UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549
(Mark One)
Commission File Number: 001-12421
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 No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer Accelerated filer Non-accelerated filer (Do not check if a smaller reporting company) Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of April 30, 2008, 63,580,490 shares of the registrant’s Class A common stock, $.001 par value per share, were outstanding.
Nu Skin, Pharmanex and Big Planet are trademarks of Nu Skin Enterprises, Inc. or its subsidiaries. The italicized product names used in this Quarterly Report on Form 10-Q are product names, and also, in certain cases, our trademarks.
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NU SKIN ENTERPRISES, INC. Consolidated Balance Sheets (Unaudited)(U.S. dollars in thousands)
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)(U.S. dollars in thousands, except per share amounts)
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NU SKIN ENTERPRISES, INC. Consolidated Statements of Cash Flows (Unaudited)(U.S. dollars in thousands)
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NU SKIN ENTERPRISES, INC. Notes to Consolidated Financial Statements
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Each of the credit facilities and arrangements listed in the table are secured by guarantees issued by the Company’s material domestic subsidiaries and by pledges of 65% of the outstanding stock of the Company’s material foreign subsidiaries.
The current portion of the Company’s long-term debt (i.e. becoming due in the next 12 months) is $33.4 million and includes $13.9 million of the balance on the Company’s 2000 Japanese yen denominated notes, $4.5 million of the balance of the Company’s Japanese yen denominated debt under the 2003 multi-currency uncommitted shelf facility and $15.0 million of the balance on the Company’s U.S. dollar denominated debt under the 2003 multi-currency uncommitted shelf facility.
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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, 2007 filed with the Securities and Exchange Commission (“SEC”) on February 29, 2008, and our other filings, including Current Reports on Form 8-K, filed with the SEC through the date of this report.
Our revenue for the three-month period ended March 31, 2008 increased 9% to $298.1 million compared to the same period in 2007. Foreign currency exchange rate fluctuations positively impacted revenue by 6%. In addition, solid year-over-year growth in South Korea, the United States, Europe, Hong Kong and our South Asia/Pacific region also contributed to the increase in revenue. During the quarter we saw strong results in our personal care product line, including the continued demand for the Galvanic Spa System II as well as the Tru Face Essence line, which helped fuel the year-over-year improvement in many of our markets. These gains were partially offset by a larger than anticipated decline in local currency revenue in Japan as well as continued softness in China.
Earnings per share for the first quarter of 2008 were $0.21, compared to $0.16 for the same period in 2007. The increase in earnings is largely due to our business transformation initiatives, which have resulted in lower general and administrative expenses, as well as the overall increase in revenue. First quarter 2008 earnings were negatively impacted by a foreign currency translation loss of $4.5 million primarily related to the translation of our Japanese yen denominated debt into U.S. dollars, as the yen strengthened from 111.5 yen per U.S. dollar at the beginning of the year to 99.7 at the end of the quarter, an 11% change. Earnings per share were positively impacted approximately 5% as a result of our repurchases of stock during the past 12 months under our stock repurchase program.
Revenue
North Asia. The following table sets forth revenue for the three-month periods ended March 31, 2008 and 2007 for the North Asia region and its principal markets (U.S. dollars in millions):
Foreign currency exchange rate fluctuations positively impacted revenue in the region by approximately 9%.
Local currency revenue in Japan declined 10% for the three month period ended March 31, 2008 compared to the same period in 2007. We believe the larger than anticipated local currency decline can be attributed to several factors. First, we experienced a decline of 7% and 10% in active and executive distributors, respectively, as a result of continued weakness in sponsoring activity due in part to the environmental factors described below. Second, we also ran more limited product promotions in the first quarter than we had been running in past quarters. In addition, we also held a convention in Japan the first quarter of last year which positively impacted the prior-year period. The Japan convention is being held in the second quarter this year. Finally, regulatory scrutiny of the industry has increased. In the first quarter, the Japanese government took regulatory action against one of the largest direct selling companies and prohibited them from signing up new distributors for three months. This sanction attracted media attention in Japan. In response to this increased scrutiny and a higher level of complaints to consumer centers related to the activities of some of our distributors, we are taking additional steps to increase our focus on distributor compliance and ensure that our distributors understand and comply with our policies. It appears these issues have had a negative impact on the market and our distributor’s sponsoring activity.
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In the second quarter, we have a distributor convention where we will introduce several initiatives and products, including LifePak nano and Tru Face Essence Plus, both enhanced reformulations of our top selling products that have been successful in the United States where they were first launched. We will also unveil plans for a new anti-aging platform that we plan to introduce in the fourth quarter.
South Korea continues to post solid growth as our initiatives and product introductions have contributed to a strong sponsoring environment for our distributors and significant growth in the number of our distributor leaders. The number of active distributors increased 29% and the number of executive distributors increased 27% compared to the prior year period. The growth in this market was positively impacted by the very successful launch ofEstera, a Pharmanex product designed for women’s health.
Greater China. The following table sets forth revenue for the three-month periods ended March 31, 2008 and 2007 for the Greater China region and its principal markets (U.S. dollars in millions):
Foreign currency exchange rate fluctuations positively impacted revenue by approximately 5% in this region during the first quarter of 2008. Active distributors decreased 11% and executive distributors decreased 5% in the region,
On a local currency basis, revenue in Mainland China decreased 12% in the first quarter of 2008 compared to the same period in 2007. We believe the decline is largely attributed to continued declines in our preferred customers and employed sales representatives, which declined 19% and 9%, respectively, compared to the prior-year period. Given the regulatory environment in China we continue to be cautious in our promotions and the sales activities of our sales representatives. We also adjusted our store strategy to focus our business around flagship stores in major cities, which resulted in the closure of nearly 70 of our smaller stores in this market in December 2007. Additionally, we modified our business model to engage sales promoters under a service contract as well as offer part-time employment to allow us to provide a supplemental income opportunity to individuals who may not be interested in working full-time. Business model adjustments of this nature are often disruptive to short-term business results.
Local currency revenue in Taiwan was down 2%, and Hong Kong local currency revenue was up 11% on a year-over-year basis in the first quarter of 2008 compared to the same prior-year period. The first quarter executive distributor count in Taiwan was down 1% and the number of active distributors was down 5% when compared to the prior year period, while executive distributors in Hong Kong were down 1% and the active distributors in Hong Kong grew 3%. The increase in revenue in Hong Kong was largely attributed to an increase in personal care sales driven by increased interest in the Galvanic Spa System II.
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Americas. The following table sets forth revenue for the three-month periods ended March 31, 2008 and 2007 for the Americas region and its principal markets (U.S. dollars in millions):
Revenue in the United States continued to be positively impacted by strong growth in the personal care brand. This growth is being driven by strong interest in our Galvanic Spa System II as well as complimentary products such as Tru Face Essence Ultra and Tru Face Line Corrector. Revenue from the sale of the Galvanic Spa System II and related gels increased to approximately $7.5 million in the first quarter of 2008 compared to approximately $0.4 million in the prior-year period. This interest has also driven growth in our distributors, with active distributors in the United States increasing 7% and executive distributors increasing 9% in the first quarter of 2008 compared to the same prior-year period.
On a local currency basis, revenue in Canada and Latin America both increased by approximately 22% over the prior-year period. The growth in Latin America can be attributed largely to our opening of operations in Venezuela, which offset the loss of revenue from Brazil following our decision to close our operations in this market in the second quarter of last year, as well as strength in our Mexico and Central America markets. Similar to the United States, revenue growth in Canada and Latin America are also being driven by the strong sales in our Nu Skin brand personal care products.
Active distributors in the region increased 9% and executive distributors increased 7% compared to the prior year period.
South Asia/Pacific. The following table sets forth revenue for the three-month periods ended March 31, 2008 and 2007 for the South Asia/Pacific region and its principal markets (U.S. dollars in millions):
Foreign currency exchange rate fluctuations positively impacted revenue in South Asia/Pacific by 9% in the first quarter of 2008 compared to the same prior-year period. Steady performances in the majority of our markets within this region contributed to the growth. Successful product launches and initiatives centered around our weight loss products have helped boost revenue in these markets over the last few quarters. In addition, we are seeing increased focus on our personal care products, in particular in Thailand where theGalvanic Spa System II is contributing to the revenue growth in that market. The growth in these markets was offset by the significant decline in Australia/New Zealand which is largely related to a decline in our Big Planet business in these markets. Active distributors in the region decreased 10% and executive distributors increased 1% in the first quarter compared to the same prior-year period.
Europe. The following table sets forth revenue for the three-month periods ended March 31, 2008 and 2007 for Europe (U.S. dollars in millions):
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We experienced growth throughout our European markets in the first quarter. In particular, we benefited from strong distributor activity in Eastern Europe, which includes the markets of Slovakia, Russia, Poland, Hungary, and Romania, where we are expanding our business. We also opened operations in South Africa during the quarter. We believe that our success in Europe is attributable to enthusiasm and alignment of our distributor leaders behind key initiatives, including the Galvanic Spa System II, as well as excitement for expansion in Eastern Europe.
Gross profit
Gross profit as a percentage of revenue increased to 81.8% for the first quarter of 2008 from 81.5% for the same period in 2007, due in part to lower air freight expense as well as a weaker U.S. dollar.
Selling expenses
Selling expenses as a percentage of revenue increased slightly to 42.9% for the first quarter of 2008 from 42.6% for the same period in 2007, but remained level with fourth quarter results.
General and administrative expenses
General and administrative expenses decreased to $88.6 million for the first quarter of 2008 from $89.0 million for the same period in 2007. As a percentage of revenue, general and administrative expenses decreased to 29.7% for the first quarter of 2008 from 32.5% for the same period in 2007. The decrease is attributable primarily to our transformation initiatives which we began implementing in early 2006 to (i) eliminate organizational redundancies, (ii) revamp administrative support functions, (iii) prioritize investments to favor profitable initiatives and markets, and (iv) increase efficiencies in the supply chain process. General and administrative expenses were negatively impacted by approximately $3.8 million as a result of strengthening currencies in our foreign markets.
Other income (expense), net
Other income (expense), net for the first quarter of 2008 was approximately $5.8 million of expense compared to $0.8 million of expense for the same period in 2007. This expense consisted primarily of approximately $1.8 million in interest expense as well as approximately $4.5 million in foreign currency losses largely related to the strengthening of the Japanese yen from 111.5 yen per U.S. dollar at December 31, 2007 to 99.7 at March 31, 2008. We currently have 11.8 billion yen in indebtedness on our balance sheet. We are able to get significantly lower interest rates by borrowing in yen and also use these borrowings to hedge against fluctuations in exchange rates between the yen and the U.S. dollar. We translate these borrowings to the U.S. dollar at the end of each quarter based on the current exchange rate. Because of the significant strengthening of the yen during the quarter, we recorded a loss of $5.5 million in connection with such translation.
Provision for income taxes
Provision for income taxes for the first quarter of 2008 was $8.1 million compared to $6.3 million for the same period in 2007. The effective tax rate was 37.5% of pre-tax income during the first quarter of 2008, compared to a rate of 37.3% in the same prior-year period.
Net income
As a result of the foregoing factors, net income for the first quarter of 2008 increased to $13.5 million from $10.5 million for the same period in 2007.
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Historically, our principal uses of cash have included operating expenses, particularly selling expenses, and working capital (principally inventory purchases), as well as capital expenditures, stock repurchases, dividends, debt repayment and the development of operations in new markets. We have generally relied on cash flow from operations to fund operating activities, and we have at times incurred long-term debt in order to fund strategic transactions and stock repurchases.
We typically generate positive cash flow from operations due to favorable gross margins and the variable nature of selling expenses, which constitute a significant percentage of operating expenses. We generated $14.1 million in cash from operations during the three-month period ended March 31, 2008, compared to $8.2 million during the same period in 2007. This increase in cash generated from operations is due primarily to increased profitability in 2008.
As of March 31, 2008, working capital was $111.4 million, compared to $95.2 million as of December 31, 2007. Cash and cash equivalents at March 31, 2008 and December 31, 2007 were $99.4 million and $92.6 million, respectively. The increase in cash balances was primarily due to improved net income. This increase in cash positively impacted our working capital.
Capital expenditures in the first three months of 2008 totaled $2.7 million, and we anticipate capital expenditures of approximately $20 million to $25 million for 2008. These capital expenditures are primarily related to:
We currently have long-term debt pursuant to various credit facilities and other borrowings. The following table summarizes these long-term debt arrangements as of March 31, 2008:
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Our board of directors has approved a stock repurchase program authorizing us to repurchase our outstanding shares of Class A common stock on the open market or in private transactions. The repurchases are used primarily to offset dilution from our equity incentive plans and for strategic initiatives. During the first quarter of 2008, we did not repurchase any shares of Class A common stock under this program. At March 31, 2008, approximately $89.6 million was available for repurchases under the stock repurchase program.
In February 2008, our board of directors declared a quarterly cash dividend of $0.11 per share for Class A common stock. This quarterly cash dividend of $7.0 million was paid on March 19, 2008 to stockholders of record on February 29, 2008. Currently, we anticipate that our board of directors will continue to declare quarterly cash dividends and that the cash flows from operations will be sufficient to fund our future dividend payments. However, the continued declaration of dividends is subject to the discretion of our board of directors and will depend upon various factors, including our net earnings, financial condition, cash requirements, future prospects and other factors deemed relevant by our board of directors.
We believe we have sufficient liquidity to be able to meet our obligations on both a short- and long-term basis. We currently believe that existing cash balances, future cash flows from operations and existing lines of credit will be adequate to fund our cash needs on both a short- and long-term basis. The majority of our historical expenses have been variable in nature and as such, a potential reduction in the level of revenue would reduce our cash flow needs. In the event that our current cash balances, future cash flow from operations and current lines of credit are not sufficient to meet our obligations or strategic needs, we would consider raising additional funds in the debt or equity markets or restructuring our current debt obligations. Additionally, we would consider realigning our strategic plans, including a reduction in capital spending, stock repurchases or dividend payments.
Due to the international nature of our business, we are subject from time to time to reviews and audits by the foreign taxing authorities of the various jurisdictions in which we conduct business throughout the world. In 1999, we implemented a duty valuation methodology with respect to the importation of certain products into Japan. For purposes of the import transactions at issue, we had taken the position that, under applicable customs law, there was a sale between the manufacturer and our Japan subsidiary, and that customs duties should be assessed on the manufacturer’s invoice. The Valuation Department of the Yokohama customs authorities reviewed and approved this methodology at that time, and it had been reviewed on several occasions by the audit division of the Japan customs authorities since then. In connection with subsequent audits in 2004, the Yokohama customs authorities assessed us additional duties and penalties on these products imported into Japan from October 2002 to October 2004, based on a different valuation methodology than what was previously approved. With respect to the periods under audit, the customs authorities took the position that the relevant import transaction involved a sale between our U.S. affiliate and our Japan subsidiary, rather than a sale between the manufacturer and our Japan subsidiary, and that duties should be assessed on the value of that transaction. We disputed this assessment. We also disputed the amount of duties we were required to pay on products imported from November of 2004 to June of 2005 for similar reasons. The total amount assessed or in dispute is approximately $25.0 million, net of any recovery of consumption taxes. Effective July 1, 2005, we implemented some modifications to our business structure in Japan and in the United States that we believe will eliminate any further customs valuation disputes on these issues with respect to product imports in Japan after that time.
Because we believe the documentation and legal analysis supports our position and the valuation methodology we used with respect to the products in dispute had been reviewed and approved by the customs authorities in Japan, we believe the assessments are improper and we filed letters of protest with Yokohama customs with respect to this entire amount. Yokohama customs rejected our letters of protest, and we filed appeals with the Japan Ministry of Finance. In order to appeal, we were required to pay the $25.0 million in customs duties and assessments related to all of the amounts at issue, which we recorded in “Other Assets” in our Consolidated Balance Sheet. On June 26, 2006, we were advised that the Ministry of Finance had rejected the appeals filed with their office relating to the imports from October 2002 to October 2004. On December 22, 2006, we filed a complaint with the Tokyo District Court Civil Action Section to appeal the decision with respect to this period. In January 2007, we were advised that the Ministry of Finance also rejected our appeal for the imports from November 2004 to June 2005. We appealed this decision with the court system in Japan in July 2007. Currently, all appeals are pending with the Tokyo District Court Civil Action Section. One of the findings cited by the Ministry of Finance in its decisions was that we had treated the transactions as sales between our U.S. affiliate and our Japan subsidiary on our corporate income tax return under applicable income tax and transfer pricing laws. To the extent that we are unsuccessful in recovering the amounts assessed and paid, we will be required to take a corresponding charge to our earnings.
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On May 2, 2007, Bodywise International, LLC, a direct sales company headquartered in Tustin, California, filed a complaint in the Superior Court of the State of California for Orange County, naming Pharmanex, Inc., our subsidiary, and several Nu Skin distributors who had formerly been distributors for Bodywise as defendants. The plaintiff subsequently filed an amended complaint on May 25, 2007. The complaint alleges that the individual defendants breached the terms of their distributor agreements by utilizing trade secrets and violating non-solicitation covenants in connection with the alleged recruitment of distributors of Bodywise to become Nu Skin distributors. The complaint includes additional claims against all defendants for intentional interference with contractual relations and prospective economic advantage, misappropriation of trade secrets, unfair competition, and unjust enrichments related to the alleged activities. The complaint seeks recovery of damages in an amount presently unascertained, but which plaintiff estimates will likely exceed $25 million. We believe the allegations against us are without merit. The lawsuit is still in the discovery stage.
The following critical accounting policies and estimates should be read in conjunction with our audited consolidated financial statements and related notes thereto, and our interim unaudited consolidated financial statements and related notes thereto. Management considers the most critical accounting policies to be the recognition of revenue, accounting for income taxes, accounting for intangible assets and accounting for stock-based compensation. In each of these areas, management makes estimates based on historical results, current trends and future projections.
Revenue. We recognize revenue when products are shipped, which is when title and risk of loss pass to our independent distributors. With some exceptions in various countries, we offer a return policy whereby distributors can return unopened and unused product for up to 12 months subject to a 10% restocking fee. Reported revenue is net of returns, which have historically been less than 5% of gross sales. A reserve for product returns is accrued based on historical experience. We classify selling discounts as a reduction of revenue. Our selling expenses are computed pursuant to our global compensation plan for our distributors, which is focused on remunerating distributors based primarily upon the selling efforts of the distributors and the volume of products purchased by their downlines, and not their personal purchases.
Income Taxes. We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. This statement establishes financial accounting and reporting standards for the effects of income taxes that result from an 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 among our affiliates around the world. Deferred tax assets and liabilities are created in this process. As of March 31, 2008, we had net deferred tax assets of $77.8 million. These net deferred tax assets assume sufficient future earnings will exist for their realization, as well as the continued application of current tax rates. In certain foreign jurisdictions valuation allowances have been recorded against the deferred tax assets specifically related to use of net operating losses. When we determine that there is sufficient taxable income to utilize the net operating losses, the valuation allowances will be released. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period such determination was made.
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In June 2006, the FASB issued FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS 109 (“FIN 48”). We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recognized a $2.6 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balances of retained earnings and additional paid in capital.
We file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With a few exceptions, we are no longer subject to U.S. federal, state and local income tax examination by tax authorities for years before 2004. In major foreign jurisdictions, we are no longer subject to income tax examinations for years before 2001. We are currently under examination in certain foreign jurisdictions; however, the final outcomes of these reviews are not yet determinable.
At December 31, 2007, we had $31.9 million in unrecognized tax benefits of which $9.1 million, if recognized, would affect the effective tax rate. Our unrecognized tax benefits relate to multiple foreign and domestic jurisdictions. Due to potential increases in unrecognized tax benefits from the multiple jurisdictions in which we operate, as well as the expiration of various statutes of limitation, it is reasonably possible that our gross unrecognized tax benefits may change with the next 12 months by a range of approximately zero to $5 million. The amount of unrecognized tax benefits did not change significantly during the three months ended March 31, 2008.
We are subject to regular audits by federal, state and foreign tax authorities. These audits may result in additional tax liabilities. We account for such contingent liabilities in accordance with FIN 48, and believe we have appropriately provided for income taxes for all years. Several factors drive the calculation of our tax reserves. Some of these factors include: (i) the expiration of various statutes of limitations; (ii) changes in tax law and regulations; (iii) issuance of tax rulings; and (iv) settlements with tax authorities. Changes in any of these factors may result in adjustments to our reserves, which would impact our reported financial results.
Intangible Assets. Under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets(“SFAS 142”), our goodwill and intangible assets with indefinite useful lives are not amortized. Our intangible assets with finite lives are recorded at cost and are amortized over their respective estimated useful lives and are reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (see Note 5 to the Consolidated Financial Statements).
We are required to make judgments regarding the useful lives of our intangible assets. With the implementation of SFAS 142, we determined certain intangible assets to have indefinite lives based upon our analysis of the requirements of SFAS No. 141, Business Combinations (“SFAS 141”), and SFAS 142. Under the provisions of SFAS 142, we are required to test these assets for impairment at least annually. The annual impairment tests were completed and did not result in an impairment charge. To the extent an impairment is identified in the future, we will record the amount of the impairment as an operating expense in the period in which it is identified.
Stock-Based Compensation. Effective January 1, 2006, we adopted the fair value recognition provisions of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), using the modified prospective transition method. Under this method we recognize compensation expense for all share-based payments granted after January 1, 2006 and prior to but not yet vested as of January 1, 2006, in accordance with SFAS 123R. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation net of any estimated forfeitures on a straight-line basis over the requisite service period of the award. The fair value of our stock-based compensation expense is based on estimates using the Black-Scholes option-pricing model. This option-pricing model requires the input of highly subjective assumptions including the option’s expected life, risk-free interest rate, expected dividends and price volatility of the underlying stock. The stock price volatility assumption was determined using the historical volatility of our common stock.
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In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2008, the FASB issued Staff Position 157-2, Effective Date of FASB Statement No. 158, which delays the effective date of SFAS No. 157 for nonfinancial assets and liabilities, except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. We adopted SFAS 157 as of January 1, 2008, with the exception of the application of the statement to non-recurring, nonfinancial assets and liabilities. The adoption of SFAS 157 did not have a material impact on our consolidated financial statements. See Note 12, Fair Value, for additional information.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). Under SFAS 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS 159 for fiscal 2008; however, we did not elect to apply the fair value option to any financial instruments or other items upon adoption of SFAS 159 or during the three months ended March 31, 2008. Therefore, the adoption of SFAS 159 did not impact our consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, (“SFAS 141R”), which changes how business combinations are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 141R is effective January 1, 2009, and will be applied prospectively. The impact of adopting SFAS 141R will depend on the nature and terms of future acquisitions.
In June 2007, the FASB’s Emerging Issues Task Force reached a consensus on EITF No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities, that would require nonrefundable advance payments made by us for future research and development activities to be capitalized and recognized as an expense as the goods or services are received by us. EITF Issue No. 07-3 is effective with respect to new arrangements entered into beginning January 1, 2008. We have implemented the impacts and disclosures of this standard, and it did not have a material impact on our consolidated results of operations or financial condition.
In December 2007, the FASB ratified the Emerging Issues Task Force consensus on EITF Issue No. 07-1, Accounting for Collaborative Arrangements, that discusses how parties to a collaborative arrangement (which does not establish a legal entity within such arrangement) should account for various activities. The consensus indicated that costs incurred and revenues generated from transactions with third parties (i.e. parties outside of the collaborative arrangement) should be reported by the collaborators on the respective line items in their income statements pursuant to EITF Issue No. 99-19,Reporting Revenue Gross as a Principal Versus Net as an Agent. Additionally, the consensus provides that income statement characterization of payments between the participants in a collaborative arrangement should be based upon existing authoritative pronouncements; analogy to such pronouncements if not within their scope; or reasonable, rational, and consistently applied accounting policy election. EITF Issue 07-1 is effective for us beginning January 1, 2009 and is to be applied retrospectively to all periods presented for collaborative arrangements existing as of the date of adoption. We are currently evaluating the impacts and disclosures of this standard, but would not expect EITF Issue No. 07-1 to have a material impact on our consolidated results of operations or financial condition.
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In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”), which changes the accounting and reporting standards for the noncontrolling interests in a subsidiary in consolidated financial statements. SFAS 160 recharacterizes minority interests as noncontrolling interests and requires noncontrolling interests to be classified as a component of shareholders’ equity. SFAS 160 is effective January 1, 2009 and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. We are currently evaluating the impact of SFAS 160 on our consolidated financial statements.
In addition to general economic factors, we are impacted by seasonal factors and trends such as major cultural events and vacation patterns. For example, most Asian markets celebrate their respective local New Year in the first quarter, which generally has a negative impact on that quarter. We believe that direct selling in Japan, the United States and Europe is also generally negatively impacted during the third quarter, when many individuals, including our distributors, traditionally take vacations.
We have experienced rapid revenue growth in certain new markets following commencement of operations. This initial rapid growth has often been followed by a period of stable or declining revenue, then followed by renewed growth fueled by product introductions, an increase in the number of active distributors and increased distributor productivity. The contraction following initial rapid growth has been more pronounced in certain new markets, due to other factors such as business or economic conditions or distributor distractions outside the market.
The following table provides information concerning the number of active and executive distributors as of the dates indicated. Active distributors are those distributors and preferred customers who were resident in the countries in which we operated and purchased products for resale or personal consumption directly from us during the three months ended as of the date indicated. Executive distributors are active distributors who have achieved required monthly personal and group sales volumes as well as sales representatives in China who have completed a qualification process.
A majority of our revenue and many of our expenses are recognized outside of the United States, except for inventory purchases, which are primarily transacted in U.S. dollars from vendors in the United States. The local currency of each of our Subsidiaries’ primary markets is considered the functional currency. All revenue and expenses are translated at weighted-average exchange rates for the periods reported. Therefore, our reported revenue and earnings will be positively impacted by a weakening of the U.S. dollar and will be negatively impacted by a strengthening of the U.S. dollar. Given the large portion of our business derived from Japan, any weakening of the yen negatively impacts reported revenue and profits, whereas a strengthening of the yen positively impacts our reported revenue and profits. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing and results of operation or financial condition.
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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.
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 that 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:
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 and amendments thereto (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, except as required by law. Some of the risks and uncertainties that might cause actual results to differ from those anticipated include, but are not limited to, the following:
(a) We have experienced revenue declines in Japan over the last couple of years and continue to face challenges in this market. If we are unable to renew growth in this market our results could be harmed. Factors that could impact our results in the market include:
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(b) Our operations in China are subject to significant regulatory scrutiny, and we have experienced challenges in the past, including interruption of sales activities at certain stores and fines being paid in some cases. Even though we have now obtained a direct selling license, government regulators continue to scrutinize our activities and the activities of our distributors and sales employees to monitor our compliance with the new regulations and other applicable regulations as we integrate direct selling into our business model. We continue to be subject to current governmental reviews and investigations. Any determination that our operations or activities, or the activities of our employed sales representatives or distributors, are not in compliance with applicable regulations, could result in the imposition of substantial fines, extended interruptions of business, termination of necessary licenses and permits, including our direct selling licenses, or restrictions on our ability to open new stores or obtain approvals for service centers or expand into new locations, all of which could harm our business.
(c) The new direct selling regulations in China are restrictive and there continues to be some confusion and uncertainty as to the meaning of the new regulations and the specific types of restrictions and requirements imposed under them. It is also difficult to predict how regulators will interpret and enforce these new regulations and the impact of these new regulations on pending regulatory reviews and investigations. Our business and our growth prospects may be harmed if Chinese regulators interpret the anti-pyramiding regulations or direct selling regulations in such a manner that our current method of conducting business through the use of employed sales representatives violates these regulations. In particular, our business would be harmed by any determination that our current method of compensating our sales employees, including our use of the sales productivity of a sales employee and the group of sales employees whom he or she trains and supervises as one of the factors in establishing such sales employee’s salary and compensation, violates the restriction on multi-level compensation under the new rules. Our business could also be harmed if regulators inhibit our ability to concurrently operate our retail store/employed sales representative business model and our direct selling business.
(d) Our ability to retain key and executive level distributors or to sponsor new executive distributors is critical to our success. Because our products are distributed exclusively through our distributors and we compete with other direct selling companies in attracting distributors, our operating results could be adversely affected if our existing and new business opportunities and incentives, products, business tools and other initiatives do not generate sufficient enthusiasm and economic incentive to retain our existing distributors or to sponsor new distributors on a sustained basis. In addition, in our more mature markets, one of the challenges we face is keeping distributor leaders with established businesses and high income levels motivated and actively engaged in business building activities and in developing new distributor leaders. There can be no assurance that our initiatives will continue to generate excitement among our distributors in the long-term or that planned initiatives will be successful in maintaining distributor activity and productivity or in motivating distributor leaders to remain engaged in business building and developing new distributor leaders.
(e) There have been a series of third party actions and governmental actions involving some of our competitors in the direct selling industry as well. These actions have generated negative publicity for the industry and likely have resulted in increased regulatory scrutiny of other companies in the industry. There can be no assurance that similar allegations will not be made against us. In addition, adverse rulings in these cases could harm our business if they create adverse publicity or interpret laws in a manner inconsistent with our current business practices.
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(f) Distributor activities that violate applicable laws or regulations could result in government or third party actions against us. We have experienced an increase in complaints to consumer protection agencies in Japan and have taken steps to try to resolve these issues including providing additional training and restructuring our compliance group in Japan. We have also been in contact with general consumer agencies in Japan. If consumer complaints escalate to a government review or if the current level of complaints don’t improve, regulators could take action against us.
(g) As we continue to implement our business transformation initiative, there could be unintended negative consequences, including business disruptions and/or a loss of employees. Further, we may not realize the cost improvements and greater efficiencies as we hope for as a result of this realignment. In addition, as we continually evaluate strategic reinvestment of any savings generated as a result of our transformation initiative, we may not ultimately achieve the amount of savings that we currently anticipate.
(h) The network marketing and nutritional supplement industries are subject to various laws and regulations throughout our markets, many of which involve a high level of subjectivity and are inherently fact-based and subject to interpretation. Negative publicity concerning supplements with controversial ingredients has spurred efforts to change existing regulations or adopt new regulations in order to impose further restrictions and regulatory control over the nutritional supplement industry. If our existing business practices or products, or any new initiatives or products, are challenged or found to contravene any of these laws by any governmental agency or other third party, or if there are any new regulations applicable to our business that limit our ability to market such products or impose additional requirements on us, our revenue and profitability may be harmed.
(i) Production difficulties and quality control problems could harm our business, in particular our reliance on third party suppliers to deliver quality products in a timely manner. Occasionally, we have experienced production difficulties with respect to our products, including the delivery of products that do not meet our quality control standards. These quality problems have resulted in the past, and could result in the future, in stock outages or shortages in our markets with respect to such products, harming our sales and creating inventory write-offs for unusable products.
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 Operation” of Part I and also in Note 6 to the Financial Statements contained in Item 1 of Part I.
As of the end of the period covered by this report, 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, our Chief Executive Officer and Chief Financial Officer concluded that, our disclosure controls and procedures were effective as of March 31, 2008.
There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15 (f) under the Exchange Act) during the most recent fiscal quarter covered by this report, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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No updates to report. Please refer to our recent SEC filings, including our Annual Report on Form 10-K for the 2007 fiscal year, for information regarding the status of certain legal proceedings.
Our 2007 Annual Report on Form 10-K includes a detailed discussion of our risk factors. The information presented below updates one of these risk factors and should be read in conjunction with the risk factors and information disclosed in that Form 10-K and in subsequent Form 10-Q filings.
The loss of suppliers or shortages in ingredients could harm our business.
We acquire ingredients and products from two suppliers that each currently manufacture a significant portion of our Nu Skin personal care products. In addition, we currently rely on two suppliers for a majority of Pharmanex nutritional supplement products. In the event we were to lose any of these suppliers and experience any difficulties in finding or transitioning to alternative suppliers, this could harm our business. In addition, we obtain some of our products from sole suppliers that own or control the product formulations, ingredients, or other intellectual property rights associated with such products. These products include our Galvanic Spa System II, True Face Essence products, and our G3 juice. We also license the right to distribute some of our products from third parties. In the event we are unable to renew these contracts, we may need to discontinue some products or develop substitute products, which could harm our revenue. In addition, if we experience supply shortages or regulatory impediments with respect to the raw materials and ingredients we use in our products, we may need to seek alternative supplies or suppliers. Some of our nutritional products, including our recently introducedg3 juice, incorporate natural products that are only harvested once a year and may have limited supplies. If demand exceeds forecasts, we may have difficulties in obtaining additional supplies to meet the excess demand until the next growing season. If we are unable to successfully respond to such issues, our business could be harmed.
In August 1998, our board of directors approved a plan to repurchase $10.0 million of our Class A common stock on the open market or in private transactions. Our board has from time to time increased the amount authorized under the plan and a total amount of $335.0 million is currently authorized. As of March 31, 2008, we had repurchased approximately $245.4 million of shares under the plan. There has been no termination or expiration of the plan since the initial date of approval.
We have authorized the repurchase of shares acquired by our employees and distributors in certain foreign markets because of regulatory and other issues that make it difficult or 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 at an average price per share of $16.43.
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None.
On May 12, 2008, our Compensation Committee met and approved certain changes to the compensation of Truman Hunt, the Chief Executive Officer of the Company, as reflected in Mr. Hunt's Employment Letter, as amended, based on its review of Mr. Hunt's performance, the Company's performance and Mr. Hunt's current compensation levels. The Committee engaged an independent compensation consultant to assist it in its review of Mr. Hunt's compensation. Mr. Hunt's base salary was increased to $750,000 per year from $550,000. Mr. Hunt had previously unilaterally reduced his salary from $665,000 to $550,000 in 2006. The dividend equivalent being paid to Mr. Hunt on a hypothetical 250,000 shares (approximately $105,000 in 2007) was terminated in connection with the increase in salary.
The Committee also approved a special grant of 350,000 performance stock options. The exercise price will be the closing price of our Class A common stock on May 12, 2008, the date of grant. Vesting for the options is performance based, with the options vesting in two installments if the Company's earnings per share equal or exceed the two established performance levels, measured in terms of diluted earnings per share. Fifty percent of the options will vest upon earnings per share meeting or exceeding the first performance level of $1.50 and 50% of the options will vest upon earnings per share meeting or exceeding the second performance level of $2.00. If the performance levels have not been met on or prior to the 2nd business day following the filing of the Company's Annual Report on Form 10-K for the year ended December 31, 2012, then any unvested options shall terminate at such time. Under the terms of the options, earnings per share is calculated in accordance with generally accepted accounting principles; provided, however, that the following shall be excluded from the calculation of "earnings per share: (A) asset write-downs, (B) litigation or claim judgments or settlements related to claims arising prior to the date of grant or claims based, in whole or in part, on events or actions occurring prior to the date of grant, (C) accruals for recapitalization, reorganization and restructuring programs, (D) the discontinuation, disposal or acquisition of a business or division, and (E) any other extraordinary items. The Committee shall review and approve the calculation of "earnings per share," and shall determine, exercising its judgment, the items to be excluded pursuant to the exceptions. The other terms of the performance options are similar to the terms of the Company's standard options including acceleration of vesting if there is a termination of employment following a change-in-control and forfeiture of awards upon the occurrence of certain acts by the option holder. The options expire seven years following the grant date. Mr. Hunt's semi-annual option grant was increased to 50,000 options for 2008 and will increase to 92,500 in 2009. Mr. Hunt had previously unilaterally reduced his semi-annual option grant from 100,000 per year to 25,000 per year in 2006.
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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 12, 2008
By: /s/ Ritch N. Wood Ritch N. WoodIts: Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)
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