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). Yes No
As of October 31, 2008, 64,561,484 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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Revenue generated in each of these regions is set forth below (in thousands):
Revenue generated by each of the Company’s three product lines is set forth below (in thousands):
Additional information as to the Company’s operations in its most significant geographic areas is set forth below (in thousands):
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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 $27.2 million and includes $13.0 million of the balance on the Company’s 2000 Japanese yen denominated notes, $4.1 million of the balance of the Company’s Japanese yen denominated debt under the 2003 multi-currency uncommitted shelf facility and $10.0 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.
Revenue for the three and nine-month periods ended September 30, 2008 increased 7% and 9% to $310.3 million and $930.1 million compared to the same periods in 2007, respectively. Foreign currency exchange rate fluctuations positively impacted revenue by 2% and 5%, respectively, for the three and nine-month periods ended September 30, 2008. Strong growth in the United States, Canada, Latin America, Europe, South Korea and South East Asia drove our overall increase in revenue. Solid growth trends in our personal care product line, including the continued demand for the Galvanic Spa System II as well as the Tru Face Essence line, helped fuel the year-over-year improvement in these markets. Revenue results were negatively impacted by significant declines in local currency revenue in Japan and China.
Earnings per share for the third quarter and first nine months of 2008 were $0.26 and $0.79 compared to $0.21 and $0.57 for the same periods in 2007. The increase in earnings is largely due to our business transformation initiatives, which have contributed significantly to our improved operating margins, as well as the overall increase in revenue.
Revenue
North Asia. The following table sets forth revenue for the three- and nine-month periods ended September 30, 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 for the three- and nine-month periods ended September 30, 2008 by 2% and 6% compared to the same prior-year periods, as a significant strengthening of the yen offset the impact of a weakening of the South Korean won. Executive distributors in the region decreased 8% and active distributors remained level compared to the prior-year period.
Local currency revenue in Japan declined 12% for the three- and nine-month periods ended September 30, 2008 compared to the same periods in 2007, respectively. We continue to experience weakness in our distributor numbers and distributor activity in this market, with active and executive distributor counts decreasing 8% and 14%, respectively. We believe our business continues to be negatively affected by the increased regulatory and media scrutiny of the industry and by our increased focus on distributor compliance in response to this scrutiny and to the number of complaints to consumer centers regarding the activities of some of our distributors. During the quarter, we began to implement some new distributor initiatives that have been patterned after initiatives that have contributed to growth in our other markets in order to help generate increased distributor activity and productivity.
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South Korea continues to post solid growth with local-currency revenue increasing 29% and 26% for the three- and nine-month periods ended September 30, 2008, respectively. Successful and consistent product launches in both nutritional and personal care categories 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 26% and the number of executive distributors increased 17% in the third quarter of 2008 compared to the same prior-year period.
Americas. The following table sets forth revenue for the three- and nine-month periods ended September 30, 2008 and 2007 for the Americas region and its principal markets (U.S. dollars in millions):
Revenue in the United States for the third quarter of 2007 included approximately $5 million in sales to foreign distributors attending our international convention in the United States. Excluding these sales, revenue for the third quarter of 2008 would have increased by approximately 15% compared to the prior-year period. We continue to experience significant growth in the United States with strong sales in the personal care brand. The revenue growth is being driven by strong interest in our Galvanic Spa System II as well as complementary products such as Galvanic Spa Facial Gels, Tru Face Essence Ultra and Tru Face Line Corrector. These products provide highly demonstrable results and are generating significant consumer interest. This interest has also driven growth in our distributors, with active distributors in the United States increasing 6% and executive distributors increasing 12% in the third quarter of 2008 compared to the same prior-year period.
Local currency revenue increased by 41% and 38% in Canada and by 98% and 68% in Latin America for the three- and nine- month periods ended September 30, 2008 over the prior-year periods, respectively. The growth in Latin America can be attributed to our opening of operations in Venezuela and strength in our Mexico market. Revenue growth in Latin America also benefited from a product price increase of approximately 15%-20% on average in the second quarter of 2008. Similar to the United States, revenue growth in Canada and Latin America is also being driven by the strong sales in our Nu Skin brand personal care products.
In the third quarter of 2008, active and executive distributors in the Americas region increased 10% compared to the same prior-year period.
Greater China. The following table sets forth revenue for the three- and nine-month periods ended September 30, 2008 and 2007 for the Greater China region and its principal markets (U.S. dollars in millions):
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Foreign currency exchange rate fluctuations positively impacted revenue by approximately 5% and 6% in this region during the third quarter and first nine months of 2008, respectively. Active distributors decreased 15% and executive distributors increased 1% in the region.
On a local currency basis, revenue in Mainland China decreased 12% and 13% in the three- and nine- month periods ended September 30, 2008 compared to the same periods in 2007, respectively. Our revenue decline was primarily the result of a 20% decline in our preferred customers compared to the prior-year period. The number of employed sales representatives remained relatively level compared to the prior-year period. We currently have plans to introduce the Galvanic Spa System II to a limited number of sales leaders in China in the fourth quarter of 2008, with a general launch in the first quarter of 2009, which we expect will have a positive impact on revenue given its success in Hong Kong and other markets.
Local currency revenue in Taiwan was down 11% and 5% in the three- and nine- month periods ended September 30, 2008 compared to the same periods in 2007, respectively. We believe that the decline in Taiwan is primarily attributed to regulatory restrictions that currently prevent us from marketing the Galvanic Spa System II in this market and a softening of sales of our weight loss products. The third quarter executive distributor count in Taiwan was up 3%, while the number of active distributors was down 14% when compared to the prior-year period. Hong Kong local currency revenue was up 13% and 17%, for the three- and nine-month periods compared to the same prior-year periods, respectively, primarily as a result of the strength of our personal care initiatives. Executive distributors in Hong Kong were up 3% and the active distributors in Hong Kong remained level compared to the prior-year period.
Europe. The following table sets forth revenue for the three- and nine-month periods ended September 30, 2008 and 2007 for Europe (U.S. dollars in millions):
We continue to experience strong growth throughout our European markets. Growth in these markets is being driven by strong interest in the Galvanic Spa System II as well as momentum generated from the expansion of our business in Eastern Europe, which includes the markets of Hungary, Romania, Russia, Slovakia and Poland. In November, we plan to open the Czech Republic. We also opened operations in South Africa during the first quarter.
South Asia/Pacific. The following table sets forth revenue for the three- and nine-month periods ended September 30, 2008 and 2007 for the South Asia/Pacific region and its principal markets (U.S. dollars in millions):
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Foreign currency exchange rate fluctuations positively impacted revenue in South Asia/Pacific by 1% and 5% in the third quarter and first nine months of 2008 compared to the same prior-year periods. Steady performances in the majority of our markets within this region contributed to the growth, driven primarily by strong sales of the Galvanic Spa System II. The growth in these markets was partially offset by a decline in Australia/New Zealand that is largely related to a transition away from Photomax, which has not proven to be a strong, long-term business initiative for our distributors. Active and executive distributors in the region increased 2% and 7%, respectively, in the third quarter compared to the same prior-year period.
Gross profit
Gross profit as a percentage of revenue decreased to 81.7% for the three- and nine- month periods ended September 30, 2008 from 82.0% and 81.9% for the same periods in 2007. This decline is due in large part to the revenue shift from Japan, which has higher gross margins, to markets such as the United States, with slightly lower gross margins. Additionally, the increase in sales of the Galvanic Spa System II, which has a slightly lower gross margin than our other personal care products, contributed to this decrease.
Selling expenses
Selling expenses as a percentage of revenue decreased to 42.6% and 42.7% for the three- and nine-month periods ended September 30, 2008 from 43.1% and 42.9% from the same prior-year periods, respectively. This improvement is largely related to the phase-in of compensation plan adjustments in several markets.
General and administrative expenses
General and administrative expenses as a percentage of revenue for the three- and nine-month periods ended September 30, 2008 decreased to 29.3% and 29.7% from 32.3% for each of the same periods in 2007. Our business transformation efforts have contributed to this improvement as we have been able to contain our costs while growing our revenue. In addition, we incurred approximately $6 million in expenses related to our international convention in the third quarter of 2007, but did not have any convention or related expenses in the third quarter of 2008.
Other income (expense), net
Other income (expense), net for the three- and nine-month periods ended September 30, 2008 was approximately ($8.3) million and ($10.0) million compared to zero and $0.1 million for the same periods in 2007. The large expense in 2008 is primarily related to significant weakening of foreign currencies against the U.S. dollar, which resulted in a large foreign currency translation loss with respect to intercompany receivables from certain international subsidiaries in markets that are newly opened or have remained in a loss position since inception. Generally, translation losses associated with these assets would be offset by gains related to the translation of yen-based bank debt. However, during the quarter the yen strengthened against the U.S. dollar while most other foreign currencies weakened against the U.S. dollar. Consequently, we did not have the benefit of an offsetting gain. Other income (expense), net also includes approximately $1.6 million and $4.2 million in interest expense for the three- and nine- month periods ended September 30, 2008.
Provision for income taxes
Provision for income taxes for the three- and nine-month periods ended September 30, 2008 was $5.2 million and $25.8 million of expense compared to $5.7 million and $20.1 million of expense for the same periods in 2007. The effective tax rate was 23.8% and 33.6% of pre-tax income during the three- and nine-month periods ended September 30, 2008, compared to a rate of 29.6% and 34.7% in the same prior-year periods. The decrease in tax rates in the third quarter from our historical rate of approximately 37-38% was due primarily to the expiration of the statute of limitations in certain tax jurisdictions during the quarter. We expect our tax rate to return in the fourth quarter to its historical rate of between 37.5% and 38.0%.
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Net income
Net income for the three- and nine-month periods ended September 30, 2008 increased to $16.8 million and $50.9 million compared to $13.5 million and $37.8 million for the same prior-year periods based on the factors described above.
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 $63.8 million in cash from operations during the first nine months of 2008, compared to $31.4 million during the same period in 2007. This increase in cash generated from operations is due primarily to increased profitability in 2008 and is also impacted by the timing of cash payments related to fluctuations in operating assets and liabilities.
As of September 30, 2008, working capital was $124.5 million, compared to $123.2 million as of December 31, 2007. Cash and cash equivalents, including current investments, at September 30, 2008 and December 31, 2007 were $101.3 million and $92.6 million, respectively.
Capital expenditures in the first nine months of 2008 totaled $12.0 million, and we anticipate capital expenditures of approximately $20 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 September 30, 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 nine months of 2008, we repurchased approximately 213,100 shares of Class A common stock under this program for an aggregate amount of approximately $3.6 million. At September 30, 2008, approximately $84.0 million was available for repurchases under the stock repurchase program.
In February, May and August 2008, our board of directors declared a quarterly cash dividend of $0.11 per share for Class A common stock. These quarterly cash dividends of $7.0 million were each paid on March 19, 2008, June 18, 2008 and September 17, 2008, to stockholders of record on February 29, 2008, May 30, 2008 and August 29, 2008. Our board of directors declared a quarterly cash dividend of $0.11 per share for Class A common stock to be paid December 10, 2008 to stockholders of record on November 28, 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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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 September 30, 2008, we had net deferred tax assets of $69.4 million. These net deferred tax assets assume sufficient future earnings will exist for their realization, as well as the continued application of current tax rates. In certain foreign jurisdictions valuation allowances have been recorded against the deferred tax assets specifically related to use of net operating losses. When we determine that there is sufficient taxable income to utilize the net operating losses, the valuation allowances will be released. In the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period such determination was made.
In June 2006, the FASB issued FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS 109 (“FIN 48”). We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recognized a $2.6 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balances of retained earnings and additional paid in capital.
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 2005. 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.
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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 within 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 September 30, 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 in the second quarter 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.
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.
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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 September 30, 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 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 impact and required 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.
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, but would not expect SFAS 160 to have a material impact on our consolidated results of operations or financial condition.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of SFAS No. 133 (“SFAS 161”). This Standard requires enhanced disclosures regarding derivatives and hedging activities, including: (a) the manner in which an entity uses derivative instruments; (b) the manner in which derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities; and (c) the effect of derivative instruments and related hedged items on an entity’s financial position, financial performance, and cash flows. The Standard is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. As SFAS 161 relates specifically to disclosures, the Standard will have no impact on our financial condition, results of operations or cash flows.
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In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). This Standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS 162 directs the hierarchy to the entity, rather than the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with generally accepted accounting principles. The Standard is effective 60 days following SEC approval of the Public Company Accounting Oversight Board amendments to remove the hierarchy of generally accepted accounting principles from the auditing standards. SFAS 162 is not expected to have an impact on our financial condition, results of operations or cash flows.
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. In the third quarter of 2008, global active and executive distributors each increased 2% compared to the same prior-year period. Active distributors are those distributors and preferred customers who 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.
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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.
We may seek to reduce our exposure to fluctuations in foreign currency exchange rates through the use of foreign currency exchange contracts, through intercompany loans of foreign currency and through our Japanese yen-denominated debt. We do not use derivative financial instruments for trading or speculative purposes. We regularly monitor our foreign currency risks and periodically take measures to reduce the impact of foreign exchange fluctuations on our operating results. At December 31, 2007, we did not hold any forward contracts designated as foreign currency cash flow hedges. At September 30, 2008, we held forward contracts to purchase 1.4 billion yen ($13.2 million as of September 30, 2008). We applied mark to market accounting for this forward contract and the loss was not material to our results in the quarter. These forward contracts were fulfilled as of October 14, 2008.
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:
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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, Quarterly Reports on Form 10-Q, 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) Deteriorating economic conditions globally, including the current financial crisis, rising unemployment and declining consumer confidence may not improve or may worsen. Although such economic conditions may benefit our business initially as more individuals may become interested in supplementing their income, a more severe or a prolonged economic downturn can adversely impact our business by causing a decline in demand for our products. In addition, such economic conditions may adversely impact access to capital for us and our suppliers, may decrease our distributors' ability to obtain or maintain credit cards, and may otherwise adversely impact our operations and overall financial condition. Although we have historically met our funding needs utilizing cash flow from operations and while we believe we will have sufficient resources to meet current debt service obligations in a timely manner, no assurances can be given that we will not need to obtain additional equity or debt financing and that such financing will be available to us on terms that are favorable.
(b) Recently, numerous foreign currencies have weakened against the U.S. dollar, including substantial devaluations of the South Korean won and the euro. If these currencies continue at present levels or weaken further, our results could be negatively impacted.
(c) We have experienced revenue declines in Japan over the last several years and continue to face challenges in this market. If we are unable to renew growth in this market our results could be harmed. Factors that could impact our results in the market include:
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(d) 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. 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.
(e) 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.
(f) 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.
(g) 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.
(h) 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 regarding some inappropriate activities by some distributors. If consumer complaints escalate to a government review or, if the current level of complaints does not improve, regulators could take action against us.
(i) As we continue to implement our business transformation initiative, there could be unintended negative consequences, including business disruptions and/or a loss of employees. Further, we may not realize the cost improvements and greater efficiencies we hope for as a result of this realignment. In addition, as we continually evaluate strategic reinvestment of any savings generated as a result of our transformation initiative, we may not ultimately achieve the amount of savings that we currently anticipate.
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(j) 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.
(k) 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 4 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 September 30, 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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Please refer to our recent SEC filings, including our Annual Report on Form 10-K for the 2007 fiscal year and subsequent Quarterly Reports on Form 10-Q for information regarding the status of certain legal proceedings that have been previously disclosed.
As previously reported, Bodywise International, LLC, a direct sales company headquartered in Tustin, California, filed claims in the Superior Court of the State of California for Orange County, against us and several Nu Skin distributors who had formerly been distributors for Bodywise as defendants. In July 2008, the parties resolved the matter by entering into a settlement agreement that included a release of all claims against us and our distributors. Pursuant to the terms of the settlement, this case was dismissed on July 23, 2008. The amount of the settlement was not material to our results.
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 Quarterly Reports on Form 10-Q.
Deteriorating economic conditions globally, including the current financial crisis, rising unemployment and declining consumer confidence may not improve or may worsen.
Deteriorating economic conditions globally, including the current financial crisis, rising unemployment and declining consumer confidence may not improve or may worsen. Although such economic conditions may benefit our business initially as more individuals may become interested in supplementing their income, a more severe or a prolonged economic downturn can adversely impact our business by causing a decline in demand for our products. In addition, such economic conditions may adversely impact access to capital for us and our suppliers, may decrease our distributors' ability to obtain or maintain credit cards, and may otherwise adversely impact our operations and overall financial condition. Although we have historically met our funding needs utilizing cash flow from operations and while we believe we will have sufficient resources to meet current debt service obligations in a timely manner, no assurances can be given that we will not need to obtain additional equity or debt financing and that such financing will be available to us on terms that are favorable.
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 September 30, 2008, we had repurchased approximately $248.9 million of shares under the plan. There has been no termination or expiration of the plan since the initial date of approval.
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None.
On November 7, 2008, we executed an amendment of a lease with Scrub Oak, LLC, an entity owned by the following executive officers, directors and 5% or greater stockholders, and their family members: Blake M. Roney, Sandra N. Tillotson and Steven J. Lund. The purpose of the amendment was to extend the term of the lease with respect to certain warehouse facilities for three years with an option to extend the lease an additional five years. Payments under the lease and the option are as follows:
Lease:
Option:
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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.
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