SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------------
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO ______________
Commission file number 001-12421
Nu Skin Enterprises, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 87-0565309
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
75 West Center Street, Provo, Utah 84601
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(Address of Principal Executive Offices) (Zip Code)
(801) 345-6100
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No _____
As of July 15, 1998, 15,090,652 shares of the Company's Class A Common
Stock, $.001 par value per share, and 70,280,759 shares of the Company's Class B
Common Stock, $.001 par value per share, were outstanding.
NU SKIN ENTERPRISES, INC.
1998 FORM 10-Q QUARTERLY REPORT - SECOND QUARTER
TABLE OF CONTENTS
Page
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets.................................2
Consolidated Statements of Income...........................3
Consolidated Statements of Cash Flows.......................4
Notes to Consolidated Financial Statements ..........5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................9
Part II. Other Information
Item 1. Legal Proceedings..............................................14
Item 2. Changes in Securities..........................................14
Item 3. Defaults upon Senior Securities................................14
Item 4. Submission of Matters to a Vote of Security Holders............14
Item 5. Other Information..............................................15
Item 6. Exhibits and Reports on Form 8-K...............................15
Signatures..............................................................16
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Nu Skin Enterprises, Inc.
Consolidated Balance Sheets (Unaudited)
(in thousands, except share amounts)
- --------------------------------------------------------------------------------
June 30, December 31,
1998 1997
----------- -----------
ASSETS
Current assets
Cash and cash equivalents $ 156,226 $ 174,300
Accounts receivable 10,192 11,074
Related parties receivable 20,193 23,008
Inventories, net 80,615 69,491
Prepaid expenses and other 48,764 38,716
--------- ---------
315,990 316,589
Property and equipment, net 35,917 27,146
Other assets, net 109,715 61,269
--------- ---------
Total assets $ 461,622 $ 405,004
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 12,023 $ 23,259
Accrued expenses 127,627 140,615
Related parties payable 26,098 10,038
Current portion of long-term debt 10,304 --
Notes payable to stockholders, current portion -- 19,457
--------- ---------
176,052 193,369
--------- ---------
Long-term debt, less current portion 129,600 --
Notes payable to stockholders, less current portion -- 116,743
Minority interest -- (15,753)
Commitments and contingencies
Stockholders' equity
Preferred stock - 25,000,000 shares authorized, $.001 par value,
none and 1,941,331 shares issued and outstanding -- 2
Class A common stock - 500,000,000 shares authorized, $.001
par value, 15,086,136 and 11,758,011 shares issued and
outstanding 15 12
Class B common stock - 100,000,000 shares authorized, $.001
par value, 70,280,759 shares issued and outstanding 70 70
Additional paid-in capital 93,949 115,053
Retained earnings 111,647 33,541
Deferred compensation (7,566) (9,455)
Accumulated other comprehensive income (42,145) (28,578)
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155,970 110,645
--------- ---------
Total liabilities and stockholders' equity $ 461,622 $ 405,004
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
2
Nu Skin Enterprises, Inc.
Consolidated Statements of Income (Unaudited)
(in thousands, except per share amounts)
- --------------------------------------------------------------------------------
Three Three Six Six
Months Ended Months Ended Months Ended Months Ended
June 30, June 30, June 30, June 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenue $209,051 $245,934 $436,914 $470,119
Cost of sales 44,602 50,637 90,291 95,864
Cost of sales - amortization of inventory
step-up (Note 2) 12,960 -- 12,960 --
-------- -------- -------- --------
Gross profit 151,489 195,297 333,663 374,255
-------- -------- -------- --------
Operating expenses
Distributor incentives 75,271 92,732 158,398 175,680
Selling, general and administrative 46,630 51,428 94,701 104,688
Distributor stock expense -- 4,477 -- 8,954
-------- -------- -------- --------
Total operating expenses 121,901 148,637 253,099 289,322
Operating income 29,588 46,660 80,564 84,933
Other income (expense), net 5,309 1,421 7,494 4,958
-------- -------- -------- --------
Income before provision for income taxes
and minority interest 34,897 48,081 88,058 89,891
Provision for income taxes 12,912 13,687 29,317 25,718
Minority interest -- 4,394 3,081 8,437
-------- -------- -------- --------
Net income $ 21,985 $ 30,000 $ 55,660 $ 55,736
======== ======== ======== ========
Net income per share (Note 4):
Basic $ .26 $ .36 $ .67 $ .67
Diluted $ .25 $ .34 $ .64 $ .64
Weighted average common shares outstanding :
Basic 83,842 83,420 82,928 83,420
Diluted 87,303 87,368 86,812 87,362
Pro forma data: $ 48,081 $ 88,058 $ 89,891
Income before pro forma provision for
income taxes and minority interest
Pro forma provision for income taxes (Note 3) 18,271 32,475 34,150
Pro forma minority interest 2,724 1,947 5,231
-------- -------- --------
Pro forma net income $ 27,086 $ 53,636 $ 50,510
======== ======== ========
Pro forma net income per share (Note 4):
Basic $ .32 $ 65 $ .61
Diluted $ .31 $ 62 $ .58
The accompanying notes are an integral part of these consolidated financial
statements.
3
Nu Skin Enterprises, Inc.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
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Six Six
Months Ended Months Ended
June 30, June 30,
1998 1997
------------- -------------
Cash flows from operating activities:
Net income $ 55,660 $ 55,736
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 6,066 3,655
Amortization of deferred compensation 1,889 11,762
Amortization of inventory step-up 12,960 --
Income applicable to minority interest 3,081 8,437
Changes in operating assets and liabilities:
Accounts receivable 882 (162)
Related parties receivable 2,815 (5,684)
Inventories, net (2,484) (12,502)
Prepaid expenses and other (10,048) (15,624)
Other assets (9,170) (3,171)
Accounts payable (11,236) (909)
Accrued expenses (15,988) (8,520)
Related parties payable 16,060 (9,997)
--------- ---------
Net cash provided by operating activities 50,487 23,021
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (12,127) (5,950)
Payments for lease deposits (1,634) (167)
Receipt of refundable lease deposits 786 129
--------- ---------
Net cash used in investing activities (12,975) (5,988)
--------- ---------
Cash flows from financing activities:
Payments on long-term debt (41,634) --
Proceeds from long-term debt 181,538 --
Payment to stockholders for notes payable (180,000) (71,487)
Proceds from capital contributions -- 29,845
Dividends paid -- (29,341)
--------- ---------
Net cash used in financing activities (40,096) (70,983)
--------- ---------
Effect of exchange rate changes on cash (15,490) 3,038
--------- ---------
Net decrease in cash and cash equivalents (18,074) (50,912)
Cash and cash equivalents, beginning of period 174,300 214,823
--------- ---------
Cash and cash equivalents, end of period $ 156,226 $ 163,911
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
4
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
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1. THE COMPANY
Nu Skin Enterprises, Inc. (the "Company"), is a network marketing company
involved in the distribution and sale of premium quality, innovative
personal care and nutritional products. The Company distributes Nu Skin
brand products in markets throughout the world excluding North America. The
Company's operations throughout the world are divided into three regions:
North Asia, which consists of Japan and South Korea; Southeast Asia, which
consists of Taiwan, Thailand, Hong Kong (including Macau), the Philippines,
Australia, and New Zealand; and Other Markets, which consists of the United
Kingdom, Austria, Belgium, France, Germany, Italy, Ireland, Poland,
Portugal, Spain, the Netherlands (the Company's subsidiaries operating in
these countries are collectively referred to as the "Subsidiaries") and
sales to and licence fees from the Company's North American private
affiliates.
The Company was incorporated on September 4, 1996 as a holding company and
acquired certain of the Subsidiaries (the "Initial Subsidiaries") through a
reorganization (the "Reorganization") which occurred November 20, 1996.
Prior to the Reorganization, each of the Initial Subsidiaries elected to be
treated as an S corporation. In connection with the Reorganization, the
Initial Subsidiaries' S corporation status was terminated on November 19,
1996, and the Company declared a distribution to the stockholders that
included all of the Initial Subsidiaries' previously earned and
undistributed taxable S corporation earnings totaling $86.5 million (the "S
Distribution Notes").
On November 27, 1996 the Company completed its initial public offerings of
4,750,000 shares of Class A Common Stock and received net proceeds of $98.8
million (the "Underwritten Offerings").
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
the accompanying unaudited consolidated financial statements contain all
adjustments, consisting of normal recurring adjustments, considered
necessary for a fair statement of the Company's financial information as of
June 30, 1998 and December 31, 1997 and for the three and six-month periods
ended June 30, 1998 and 1997. The results of operations of any interim
period are not necessarily indicative of the results of operations to be
expected for the fiscal year. For further information, refer to the
consolidated financial statements and accompanying footnotes included in
the Company's annual report on Form 10-K for the year ended December 31,
1997.
2. ACQUISITION OF NU SKIN INTERNATIONAL, INC. ("NSI") AND CERTAIN AFFILIATES
On March 27, 1998, the Company completed the acquisition (the "NSI
Acquisition") of the capital stock of NSI, NSI affiliates in Europe, South
America, Australia and New Zealand and certain other NSI affiliates (the
"Acquired Entities") for $70 million in preferred stock and long-term notes
payable to the stockholders of the Acquired Entities ("NSI Stockholders")
totaling approximately $10.1 million. In addition, contingent upon NSI and
the Company meeting specific earnings growth targets, the Company will pay
up to $25 million in cash per year over the next four years to the NSI
Stockholders. Also, as part of the NSI Acquisition, the Company assumed
approximately $169.9 million in S Distribution Notes. As of June 30, 1998,
the S Distribution Notes and long-term notes payable to the NSI
Stockholders had been paid in full. The contingent consideration paid, if
any, will be accounted for as an adjustment to the purchase price and
allocated to the Acquired Entities' assets and liabilities.
The NSI Acquisition was accounted for by the purchase method of accounting,
except for that portion of the Acquired Entities under common control of a
group of stockholders, which portion was accounted for in a manner similar
to a pooling of interests. The common control group is comprised of the NSI
Stockholders who are immediate family members. The minority interest, which
is
5
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
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comprised of the NSI Stockholders who are not immediate family members, was
acquired during the NSI Acquisition.
In connection with the NSI Acquisition, the Company recorded inventory
step-up of $21.6 million and intangible assets of $32.4 million. The
Company recorded amortization of inventory step-up totaling $13.0 million,
and amortization of intangible assets totaling $0.5 million, respectively,
for the three-month period ended June 30, 1998.
On May 5, 1998, the stockholders of the Company approved the automatic
conversion of the preferred stock issued in the NSI Acquisition into
2,986,663 shares of Class A Common Stock.
3. INCOME TAXES
As a result of the NSI Acquisition described in Note 2, the Acquired
Entities are no longer treated as S corporations for U.S. Federal income
tax purposes. The combined statements of income include a pro forma
presentation for income taxes, including the effect on minority interest,
which would have been recorded if the Acquired Entities had been taxed as C
corporations rather than as S corporations for the six-month period ended
June 30, 1998 and for the three and six-month periods ended June 30, 1997.
4. NET INCOME PER SHARE
Net income per share is computed based on the weighted average number of
common shares and common share equivalents outstanding during the periods
presented. Additionally, diluted earnings per share data gives effect to
all dilutive potential common shares that were outstanding during the
periods presented, including the convertible preferred stock issued in the
NSI Acquisition as if such shares had been converted to Class A Common
Stock.
5. FINANCIAL INSTRUMENTS
The Company's Subsidiaries enter into significant transactions with each
other and third parties which may not be denominated in the respective
Subsidiaries' functional currencies. The Company seeks to reduce its
exposure to fluctuations in foreign exchange rates by creating offsetting
positions through the use of foreign currency exchange contracts and
through intercompany loans of foreign currency. The Company does not use
such financial instruments for trading or speculative purposes. The Company
regularly monitors its foreign currency risks and periodically takes
measures to reduce the impact of foreign exchange fluctuations on the
Company's operating results. Gains and losses on foreign currency forward
contracts and intercompany loans of foreign currency are recorded as other
income and expense in the consolidated statements of income.
At June 30, 1998 and December 31, 1997, the Company held foreign currency
forward contracts with notional amounts totaling approximately $29.9
million and $51.0 million, respectively, to hedge foreign currency items.
The realized and unrealized net gains on these contracts were $1.5 million
and $3.4 million for the three and six-month periods ended June 30, 1998.
These contracts have maturities through December 1998.
At June 30, 1998 and 1997, the intercompany loan from Nu Skin Japan to Nu
Skin Hong Kong totaled approximately $54.9 million and $43.9 million,
respectively. The Company recorded unrealized exchange gains totaling $1.9
million and $2.8 million, resulting from the intercompany loan for the
three and six-month periods ended June 30, 1998, respectively. At June 30,
1998, the intercompany loan from Nu Skin Japan to the Company totaled
approximately $67.0 million. The Company recorded unrealized exchange gains
totaling $2.0 million, resulting from the intercompany
6
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
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loan for the three and six-month periods ended June 30, 1998. There was no
loan at June 30, 1997 from Nu Skin Japan to the Company.
6. NEW ACCOUNTING STANDARDS
Reporting Comprehensive Income
During the first quarter of 1998 the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from nonowner sources, and it includes all changes in equity
during a period except those resulting from investments by owners and
distributions to owners.
The components of comprehensive income, net of related tax, for the three
and six-month periods ended June 30, 1998 and 1997, were as follows:
Three Three Six Six
Months Ended Months Ended Months Ended Months Ended
June 30, 1998 June 30, 1997 June 30, 1998 June 30, 1997
------------- ------------- ------------- -------------
Net income $ 21,985 $ 30,000 $ 55,660 $ 55,736
Other comprehensive income, net of tax:
Foreign currency translation adjustments (9,114) (2,772) (13,567) 197
-------- -------- -------- --------
Comprehensive income $ 12,871 $ 27,228 $ 42,093 $ 55,933
======== ======== ======== ========
Accumulated other comprehensive income is comprised solely of foreign
currency translation adjustments.
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. The statement is
effective for fiscal years beginning after December 15, 1998. Earlier
application is encouraged in fiscal years for which annual financial
statements have not been issued. The statement defines which costs of
computer software developed or obtained for internal use are capital and
which costs are expensed. The Company adopted SOP 98-1 effective January
1998. The adoption of SOP 98-1 does not materially affect the Company's
consolidated financial statements.
Reporting on the Costs of Start-Up Activities
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 ("SOP 98-5"), Reporting on the Costs of
Start-Up Activities. The statement is effective for fiscal years beginning
after December 15, 1998. The statement requires costs of start-up
activities and organization costs to be expensed as incurred. The Company
will adopt SOP 98-5 for calendar year 1999. The adoption of SOP 98-5 will
not materially affect the Company's consolidated financial statements.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), Accounting for
Derivative Instruments and Hedging Activities. The statement requires
companies to recognize all derivatives as either assets or liabilities,
with the instruments measured at fair value. The accounting for changes in
fair value, gains or losses, depends on the intended use of the derivative
and its resulting designation. The statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. The Company will
adopt SFAS 133 by January 1, 2000. The Company is currently evaluating the
impact the adoption of SFAS 133 will have on the Company's consolidated
financial statements.
7
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
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7. LONG-TERM DEBT
On May 8, 1998, the Company and its Japanese subsidiary Nu Skin Japan Co.,
Ltd. entered into a $180 million credit facility with a syndicate of
financial institutions for which ABN-AMRO, N.V. acted as agent. This credit
facility was used to satisfy Company liabilities which were assumed as part
of the NSI Acquisition. The Company borrowed $110 million and Nu Skin Japan
Co., Ltd. borrowed the Japanese Yen equivalent of $70 million denominated
in local currency. The balance on the credit facility was $139.9 at June
30, 1998.
The U.S. portion of the credit facility bears interest at either a base
rate as specified in the credit facility or the London Inter-Bank Offer
rate plus an applicable margin, in the borrower's discretion. The Japanese
portion of the credit facility bears interest at either a base rate as
specified in the credit facility or the Tokyo Inter-Bank Offer rate plus an
applicable margin, in the borrower's discretion. The maturity date for the
credit facility is three years from the borrowing date, with a possible
extension of the maturity date upon approval of the then outstanding
lenders. Interest expense on the credit facility totaled $1.2 million for
the three and six-month periods ended June 30, 1998.
8. SUBSEQUENT EVENT
On July 20, 1998, the Board of Directors authorized the Company to request
the holders of the Class B Common Stock to convert up to 15 million shares
of Class B Common Stock to Class A Common Stock. The Company anticipates
that upon approval from the stockholders of the Company this conversion
will occur during the third quarter of 1998.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
1998 compared to 1997
Revenue decreased 15.0% and 7.1% to $209.1 million and $436.9 million
from $245.9 million and $470.1 million for the three and six-month periods ended
June 30, 1998, respectively, compared with the same periods in 1997. The
decrease in revenue resulted primarily from significant devaluation of the yen
and other Asian currencies, an increasing competitive environment in Taiwan and
the economic downturn in South Korea and Thailand. Revenue in North and
Southeast Asia were also positively impacted by a price increase throughout Asia
that occurred in the second quarter 1997.
Revenue in North Asia, which consists of Japan and South Korea,
decreased to $148.0 million and $305.0 million from $167.8 million and $324.4
million for the three and six-month periods ended June 30, 1998, respectively,
compared with the same periods in 1997. Economic challenges, currency
devaluation and unfavorable media and consumer group attention toward foreign
companies in South Korea resulted in a significant decline in South Korean
revenue for the three and six-month periods ended June 30, 1998 compared to the
same periods in 1997. Revenue in Japan increased 0.5% and 14.8% for the three
and six-month periods ended June 30, 1998 due to the continued growth of the
personal care and IDN product lines as well as the increase in active
distributors in that market. This increase in growth in U.S. dollars was
negatively affected by a 15% devaluation of the yen from the second quarter of
1997 to the second quarter of 1998. In local currency, revenue in Japan
increased by 12.6% and 14.8% for the three and six-month periods ended June 30,
1998, respectively, compared to the same periods in 1997.
Revenue in Southeast Asia, which consists of Taiwan, Thailand, Hong
Kong, the Philippines, Australia and New Zealand, totaled $39.5 million and
$85.6 million for the three and six-month periods ended June 30, 1998, a
decrease of 38.8% and 28.8%, respectively, from revenue of $64.5 million and
$120.2 million during the three and six-month periods ended June 30, 1997. The
Company's operations in Taiwan have continued to suffer the impact of increased
competition and relatively soft nutritional product revenue. In addition, the
Company's operations in Thailand have been impacted negatively by Thailand's
economic challenges and currency devaluation.
The declines in North and Southeast Asia were partially offset by
aggregate revenue increases in the Company's other markets, which include the
United Kingdom, Germany, Italy, the Netherlands, France, Belgium, Spain,
Portugal, Ireland, Austria and sales to and license fees from the Company's
North American private affiliates. Aggregate revenue in these markets increased
to $21.6 million and $46.3 million from $13.7 million and $25.5 million, an
increase of 57.7% and 81.6%, for the three and six-month periods ended June 30,
1998, respectively, compared to the same periods in 1997. These increases were
primarily due to significantly increased sales to the Company's North American
private affiliates resulting from the successful convention held in the first
quarter of 1998 in the United States, which attracted over 13,000 distributors
and strong revenue results from sales to and license fees from these affiliates.
Gross profit as a percentage of revenue was 72.5% and 79.4% for the
three months ended June 30, 1998 and 1997, respectively, and was 76.4% and 79.6%
for the six months ended June 30, 1998 and 1997, respectively. The amortization
of the step-up of inventory from the NSI Acquisition increased cost of sales by
$13.0 million in the second quarter of 1998. Without this non-recurring charge,
gross profit would have been 78.7% and 79.3% for the three and six-month periods
ended June 30, 1998, respectively, a slight decrease from 1997 gross margins.
The remaining balance of $8.6 million of inventory step-up will be fully
amortized in the third quarter of 1998. The Company purchases goods in U.S.
dollars and recognizes revenue in local currency and is consequently subjected
to exchange rate risks in its gross margins. The negative pressure on gross
margins, due primarily to weakened currencies throughout the Company's Asian
markets, was offset by gross margin improvement as a result of price increases
throughout Asia which occurred during the second quarter of 1997. In addition,
increased local manufacturing efforts have been designed to improve and
stabilize gross margins.
Distributor incentives as a percentage of revenue decreased to 36.0%
and 36.3% for the three and six-month periods ended June 30, 1998 from 37.7% and
37.4% for the three and six-month periods ended June 30, 1997, respectively. The
primary reason for this decrease was increased revenue from sales to and license
fees from North America which is not subject to incentives being paid by the
Company.
9
Selling, general and administrative expenses as a percentage of
revenue increased to 22.3% for the three month period ended June 30, 1998 from
20.9% for the three month period ended June 30, 1997. This increase was due to
U.S. dollar based selling, general and administrative expenses, acquired from
the NSI Acquisition. Selling, general and administrative expenses as a
percentage of revenue decreased from 22.3% to 21.7% for the six month periods
ended June 30, 1998 and 1997, respectively. In dollar terms, selling, general
and administrative expenses decreased from $51.4 million and $104.7 million to
$46.6 million and $94.7 million for the three and six-month periods ended June
30, 1998, respectively, compared with the same periods in 1997.
Distributor stock expense of $4.5 million and $9.0 million for the
three and six-month periods ended June 30, 1997, respectively, reflects the
one-time grant of the distributor stock options at an exercise price of 25% of
the initial public offering price in connection with the Underwritten Offerings
completed on November 27, 1996. This non-cash expense is non-recurring and was
only recorded in the fourth quarter of 1996 and in each of the four quarters in
1997.
Operating income decreased 36.6% and 5.1% to $29.6 million and $80.6
million from $46.7 million and $84.9 million for the three and six-month periods
ended June 30, 1998, respectively, compared with the same periods in 1997.
Operating margin decreased to 14.2% from 19.0% for the three months ended June
30, 1998 compared with the same period in 1997. This operating income and margin
decrease was caused primarily by the decrease in U.S. dollar revenue and by the
non-recurring amortization of inventory step-up recorded in the second quarter
of 1998. Operating margin remained nearly constant at approximately 18% for the
six-month periods ended June 30, 1998 and 1997.
Other income increased by $3.9 million and $2.5 million for the three
and six-month periods ended June 30, 1998, respectively, compared with the same
periods in 1997. The increase was primarily caused by the strong hedging gains
from forward contracts and intercompany loans, as the Japanese yen weakened
during the quarter.
Provision for income taxes decreased to $12.9 million from $13.7
million for the three months ended June 30, 1998 compared with the same period
in 1997 due to decreased income that was offset by the increase in the effective
tax rate from 28.5% to 37.0% for the same periods. Provision for income taxes
increased to $29.3 million from $25.7 million for the six months ended June 30,
1998 compared with the same period in 1997 due to a slight decrease in income
that was offset by the increase in the effective tax rate to 33.3% from 28.6%.
The pro forma provision for income taxes presents income taxes as if the
Acquired Entities had been taxed as C corporations rather than as S corporations
for the three months ended March 31, 1997 and for the six-month periods ended
June 30, 1998 and 1997. On a pro forma basis, the effective tax rate for the
three and six-month periods ended June 30, 1997 was 38.0% and was 36.9% for the
six-months ended June 30, 1998.
Minority interest relates to the earnings of the Acquired Entities
which are not under common control. The minority interest owed at March 26, 1998
was purchased as part of the NSI Acquisition. Accordingly, minority interest
does not continue after the NSI Acquisition.
Net income decreased by $8.0 million to $22.0 million from $30.0
million for the three months ended June 30, 1998 compared with the same period
in 1997 due primarily to the amortization of inventory step-up offset by the
increases in other income. Net income for the six-month periods ended June 30,
1998 and 1997 remained constant at $55.7 million. Net income as a percentage of
revenue decreased to 10.5% for the three months ended June 30, 1998 as compared
to 12.2% for the same period in 1997 and increased from 11.9% to 12.7% for the
six months ended June 30, 1998 compared to the same period in 1997.
Liquidity and Capital Resources
Historically, the Company's principal needs for funds have been for
distributor incentives, working capital (principally inventory purchases),
capital expenditures and the development of new markets. The Company has
generally relied entirely on cash flow from operations to meet its business
objectives without incurring long-term debt to unrelated third parties to fund
operating activities.
The Company generates significant cash flow from operations due to
favorable gross margins and minimal capital requirements. Additionally, the
Company does not extend credit to distributors, but requires payment prior to
shipping products. This process eliminates the need for accounts receivable from
10
distributors. During the first quarter of each year, the Company pays
significant accrued income taxes in many foreign jurisdictions including Japan.
These large cash payments generally more than offset significant cash generated
in the first quarter. During the six months ended June 30, 1998, the Company
generated $50.5 million from operations compared to $23.5 million generated
during the six months ended June 30, 1997. This increase in cash generated from
operations is primarily due to reduced inventory levels and related party
activity.
As of June 30, 1998, working capital was $139.9 million compared to
$123.2 million as of December 31, 1997. This increase is largely due to the
step-up in inventory relating to the NSI Acquisition. Cash and cash equivalents
at June 30, 1998 were $156.2 million compared to $174.3 million at December 31,
1997.
Capital expenditures, primarily for equipment, computer systems and
software, office furniture and leasehold improvements, were $12.1 million and
$6.0 million for the six months ended June 30, 1998 and 1997, respectively. In
addition, the Company anticipates additional capital expenditures in 1998 of
$15.0 million to further enhance its infrastructure, including computer systems
and software, warehousing facilities and walk-in distributor centers in order to
accommodate future growth. The Company is currently reviewing its own and its
principal vendors' computer systems and software to evaluate and address the
"Year 2000" issue. The Company believes that the capital required to modify its
systems will not be material to the Company. The Company, however, cannot
predict or evaluate foreign governments' preparation for the "Year 2000" issue
and the resulting impact it may have on the economy or on the Company's
business.
In March 1998, the Company completed its acquisition of the Acquired
Entities for $70 million in preferred stock and long-term notes payable to the
NSI Stockholders totaling approximately $10.1 million. In addition, contingent
upon NSI and the Company meeting certain earnings growth targets, the Company
may pay up to $25 million in cash per year over the next four years. Also, as
part of the NSI Acquisition, the Company assumed approximately $169.9 million in
S Distribution Notes due in equal monthly installments over the next seven
years. As of June 30, 1998, the S Distribution Notes and long-term notes payable
to the NSI Stockholders had been paid in full. The contingent consideration
paid, if any, will be accounted for as an adjustment to the purchase price and
allocated to the Acquired Entities' assets and liabilities.
In May 1998, the Company and its Japanese subsidiary Nu Skin Japan
Co., Ltd. entered into a $180 million credit facility with a syndicate of
financial institutions for which ABN-AMRO, N.V. acted as agent. This credit
facility was used to satisfy Company liabilities which were assumed as part of
the NSI Acquisition. The Company borrowed $110 million and Nu Skin Japan Co.,
Ltd. borrowed the Japanese Yen equivalent of $70 million denominated in local
currency. During the three months ended June 30, 1998, the Company paid $41.6
million of the $180.0 million credit facility. The U.S. portion of the credit
facility bears interest at either a base rate as specified in the credit
facility or the London Inter-Bank Offer rate plus an applicable margin, in the
borrower's discretion. The Japanese portion of the credit facility bears
interest at either a base rate as specified in the credit facility or the Tokyo
Inter-Bank Offer rate plus an applicable margin, in the borrower's discretion.
The maturity date for the credit facility is three years from the borrowing
date, with a possible extension of the maturity date upon approval of the then
outstanding lenders. The credit facility provides that the amounts borrowed are
to be used for general corporate purposes. The credit facility also contains
other terms and conditions and affirmative and negative financial covenants
customary for credit facilities of this type.
Under its operating agreements with other Nu Skin affiliated
companies, the Company incurs related party payables and receivables. The
Company had related party payables of $26.1 million and $10.0 million at June
30, 1998 and December 31, 1997, respectively. In addition, the Company had
related party receivables of $20.2 million and $23.0 million, respectively, at
those dates. Related party balances outstanding in excess of 60 days bear
interest at a rate of 2% above the U.S. prime rate. As of June 30, 1998, no
material related party payables or receivables had been outstanding for more
than 60 days.
Management considers the Company to be liquid and able to meet its
obligations on both a short and long-term basis. Management currently believes
existing cash balances together with future cash flows from operations will be
adequate to fund cash needs relating to the implementation of the Company's
strategic plans.
11
Seasonality and Cyclicality
The direct selling industry is impacted by certain seasonal trends
such as major cultural events and vacation patterns. For example, Japan, Taiwan,
Hong Kong, South Korea and Thailand celebrate their respective local New Year in
the Company's first quarter. Management believes that direct selling in Japan
and Europe is also generally negatively impacted during August, when many
individuals traditionally take vacations.
Generally, the Company has experienced rapid revenue growth in each
new market from the commencement of operations. In Japan, Taiwan and Hong Kong,
the initial rapid growth was followed by a short period of stable or declining
revenue followed by renewed growth fueled by new product introductions, an
increase in the number of active distributors and increased distributor
productivity. In South Korea, the Company experienced a significant decline in
its 1997 revenue from revenue in 1996 and is experiencing additional declines in
1998. Revenue in Thailand also decreased significantly after the commencement of
operations in March 1997. Management believes that the revenue declines in South
Korea and Thailand were partly due to normal business cycles in new markets but
were primarily due to volatile economic conditions in those markets. See
"--Outlook." In addition, the Company may experience variations on a quarterly
basis in its results of operations, as new products are introduced and new
markets are opened. No assurance can be given that the Company's revenue growth
rate in new markets where Nu Skin operations have not commenced will follow this
pattern.
Currency Fluctuation and Exchange Rate Information
The Company's revenue and most of its 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
entity's local currency is considered the functional currency. All revenue and
expenses are translated at weighted average exchange rates for the periods
reported. Therefore, the Company's reported sales 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 uncertainty of exchange rate fluctuations, the Company
cannot estimate the effect of these fluctuations on its future business, product
pricing, results of operations or financial condition. However, because nearly
all of the Company's revenue is realized in local currencies and the majority of
its cost of sales is denominated in U.S. dollars, the Company's gross profits
will be positively affected by a weakening in the U.S. dollar and will be
negatively affected by a strengthening in the U.S. dollar. The Company reduces
its exposure to fluctuations in foreign exchange rates by creating offsetting
positions through the use of foreign currency exchange contracts. The Company
does not use such financial instruments for trading or speculative purposes. The
Company regularly monitors its foreign currency risks and periodically takes
measures to reduce the impact of foreign exchange fluctuations on the Company's
operating results.
Outlook
Management currently anticipates annual revenue and earnings growth
overall in 1998. This growth is expected to result in part from improved margins
resulting from the recent NSI Acquisition as well as from anticipated growth in
Japan and Taiwan. Further, expansion into new markets, specifically Brazil, is
expected to contribute to growth in revenue and earnings. Additionally, the
Company intends to continue pursuing strategic initiatives to minimize the
impact of fluctuating currencies and economies in Asia by diversifying its
markets, moving more of its manufacturing to local markets, implementing
enhancements to its sales compensation plan and seeking cost reductions from
vendors. The Company's anticipated revenue and earnings growth, however, could
be adversely affected by continued fluctuations in Asian currencies,
particularly the yen, and the economic downturn in its Asian markets.
Revenue in the third quarter of 1998 is anticipated to be down
sequentially and from the third quarter of 1997 primarily due to the impact of
currency translation. In the fourth quarter of 1998, however, management
anticipates that nearly all markets will record sequential revenue gains. These
revenue gains are expected to be led by Japan where current plans include a
major convention and the introduction of a new water purification product line
as well as other nutritional and personal care products. Additionally, the
Company has announced plans for operations in Brazil to commence in the fourth
quarter. The Company also plans to re-introduce locally manufactured LifePak in
Taiwan in the third quarter of 1998 that will be sold
12
at 20 percent less than the current product with no gross margin erosion.
Management anticipates that this repositioning of LifePak will place the Company
in a much more competitive posture in Taiwan's nutrition industry.
Reported operating margins are expected to be negatively impacted in
the third quarter of 1998 due to the remaining charge of $8.6 million for
amortization of inventory step-up. This charge is a non-cash, non-recurring
expense that will not continue beyond the third quarter of 1998. Operating
margins in the fourth quarter of 1998 are expected to improve in relation to the
anticipated revenue growth in the fourth quarter of 1998.
The Company has significant forward contracts and other hedging
vehicles on foreign currencies, principally the Japanese yen. It is impossible
to predict the impact on other income due to a strengthening or weakening of the
Japanese yen. If the yen strengthens, the Company's reported revenue and
operating profits will be positively impacted, but the impact on earnings will
be offset, to a degree, by other income losses. If the yen weakens, the
Company's reported revenue and operating profits will be negatively impacted,
but the impact on earnings will be offset, to a degree, by other income gains.
Note Regarding Forward-Looking Statements
Certain statements made above in the Liquidity and Capital Resources
section and the Outlook section are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). These forward-looking statements involve risks and uncertainties and are
based on certain assumptions that may not be realized. Actual results and
outcomes may differ materially from those discussed or anticipated. The
forward-looking statements and associated risks described in this filing relate
to (i) the anticipation of significant cash flow from operations, (ii) the
Company's expectation that it will be able to rely entirely on cash flow from
operations to fund its business objectives without incurring long-term debt to
unrelated third parties, (iii) the Company's expectation that it will be able to
successfully address any issues relating to the Year 2000 issue, and to the
extent necessary, modify computer systems without incurring material capital
expenditures, (iv) management's belief that the Company is liquid and able to
meet its obligations both on a short and long-term basis, (v) the anticipation
of growth in annual revenue and earnings overall in 1998 as a result of the NSI
Acquisition, growth in Japan and Taiwan, expansion in Brazil and other new
markets, (vi) management's belief that revenue in the third quarter will be down
due to the impact of currency devaluation, (vii) management's belief that nearly
all of its markets will record sequential revenue gains in the fourth quarter,
(viii) expected revenue gains in Japan arising from the convention planned for
the fourth quarter and the introduction of a new water filtration system, (ix)
the planned expansion into Brazil, (x) the expectation that the re-introduction
of a locally-manufactured LifePak in Taiwan will improve the Company's
competitive position in Taiwan's nutrition industry without affecting margins,
(xi) the Company's intentions to pursue strategic initiatives to minimize the
impact of fluctuating foreign currencies and economies in Asia by diversifying
its markets, moving more of its manufacturing to local markets, implementing
enhancements to its sales compensation plan and seeking cost reductions from
vendors, (xii) the Company's plan to implement forward contracts and other
hedging strategies to manage foreign currency risks, and (xiii) the expected
improvement in operating margins in the fourth quarter in relation to the
anticipated revenue growth.
Important factors and risks that might cause actual results to differ
from those anticipated include, but are not limited to: (a) lower than expected
revenue, revenue growth and cash flow from operations because of adverse
economic, business or political conditions, increased competition, adverse
publicity in the Company's markets, particularly Japan and Taiwan, or the
Company's inability, for any reason, to open new markets such as Brazil,
introduce new products, implement its marketing and local sourcing initiatives
and other strategic plans as well as the potential negative effect of
distributor actions such as decreased selling efforts or increased turnover; (b)
variations in operating results including revenue, gross profit and earnings
caused by continued fluctuations in foreign currency values; (c) the Company's
inability to favorably implement forward contracts and other hedging strategies
to manage foreign currency risk; (d) difficulties in integrating the NSI
operations with the Company's operations; (e) the inability of the Company to
successfully establish manufacturing facilities in foreign markets at lower
costs while maintaining the quality and marketing position of its products; (f)
unanticipated problems or circumstances, including any regulatory and other
legal issues, that may prevent or delay the Company from expanding into new
markets, particularly Brazil, or introducing new products; (g) the inability of
the Company to gain market acceptance of new products, including the Company's
proposed home water filtration product in Japan, which
13
represents a new market segment, and the locally manufactured LifePak in Taiwan;
(h) increased expenditures required to address the Year 2000 issue if the
Company's technology requirements change or unforseen problems are discovered;
(i) risks that the Company's and its vendors' plans to remedy "Year 2000" issues
may be inadequate which could result in disruptions of the Company's business;
(j) increased government regulation of direct selling activities and products in
existing and future markets such as the PRC's recent restrictions on direct
selling; (k) management's inability to effectively manage the Company's growth;
(l) the Company's inability to renegotiate or adjust vendor relationships
favorable to the Company; (m) risks inherent in the importation, regulation and
sale of personal care and nutritional products in the Company's markets
including product liability issues; (n) the Company's reliance on and the
concentration of outside manufacturers; (o) taxation and transfer pricing
issues, including the Company's inability to fully use its foreign tax credits;
and (p) seasonal and cyclical trends. For a more detailed discussion of risks
and uncertainties related to the Company's business, please refer to the
Company's Form 10-K for the year ended December 31, 1997, and any amendments
thereto, and other documents filed by the Company with the Securities and
Exchange Commission.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Nu Skin International, Inc. ("NSI"), a recently acquired subsidiary of
the Company, is a party to an action entitled Natalie Capone on behalf of
Herself and All Others Similarly Situated v. Nu Skin Canada, Inc., Nu Skin
International, Inc., Blake Roney, et. al. which was filed with the United States
District Court for the District of Utah, Central Division (the "Court") in March
1993. This litigation was previously reported in the Company's Quarterly Report
on Form 10-Q for the quarterly period ended March 31, 1998. Ms. Capone filed a
class action complaint against NSI and certain affiliated parties (the
"Defendants"). The complaint alleges violations of the anti-fraud provisions of
the Securities Act of 1933 and the Securities Exchange Act of 1934, common law
fraud and violations of the Utah Consumer Sales Practices Act. The plaintiff
also sought injunctive relief, disgorgement by Defendants, and restitution to
plaintiff of all earnings, profits, compensation and benefits obtained by
Defendants. In June 1997 the Court denied NSI's motion for summary judgement but
also denied the plaintiff's motion to certify a similarly situated class of
distributors. In May 1998, the Court, upon reconsideration, granted the
plaintiff's motion to certify a similarly situated class of distributors based
on more limited claims under the Securities Act of 1933 and the Utah
Anti-pyramid statute. The case continues in discovery. The Company's potential
liability associated with this case is limited to the impact an adverse decision
may have upon the business of its privately-owned affiliates in the U.S. and
Canada and is also limited by certain indemnities provided to the Company in
connection with the NSI Acquisition.
ITEM 2. CHANGES IN SECURITIES
Conversion of Preferred Stock
On May 5, 1998, the stockholders of the Company approved the automatic
conversion of the preferred stock issued in the NSI Acquisition into 2,986,663
shares of Class A Common Stock. The issuance of shares of Class A Common Stock
upon conversion of the preferred stock was made in reliance upon the exemptions
provided by Section 3(a)(9) and Section 4(2) of the Securities Act of 1933.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 5, 1998.
At the Annual Meeting, Blake M. Roney, Steven J. Lund, Sandra N. Tillotson,
Keith R. Halls, Brooke B. Roney, Max L. Pinegar, E.J.
14
"Jake" Garn, Paula Hawkins and Daniel W. Campbell were elected to serve as
directors of the Company until the next annual meeting of stockholders or until
their successors are duly elected. Each director was elected by a plurality of
votes in accordance with the Delaware General Corporation Law. There was no
solicitation in opposition to management's director nominees. The following
chart reflects the vote tabulation with respect to each director nominee. The
figures reported reflect votes cast by holders of the Company's Class A Common
Stock and Class B Common Stock. Each share of Class A Common Stock entitles its
holder to one vote, and each share of Class B Common Stock entitles its holder
to ten votes.
Name of Director
Nominee Votes For Votes Withheld
------------------- ----------- --------------
Blake M. Roney 702,807,587 30,305
Steven J. Lund 702,807,587 28,394
Sandra N. Tillotson 702,807,587 28,394
Keith R. Halls 702,807,587 28,394
Brooke B. Roney 702,807,587 28,394
Max L. Pinegar 694,136,020 8,699,961
E.J. "Jake" Garn 702,807,587 28,394
Paula Hawkins 702,807,587 28,394
Daniel W. Campbell 702,807,587 28,394
The stockholders also approved an amendment to the Company's
Certificate of Incorporation that changed the name of the Company to Nu Skin
Enterprises, Inc. with 710,737,545 votes voted in favor of the amendment, 1,859
votes cast against, and 2,988,616 abstentions. The stockholders also approved
the automatic conversion of the preferred stock issued in the NSI Acquisition
into 2,986,663 shares of Class A Common Stock with 706,153,182 votes being cast
for, 42,054 votes being cast against, and 2,979,295 votes abstaining. In
addition, the stockholders ratified the appointment of PricewaterhouseCoopers
LLP as the Company's independent public accountants, with 710, 748,431 votes
being cast for, 5,131 votes being cast against, as well as 2,974,428 votes
abstaining.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Regulation S-K
Number Description
3.1 Amendment to the Company's Certificate of Incorporation
10.1 Credit Agreement - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.2 Form of Note - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.3 Subsidiary Guaranty - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.4 Pledge Agreement - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.5 NSE Guaranty - dated May 8, 1998 with ABN AMRO, N.V., as agent
27.1 Financial Data Schedule - Six Months Ended June 30, 1998
27.2 Financial Data Schedule - Year Ended December 31, 1997 - Restated
27.3 Financial Data Schedule - Nine Months Ended June 30, 1997 - Restated
27.4 Financial Data Schedule - Six Months Ended June 30, 1997 - Restated
27.5 Financial Data Schedule - Three Months Ended March 31, 1997 - Restated
27.6 Financial Data Schedule - Year Ended December 31, 1996 - Restated
15
(b) Reports on Form 8-K. The Company filed an amendment to a Current
Report on Form 8-K/A dated April 28, 1998 providing financial statements, pro
forma financial information and exhibits reflecting the NSI Acquisition.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on this
12th day of August, 1998.
NU SKIN ENTERPRISES, INC.
By: /s/ Corey B. Lindley
Corey B. Lindley
Its: Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
16
EXHIBIT INDEX
3.1 Amendment to the Company's Certificate of Incorporation
10.1 Credit Agreement - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.2 Form of Note - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.3 Subsidiary Guaranty - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.4 Pledge Agreement - dated May 8, 1998 with ABN AMRO, N.V., as agent
10.5 NSE Guaranty - dated May 8, 1998 with ABN AMRO, N.V., as agent
27.1 Financial Data Schedule - Six Months Ended June 30, 1998
27.2 Financial Data Schedule - Year Ended December 31, 1997 - Restated
27.3 Financial Data Schedule - Nine Months Ended June 30, 1997 - Restated
27.4 Financial Data Schedule - Six Months Ended June 30, 1997 - Restated
27.5 Financial Data Schedule - Three Months Ended March 31, 1997 - Restated
27.6 Financial Data Schedule - Year Ended December 31, 1996 - Restated
17