UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549
(Mark One)
Commission File Number: 011-12421
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes x No ¨
As of May 1, 2004, 71,478,517 shares of the registrant’s Class A common stock, $.001 par value per share and no shares of the registrant’s Class B common stock were outstanding.
Nu Skin, Pharmanex and Big Planet are trademarks of Nu Skin Enterprises, Inc. or its subsidiaries.
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NU SKIN ENTERPRISES, INC. Consolidated Balance Sheets(in thousands, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
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NU SKIN ENTERPRISES, INC. Consolidated Statements of Income (Unaudited)(in thousands, except per share amounts)
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NU SKIN ENTERPRISES, INC. Consolidated Statements of Cash Flows (Unaudited)(in thousands)
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NU SKIN ENTERPRISES, INC. Notes to Consolidated Finanical Statements
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The following Management’s Discussion and Analysis should be read in conjunction with Management’s Discussion and Analysis included in our Annual Report on Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission (“SEC”) on March 15, 2004, and our other filings, including Current Reports on Form 8-K, filed with the SEC through the date of this report.
Overview
Revenue for the three-month period ended March 31, 2004 increased 20.2% to $264.0 million from $219.6 million for the same period in 2003. Excluding the impact of changes in foreign currency exchange rates, we would have experienced a revenue increase of 14.2% for the three-month period ended March 31, 2004 compared to the same period in 2003. This resulted from strong momentum in Mainland China, growth in the U.S. nutrition business and continued stability in Japan in spite of the challenges associated with the Bovine Spongiform Encephalopathy (“BSE”) issue (commonly referred to as “mad cow disease”) as discussed below. These factors were partially offset by the sale of our professional employer organization (“PEO”) in the United States in August 2003 and our transition away from certain Big Planet offerings, both of which occurred as part of our continued efforts to eliminate low margin products and services. Although these actions negatively impacted first quarter 2004 to first quarter 2003 revenue comparisons by $5.0 million, they positively impacted gross and operating margins during the quarter. Earnings per share for the three-month period ended March 31, 2004 increased 25.0% to $0.20 from $0.16 for the same period in 2003. In addition to the factors noted above impacting revenue and gross and operating margins, 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.
Revenue
North Asia. The following table sets forth revenue for the three-month periods ended March 31, 2004 and 2003 for the North Asia region and its principal markets (in millions):
Growth in revenue during the quarter resulted primarily from favorable currency exchange rates and strong growth in South Korea. Excluding the impact of changes in foreign currency exchange rates, revenue in North Asia increased 3% in the first quarter of 2004 compared to the same period in 2003. In local currency, revenue in Japan increased 1% in the first quarter of 2004 compared to the same period in 2003. In local currency, revenue in South Korea increased 15% in the first quarter of 2004 compared to the same period in 2003. The growth in revenue in South Korea was due to the strength in active distributors, which primarily resulted from a management change in that market in September 2003.
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Greater China. The following table sets forth revenue for the three-month periods ended March 31, 2004 and 2003 for the Greater China region and its principal markets (in millions):
Revenue in Greater China increased primarily as a result of the continued sequential growth following the early 2003 expansion of operations in Mainland China. Foreign currency fluctuations from 2003 to 2004 did not have a notable impact on this region. On a sequential basis, revenue in Mainland China increased 27% from the fourth quarter of 2003 to the first quarter of 2004. This growth is attributed to an increased number of preferred customers and employed sales representatives in Mainland China as well as the opening of new cities and stores in December 2003 and January 2004. 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 until the new direct selling laws and regulations are published, which is anticipated to occur late in 2004. 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.
Hong Kong reached record sales during the first quarter of 2004 with revenue up approximately 40% over the same prior year period. This increase in revenue in Hong Kong resulted from the influence of the strong momentum in Mainland China as well as our success in growing monthly product subscription orders in this market.
North America. The following table sets forth revenue for the three-month periods ended March 31, 2004 and 2003 for the North America region and its principal markets (in millions):
The increase in revenue in the United States was a result of $5.8 million of sales to international distributors attending the U.S. convention as well as strong growth in our nutrition business. These revenue increases were partially offset by the inclusion in the first quarter of 2003 of $5.0 million of sales from Big Planet products and services that were eliminated in the third quarter of 2003. Pharmanex sales in the United States, excluding convention sales to international distributors, increased 40% due to increased distributor activity tied to our focus on increasing consumer participation in monthly reorder programs, the Pharmanex® BioPhotonic Scanner program, the introduction of new weight management products and the implementation of distributor leadership incentives. Sales of LifePak®, Pharmanex’s flagship product, increased
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119% in the United States over the same prior year period, partially due to monthly reorder programs. Nu Skin revenue declined slightly during the quarter as a result of our placing greater focus on Pharmanex products. Our executive distributor count grew by 14% in the United States over the same prior year quarter.
South Asia/Pacific. The following table sets forth revenue for the three-month periods ended March 31, 2004 and 2003 for the South Asia/Pacific region and its principal markets (in millions):
This increase in revenue in this region was due primarily to continued growth in Thailand, with local currency revenue up 39% over the same prior year quarter. Changes in foreign currency exchange rates also positively impacted 2004 revenue comparisons. Excluding the impact of changes in foreign currency exchange rates, revenue in South Asia/Pacific increased 2% during the three-month period ended March 31, 2004 compared to the same period in 2003. These factors were somewhat offset by the decrease in revenue from Singapore and Malaysia.
Other Markets. The following table sets forth revenue for the three-month periods ended March 31, 2004 and 2003 for our Other Markets (in millions):
This increase was primarily due to the increase in revenue in Europe, which included a 10% favorable impact of currency fluctuations in 2004 compared to 2003.
Gross profit
Gross profit as a percentage of revenue increased to 83.4% for the three-month period ended March 31, 2004 from 81.1% for the same period in 2003. Our gross profit was positively impacted by the shift away from low margin Big Planet and PEO revenue to higher margin Nu Skin and Pharmanex products, strong gross margins in Mainland China resulting from in-house manufacturing, as well as the positive impact of fluctuations in foreign currency in 2004 compared to the same prior year period. We anticipate these factors will continue to positively impact gross profit throughout 2004 with gross margins expected to range from 83.5% to 84.0% in 2004.
In late December 2003, we received notification that Japanese and South Korean regulators had suspended the importation of nutritional supplements in bovine-based capsules from the United States, which includes most of our Pharmanex products, as a result of the
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discovery of BSE in a single cow in the United States. In January 2004, Japanese regulators also determined they would no longer allow these same products to be sold by nutrition companies after February 16, 2004. During the quarter, we successfully transitioned our production of Pharmanex products for Japan to non-bovine capsules and tablets. These measures resulted in some additional expenses for production costs, inventory write-offs and expedited shipping fees during the first quarter of 2004, which totaled approximately $1.5 million. We also had some outages of products during the quarter.
Selling expenses
Selling expenses as a percentage of revenue increased to 42.7% for the three-month period ended March 31, 2004 from 40.1% for the same period in 2003. In U.S. dollars, selling expenses increased to $112.6 million for the three-month period ended March 31, 2004 from $88.0 million for the same period in 2003. The decline in revenue from Big Planet products and services, which pay lower commissions than our personal care and nutritional supplement product categories, as well as higher costs associated with our employed sales representatives in Mainland China contributed to the increase in selling expenses, as a percentage of revenue, in the first quarter of 2004. We currently pay approximately 7.0% to 9.0% of local revenue in additional labor costs, including unemployment and benefits, associated with our employed sales force in Mainland China, which is more than offset by better gross margins and lower general and administrative expenses. We anticipate these factors will continue to impact our selling expenses throughout the remainder of 2004 with selling expenses expected to range from 42.5% to 43.0% of revenue during the remainder of 2004.
General and administrative expenses
General and administrative expenses as a percentage of revenue decreased to 31.7% for the three-month period ended March 31, 2004 from 32.0% for the same period in 2003. In U.S. dollars, general and administrative expenses increased to $83.6 million for the three-month period ended March 31, 2004 from $70.3 million for the same period in 2003. Overall, general and administrative expenses improved slightly as a percent of revenue despite expenses of approximately $6.0 million associated with the U.S. distributor convention in the first quarter of 2004 verses expenses of approximately $4.0 million related to a Japan convention in the first quarter of 2003. The U.S. dollar increase in general and administrative expenses is due to the incremental costs associated with significantly larger retail operations in Mainland China versus the prior year, convention expenses and much stronger foreign currencies against the U.S. dollar.
Other income (expense), net
Other income (expense), net decreased approximately $1.4 million for the three-month period ended March 31, 2004 to a loss of $0.9 million compared to the same period in 2003. Fluctuations in other income (expense), net are impacted by 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 and interest expense. For the first quarter of 2004, interest expense was $1.5 million and we anticipate incurring approximately $1.5 million during each of the remaining quarters of 2004.
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Provision for income taxes
Provision for income taxes increased to $8.5 million for the three-month period ended March 31, 2004 compared to $7.5 million for the same period in 2003. The effective tax rate remained at 37.0% of pre-tax income during the first quarter of 2004, consistent with the rate in the same prior year period.
Net income
As a result of the foregoing factors, net income increased to $14.5 million for the three-month period ended March 31, 2004 compared to $12.8 million for the same period in 2003.
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 $17.4 million in cash from operations during the three-month period ended March 31, 2004 compared to $0.6 million during the three months ended March 31, 2003. The increase in cash generated from operations during the three months ended March 31, 2004 is primarily related to the reduction in income tax payments resulting from the utilization of foreign tax credits. The increase in cash generated from operations was negatively impacted by the increase in inventory purchases during the first quarter of 2004 to support Mainland China growth as well as our transition to new products in Japan due to the BSE issue. We currently do not foresee any additional shipping costs or material inventory write-offs related to the BSE issue in Japan and South Korea.
As of March 31, 2004, working capital was $170.9 million compared to $149.3 million as of December 31, 2003. Cash and cash equivalents at March 31, 2004 and December 31, 2003 were $135.4 million and $122.6 million, respectively. This increase in cash balances and working capital was primarily due to the increase in cash flows from operations.
Capital expenditures, primarily for equipment, including the Pharmanex® BioPhotonic Scanner, computer systems and software, office furniture and leasehold improvements, were $5.9 million for the three-month period ended March 31, 2004. In addition, we anticipate capital expenditures during the remainder of 2004 of approximately $25 million to $30 million to further enhance our infrastructure, which includes approximately $10 million for enhancements to computer systems and software and further expansion of our retail stores as well as manufacturing and related infrastructure in Mainland China. The remaining projected capital expenditures of approximately $15 million to $20 million relate to purchases of additional Pharmanex® BioPhotonic Scanners, which we lease to our distributors.
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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. In anticipation of the expiration of the revolving credit facility on May 10, 2004, we recently selected Bank One for a $25.0 million three-year revolving credit facility under substantially the same terms as the previous credit facility. Bank One will be the sole lender under the revolving credit facility and will also act as agent. As of March 31, 2004, there were no outstanding balances under our revolving credit facility.
In August 2003, we entered into a $125.0 million multi-currency private uncommitted shelf facility with Prudential Investment Management, Inc. As of March 31, 2004, 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. This long-term debt is U.S. dollar denominated, bears interest of approximately 4.5% per annum and is amortized in two tranches over five and seven years.
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 March 31, 2004, the outstanding balance on the notes was 9.7 billion Japanese yen, or $79.7 million, $13.3 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 or by pledges of 65% to 100% of the outstanding stock of our material subsidiaries.
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 three-month period ended March 31, 2004 we did not repurchase any shares of our Class A common stock. As of March 31, 2004, 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.
In January 2004, our board of directors declared a quarterly cash dividend of $0.08 per share for all classes of common stock. This quarterly cash dividend of $5.8 million was paid on March 24, 2004 to stockholders of record on March 5, 2004. We anticipate that our board of directors will continue to declare quarterly cash dividends and that the cash flows from operations will be sufficient to fund our future dividend payments. However, the 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 from our historical business model. In the event that our current cash balances, future cash flow from operations and current lines of credit are
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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, the level of stock repurchases or dividend payments.
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 5.0% 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” distributors 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 March 31, 2004, we have net deferred tax assets of $64.1 million. We have netted these deferred tax assets and deferred tax liabilities by jurisdiction as of March 31, 2004 and reclassified prior period balances to conform to the March 31, 2004 presentation. 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 asset in the future, an adjustment to the deferred tax asset would be charged to earnings in the period such determination was made.
Intangible Assets. Under the provisions of SFAS No. 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 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.”
We are required to make judgments regarding the useful life 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 No. 141, “Business
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Combinations” and SFAS No. 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 ongoing 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 our cash flow from operations.
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.
The following table provides information concerning the number of active and executive distributors as of the dates indicated. Active distributors are those distributors and preferred customers who were resident in the countries in which we operated and purchased products for resale or personal consumption directly from us during the three months ended as of the date indicated. An executive distributor is an active distributor who has achieved required monthly personal and group sales volumes.
Active distributors include preferred customers and distributors purchasing products directly from us during the quarter.
Following the opening of our retail business in Mainland China during 2003, active distributors include 138,000 and 31,000 preferred customers in Mainland China and executive distributors include 4,329 and 416 employed, full-time sales representatives for the quarters ended March 31, 2004 and 2003, respectively.
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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 March 31, 2004, we had $82.4 million of these contracts with expiration dates through February 2005. All of these contracts were denominated in Japanese yen. For the three-month period ended March 31, 2004, we recorded pre-tax losses of $2.7 million in operating income, all of which were offset against our revenue in Japan, and losses of $1.5 million, net of tax, in other comprehensive income related to the fair market valuation of our outstanding forward contracts. Based on our foreign exchange contracts at March 31, 2004, 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.
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:
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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 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:
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The information required by Item 3 of Part I of Form 10-Q is incorporated herein by reference from the section entitled “Currency Risk and Exchange Rate Information” in “Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part I and also in Note 5 to the Financial Statements contained in Item 1 of Part I.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated Subsidiaries) required to be included in the reports we file or submit under the Exchange Act.
During the most recent fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
None.
We have authorized the repurchase of shares acquired by our employees and distributors in certain Asian markets because of regulatory and other issues that make it difficult and costly for these persons to sell such shares in the open market. These shares were awarded or acquired in connection with our initial public offering in 1996. All of the shares listed in this column relate to repurchases from such employees and distributors.
In August 1998, our board of directors approved a plan to repurchase $10.0 million of our Class A common stock in open market transactions. Our board has from time to time increased the amount authorized under the plan and a total amount of $90.0 million is currently authorized. To date, we have repurchased approximately $81.6 million of shares under the plan and during the first quarter of 2004 we made no repurchases under the plan. There has been no termination or expiration of the plan since the initial date of approval.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 10, 2004
By: /s/ Ritch N. Wood Ritch N. WoodIts: Chief Financial Officer (Principal Financial and Accounting Officer)
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