The accompanying notes are an integral part of these consolidated financial
statements.
[50]
NU SKIN ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except per share amounts)
Year Ended December 31,
2001 2002 2003
Revenue $ 885,621 $ 964,067 $ 986,457
Cost of sales 178,083 190,868 176,545
Gross profit 707,538 773,199 809,912
Operating expenses:
Selling expenses 347,452 382,159 407,088
General and administrative
expenses 288,605 285,229 289,925
Restructuring and other
charges -- -- 5,592
Total operating expenses 636,057 667,388 702,605
Operating income 71,481 105,811 107,307
Other income (expense), net 8,380 (2,886 ) 432
Income before provision for income
taxes 79,861 102,925 107,739
Provision for income taxes 29,548 38,082 39,863
Net income $ 50,313 $ 64,843 $ 67,876
Net income per share:
Basic $ 0.60 $ 0.79 $ 0.86
Diluted $ 0.60 $ 0.78 $ 0.85
Weighted average common shares
outstanding (000s):
Basic 83,472 81,731 78,637
Diluted 83,915 83,128 79,541
The accompanying notes are an integral part of these consolidated financial
statements.
[51]
NU SKIN ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(U.S. dollars in thousands, except share amounts)
Accumulated
Class A Class B Other Total
Common Common Additional Comprehensive Retained Deferred Stockholders'
Stock Stock Paid-In Capital Loss Earnings Compensation Equity
Balance at January 1, 2001 $ 31 $ 54 $ 106,284 $ (45,347 ) $ 306,458 $ (747 ) $ 366,733
Net income -- -- -- -- 50,313 -- 50,313
Foreign currency
translation adjustments -- -- -- (8,298 ) -- -- (8,298 )
Net unrealized gains on
foreign currency cash flow
hedges -- -- -- 8,776 -- -- 8,776
Net gain reclassified into
current earnings -- -- -- (4,616 ) -- -- (4,616 )
Total comprehensive income 46,175
Repurchase of 2,491,000
shares of Class A common
stock (3 ) -- (18,136 ) -- -- -- (18,139 )
Conversion of shares 5 (5 ) -- -- -- -- --
Amortization of deferred
compensation -- -- -- -- -- 747 747
Exercise of distributor and
employee stock options -- -- 805 -- -- -- 805
Cash dividends -- -- -- -- (16,431 ) -- (16,431 )
Balance at December 31,
2001 33 49 88,953 (49,485 ) 340,340 -- 379,890
Net income -- -- -- -- 64,843 -- 64,843
Foreign currency
translation adjustments -- -- -- (10,031 ) -- -- (10,031 )
Net unrealized losses on
foreign currency cash flow
hedges -- -- -- (6,567 ) -- -- (6,567 )
Net gain reclassified into
current earnings -- -- -- (2,905 ) -- -- (2,905 )
Total comprehensive income 45,340
Repurchase of 1,682,000
shares of Class A common
stock
(Notes 3 and 10) (1 ) -- (20,585 ) -- -- -- (20,586 )
Conversion of shares 4 (4 ) -- -- -- -- --
Purchase of long-term
assets -- -- 936 -- -- -- 936
Exercise of distributor and
employee stock options -- -- 1,261 -- -- -- 1,261
Forfeiture of stock options -- -- (762 ) -- -- -- (762 )
Cash dividends -- -- -- -- (19,593 ) -- (19,593 )
Balance at December 31,
2002 36 45 69,803 (68,988 ) 385,590 -- 386,486
Net income -- -- -- -- 67,876 -- 67,876
Foreign currency
translation adjustments -- -- -- (1,736 ) -- -- (1,736 )
Net unrealized losses on
foreign currency cash flow
hedges -- -- -- (3,171 ) -- -- (3,171 )
Net loss reclassified into
current earnings -- -- -- 3,046 -- -- 3,046
Total comprehensive income 66,015
Repurchase of 11,622,000
shares of Class A common
stock
(Note 10) (12 ) -- (149,997 ) -- -- -- (150,009 )
Conversion of shares 45 (45 ) -- -- -- -- --
Issuance of employee stock
awards -- -- 3,113 -- -- (3,113 ) --
Amortization of deferred
compensation -- -- -- -- -- 715 715
Exercise of distributor and
employee stock options 2 -- 8,890 -- -- -- 8,892
Cash dividends -- -- -- -- (21,851 ) -- (21,851 )
Balance at December 31,
2003 $ 71 $ -- $ (68,191 ) $ (70,849 ) $ 431,615 $ (2,398 ) $ 290,248
The accompanying notes are an integral part of these consolidated financial
statements.
[52]
NU SKIN ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
Year Ended December 31,
2001 2002 2003
Cash flows from operating activities:
Net income $ 50,313 $ 64,843 $ 67,876
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and
amortization 31,679 21,602 22,369
Amortization of deferred
compensation 747 -- 715
(Gain)/loss on sale of
assets (2,328 ) (1,328 ) 525
Changes in operating
assets and liabilities:
Accounts receivable (1,127 ) 404 3,860
Related parties
receivable 215 5,971 --
Inventories, net (2,240 ) (4,051 ) 4,968
Prepaid expenses
and other (891 ) (3,674 ) 11,714
Other assets 8,491 12,473 (7,9 |