unable to convince the FDA that the scanner should be marketable as a non-medical device. We believe it could take from six to twelve months to get the scanner cleared as a medical device. In Canada, revenue increased 33% to $2.4 million for the three-month period ended March 31, 2003 from $1.8 million for the same period in the prior year.
Revenue in Other Markets, which include our European and Latin American operations, increased 21% to $8.1 million for the three-month period ended March 31, 2003 from $6.7 million for the same period in 2002. This increase is primarily due to a 26% increase in revenue in Europe in U.S. dollars compared to the same prior year period.
Net income remained nearly constant at $12.8 million for the three-month period ended March 31, 2003 compared to $12.9 million for the same period in 2002. Net income increased primarily because of the factors noted above in “revenue,” “gross profit” and “other income (expense), net” and was offset by the factors noted above in “distributor incentives” and “selling, general and administrative” above.
Liquidity and Capital Resources
Historically, our principal needs for funds have been for operating expenses including distributor incentives, working capital (principally inventory purchases), capital expenditures and the development of operations in new markets. We have generally relied on cash flow from operations to meet our cash needs and business objectives without incurring long-term debt to fund operating activities.
We typically generate positive cash flow from operations due to favorable gross margins, the variable nature of distributor incentives, which constitute a significant percentage of operating expenses, and minimal capital requirements. We generated $0.6 million in cash from operations during the three-month period ended March 31, 2003 compared to $15.1 million during the three months ended March 31, 2002. The decrease in cash generated from operations during the three months ended March 31, 2003 is primarily related to the payment of income taxes as well as the settlement of other accrued expenses during the first quarter of 2003. The 2002 reported results included significantly higher revenue and profitability in comparison to 2001 resulting in higher accrued income taxes and other expenses as of December 31, 2002 compared to December 31, 2001, which were subsequently settled during the first quarters of 2003 and 2002, respectively.
As of March 31, 2003, working capital was $184.3 million compared to $180.6 million as of December 31, 2002. Cash and cash equivalents at March 31, 2003 and December 31, 2002, were $103.9 million and $120.3 million, respectively. This decrease in cash balances was due to the decrease in cash flows from operations as well as increases in share repurchases and dividend payments during the first quarter of 2003 compared to the same prior-year period.
Capital expenditures, primarily for equipment, the BioPhotonic Scanner, computer systems and software, office furniture and leasehold improvements, were $6.2 million for the three-month period ended March 31, 2003. In addition, we anticipate capital expenditures during the remainder of 2003 of approximately $20 to $25 million to further enhance our infrastructure, including enhancements to computer systems and Internet related software in order to expand our Internet capabilities, purchase of the portable laser-based tools mentioned above, which we lease to our distributors, as well as further expansion of our retail stores, manufacturing and related infrastructure in China.
Our long-term debt consists of 9.7 billion Japanese yen-denominated ten-year senior notes issued to the Prudential Insurance Company of America. The notes bear interest at an effective rate of 3.03% per annum and are due October 2010, with annual principal payments beginning October 2004. As of March 31, 2003, the outstanding balance on the notes was 9.7 billion Japanese yen, or $82.1 million.
On May 10, 2001, we entered into a $60.0 million revolving credit agreement, or the revolving credit facility, with Bank of America, N.A. and Bank One Utah, N.A. for which Bank of America, N.A. acted as agent. Drawings on this revolving credit facility may be used for working
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capital, capital expenditures and other purposes including repurchases of our outstanding shares of Class A common stock. Per the terms of the agreement, the revolving credit facility was reduced to $45.0 million on May 10, 2002, and was further reduced to $30.0 million on May 10, 2003. The revolving credit facility is set to expire on May 10, 2004. There were no outstanding balances relating to the revolving credit facility as of March 31, 2003. The Japanese notes and the revolving credit facility are both secured by guarantees issued by our material subsidiaries and by a pledge of 65% of the outstanding stock of Nu Skin Japan Company Limited, our operating subsidiary in Japan.
Since August 1998, our board of directors has authorized us to repurchase up to $90.0 million of our outstanding shares of Class A common stock. The repurchases are used primarily to fund our equity incentive plans. During the three-month period ended March 31, 2003, we repurchased approximately 559,000 shares of Class A common stock for an aggregate amount of approximately $5.9 million. As of March 31, 2003, we had repurchased a total of approximately 8.5 million shares of Class A common stock for an aggregate price of approximately $79.2 million.
In February 2003, our board of directors declared a quarterly cash dividend of $0.07 per share for all classes of common stock. This quarterly cash dividend of $5.6 million was paid on March 26, 2003, to stockholders of record on March 7, 2003. We anticipate that our board of directors will continue to declare quarterly cash dividends and that the cash flows from operations will be sufficient to fund our future dividend payments. However, the declaration of dividends is subject to the discretion of our board of directors and will depend upon various factors, including our net earnings, financial condition, cash requirements, future prospects and other factors deemed relevant by our board of directors.
We believe we have sufficient liquidity to be able to meet our obligations on both a short and long-term basis. We currently believe that existing cash balances together with future cash flows from operations will be adequate to fund the cash needs relating to the implementation of our strategic plans. The majority of our expenses are variable in nature and as such, a potential reduction in the level of revenue would reduce our cash flow needs. However, in the event that our current cash balances, future cash flow from operations and current lines of credit are not sufficient to meet our obligations or strategic needs, we would consider raising additional funds in the debt or equity markets or restructuring our current debt obligations. Additionally, we would consider realigning our strategic plans including a reduction in capital spending and a reduction in the level of stock repurchases or dividend payments.
Critical Accounting Policies
The following critical accounting policies and estimates should be read in conjunction with our audited consolidated financial statements and related notes thereto. Management considers the most critical accounting policies to be the recognition of revenue, accounting for income taxes, accounting for intangible assets and accounting for the impact of foreign currencies. In each of these areas, management makes estimates based on historical results, current trends and future projections.
Revenue. We recognize revenue when products are shipped, which is when title passes to our independent distributors. We offer a return policy whereby distributors can generally return unopened and unused product for up to 12 months subject to a 10% restocking fee. Reported revenue is net of returns, which have historically been less than 5.0% of gross
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sales. A reserve for product returns is accrued based on historical experience. In the event that certain expenses, including our distributor incentives, were deemed to be reductions of revenue (under the provisions of EITF 01-09) rather than operating expenses, our reported revenue would be reduced as would our operating expenses. However, since our global distributor compensation plan for our distributors does not provide rebates or selling discounts to distributors who purchase our products and services, we believe that no adjustment to reported revenue and operating expenses is necessary.
Income Taxes. We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” This statement establishes financial accounting and reporting standards for the effects of income taxes that result from an enterprise’s activities during the current and preceding years. It requires an asset and liability approach for financial accounting and reporting of income taxes. We pay income taxes in many foreign jurisdictions based on the profits realized in those jurisdictions, which can be significantly impacted by terms of intercompany transactions between our foreign affiliates and us. Deferred tax assets and liabilities are created in this process. As of March 31, 2003, we have net deferred tax assets of $49.2 million. These net deferred tax assets assume sufficient future earnings will exist for their realization, as well as the continued application of current tax rates. We have considered projected future taxable income and ongoing tax planning strategies in determining that no valuation allowance is required. In the event we were to determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to earnings in the period such determination was made.
Intangible Assets. As of March 31, 2003, we had approximately $158 million of unamortized goodwill and other indefinite-life intangible assets. Under the provisions of SFAS No. 142, we are required to test these assets for impairment at least annually. The annual impairment tests have been completed for the year ended December 31, 2002 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.
Foreign Currency Fluctuations. We operate in more than 30 countries and generate the majority of our revenue and income in foreign currencies in international markets. Consequently, significant fluctuations in foreign currencies, particularly the Japanese yen, will have an impact on reported results. We seek to reduce our exposure to fluctuations in foreign currency exchange rates through intercompany loans of foreign currency, our Japanese yen denominated debt, and the use of derivative financial instruments to hedge certain forecasted transactions as well as receivables and payables denominated in foreign currencies. We currently account for derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” We do not utilize derivatives for trading or speculative purposes. Hedge effectiveness is documented, assessed and monitored.
Seasonality
In addition to general economic factors, we are impacted by seasonal factors and trends such as major cultural events and vacation patterns. For example, most Asian markets celebrate their respective local New Year in the first quarter, which generally has a negative impact on that quarter. We believe that direct selling in Japan, the United States and Europe is
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also generally negatively impacted during the month of August, which is in our third quarter, when many individuals, including our distributors, traditionally take vacations.
Distributor Information
The following table provides information concerning the number of active and executive distributors as of the dates indicated. Active distributors are those distributors who were resident in the countries in which we operated and purchased products for resale or personal consumption during the three months ended as of the date indicated. An executive distributor is an active distributor who has achieved required monthly personal and group sales volumes.
| As of March 31, 2003
| As of March 31, 2002
|
|---|
| Active
| Executive
| Active
| Executive
|
|---|
| North Asia | | 296,000 | | 16,601 | | 311,000 | | 17,727 | |
| Greater China and Southeast Asia* | | 159,000 | | 5,850 | | 138,000 | | 4,992 | |
| North America | | 71,000 | | 2,662 | | 75,000 | | 2,331 | |
| Other Markets | | 31,000 | | 1,063 | | 26,000 | | 1,028 | |
|
| |
| |
| |
| |
| Totals | | 557,000 | | 26,176 | | 550,000 | | 26,078 | |
|
| |
| |
| |
| |
|
| |
| |
| |
| |
| * | Following the opening of 100 retail stores in China in 2003, active distributors include 31,000 preferred customers and executive distributors include 446 employed, full-time sales representatives. |
Currency Risk and Exchange Rate Information
A majority of our revenue and many of our expenses are recognized primarily outside of the United States, except for inventory purchases which are primarily transacted in U.S. dollars from vendors in the United States. Each of our subsidiary’s local currency 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. For example, in 2001, the Japanese yen significantly weakened, which reduced our operating results on a U.S. dollar reported basis. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, results of operations or financial condition.
We seek to reduce our exposure to fluctuations in foreign currency exchange rates through the use of foreign currency exchange contracts, through intercompany loans of foreign currency and through our Japanese yen denominated debt. We do not use derivative financial instruments for trading or speculative purposes. We regularly monitor our foreign currency risks and periodically take measures to reduce the impact of foreign exchange fluctuations on our operating results.
Our foreign currency derivatives are comprised of over-the-counter forward contracts with major international financial institutions. As of March 31, 2003, we had $117.6 million of these contracts with expiration dates through April 2004. All of these contracts were denominated in Japanese yen. For the three months ended March 31, 2003, we recorded a loss of $1.3 million in operating income related to the fair market valuation on our outstanding forward contracts. Based on our foreign exchange contracts at March 31, 2003, the impact of a
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10% appreciation or 10% depreciation of the U.S. dollar against the Japanese yen would not represent a material potential loss in fair value, earnings or cash flows against these contracts. This potential loss does not consider the underlying foreign currency transaction or translation exposures to which we are subject.
Note Regarding Forward-Looking Statements
With the exception of historical facts, the statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”) which reflect our current expectations and beliefs regarding our future results of operations, performance and achievements. These statements are subject to risks and uncertainties and are based upon assumptions and beliefs that may not materialize. These forward-looking statements include, but are not limited to, statements concerning:
| • | our belief that we are making good progress in establishing a strong foundation for growth in China; |
| • | our belief that the scanner should be marketable in the U.S. as a non-medical device; |
| • | our belief that existing cash and cash flow from operations will be adequate to fund cash needs; |
| • | the expectation that we will spend $20 to $25 million for capital expenditures during the remainder of 2003; and |
| • | the anticipation that cash will be sufficient to pay future dividends. |
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 in our Annual Report on Form 10-K which contains a more detailed discussion of the risks and uncertainties related to our business. We also wish to advise readers not to place any undue reliance on the forward-looking statements contained in this report, which reflect our beliefs and expectations only as of the date of this report. We assume no obligation to update or revise these forward-looking statements to reflect new events or circumstances or any changes in our beliefs or expectations. Some of the risks and uncertainties that might cause actual results to differ from those anticipated include, but are not limited to, the following:
| (a) | | Because a substantial majority of our sales are generated from the Asian regions, particularly Japan, significant variations in operating results including revenue, gross margin and earnings from those expected could be caused by: |
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| • | renewed or sustained weakness of Asian economies or consumer confidence; |
| • | weakening of foreign currencies, particularly the Japanese yen; |
| • | failure of planned initiatives to generate continued interest and enthusiasm among distributors in these markets or to attract new distributors; or |
| • | any problems with our expansion of operations in China, which has spurred growth in other Asia markets, and any other distractions caused by the expansion of operations in China. |
| (b) | | Our expansion of operations in China is subject to risks and uncertainties. We have been subject to significant regulatory scrutiny and have experienced challenges including interruption of sales activities at certain stores and guidance from regulators to keep the number of sales employees at reasonable levels. We believe we could experience similar challenges in the future as we expand operations in China and work with regulators to help them understand our business model. Our operations in China may be modified or otherwise harmed by regulatory changes, subjective interpretations of laws or an inability to work effectively with national and local government agencies. In addition, actions by distributors in violation of local laws could harm our efforts. Because of restrictions on direct selling activities, we have implemented a modified business model for this market using retail stores and an employed sales force. We have not previously operated a large number of retail outlets and we cannot assure that we will be able to do so effectively. |
| (c) | | The Pharmanex BioPhotonic Scanner is still in the final development stages. As with any new technology, we have experienced delays and technical issues in developing a production model. In addition, the FDA has challenged its status as a non-medical device. If the full launch or use of this tool is delayed or otherwise inhibited by production or development issues, or if the FDA takes action to prevent us from selling the scanner as a non-medical device, this would harm our business. |
| (d) | | The network marketing and nutritional supplement industries are subject to various laws and regulations throughout our markets, many of which involve a high level of subjectivity and are inherently fact based and subject to interpretation. If our existing business practices or products, or any new initiatives or products, are challenged or found to contravene any of these laws by any governmental agency or other third party, or if there are any changes in regulations applicable to our business, our revenue and profitability may be harmed. |
| (e) | | 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, our operating results could be adversely affected if our existing and new business opportunities and products do not generate sufficient excitement and economic incentive to retain our existing distributors or to sponsor new distributors on a sustained basis. |
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| (f) | | The network marketing and nutritional supplement industries receive negative publicity from time to time. There is a risk that we could continue to receive negative publicity in the future related to our marketing practices or new initiatives or products. Any such publicity could negatively impact our ability to successfully sponsor new distributors and grow revenue. |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 3 of Part I of Form 10-Q is incorporated herein by reference from the section entitled “Currency Risk and Exchange Rate Information” in “Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part I and also in Note 5 to the Financial Statements contained in Item 1 of Part I.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
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 defined in Rules 13a-14(c) and 15d-14(c) under the Exchange Act) as of a date (the “Evaluation Date”) within 90 days prior to the filing date of this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings.
Changes in internal controls.
There were no significant changes made in our internal controls during the period covered by this report, or to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 2. �� CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)
| Exhibits
Regulations S-K
Number
| | Description
|
| | | | |
| | 10.1 | | Amendment No. 1 to the Second Amended and Restated Nu Skin Enterprises, Inc. 1996 Stock Incentive Plan |
| | | | |
| | 99.1 | | Certification of Steven J. Lund |
| | | | |
| | 99.2 | | Certification of Ritch N. Wood |
| | | | |
| | | | |
| (b) | Current Reports on Form 8-K. None. | | |
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SIGNATURES
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 15, 2003
| |
|---|
| | | NU SKIN ENTERPRISES, INC. | |
| | |
| | By: | /s/ Ritch N. Wood | |
| | | Ritch N. Wood | |
| | Its: | Chief Financial Officer | |
| | | (Principal Financial and Accounting | |
| | | Officer) | |
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CERTIFICATION
I, Steven J. Lund, Chief Executive Officer of the registrant, certify that:
| 1. | | I have reviewed this quarterly report on Form 10-Q of Nu Skin Enterprises, Inc.; |
| 2. | | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; |
| 3. | | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; |
| 4. | | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: |
| a) | | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| b) | | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| c) | | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
| 5. | | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): |
| a) | | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| b) | | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
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| 6. | | The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
Date: May 15, 2003
| | |
| /s/ Steven J. Lund | |
| Steven J. Lund | |
| Chief Executive Officer | |
A signed original of this written statement required by Section 906 has been provided to Nu Skin Enterprises, Inc. and will be retained by Nu Skin Enterprises, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
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CERTIFICATION
I, Ritch N. Wood, Chief Financial Officer of the registrant, certify that:
| 1. | | I have reviewed this quarterly report on Form 10-Q of Nu Skin Enterprises, Inc.; |
| 2. | | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; |
| 3. | | Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; |
| 4. | | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: |
| a) | | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; |
| b) | | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and |
| c) | | presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; |
| 5. | | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): |
| a) | | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and |
| b) | | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and |
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| 6. | | The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. |
Date: May 15, 2003
| | |
| /s/ Ritch N. Wood | |
| Ritch N. Wood | |
| Chief Financial Officer | |
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EXHIBIT INDEX
10.1 Amendment No. 1 to the Second Amended and Restated Nu Skin Enterprises, Inc. 1996 Stock Incentive Plan
99.1 Certification of Steven J. Lund
99.2 Certification of Ritch N. Wood
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