EX-13
SELECTED FINANCIAL DATA
Year Ended December 31,
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
Income Statement Data:
Revenue............................................ $ 330,680 $ 435,855 $ 761,638 $ 953,422 $ 913,494
Cost of sales...................................... 76,012 101,474 171,187 191,218 188,457
Cost of sales - amortization of inventory step-up.. -- -- -- -- 21,600
---------- ---------- ---------- ---------- ----------
Gross profit....................................... 254,668 334,381 590,451 762,204 703,437
---------- ---------- ---------- ---------- ----------
Operating expenses:
Distributor incentives......................... 104,994 139,495 282,588 362,195 331,448
Selling, general and administrative 86,931 115,950 168,706 201,880 202,150
Distributor stock expense...................... -- -- 1,990 17,909 --
In-process research and development -- -- -- -- 13,600
---------- ---------- ---------- ---------- ----------
Total operating expenses........................... 191,925 255,445 453,284 581,984 547,198
---------- ---------- ---------- ---------- ----------
Operating income................................... 62,743 78,936 137,167 180,220 156,239
Other income (expense), net........................ (394) 650 10,771 8,973 13,599
---------- ---------- ---------- ---------- ----------
Income before provision for income
taxes and minority interest.................... 62,349 79,586 147,938 189,193 169,838
Provision for income taxes......................... 10,071 19,141 49,526 55,707 62,840
Minority interest 7,561 10,498 13,700 14,993 3,081
---------- ---------- ---------- ---------- ----------
Net income......................................... $ 44,717 $ 49,947 $ 84,712 $ 118,493 $ 103,917
========== ========== ========== ========== ==========
Net income per share:
Basic................................................................ $ 1.07 $ 1.42 $ 1.22
Diluted.............................................................. $ 1.02 $ 1.36 $ 1.19
Weighted average common shares outstanding:
Basic.................................................................... 79,194 83,331 84,894
Diluted.................................................................. 83,001 87,312 87,018
As of December 31,
--------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents....................... $ 63,550 $ 84,000 $ 214,823 $ 174,300 $ 188,827
Working capital................................. 65,446 56,801 143,308 123,220 164,597
Total assets.................................... 119,908 182,154 380,482 405,004 606,433
Short term notes payable to stockholders........ -- -- 71,487 19,457 --
Long term notes payable to stockholders......... -- -- -- 116,743 --
Short term debt................................. -- -- -- -- 14,545
Long term debt.................................. -- -- -- -- 138,734
Stockholders' equity............................ 63,849 68,363 113,495 94,892 254,642
As of December 31,
--------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
Other Information(1):
Number of active distributors................... 182,000 260,000 397,000 448,000 470,000
Number of executive distributors................ 6,391 8,173 21,479 22,689 22,781
- ---------------------
<FN>
(1) Active distributors are those distributors who are resident in the countries
in which the Company operates and who have purchased products during the
three months ended as of the date indicated, rounded to the nearest
thousand. An executive distributor is an active distributor who has
submitted a qualifying letter of intent to become an executive distributor,
achieved specified personal and group sales volumes for a four month period
and maintained such specified personal and group sales volumes thereafter.
</FN>
-1-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the Company's financial condition and
results of operations should be read in conjunction with the Consolidated
Financial Statements and the related notes thereto, which are included in this
report.
General
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 and, following the planned acquisition of
Big Planet, Inc. discussed below, Internet and telecommunication products and
services. The Company distributes Nu Skin-branded products in markets throughout
the world. 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, Denmark, France, Germany, Italy, Ireland,
Poland, Portugal, Spain, Sweden, the Netherlands, Brazil (the Company's
subsidiaries operating in these countries are collectively referred to as the
"Subsidiaries") and sales to and license fees from the Company's North American
private affiliates. In 1998, the Company acquired Generation Health Holdings,
Inc., the parent of Pharmanex, Inc. (the "Pharmanex Acquisition"). With the
Pharmanex Acquisition, the Company increased its nutritional product development
and formulation capabilities. In February 1999, the Company announced its intent
to acquire certain assets of its North American private affiliates as well as to
acquire Big Planet, Inc., an Internet-based affiliate of the Company.
The Company's revenue is primarily dependent upon the efforts of a
network of independent distributors who purchase products and sales materials
from the Company in their local currency and who constitute and/or sell to the
Company's customers. The Company recognizes revenue when products are shipped
and title passes to these independent distributors. Revenue is net of returns,
which have historically been less than 3.5% of gross sales. Distributor
incentives are paid to several levels of distributors on each product sale. The
amount and recipient of the incentive varies depending on the purchaser's
position within the Global Compensation Plan. These incentives are classified as
operating expenses. The following table sets forth revenue information for the
time periods indicated. This table should be reviewed in connection with the
tables presented under "Results of Operations" which disclose distributor
incentives and other costs associated with generating the aggregate revenue
presented.
Year Ended December 31,
Region 1996 1997 1998
------ ------------ ------------ ------------
(in millions)
North Asia $ 502.4 $ 673.6 $ 665.5
Southeast Asia 183.7 225.3 159.7
Other Markets 75.5 54.5 88.3
------------ ------------ ------------
$ 761.6 $ 953.4 $ 913.5
============ ============ ============
Revenue generated in North Asia represented 73% of total revenue
generated during 1998. The Company's operations in Japan generated 98% of the
North Asia revenue. Revenue from the Southeast Asia operations generated 17% of
total revenue generated in 1998. The Company's operations in Taiwan generated
75% of the Southeast Asia revenue. Revenue generated in Other Markets
represented the remaining 10% of total revenue generated in 1998. The majority
of the Other Market revenue in 1998 is generated from sales to and license fees
from the Company's North American private affiliates.
[GRAPHIC OMITTED] - Pie chart showing 1998 revenue by region
Cost of sales primarily consists of the cost of products purchased from
third-party vendors (generally in U.S. dollars), the freight cost of shipping
these products to distributors as well as duties related to the importation of
such products. Additionally, cost of sales includes the cost of sales materials
sold to distributors at or near cost. Sales
-2-
materials are generally purchased in local currencies. As the sales mix changes
between product categories and sales materials, cost of sales and gross profit
may fluctuate to some degree due primarily to the margin on each product line as
well as varying import duty rates levied on imported product lines. In each of
the Company's current markets, duties are generally higher on nutritional
products than on personal care products. Also, as currency exchange rates
fluctuate, the Company's gross margin will fluctuate. In general, however, costs
of sales move proportionate to revenue.
Distributor incentives are the Company's most significant expense.
Distributor incentives are paid to distributors on a monthly basis based upon
their personal and group sales volume as well as the group sales volume of up to
six levels of executive distributors in their downline sales organization. These
incentives are computed each month based on the sales volume and network of the
Company's global distributor force. Small fluctuations occur in the amount of
incentives paid as the network of distributors actively purchasing products
changes from month to month. However, due to the size of the Company's
distributor force, with nearly 500,000 active distributors, the fluctuation in
the overall payout is relatively small. The overall payout averages from 39% to
41% of global product sales. Pursuant to the agreements between the Company and
its North American affiliates, the North American affiliated entities are
contractually obligated to pay a distributor commission expense of 42.0% of
commissionable product sales to the Company each month to cover the commission
obligation from the sales of Nu Skin products in North America. Additionally,
distributor incentives include the cost of computing and paying commissions as
well as the cost of various incentive programs for distributors including an
annual trip to Hawaii for the Company's leading distributors. These additional
costs average approximately 1% of revenue and are included in distributor
incentives. Because the Company's revenue includes sales of both commissionable
and non-commissionable items, distributor incentives as a percentage of total
revenue have ranged from approximately 36.8% to 38.9% since December 31, 1994.
Non-commissionable items consist of sales materials and starter kits as well as
sales to the Company's North American private affiliates.
In the fourth quarter of 1996, the Company implemented a one-time
distributor equity incentive program. This global program provided for the
granting of options to distributors to purchase 1.6 million shares of the
Company's Class A Common Stock. The number of options each distributor received
was based on his or her performance and productivity through August 31, 1997.
The options are exercisable at a price of $5.75 per share and vested on December
31, 1997. The Company recorded a $2.0 million charge in 1996 and recorded
additional charges in 1997 of $17.9 million for the non-cash and non-recurring
expenses associated with this program. There are currently no plans to repeat
this or similar distributor stock incentive programs.
Selling, general and administrative expenses include wages and benefits,
rents and utilities, travel and entertainment, promotion and advertising,
research and development and professional fees.
Provision for income taxes is dependent on the statutory tax rates in
each of the countries in which the Company operates. For example, statutory tax
rates are 16.0% in Hong Kong, 25.0% in Taiwan, 30.0% in Thailand, 30.1% in South
Korea, 35.0% in the Philippines and 57.9% in Japan. However, the statutory tax
rate in Japan is scheduled to be reduced to 54.3% for fiscal years beginning in
1999 and in the Philippines the rate is scheduled to be reduced to 33% and 32%
in 1999 and 2000, respectively. The Company operates a regional business center
in Hong Kong, which bears inventory obsolescence and currency exchange risks.
Any income or loss incurred by the regional business center is not subject to
taxation in Hong Kong. In addition, since the incorporation of the Company in
1996, the Company has been subject to taxation in the United States, where it is
incorporated, at a statutory corporate federal tax rate of 35.0%. However, the
Company receives foreign tax credits in the U.S. for the amount of foreign taxes
actually paid in a given period, which are utilized to reduce taxes payable in
the United States.
In March 1998, the Company completed the acquisition (the "NSI
Acquisition") of the capital stock of Nu Skin International, Inc. ("NSI"), NSI
affiliates in Europe, South America, Australia and New Zealand and certain other
NSI affiliates (the "Acquired Entities"). Inasmuch as a portion of the Acquired
Entities were under common control, the Company's consolidated financial
statements have been combined and restated as if the Company and the Acquired
Entities had been combined during all periods presented.
-3-
Minority interest represents the earnings of the Acquired Entities which
are not under common control. The minority interest at March 26, 1998 was
purchased as part of the NSI Acquisition.
In connection with the Pharmanex Acquisition, the Company allocated
$13.6 million to purchased in-process research and development. During 1998, the
in-process research and development amount was fully written off.
In February 1999, the Company announced its intent to acquire Big
Planet, Inc., certain assets of Nu Skin USA, Inc. and the Company's remaining
affiliates in Canada, Mexico and Guatemala for approximately $40.0 million in
cash, $14.5 million in a three-year note and the assumption of certain
liabilities. In connection with the Nu Skin USA acquisition which was concluded
in March 1999, the Company, through a newly formed wholly owned subsidiary,
acquired certain assets of Nu Skin USA, including equipment, inventory,
intellectual property, marketing materials, contracts related to the network
marketing of NSI's personal care and nutritional products, and approximately
620,000 shares of Class A Common Stock of the Company, in exchange for cash in
the amount of approximately $8.7 million and the assumption of approximately
$8.0 million of Nu Skin USA liabilities. NSI, a subsidiary of the Company,
terminated various license agreements and other intercompany agreements with Nu
Skin USA and paid Nu Skin USA a $10.0 million termination fee.
The Company is currently pursuing the proposed acquisitions of Big
Planet, Inc., and the Company's remaining private affiliates in Canada, Mexico
and Guatemala.
Results of Operations
The following tables set forth operating results and operating results
as a percentage of revenue, respectively, for the periods indicated.
Year Ended December 31,
(in millions)
1996 1997 1998
-------- -------- --------
Revenue .......................................................... $ 761.6 $ 953.4 $ 913.5
Cost of sales .................................................... 171.2 191.2 188.5
Cost of sales - amortization of inventory step-up ................ -- -- 21.6
-------- -------- --------
Gross profit ..................................................... 590.4 762.2 703.4
Operating expenses:
Distributor incentives ....................................... 282.6 362.2 331.4
Selling, general and administrative .......................... 168.7 201.9 202.2
Distributor stock expense .................................... 2.0 17.9 --
In-process research and development .......................... -- -- 13.6
-------- -------- --------
Total operating expenses ......................................... 453.3 582.0 547.2
-------- -------- --------
Operating income ................................................. 137.1 180.2 156.2
Other income (expense), net ...................................... 10.8 9.0 13.6
-------- -------- --------
Income before provision for income taxes and minority interest ... 147.9 189.2 169.8
Provision for income taxes ....................................... 49.5 55.7 62.8
Minority interest ................................................ 13.7 15.0 3.1
-------- -------- --------
Net income ....................................................... $ 84.7 $ 118.5 $ 103.9
======== ======== ========
Unaudited supplemental data(1):
Income before pro forma provision for income taxes and
minority interst.......................................... $ 147.9 $ 189.2 $ 169.8
Pro forma provision for income taxes.......................... 54.7 71.9 66.0
Pro forma minority interest................................... 8.6 9.3 1.9
-------- -------- --------
Pro forma net income.......................................... $ 84.6 $ 108.0 $ 101.9
======== ======== ========
-4-
Year Ended December 31,
1996 1997 1998
-------- -------- --------
Revenue......................................................... 100.0% 100.0% 100.0%
Cost of sales................................................... 22.5 20.1 20.6
Cost of sales - amortization of inventory step-up............... -- -- 2.4
-------- -------- --------
Gross profit.................................................... 77.5 79.9 77.0
Operating expenses:
Distributor incentives...................................... 37.1 38.0 36.3
Selling, general and administrative......................... 22.1 21.2 22.1
Distributor stock expense................................... .3 1.9 --
In-process research and development......................... -- -- 1.5
-------- -------- --------
Total operating expenses........................................ 59.5 61.1 59.9
-------- -------- --------
Operating income................................................ 18.0 18.8 17.1
Other income (expense), net..................................... 1.4 .9 1.5
-------- -------- --------
Income before provision for income taxes and minority interest.. 19.4 19.7 18.6
Provision for income taxes...................................... 6.5 5.8 6.9
Minority interest............................................... 1.8 1.5 .3
-------- -------- --------
Net income...................................................... 11.1% 12.4% 11.4%
======== ======== ========
Unaudited supplemental data(1):
Income before pro forma provision for income taxes and
minority interest....................................... 19.4% 19.7% 18.6%
Pro forma provision for income taxes........................ 7.2 7.5 7.2
Pro forma minority interest................................. 1.1 .9 .2
-------- -------- --------
Pro forma net income........................................ 11.1% 11.3% 11.2%
======== ======== ========
- -------------------
<FN>
(1) Reflects adjustment for Federal and state income taxes as if the Company's
subsidiaries had been taxed as C corporations rather than as S corporations
for the years ended December 31, 1996, 1997 and 1998.
</FN>
1998 Compared to 1997
Revenue decreased 4.2% to $913.5 million from $953.4 million for the
years ended December 31, 1998 and 1997, respectively. The decrease in revenue
resulted primarily from significant weakening of the Japanese yen and other
Asian currencies relative to the U.S. dollar, an increasing competitive
environment in Taiwan and the economic downturn in Asia, particularly in South
Korea and Thailand. These issues more than offset the increase in revenue from
the Company's other markets including license fees from and product sales to the
Company's private North American affiliated entities.
Revenue in North Asia, which consists of Japan and South Korea,
decreased to $665.5 million from $673.6 million for the years ended December 31,
1998 and 1997, respectively. Economic challenges and a weakened currency in
South Korea resulted in a significant decline in South Korean revenue from $74.2
million for the year ended December 31, 1997 to $11.4 million in 1998. This
revenue decline was offset by revenue in Japan which increased from $599.4
million for the year ended December 31, 1997 to $654.2 million in 1998. In spite
of challenging economic conditions in Japan, the Company recorded increases in
revenue in Japan of 9.1% in U.S. dollar terms and 17.6% in local currency terms
from 1997 to 1998. This increase is attributed to continued growth of the
personal care and nutritional product lines and a strong Japanese distributor
force.
Revenue in Southeast Asia, which consists of Taiwan, Thailand, Hong
Kong, the Philippines, Australia and New Zealand, totaled $159.7 million for the
year ended December 31, 1998, down from revenue of $225.3 million for the year
ended December 31, 1997, a decrease of 29.1%. The Company's operations in Taiwan
have continued to suffer the impact of increased competition and currency
devaluation which resulted in a decline in revenue from $168.6 million in 1997
to $119.5 million in 1998. In addition, the Company's operations in Thailand
have been impacted negatively by Thailand's economic challenges and currency
devaluation resulting in a revenue decrease to $8.3 million in 1998 from $22.8
million in 1997.
-5-
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, Poland, Denmark, Sweden, Brazil and product sales to
and license fees from the Company's North American private affiliates. Aggregate
revenue in these markets increased to $88.3 million for the year ended December
31, 1998 from $54.5 million for the year ended December 31, 1997, an increase of
62.0%. These increases were primarily due to increased revenue from the
Company's North American private affiliates following a successful global
convention held in the first quarter of 1998, as well as increased sales from
the openings of the Company's operations in Poland, Denmark, Sweden and Brazil
in 1998 and the introduction of nutritional products in several European markets
in 1998.
Gross profit as a percentage of revenue was 77.0% for the year ended
December 31, 1998 compared to 79.9% for the year ended December 31, 1997. The
amortization of the step-up of inventory from the NSI Acquisition increased cost
of sales by $21.6 million for the year ended December 31, 1998. Without this
non-recurring charge, gross profit as a percentage of revenue would have been
79.4% for the year ended December 31, 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 somewhat offset by gross margin improvement as a result of price
increases in certain markets in 1998. In addition, increased local
manufacturing, including the local manufacturing in Taiwan of LIFEPAK, the
Company's leading nutritional product, improved and stabilized gross margins.
Distributor incentives as a percentage of revenue decreased to 36.3% for
the year ended December 31, 1998 from 38.0% for the year ended December 31,
1997. The primary reason for this decrease was increased revenue in 1998 from
product sales to and license fees from the Company's North American private
affiliates which is not subject to incentives being paid by the Company.
Selling, general and administrative expenses as a percentage of revenue
increased to 22.1% for the year ended December 31, 1998 from 21.2% for the year
ended December 31, 1997. This increase was primarily due to the revenue declines
in 1998 and increases in U.S. dollar-based selling, general and administrative
expenses, resulting from the NSI Acquisition. In dollar terms, selling, general
and administrative expenses increased slightly from $201.9 million in 1997 to
$202.2 million in 1998. In spite of the increases in selling, general and
administrative expenses from the NSI Acquisition, the selling, general and
administrative expenses in the local markets decreased in U.S.
dollar terms due to weakened local currencies.
Distributor stock expense of $17.9 million for the year ended December
31, 1997 reflects a one-time grant of distributor stock options at an exercise
price of $5.75 per share, 25% of the per share offering price in the Company's
initial public offering completed in November 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 of 1997. There are currently no plans to repeat this or other
similar distributor stock incentive programs.
In-process research and development expense of $13.6 million for the
year ended December 31, 1998 reflects a one-time expense for research and
development intangible assets purchased in the Pharmanex Acquisition during the
fourth quarter of 1998. This non-cash expense is non-recurring and was only
recorded in the fourth quarter of 1998.
Operating income decreased 13.3% to $156.2 million for the year ended
December 31, 1998 from $180.2 million in 1997. Operating margin decreased to
17.1% in 1998 from 18.8% in 1997. The operating income and margin decreases
resulted from declines in U.S. dollar revenue in North and Southeast Asia, lower
gross margins as a result of significant weakening in foreign currencies in
North and Southeast Asia and by the non-recurring amortization of inventory
step-up and in-process research and development expenses recorded in the
Company's other markets in 1998, and was partially offset by the distributor
stock expense recorded in 1997.
-6-
Other income increased from $9.0 million for the year ended December 31,
1997 to $13.6 million for the year ended December 31, 1998. The increase was
primarily caused by yen-based hedging gains from forward contracts and
intercompany loans during 1998.
Provision for income taxes increased to $62.8 million for the year ended
December 31, 1998 from $55.7 million for the year ended December 31, 1997 due to
an increase in the effective tax rate from 29.4% to 37.0% for the same periods,
which more than offset the decreased operating income in 1998 compared to 1997.
The increase in the effective tax rate is due to the Acquired Entities being
taxed as C corporations rather than as S corporations during most of 1998. The
pro forma provision for income taxes decreased to $66.0 million for the year
ended December 31, 1998 from $71.9 million for the year ended December 31, 1997
due to decreased income in 1998. 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 years ended December 31, 1998
and 1997.
Minority interest relates to the earnings of the Acquired Entities which
are not under common control. The minority interest 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 $14.6 million to $103.9 million for the year
ended December 31, 1998 compared with the same period in 1997 due primarily to
the amortization of inventory step-up and in-process research and development
expense recorded in 1998 partially offset by distributor stock expense recorded
in 1997. Net income as a percentage of revenue decreased to 11.4% for the year
ended December 31, 1998 as compared to 12.4% for the same period in 1997.
1997 Compared to 1996
Revenue increased 25.2% to $953.4 million from $761.6 million for the
years ended December 31, 1997 and 1996, respectively. The increase in revenue
resulted primarily from continued revenue growth in North and Southeast Asia
related to the personal care and nutritional product lines.
Revenue in North Asia, which consists of Japan and South Korea,
increased to $673.6 million from $502.4 million for the years ended December 31,
1997 and 1996, respectively. Revenue in Japan increased from $380.0 million for
the year ended December 31, 1996 to $599.4 million in 1997. This increase in
revenue was primarily a result of continued growth of the personal care and
nutritional product lines, which grew 43.8% and 94.9%, respectively, in 1997 and
1996. Additionally, revenue in Japan increased following a distributor
convention held in the first quarter of 1997 and the sponsorship of the Japan
Supergames featuring National Basketball Association stars in the third quarter
of 1997. Offsetting revenue growth in North Asia was the decrease in revenue in
South Korea from $122.3 million in 1996 to $74.2 million in 1997, which was
primarily due to economic challenges and a weakened currency in South Korea.
Revenue in Southeast Asia, which consists of Taiwan, Thailand, Hong
Kong, Australia and New Zealand, totaled $225.3 million for the year ended
December 31, 1997 from revenue of $183.7 million for the year ended December 31,
1996, an increase of 22.6%. Revenue in Taiwan increased to $168.6 million in
1997 from $154.5 million in 1996, an increase of 9.1%, primarily as a result of
growth in nutritional product sales following the late 1996 introduction of
LIFEPAK, the Company's leading nutritional supplement. In addition, the
Company's operations in Thailand commenced in March 1997 and generated revenue
of $22.8 million in 1997. Revenue in Hong Kong increased to $21.3 million in
1997 from $17.0 million in 1996 as a result of growth in nutritional product
sales following the introduction of LIFEPAK in the first quarter of 1997.
The increases in North and Southeast Asia were partially offset by an
aggregate revenue decrease in the Company's other markets, which include the
United Kingdom, Germany, Italy, the Netherlands, France, Belgium, Spain,
Portugal, Ireland, Austria and product sales to and license fees from the
Company's North American private
-7-
affiliates. Aggregate revenue in these markets decreased to $54.5 million for
the year ended December 31, 1997 from $75.5 million for the year ended December
31, 1996, a decrease of 27.8%. These decreases were primarily due to higher
revenue recorded in 1996 as a result of a successful global convention held in
1996 by the Company's North American private affiliates.
Gross profit as a percentage of revenue was 79.9% for the year ended
December 31, 1997 compared to 77.5% for the year ended December 31, 1996. Gross
margin improvement resulted from price increases throughout North and Southeast
Asia which occurred during the second quarter of 1997. In addition, increased
local manufacturing efforts were designed to improve and stabilize gross
margins.
Distributor incentives as a percentage of revenue increased to 38.0% for
the year ended December 31, 1997 from 37.1% for the year ended December 31,
1996. The primary reason for this increase was decreased revenue in 1997 from
product sales to and license fees from the Company's North American private
affiliates which is not subject to incentives being paid by the Company.
Selling, general and administrative expenses as a percentage of revenue
decreased to 21.2% for the year ended December 31, 1997 from 22.1% for the year
ended December 31, 1996. In dollar terms, selling, general and administrative
expenses increased from $168.7 million in 1996 to $201.9 million in 1997. This
increase, in dollar terms, was primarily due to increased promotion expenses of
approximately $4.0 million resulting from the expense of sponsoring the Japan
Supergames and approximately $2.0 million resulting from distributor conventions
held during the first quarter of 1997. In addition, other general and
administrative expenses were higher in 1997 as a result of expenses of operating
as a public company and as a result of increased spending in each of the
Company's markets to support current operations. These increased costs were
offset as a percentage of revenue by increased operating efficiencies as the
Company's revenue increased.
Distributor stock expense of $17.9 million and $2.0 million for the
years ended December 31, 1997 and 1996, respectively, reflects a one-time grant
of distributor stock options at an exercise price of $5.75 per share, 25% of the
per share offering price in the Company's initial public offering completed in
November 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 of 1997.
Operating income increased 31.3% to $180.2 million for the year ended
December 31, 1997 from $137.1 million in 1996. Operating margin increased to
18.8% in 1997 from 18.0% in 1996. The operating income and margin increases
resulted from increases in U.S. dollar revenue in North and Southeast Asia and
improved gross margins as a result of price changes during the second quarter of
1997 in North and Southeast Asia, which were partially offset by the $17.9
million distributor stock expense recorded in 1997.
Other income decreased from $10.8 million for the year ended December
31, 1996 to $9.0 million for the year ended December 31, 1997. The decrease was
primarily caused by the exchange losses relating to intercompany balances
denominated in foreign currencies offset by hedging gains from forward contracts
and intercompany loans.
Provision for income taxes increased to $55.7 million for the year ended
December 31, 1997 from $49.5 million for the year ended December 31, 1996 due to
increased income that was offset partially by the decrease in the effective tax
rate to 29.4% from 33.5% for the same periods. The decrease in the effective tax
rate is due to the Company's termination of its S corporation status during
1996. The pro forma provision for income taxes increased to $71.9 million for
the year ended December 31, 1997 from $54.7 million for the year ended December
31, 1996 due to increased income in 1997. 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 years ended December 31, 1997
and 1996.
Minority interest relates to the earnings of the Acquired Entities which
are not under common control. The minority interest at March 26, 1998 was
purchased as part of the NSI Acquisition. Accordingly, minority interest does
not continue after the NSI Acquisition.
-8-
Net income increased by $33.8 million to $118.5 million for the year
ended December 31, 1997 compared with the same period in 1996 due primarily to
the increase in revenue and improvements in gross margins in 1997 partially
offset by distributor stock expense recorded in 1997. Net income as a percentage
of revenue increased to 12.4% for the year ended December 31, 1997 as compared
to 11.1% for the same period in 1996.
Liquidity and Capital Resources
Historically, the Company's principal needs for funds have been for
distributor incentives, working capital (principally inventory purchases),
operating expenses, 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 generally extend credit to distributors, but requires payment
prior to shipping products. This process eliminates the need for significant
accounts receivable from 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 year ended December
31, 1998, the Company generated $118.6 million from operations compared to
$108.6 million generated during the year ended December 31, 1997. This increase
in cash generated from operations is primarily due to the repayment of
significant related party payables to the Company's North American private
affiliates in 1997 by NSI in connection with the spin-off of its U.S. operations
and reduced purchases of inventories and other assets in 1998.
As of December 31, 1998, working capital was $164.6 million compared to
$123.2 million as of December 31, 1997. This increase is largely due to
increased cash balances as well as increased inventory levels and other current
assets. Cash and cash equivalents at December 31, 1998 and 1997 were $188.8
million and $174.3 million, respectively.
Key Management Ratios
-----------------------------
Quick Ratio 1.1
Current Ratio 1.9
Debt/Equity .54
ROA 20.5%
ROE 56.9%
Capital expenditures, primarily for equipment, computer systems and
software, office furniture and leasehold improvements, were $18.3 million and
$14.4 million for the years ended December 31, 1998 and 1997, respectively. In
addition, the Company anticipates additional capital expenditures in 1999 of
$40.0 million to further enhance its infrastructure, including enhancements to
computer systems and software and call-center facilities in order to accommodate
anticipated future growth.
In March 1998, the Company completed its acquisition of the Acquired
Entities for $70.0 million in preferred stock and long-term notes payable to the
stockholders of the Acquired Entities (the"NSI Stockholders") totaling
approximately $6.2 million. Also, as part of the NSI Acquisition, the Company
assumed approximately $171.3 million in S distribution notes and incurred
acquisition costs totaling $3.0 million. During the second quarter of 1998, the
S distribution notes and long-term notes payable to the NSI Stockholders were
paid in full with proceeds from the credit facility described below. In
addition, NSI and the Company met certain earnings growth targets in 1998
resulting in a contingent payment payable to the NSI Stockholders of $25.0
million as of December 31, 1998. Contingent upon NSI and the Company meeting
certain earnings growth targets over the next three years, the Company may pay
up to $25.0 million in cash in each of the next three years to the NSI
Stockholders. The contingent consideration of $25.0 million earned in 1998 is to
be paid in the second quarter of 1999 and has been accounted for as an
adjustment to the purchase price and allocated to the Acquired Entities' assets
and liabilities. Any additional contingent consideration paid over the next
three years, if any, will be accounted for in a similar manner.
In May 1998, the Company and its Japanese subsidiary Nu Skin Japan Co.,
Ltd. entered into a $180.0 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 $110.0 million and Nu Skin Japan Co., Ltd.
borrowed the Japanese yen equivalent of $70.0
-9-
million denominated in local currency. Payments totaling $41.6 million were made
during the second quarter of 1998 relating to the $180.0 million credit
facility. As of December 31, 1998, the balance relating to the $180.0 million
credit facility totaled $153.3 million. 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. As of December 31, 1998, the Company has continued to
comply with all financial and other covenants under the credit facility.
During 1998, the Board of Directors authorized the Company to repurchase
up to $20.0 million of the Company's outstanding shares of Class A Common Stock.
As of December 31, 1998, the Company had repurchased 917,254 shares for an
aggregate price of approximately $10.5 million.
In October 1998, the Company completed the Pharmanex Acquisition for
$77.6 million, which consisted of approximately 4.0 million shares of the
Company's Class A Common Stock, including 261,008 shares issuable upon exercise
of options assumed by the Company. Contingent upon Pharmanex meeting specific
revenue and other requirements, approximately 565,000 of the 4.0 million shares
are being held in escrow and will be returned to the Company if such
requirements are not met within one year from the date of the Pharmanex
Acquisition. The contingent shares issued, if any, will be accounted for as an
adjustment to the purchase price and allocated to the acquired assets and
liabilities. Also, as part of the Pharmanex Acquisition, the Company assumed
approximately $34.0 million in liabilities and incurred acquisition costs
totaling $1.3 million. The net assets acquired totaling $3.6 million include net
deferred tax assets totaling $0.8 million. In connection with the closing of the
Pharmanex Acquisition, the Company paid approximately $29.0 million relating to
the assumed liabilities. Under the terms of the Pharmanex Acquisition, the
Company was required to pay up to an additional $32.0 million in consideration
if the Company's stock price failed to trade at certain agreed upon levels.
Based on the Company's stock price performance following the Pharmanex
Acquisition, the Company is no longer obligated to make any further payments.
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 $25.0 million and $10.0 million at December 31, 1998
and 1997, respectively. In addition, the Company had related party receivables
of $22.3 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 December 31, 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.
Year 2000
The Company has developed a comprehensive plan to address Year 2000
issues. In connection with this plan, the Company has established a committee
that is responsible for assessing and testing the Company's systems to identify
Year 2000 issues, and overseeing the upgrade or remediation of non-compliant
Year 2000 systems. This committee reports on a regular basis to the executive
management team of the Company and the Audit Committee of the Board of Directors
on the progress and status of the plan and the Year 2000 issues affecting the
Company.
To date, the Company has completed a broad scope assessment and audit of
its information technology systems and non-information technology systems to
identify and prioritize potential Year 2000 issues and is currently
-10-
performing a micro-based assessment designed to identify specific Year 2000
issues at the hardware, software, and processing levels. Through this process
the Company has identified potential Year 2000 issues in its information systems
and is in the process of addressing these issues through upgrades and other
remediation. The Company currently estimates that the cost of all upgrades
related to Year 2000 issues, including scheduled upgrades intended primarily to
increase efficiencies within the Company and also address Year 2000 issues, is
anticipated to be approximately $10.0 million through 1999, which the Company
anticipates will be funded by cash from operations. The Company currently
anticipates that it will complete the micro-based analysis and remediation on
all of its significant in-house systems by the second quarter of 1999. In 1999,
the Company will continue to run broad scope tests of its in-house systems to
confirm that it has adequately addressed all Year 2000 issues and continue its
work on the systems of its foreign offices.
As part of the Year 2000 plan, the Company is also assessing and
monitoring the Company's vendors and suppliers and other third parties for Year
2000 readiness. To date the committee has sent questionnaires to these third
parties seeking their assessment and evaluation of their own Year 2000 readiness
and has received responses back from a substantial majority of these third
parties. Members of the committee have already begun follow-up calls to the top
fifty vendors of the Company and plan to visit the Company's significant
suppliers and vendors in person for purposes of evaluating their Year 2000
readiness and sharing Year 2000 information. The Company will continue the
follow-up with third party vendors throughout 1999.
Based on the Company's evaluation of the Year 2000 issues affecting the
Company, the Company believes that Year 2000 readiness of its vendors and
suppliers, which is beyond the control of the Company, is currently the most
significant area of risk, particularly in its foreign markets. The Company does
not believe it is possible at this time to quantify or estimate the most
reasonable worst case Year 2000 scenario. However, the Company is beginning to
formulate contingency plans to limit, to the extent possible, interruption of
the Company's operations arising from the failure of third parties to be Year
2000 compliant as it moves forward in the implementation of its Year 2000 plan.
The Company will continue to work with third parties as indicated above to
further evaluate and quantify this risk and will continue the development of
contingency plans throughout 1999 as this process moves forward. There can be no
assurance, however, that the Company will be able to successfully identify and
develop contingency plans for all Year 2000 issues that could, directly or
indirectly, adversely affect the Company's operations, some of which are beyond
the control of the Company. In particular, the Company cannot predict or
evaluate domestic and foreign governments' and utility companies' preparation
for the Year 2000 or the readiness of other third parties (domestic and foreign)
that do not have relationships with the Company, and the resulting impact that
the failure of such parties to be Year 2000 compliant may have on the economy in
general and on the Company's business.
The foregoing discussion of the Year 2000 issues contains
forward-looking statements that represent the Company's current expectations or
beliefs. These forward-looking statements are subject to various risks and
uncertainties that could cause outcomes to be different from those currently
anticipated including those risks identified under the heading "Note Regarding
Forward-looking Statements."
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 the month of August which is
in the Company's third quarter, when many individuals traditionally take
vacations.
The Company has experienced rapid revenue growth in certain new markets
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
-11-
decline in its 1997 revenue from revenue in 1996 and experienced additional
quarterly sequential 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. 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.
Quarterly Results
The following table sets forth certain unaudited quarterly data for the
periods shown, restated for the NSI Acquisition.
1997 1998
---------------------------------------- ----------------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
(in millions, except per share amounts)
Revenue............... $ 224.2 $ 245.9 $ 243.1 $ 240.2 $ 227.9 $ 209.1 $ 217.9 $ 258.7
Gross profit.......... 179.0 195.3 194.4 193.5 182.2 151.5 164.9 204.9
Operating income...... 38.3 46.7 45.7 49.6 51.0 29.6 37.4 38.3
Net income............ 25.7 30.0 30.7 32.0 33.7 22.0 25.5 22.8
Net income per share:
Basic........... 0.31 0.36 0.37 0.39 0.41 0.26 0.30 0.26
Diluted......... 0.29 0.34 0.35 0.37 0.39 0.25 0.30 0.26
Currency Risk and Exchange Rate Information
A majority of the Company's revenue and many 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.
[GRAPHIC OMITTED] Bar chart showing yen to the dollar - yen devaluation for 1997
and 1998
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 a
majority 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
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 certain intercompany loans of foreign currency. The
Company does not use such derivative 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.
The Company's foreign currency derivatives are comprised of
over-the-counter forward contracts with major international financial
institutions. As of December 31, 1998, the primary currency for which the
Company has net underlying foreign currency exchange rate exposure is the
Japanese yen. Based on the Company's foreign exchange contracts at December 31,
1998 as discussed in Note 14 of the notes to Consolidated Financial Statements,
the impact of a 10% appreciation or 10% depreciation of the U.S. dollar against
the Japanese yen would not result in significant other income or expense
recorded in the Consolidated Statements of Income.
Following are the weighted average currency exchange rates of $1 into
local currency for each of the Company's markets in which revenue exceeded $5.0
million for at least one of the quarters listed:
-12-
1996 1997 1998
---------------------------------- ---------------------------------- ----------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Japan(1) 105.8 107.5 109.0 112.9 121.4 119.1 118.1 125.6 128.2 135.9 139.5 119.3
Taiwan 27.4 27.4 27.5 27.5 27.5 27.7 28.4 31.0 32.8 33.6 34.5 32.6
Hong Kong 7.7 7.7 7.7 7.7 7.7 7.7 7.7 7.7 7.7 7.8 7.8 7.8
South Korea 782.6 786.5 815.5 829.4 863.9 889.6 894.8 1,097.0 1,585.7 1,392.6 1,327.0 1,278.9
Thailand 25.2 25.3 25.3 25.5 26.0 25.4 31.5 40.3 45.1 40.3 40.9 37.1
- ------------------
<FN>
(1) Since January 1, 1992, the highest and lowest exchange rates for the
Japanese yen have been 147.3 and 80.6, respectively.
</FN>
Outlook
Management currently anticipates revenue and earnings growth during
calendar 1999. This growth is expected to result in part from continued growth
in Japan, improved margins resulting from the NSI Acquisition, the strengthening
of local currencies against the U.S. dollar and the addition of recent, and
anticipated acquisitions as discussed below. Further, markets where the Company
recently commenced operations, specifically Brazil, which began operations in
the fourth quarter of 1998, are expected to contribute to revenue growth. The
Company's anticipated revenue and earnings growth, however, could be adversely
affected by fluctuations in Asian currencies, particularly the yen, and a
renewed weakening of Asian economies.
The Company anticipates that its growth in local currencies will be
largely attributed to the introduction of new products, including nutritional
supplements provided to the Company as part of the Pharmanex Acquisition.
Currently, the Company's intent is to begin introducing some of these products
in Japan, Taiwan and South Korea by the third quarter of 1999. Also, these
Pharmanex nutritional supplements are intended to be introduced in other markets
throughout 1999 and into the year 2000. Also, in Japan, the Company's leading
market, a repositioned and locally manufactured color cosmetic line of products,
including shades more suited to Japanese preferences, is scheduled to be
launched in the second quarter of 1999.
The Company acquired certain assets of Nu Skin USA and began
distributing nutritional and personal care products in the United States in
March 1999. The Company expects increases in annual revenue and earnings in 1999
as a result of sales of the Company's existing products and Pharmanex
nutritional products in the United States market. Additionally, the Company
recently announced its intent to acquire Big Planet, Inc., Nu Skin Canada, Nu
Skin Mexico and Nu Skin Guatemala. The acquisition of assets from Nu Skin USA
and the proposed acquisitions of Big Planet, Inc., Nu Skin Canada, Nu Skin
Mexico and Nu Skin Guatemala are anticipated to increase revenue and gross
margins, but reduce operating margins due to the absorption of their operating
expense structures as these acquisitions are concluded. Management believes that
the Company's proposed acquisition of Big Planet, Inc. presents a significant
revenue growth opportunity in the United States as well as potential growth in
many international markets, including Japan and Europe. During 1998, Big Planet,
Inc. generated significant operating losses and the Company anticipates further
operating losses in 1999. In Japan, the Company has already invested more than
$5.0 million in Internet-based initiatives designed to prepare distributors in
that market for the eventual launch of Big Planet products and services.
Currently, it is anticipated that these services will begin to be offered to
Japanese distributors in late 1999 or in the year 2000.
Note Regarding Forward-looking Statements
Management's Discussion and Analysis of Financial Condition and
Results of Operations, particularly the "Liquidity and Capital Resources", "Year
2000" and "Outlook" sections, contain forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
concerning, among other things, the adequacy of current cash and future cash
flows to meet the required cash needs of the Company, the Company's anticipated
revenue and earnings growth in 1999, planned product introductions in the
Company's markets,
-13-
the effect of the recent and planned acquisitions of the Company's private
affiliates on the financial and operating results of the Company, the Company's
expectation that it will be able to successfully address any Year 2000 related
issues, including with third parties, and develop contingency plans as more
fully described under the Year 2000 section above, and the Company's plan to
implement forward contracts and other hedging strategies to manage foreign
currency risks. These forward-looking statements represent the Company's
expectations and/or beliefs concerning future events. The Company wishes to
caution readers that these forward-looking statements are subject to numerous
risks and uncertainties that could cause actual results and outcomes to differ
materially from any forward-looking statement views expressed herein. These
risks and uncertainties include, but are not limited to: (A) any weakening of
Asian currencies, particularly the yen, from their current levels; (B) renewed
and/or sustained weakness of the Asian economies, particularly Japan, or such
weakness adversely affecting the Company's operations more than in the past; (C)
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, adverse developments or changes in regulatory or legal requirements
applicable to the Company or its business, or the Company's inability, for any
reason, to open new markets, 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; (D) the inability of the Company to consummate the
acquisition of Big Planet, Inc. and the Company's other North American private
affiliates; (E) the inability of the Company to gain market acceptance of new
products, including the Pharmanex products and Big Planet products and services
if the Big Planet acquisition is consummated; (F) increased expenditures
required to address the Year 2000 issue if the Company's technology requirements
change or unforseen problems are discovered; (G) 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; (H) the significant regulatory
and legal requirements in the Company's markets applicable to nutritional
products and telecommunication products which could delay or inhibit the ability
of the Company to introduce and market certain products, including certain
Pharmanex and Big Planet products, into its markets;(I) the risk that the
Company could incur difficulties and undue expense in integrating the business
of Pharmanex and Big Planet into the Company's operations, distribution channel
and markets. These forward-looking statements are further qualified by a more
detailed discussion of risks and uncertainties related to the Company's business
contained in the Company's Form 10-K for the year ended December 31, 1998, and
any amendments thereto, and other documents filed by the Company with the
Securities and Exchange Commission.
-14-
Nu Skin Enterprises, Inc.
- --------------------------------------------------------------------------------
Index to Consolidated Financial Statements
Consolidated Financial Statements:
Consolidated Balance Sheets at December 31, 1997 and 1998
Consolidated Statements of Income for the years ended December 31, 1996,
1997 and 1998
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998
Notes to Consolidated Financial Statements
Report of Independent Accountants
All schedules are omitted because they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
-15-
Nu Skin Enterprises, Inc.
Consolidated Balance Sheets
(in thousands, except share amounts)
- --------------------------------------------------------------------------------
December 31,
----------------
1997 1998
--------- ---------
ASSETS
Current assets
Cash and cash equivalents $ 174,300 $ 188,827
Accounts receivable 11,074 13,777
Related parties receivable 23,008 22,255
Inventories, net 69,491 79,463
Prepaid expenses and other 38,716 50,475
--------- ---------
316,589 354,797
Property and equipment, net 27,146 42,218
Other assets, net 61,269 209,418
--------- ---------
Total assets $ 405,004 $ 606,433
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 23,259 $ 17,903
Accrued expenses 140,615 132,723
Related parties payable 10,038 25,029
Current portion of long-term debt -- 14,545
Current portion of notes payable to stockholders 19,457 --
--------- ---------
193,369 190,200
Long-term debt, less current portion -- 138,734
Other liabilities -- 22,857
Notes payable to stockholders, less current portion 116,743 --
Minority interest -- --
Commitments and contingencies (Notes 10 and 17)
Stockholders' equity
Preferred stock - 25,000,000 shares authorized, $.001 par value, 2 --
1,941,331 and no shares issued and outstanding
Class A common stock - 500,000,000 shares authorized, $.001 par value, 12 34
11,758,011 and 33,709,251 shares issued and outstanding
Class B common stock - 100,000,000 shares authorized, $.001 par value, 70 55
70,280,759 and 54,606,905 shares issued and outstanding
Additional paid-in capital 115,053 146,781
Accumulated other comprehensive income (28,578) (43,604)
Retained earnings 17,788 158,064
Deferred compensation (9,455) (6,688)
--------- ---------
94,892 254,642
--------- ---------
Total liabilities and stockholders' equity $ 405,004 $ 606,433
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
-16-
Nu Skin Enterprises, Inc.
Consolidated Statements of Income
(in thousands, except per share amounts)
- --------------------------------------------------------------------------------
Year Ended December 31,
---------------------------
1996 1997 1998
--------- --------- ---------
Revenue $ 761,638 $ 953,422 $ 913,494
Cost of sales 171,187 191,218 188,457
Cost of sales - amortization of inventory step-up -- -- 21,600
--------- --------- ---------
Gross profit 590,451 762,204 703,437
--------- --------- ---------
Operating expenses:
Distributor incentives 282,588 362,195 331,448
Selling, general and administrative 168,706 201,880 202,150
Distributor stock expense 1,990 17,909 --
In-process research and development (Note 4) -- -- 13,600
--------- --------- ---------
Total operating expenses 453,284 581,984 547,198
--------- --------- ---------
Operating income 137,167 180,220 156,239
Other income (expense), net 10,771 8,973 13,599
--------- --------- ---------
Income before provision for income taxes
and minority interest 147,938 189,193 169,838
Provision for income taxes (Note 12) 49,526 55,707 62,840
Minority interest 13,700 14,993 3,081
--------- --------- ---------
Net income $ 84,712 $ 118,493 $ 103,917
========= ========= =========
Net income per share (Note 2):
Basic $ 1.07 $ 1.42 $ 1.22
Diluted $ 1.02 $ 1.36 $ 1.19
Weighted average common shares outstanding:
outstanding
Basic 79,194 83,331 84,894
Diluted 83,001 87,312 87,018
Unaudited pro forma data (Note 12):
Income before pro forma provision for
income taxes and minority interest $ 147,938 $ 189,193 $ 169,838
Pro forma provision for income taxes 54,752 71,856 65,998
Pro forma minority interest 8,630 9,299 1,947
--------- --------- ---------
Pro forma net income $ 84,556 $ 108,038 $ 101,893
========= ========= =========
Pro forma net income per share:
Basic $ 1.07 $ 1.30 $ 1.20
Diluted $ 1.02 $ 1.24 $ 1.17
The accompanying notes are an integral part of these consolidated financial
statements.
-17-
Nu Skin Enterprises, Inc.
Consolidated Statements of Stockholders' Equity
(in thousands)
- --------------------------------------------------------------------------------
Accumulated
Class A Class B Additional Other Total
Capital Preferred Common Common Paid-In Comprehensive Retained Deferred Stockholders'
Stock Stock Stock Stock Capital Income Earnings Compensation Equity
------- --------- ------- ------- ---------- ------------- -------- ------------ -------------
Balance at January 1, 1996 $ 5,595 $ (2,858)$ 65,626 $ 68,363
Net income -- -- 84,712 84,712
Foreign currency translation
adjustments -- (3,196) -- (3,196)
------------
Total comprehensive income 81,516
Reorganization and termination of S
corporation status (Note 1) (4,550) $ 80 $ 1,209 -- 3,261 --
Net proceeds from the Offerings and
conversion of shares by
stockholders (Notes 1 and 11) -- $ 12 (8) 98,829 -- -- 98,833
Contributed capital 1,570 -- -- -- -- -- 1,570
Purchase of Acquired Entities (Note 3) (2,615) $ 2 -- -- 2,613 -- -- --
Dividends -- -- -- -- -- -- (65,139) (65,139)
Issuance of notes payable to
stockholders -- -- -- -- -- -- (86,487) (86,487)
Issuance of distributor stock options -- -- -- -- 33,039 -- -- $ (20,688) 12,351
Issuance of employee stock awards -- -- -- -- 13,280 -- -- (13,280) --
Amortization of deferred compensation -- -- -- -- -- -- -- 2,488 2,488
------- --------- ------- ------- ---------- ------------- -------- ------------ ------------
Balance at December 31, 1996 -- 2 12 72 148,970 (6,054) 1,973 (31,480) 113,495
Net income -- -- -- -- -- -- 118,493 -- 118,493
Foreign currency translation
adjustments -- -- -- -- -- (22,524) -- -- (22,524)
------------
Total comprehensive income 95,969
Conversion of shares from Class B to
Class A -- -- 2 (2) -- -- -- -- --
Repurchase of 1,416 shares of Class A
common stock (Note 11) -- -- (2) (20,260) -- -- -- (20,262)
Adjustment to distributor stock
options (Note 11) -- -- -- -- (2,546) -- -- (690) (3,236)
Forfeitures of employee stock awards -- -- -- -- (1,181) -- -- 1,181 --
Amortization of deferred compensation -- -- -- -- -- -- -- 23,247 23,247
Contributed capital -- -- -- -- 7,383 -- -- -- 7,383
Dividends -- -- -- -- (19,026) -- (46,054) -- (65,080)
Issuance of employee stock awards and
options -- -- -- -- 1,713 -- -- (1,713) --
Issuance of notes payable to
stockholders -- -- -- -- -- -- (56,624) -- (56,624)
------- --------- ------- ------- ---------- ------------- -------- ------------ ------------
Balance at December 31, 1997 -- 2 12 70 115,053 (28,578) 17,788 (9,455) 94,892
Net income -- -- -- -- -- -- 103,917 -- 103,917
Foreign currency translation
adjustments -- -- -- -- -- (15,026) -- -- (15,026)
------------
Total comprehensive income 88,891
Amortization of deferred compensation -- -- -- -- -- -- -- 3,626 3,626
Issuance of notes payable to
stockholders -- -- -- -- -- -- (24,413) -- (24,413)
Purchase of Acquired Entities and
termination of S corporation
status -- 1 -- -- (22,144) -- 60,772 -- 38,629
Purchase of Pharmanex (Note 4) -- -- 4 -- 78,710 -- -- (859) 77,855
Repurchase of 917 shares of Class A
common stock (Note 11) -- -- -- -- (10,549) -- -- -- (10,549)
Exercise of distributor and employee
stock options -- -- -- -- 1,961 -- -- -- 1,961
Conversion of preferred stock (Note 3) -- (3) 3 -- -- -- -- -- --
Conversion of shares from Class B to
Class A -- -- 15 (15) -- -- -- -- --
Contingent payments to stockholders
(Note 5) -- -- -- -- (16,250) -- -- -- (16,250)
------- --------- ------- ------- ---------- ------------- -------- ------------ ------------
Balance at December 31, 1998 $ -- $ -- $ 34 $ 55 $ 146,781 $ (43,604) $158,064 $ (6,688) $ 254,642
======= ========= ======= ======= ========== ============= ======== ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
-18-
Nu Skin Enterprises, Inc.
Consolidated Statements of Cash Flows
(in thousands)
- --------------------------------------------------------------------------------
Year Ended December 31,
1996 1997 1998
---------- ---------- ----------
Cash flows from operating activities:
Net income $ 84,712 $ 118,493 $ 103,917
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 9,615 8,809 15,768
Amortization of deferred compensation 2,488 23,247 3,626
Amortization of inventory step-up -- -- 21,600
Write-off of in-process research and development -- -- 13,600
Income applicable to minority interest 13,700 14,993 3,081
Changes in operating assets and liabilities:
Accounts receivable (5,939) (614) (900)
Related parties receivable (4,097) (2,726) 1,215
Inventories, net (6,060) (10,206) (3,556)
Prepaid expenses and other (10,132) (24,641) (7,248)
Other assets (24,814) (23,161) (4,100)
Accounts payable (1,682) 3,336 (8,767)
Accrued expenses and other liabilities 82,844 31,058 (8,973)
Related parties payable 1,733 (29,986) (10,703)
---------- ---------- ----------
Net cash provided by operating activities 142,368 108,602 118,560
---------- ---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (9,172) (14,389) (18,320)
Purchase of Pharmanex, net of cash acquired -- -- (28,750)
Payments for lease deposits (562) (3,457) (633)
Receipt of refundable lease deposits 98 120 1,650
---------- ---------- ----------
Net cash used in investing activities (9,636) (17,726) (46,053)
---------- ---------- ----------
Cash flows from financing activities:
Payments on long-term debt -- -- (41,634)
Proceeds from capital contributions 1,570 11,358 --
Proceeds from long-term debt -- -- 181,538
Net proceeds from the Offerings (Note 1) 98,833 -- --
Dividends paid (80,025) (30,468) --
Repurchase of shares of common stock -- (20,262) (10,549)
Exercise of distributor and employee stock options -- -- 1,961
Payment to stockholders for notes payable (Note 5) (15,000) (71,487) (180,000)
---------- ---------- ----------
Net cash provided by (used in) financing activities 5,378 (110,859) (48,684)
---------- ---------- ----------
Effect of exchange rate changes on cash (7,287) (20,540) (9,296)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 130,823 (40,523) 14,527
Cash and cash equivalents, beginning of period 84,000 214,823 174,300
---------- ---------- ----------
Cash and cash equivalents, end of period $ 214,823 $ 174,300 $ 188,827
========== ========== ==========
-19-
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. The
Company's operations are divided into three segments: 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, Denmark, France, Germany, Italy,
Ireland, Poland, Portugal, Spain, Sweden, the Netherlands, Brazil (the
Company's subsidiaries operating in these countries are collectively
referred to as the "Subsidiaries") and product sales to and license 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. 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 "Offerings").
As discussed in Note 3, the Company completed the NSI Acquisition on
March 27, 1998. Prior to the Reorganization and the NSI Acquisition,
each of the 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. In connection with the NSI
Acquisition, the Acquired Entities' S corporation status was terminated,
and the Acquired Entities declared distributions to the stockholders
that included all of the Acquired Entities' previously earned and
undistributed taxable S corporation earnings totaling $87.1 million in
1997 and $37.6 million in 1998 (the "S Distribution Notes").
Inasmuch as a portion of the Acquired Entities were under common control
(Note 3), the Company's consolidated financial statements for 1996 and
1997 have been combined and restated as if the Company and the Acquired
Entities had been combined during all periods presented.
Also in connection with the NSI Acquisition, on December 31, 1997, NSI
carved-out and distributed the net assets of its USA division ("Nu Skin
USA") to the NSI Stockholders. Immediately prior to this distribution,
NSI declared a distribution to the NSI Stockholders that included all of
Nu Skin USA's previously earned and undistributed taxable S corporation
earnings totaling $49.1 million. This distribution and all other
historical transactions of Nu Skin USA are excluded from the restatement
of the Company's consolidated financial statements for 1996 and 1997.
As discussed in Note 4, the Company completed the Pharmanex Acquisition
on October 16, 1998, which enhanced the Company's involvement with the
distribution and sale of nutritional products.
As discussed in Note 18, in February 1999, the Company announced its
intent to acquire Big Planet, Inc., an Internet-based company that
offers Internet connectivity, e-commerce, telecommunications and other
technology products and services to consumers in North America. The
Company also announced its intent to acquire certain assets of Nu Skin
USA, Inc. and to acquire the Company's remaining affiliates in Canada,
Mexico and Guatemala.
-20-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of the
Company and the Subsidiaries. All significant intercompany accounts and
transactions are eliminated in consolidation.
Use of estimates
The preparation of these financial statements in conformity with
generally accepted accounting principles required management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Significant estimates include
reserves for product returns, obsolete inventory and taxes. Actual
results could differ from these estimates.
Cash and cash equivalents
Cash equivalents are short-term, highly liquid instruments with original
maturities of 90 days or less.
Inventories
Inventories consist primarily of merchandise purchased for resale and
are stated at the lower of cost, using the first-in, first-out method,
or market. The Company had reserves for obsolete inventory totaling
$11,000,000, $13,500,000 and $13,600,000 as of December 31, 1996, 1997
and 1998, respectively.
Property and equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over the following estimated useful lives:
Furniture and fixtures 5 - 7 years
Computers and equipment 3 - 5 years
Leasehold improvements Shorter of estimated useful
life or lease term
Vehicles 3 - 5 years
Expenditures for maintenance and repairs are charged to expense as
incurred.
Other assets
Other assets consist primarily of deferred tax assets, deposits for
noncancelable operating leases, distribution rights, goodwill and
long-term intangibles acquired in the NSI Acquisition (Note 3) and the
Pharmanex Acquisition (Note 4). These intangibles are amortized on the
straight-line basis over the estimated useful lives of the assets. The
Company assesses the recoverability of long-lived assets by determining
whether the amortization of the balance over its remaining life can be
recovered through undiscounted future operating cash flows attributable
to the assets.
Revenue recognition
Revenue is recognized when products are shipped and title passes to
independent distributors who are the Company's customers. A reserve for
product returns is accrued based on historical experience. The Company
generally requires cash or credit card payment at the point of sale. The
Company has determined that no allowance for doubtful accounts is
necessary. Amounts received prior to shipment and title passage to
distributors are recorded as deferred revenue.
Research and development
The Company's research and development activities are conducted
primarily out of its research and development facility located in
Shanghai, China. Research and development costs are expensed as
incurred.
-21-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Income taxes
The Company has adopted Statement of Financial Accounting Standards No.
109 ("SFAS 109"), Accounting for Income Taxes. Under SFAS 109, the
liability method is used in accounting for income taxes. Under this
method, deferred tax assets and liabilities are determined based on the
differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that
will be in effect when the differences are expected to reverse.
Net income per share
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 ("SFAS 128"), Earnings per Share. SFAS 128 specifies the
computation, presentation and disclosure requirements for earnings per
share data, and requires the restatement of earnings per share data in
prior periods. SFAS 128 also requires the presentation of both basic and
diluted earnings per share data for entities with complex capital
structures. Diluted earnings per share data gives effect to all dilutive
potential common shares that were outstanding during the periods
presented. Net income per share for the year ended December 31, 1996 is
computed assuming that the Company's Reorganization and the resultant
issuance of Class B Common Stock occurred as of January 1, 1996.
Foreign currency translation
Most of the Company's business operations occur outside of the United
States. Each Subsidiary's local currency is considered the functional
currency. Since a substantial portion of the Company's inventories are
purchased with U.S. dollars in the United States and since the Company
is incorporated in the United States, all assets and liabilities are
translated into U.S. dollars at exchange rates existing at the balance
sheet dates, revenues and expenses are translated at weighted average
exchange rates, and stockholders' equity is recorded at historical
exchange rates. The resulting foreign currency translation adjustments
are recorded as a separate component of stockholders' equity in the
consolidated balance sheets, and transaction gains and losses are
included in other income and expense in the consolidated financial
statements.
Fair value of financial instruments
The fair value of financial instruments including cash and cash
equivalents, accounts receivable, related parties receivable, accounts
payable, related parties payable and notes payable approximate book
values. The carrying amount of long-term debt approximates fair value
because the applicable interest rates approximate current market rates.
Fair value estimates are made at a specific point of time, based on
relevant market information.
Stock-based compensation
The Company measures compensation expense for its stock-based employee
compensation plans using the intrinsic value method prescribed by
Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting for
Stock Issued to Employees, and provides pro forma disclosures of net
income and net income per share as if the fair value based method
prescribed by Statement of Financial Accounting Standards No. 123 ("SFAS
123"), Accounting for Stock-Based Compensation, had been applied in
measuring compensation expense (Note 11).
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.
-22-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending 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 its consolidated
financial statements.
3. 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 $70.0 million in preferred
stock and long-term notes payable to the stockholders of the Acquired
Entities (the "NSI Stockholders") totaling approximately $6.2 million.
In addition, contingent upon NSI and the Company meeting specific
earnings growth targets, the Company may pay up to $25.0 million in cash
per year over a four year period to the NSI Stockholders. Also, as part
of the NSI Acquisition, the Company assumed approximately $171.3 million
in S Distribution Notes and incurred acquisition costs totaling $3.0
million. The net assets acquired totaling $90.4 million include net
deferred tax liabilities totaling $7.4 million recorded upon the
conversion of the Acquired Entities from S to C corporations. All
contingent consideration paid 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 represents the ownership interests
of the NSI Stockholders who are not immediate family members, was
acquired during the NSI Acquisition. Prior to the NSI Acquisition, a
portion of the Acquired Entities' net income, capital contributions and
distributions (including cash dividends and S Distribution Notes) had
been allocated to the minority interest.
-23-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
For the portion of the NSI Acquisition accounted for by the purchase
method, the Company recorded inventory step-up of $21.6 million and
intangible assets of $34.8 million. During 1998, the inventory step-up
was fully amortized and the Company recorded amortization of intangible
assets totaling $1.6 million.
For the portion of the NSI Acquisition accounted for in a manner similar
to a pooling of interests, the excess of purchase price paid over the
book value of the net assets acquired was recorded as a reduction of
stockholders' equity.
In connection with the restatement of the Company's consolidated
financial statements for 1996 and 1997, the portion of the NSI
Acquisition and the resulting Preferred Stock issued to the common
control group is reflected as if such stock had been issued on the date
of the Company's incorporation on September 4, 1996. 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. Under the terms of the NSI Acquisition, the
2,986,663 shares of Class A Common Stock were adjusted down by 8,504
shares in June 1998.
4. ACQUISITION OF PHARMANEX, INC.
On October 16, 1998, the Company completed the acquisition of
privately-held Generation Health Holdings, Inc., the parent company of
Pharmanex, Inc. (the "Pharmanex Acquisition"), for $77.6 million, which
consisted of approximately 4.0 million shares of the Company's Class A
Common Stock, including 261,008 shares issuable upon exercise of options
assumed by the Company (Note 11). Contingent upon Pharmanex meeting
specific revenue and other requirements, approximately 565,000 of the
4.0 million shares are being held in escrow and will be returned to the
Company if such requirements are not met within one year from the date
of the Pharmanex Acquisition. The contingent shares issued, if any, will
be accounted for as an adjustment to the purchase price and allocated to
the acquired assets and liabilities. Also, as part of the Pharmanex
Acquisition, the Company assumed approximately $34.0 million in
liabilities and incurred acquisition costs totaling $1.3 million. The
net assets acquired totaling $3.6 million include net deferred tax
assets totaling $0.8 million. In connection with the closing of the
Pharmanex Acquisition, the Company paid approximately $29.0 million
relating to the assumed liabilities.
The Pharmanex Acquisition was accounted for by the purchase method of
accounting. The Company recorded inventory step-up of $3.7 million and
intangible assets of $92.4 million. In addition, the Company allocated
$13.6 million to purchased in-process research and development based on
a discounted cash-flow method reflecting the stage of completion of the
related projects. During 1998, the in-process research and development
amount was fully written off and the Company recorded amortization of
intangible assets totaling $1.3 million.
Pro forma results as if the Pharmanex Acquisition had occurred at
January 1,1998 have not been presented because the results are not
considered material.
5. RELATED PARTY TRANSACTIONS
Scope of related party activity
The Company has transactions with affiliated entities that are under
common control. The entities are Nu Skin USA, Nu Skin Canada, Nu Skin
Mexico and Nu Skin Guatemala. The transactions with these entities are
as follows: (1) In addition to selling products to consumers in its
geographic territories, the Company sells products and marketing
materials to affiliated entities in geographic areas outside those held
by the Company (primarily the USA, Canada, Mexico and Guatemala). (2)
The Company collects trademark
-24-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
royalty fees on products bearing NSI trademarks and marketed outside the
Company's geographic areas that are not purchased from NSI. (3) The
Company enters into a distribution agreement with each independent
distributor. (4) The Company collects license fees from affiliated
entities outside its geographical regions for the right to use the
distributors, and for the right to use the Company's distribution system
and other related intangibles. (5) The Company operates a global
commission plan whereby distributors' commissions are determined by
aggregate worldwide purchases made by down-line distributors. Thus,
commissions on purchases from the Company earned by distributors located
in geographic areas outside those held by the Company are remitted to
the Company, which then forwards these commissions to the distributors.
(6) The Company collects fees for management and support services
provided to affiliated entities outside its geographic areas.
The purchase prices paid by the affiliated entities for the purchase of
product and marketing materials are determined pursuant to the
Distribution Agreement between the Company and the affiliated entities.
The selling prices to these affiliated entities of products and
marketing materials are determined pursuant to the Wholesale
Distribution Agreements between the Company and these affiliated
entities. Trademark royalty fees and license fees are charged pursuant
to the Trademark/Tradename License Agreement between the Company and
these affiliated entities and the Licensing and Sales Agreement between
the Company and these affiliated entities, respectively. The independent
distributor commission program is managed by the Company. Charges to the
affiliated entities are based on a worldwide commission fee of 42% of
product revenue which covers commissions paid to distributors on a
worldwide basis and the direct costs of administering the global
compensation plan. Management and support services fees are billed to
the affiliated entities pursuant to the Management Services Agreement
between the Company and the affiliated entities and consist of all
direct expenses incurred by the Company and indirect expenses allocated
to the affiliated entities based on its net sales. The sales revenue,
royalties, licenses and management fees charged to the affiliated
entities are recorded as revenue in the consolidated statements of
income and totaled $68,556,000, $53,135,000 and $72,691,000 for the
years ended December 31, 1996, 1997 and 1998, respectively.
Notes payable to stockholders
In connection with the Reorganization described in Note 1, the aggregate
undistributed taxable S corporation earnings of the Initial Subsidiaries
were $86.5 million. These earnings were distributed in the form of
promissory notes bearing interest at 6.0% per annum. From proceeds from
the Offerings, $15.0 million was used to pay a portion of the notes, and
the remaining balance of $71.5 million with the related accrued interest
of $1.6 million was paid on April 4, 1997.
In connection with the NSI Acquisition described in Notes 1 and 3, the
Company assumed S Distribution Notes totaling $171.3 million and
long-term notes payable to the NSI Stockholders totaling $6.2 million,
both bearing interest at 6.0% per annum. These amounts were paid in
full, including accrued interest of $3.3 million, during the second
quarter of 1998. Prior to the NSI Acquisition, the Acquired Entities
paid $2.5 million of the S Distribution Notes, plus accrued interest of
$1.8 million.
Certain relationships with stockholder distributors
Two major stockholders of the Company have been independent distributors
for the Company since 1984. These stockholders are partners in an entity
which receives substantial commissions from the Company, including
commissions relating to sales within the countries in which the Company
operates. By agreement, the Company pays commissions to this partnership
at the highest level of distributor compensation to allow the
stockholders to use their expertise and reputations in network marketing
to further develop the Company's distributor force, rather than focusing
solely on their own distributor organizations. The commissions paid
-25-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
to this partnership relating to sales within the countries in which the
Company operates were $1,200,000, $1,100,000 and $800,000 for the years
ended December 31, 1996, 1997 and 1998, respectively.
Loan to stockholder
In December 1997, the Company loaned $5.0 million to a non-management
stockholder. The loan is secured by 349,406 shares of Class B Common
Stock, and matures in December 2000. Interest accrues at a rate of 6.0%
per annum on this loan. The loan may be repaid by transferring to the
Company the shares pledged to secure the loan. The loan balance,
including accrued interest, totaled $5.0 million and $5.3 million at
December 31, 1997 and 1998, respectively.
Contingent payments to stockholders under the NSI Acquisition
The Company and NSI met specific earnings growth targets for the year
ended December 31, 1998 that resulted in $25.0 million of contingent
consideration payable to the NSI Stockholders. The contingent
consideration is payable in April 1999. In addition, contingent upon NSI
and the Company meeting specific earnings growth targets, the Company
may pay up to $25.0 million in cash per year over the next three years
to the NSI Stockholders.
Lease agreements
The Company leases corporate office and warehouse space from two
affiliated entities. The Company then sub-leases a portion of the
corporate office and warehouse space to Nu Skin USA, Inc. and Big
Planet, Inc. These lease transactions between the Company and affiliated
entities approximate fair market value.
6. PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following (in thousands):
December 31,
1997 1998
------------ ------------
Furniture and fixtures $ 25,587 $ 30,997
Computers and equipment 36,836 44,267
Leasehold improvements 8,068 13,874
Vehicles 745 1,153
------------ ------------
71,236 90,291
Less: accumulated depreciation (44,090) (48,073)
------------ ------------
$ 27,146 $ 42,218
============ ============
Depreciation of property and equipment totaled $8,733,000, $8,060,000
and $11,543,000 for the years ended December 31, 1996, 1997 and 1998,
respectively.
7. OTHER ASSETS
Other assets consist of the following (in thousands):
December 31,
1997 1998
----------- -----------
Goodwill and intangibles $ 7,563 $ 147,246
Deposits for noncancelable operating leases 9,127 10,282
Distribution rights 8,750 8,750
Deferred taxes 30,399 42,747
Other 7,815 6,023
----------- -----------
63,654 215,048
Less: accumulated amortization (2,385) (5,630)
----------- -----------
$ 61,269 $ 209,418
=========== ===========
The goodwill and intangible assets are being amortized on a
straight-line basis over their estimated useful lives ranging from 4 to
20 years. Amortization of goodwill and intangible assets totaled
$726,000, $311,000 and $3,248,000 for the years ended December 31, 1996,
1997 and 1998, respectively. The distribution rights asset is being
amortized on a straight-line basis over its estimated useful life of 20
years. Amortization of the distribution rights asset totaled $156,000,
$438,000 and $438,000 for the years ended December 31, 1996, 1997 and
1998, respectively.
8. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
December 31,
1997 1998
----------- -----------
Income taxes payable $ 53,079 $ 40,726
Accrued commission payments to distributors 36,289 36,431
Other taxes payable 16,496 11,646
Other accruals 34,751 43,920
----------- -----------
$ 140,615 $ 132,723
=========== ===========
9. LONG-TERM DEBT
On May 8, 1998, the Company and its Japanese subsidiary Nu Skin Japan
Co., Ltd. entered into a $180.0 million credit facility with a syndicate
of financial institutions for which ABN-AMRO, N.V. acted as agent. This
unsecured credit facility was used to satisfy Company liabilities which
were assumed as part of the NSI Acquisition. The Company borrowed $110.0
million and Nu Skin Japan Co., Ltd. borrowed the Japanese yen equivalent
of $70.0 million denominated in local currency. The outstanding balance
on the credit facility was $153.3 million at December 31, 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 $4.7 million for the year ended December 31,1998.
The credit facility contains other terms and conditions and affirmative
and negative financial covenants customary for credit facilities of this
type. As of December 31, 1998, the Company has continued to comply with
all financial covenants under the credit facility.
During 1998, the Company entered into a $10.0 million revolving credit
agreement with ABN-AMRO, N.V. Advances are available under the agreement
through May 18, 1999. There were no outstanding balances under the
credit facility at December 31, 1998.
-26-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Maturities of long-term debt at December 31, 1998 are as follows (in
thousands):
Year Ending December 31,
1999 $ 14,545
2000 53,359
2001 85,375
------------
Total $ 153,279
============
10. LEASE OBLIGATIONS
The Company leases office space and computer hardware under
noncancelable long-term operating leases. Most leases include renewal
options of up to three years. Minimum future operating lease obligations
at December 31, 1998 are as follows (in thousands):
Year Ending December 31,
1999 $ 8,882
2000 6,821
2001 5,185
2002 5,017
2003 3,685
------------
Total minimum lease payments $ 29,590
============
Rental expense for operating leases totaled $12,558,000, $15,518,000 and
$15,969,000 for the years ended December 31, 1996, 1997 and 1998,
respectively.
11. STOCKHOLDERS' EQUITY
The Company's capital stock consists of Preferred Stock, Class A Common
Stock and Class B Common Stock. The shares of Class A Common Stock and
Class B Common Stock are identical in all respects, except for voting
rights and certain conversion rights and transfer restrictions, as
follows: (1) each share of Class A Common Stock entitles the holder to
one vote on matters submitted to a vote of the Company's stockholders
and each share of Class B Common Stock entitles the holder to ten votes
on each such matter; (2) stock dividends of Class A Common Stock may be
paid only to holders of Class A Common Stock and stock dividends of
Class B Common Stock may be paid only to holders of Class B Common
Stock; (3) if a holder of Class B Common Stock transfers such shares to
a person other than a permitted transferee, as defined in the Company's
Certificate of Incorporation, such shares will be converted
automatically into shares of Class A Common Stock; and (4) Class A
Common Stock has no conversion rights; however, each share of Class B
Common Stock is convertible into one share of Class A Common Stock, in
whole or in part, at any time at the option of the holder.
Equity incentive plans
Effective November 21, 1996, the Company implemented a one-time
distributor equity incentive program. This program provided for grants
of options to selected distributors for the purchase of 1,605,000 shares
of the Company's previously issued Class A Common Stock. The number of
options each distributor ultimately received was based on their
performance and productivity through August 31, 1997. The options are
exercisable at a price of $5.75 per share and vested on December 31,
1997. The related compensation expense was deferred in the Company's
financial statements and was expensed to the statement of income as
distributor stock expense ratably through December 31, 1997. As of
December 31, 1998, 392,417 of the 1,605,000 stock options had been
exercised.
-27-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company recorded compensation expense using the fair value method
prescribed by SFAS 123 based upon the best available estimate of the
number of shares that were expected to be issued to each distributor at
the measurement date, revised as necessary if subsequent information
indicated that actual forfeitures were likely to differ from initial
estimates. Any options forfeited were reallocated and resulted in an
additional compensation charge.
As a part of this program, 600,000 options were sold to affiliated
entities at fair value in exchange for notes receivable totaling
$12,351,000. As the number of distributor stock options to be issued to
each distributor was revised through August 31, 1997, the options
allocated to the affiliated entities were adjusted to 480,000 and the
notes receivable were adjusted to $9,115,000. The affiliated entities
are repaying these notes as distributors exercise their options. The
notes receivable balance totaled $9,115,000 and $6,251,000 as of
December 31, 1997 and 1998, respectively.
Prior to the Offerings, the Company's stockholders contributed 1,250,000
shares of the Company's Class A Common Stock to the Company and other
affiliated entities held by them for issuance to employees of the
Company and other affiliated entities as a part of an employee equity
incentive plan. Equity incentives granted or awarded under this plan
will vest over four years. Compensation expense related to equity
incentives granted to employees of the Company and other Nu Skin
entities who perform services on behalf of the Company will be
recognized by the Company ratably over the vesting period.
Approximately 743,000 of the 1,250,000 shares were contributed to
affiliated entities and the remaining 507,000 shares were contributed to
the Company. In November 1996, the Company granted 462,791 shares to
certain employees. The Company has recorded deferred compensation
expense of $10,773,000 related to these stock awards and is recognizing
such expense ratably over the vesting period. As of December 31, 1998,
217,606 of the stock awards had vested and 16,970 of the stock awards
had been forfeited.
1996 Stock Incentive Plan
During the year ended December 31, 1996, the Company's Board of
Directors adopted the Nu Skin Enterprises, Inc. 1996 Stock Incentive
Plan (the "1996 Stock Incentive Plan"). The 1996 Stock Incentive Plan
provides for granting of stock awards and options to purchase common
stock to executives, other employees, independent consultants and
directors of the Company and its Subsidiaries. A total of 7,500,000
shares of Class A Common Stock have been reserved for issuance under the
1996 Stock Incentive Plan.
In 1996, the Company granted stock awards to certain employees for an
aggregate of 109,000 shares of Class A Common Stock and in 1997 the
Company granted additional stock awards to certain employees and
directors in the amount of 55,459 shares of Class A Common Stock. The
Company has recorded deferred compensation expense of $3,780,000 related
to these stock awards and is recognizing such expense ratably over the
vesting period. As of December 31, 1998, 83,463 of the stock awards had
vested and 34,378 of the stock awards had been forfeited.
In 1997, the Company granted options to purchase 298,500 shares of Class
A Common Stock to certain employees and directors pursuant to the 1996
Stock Incentive Plan. Of the 298,500 options granted, 30,000 options
vested in May 1997 and 265,500 options vest ratably over a period of
four years. All options granted in 1997 will expire ten years from the
date of grant. The exercise price of the options was set at $20.88 per
share. The Company has recorded deferred compensation expense of
$578,000 related to the options and is recognizing such expense ratably
over the vesting periods. As of December 31, 1998, none of these 298,500
stock options had been exercised.
During 1998, the Company granted options to purchase 507,500 shares of
Class A Common Stock to certain employees and directors of the Company
pursuant to the 1996 Stock Incentive Plan. Of the 507,500 options
granted, 500,000 options vest ratably over a period of four years and
expire ten years from the date of grant
-28-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
and 7,500 vest in one year from the date of grant and expire in ten
years or six months after termination from service as a director. The
exercise price of the 500,000 options was set at $13.91 per share and
the exercise price of the 7,500 options was set at $28.50 per share. No
compensation expense has been recorded related to these options. As of
December 31, 1998, none of these 507,500 stock options had been
exercised.
Additionally in 1998, the Company granted options to purchase 1,080,000
shares of Class A Common Stock to certain employees pursuant to the 1996
Stock Incentive Plan. All of the 1,080,000 options vest seven years from
the date of grant and expire ten years from the date of grant. Subject
to the Company meeting certain revenue and profitability benchmarks, the
vesting of these options may be accelerated over the three-year period
ended December 31, 2001. The exercise price of the options was set at
$17.00 per share. No compensation expense has been recorded related to
these options. As of December 31, 1998, none of these 1,080,000 stock
options had been exercised.
Generation Health Holdings, Inc. 1996 Stock Option Plan
In connection with the Pharmanex Acquisition (Note 4), the Company
assumed the Generation Health Holdings, Inc. 1996 Stock Option Plan.
Under this plan, the Company assumed options to purchase 261,008 shares
of Class A Common Stock granted to certain employees of Pharmanex. In
accordance with the terms of the plan, 173,785 of these options vested
immediately due to the involuntary termination of certain employees. The
value of these vested options was included as an acquisition cost in the
Pharmanex Acquisition. The remaining 87,223 options vest ratably over
periods ranging from 1 to 5 years. The exercise prices of the options
range from $.92 to $10.03 per share. The Company has recorded deferred
compensation expense of $859,000 related to the 87,223 unvested options
and is recognizing such expense ratably over the vesting periods. As of
December 31, 1998, 1,863 of these 261,008 stock options had been
exercised.
SFAS 123 pro forma disclosures
The Company's pro forma net income would have been $118,413,000 and
$103,023,000 for the years ended December 31, 1997 and 1998,
respectively, if compensation expense had been measured under the fair
value method prescribed by SFAS 123. The Company's pro forma basic and
diluted net income per share for the year ended December 31, 1997 would
not have changed had compensation expense been measured under the fair
value method. The Company's pro forma basic and diluted net income per
share for the year ended December 31, 1998 would have been $1.21 and
$1.18, respectively, had compensation expense been measured under the
fair value method.
The fair value of the options granted during 1997 was estimated at
$10.55 per share as of the date of grant using the Black-Scholes option
pricing model with the following assumptions: risk-free interest rate of
6%; expected life of 4 years; expected volatility of 46%; and expected
dividend yield of 0%.
The fair values of the options granted during 1998 ranged from $13.51 to
$22.16 per share, and were estimated as of the dates of grant using the
Black-Scholes option pricing model with the following assumptions:
risk-free interest rate of 4.5%; expected life of 2 to 4 years; expected
volatility of 48%; and expected dividend yield of 0%.
-29-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Weighted average common shares outstanding
The following is a reconciliation of the weighted average common shares
outstanding for purposes of computing basic and diluted net income per
share (in thousands):
Year Ended December 31,
1996 1997 1998
-------- -------- --------
Basic weighted average common
shares outstanding 79,194 83,331 84,894
Effect of dilutive securities:
Stock awards and options 3,807 3,981 2,124
-------- -------- --------
Diluted weighted average common
shares outstanding 83,001 87,312 87,018
======== ======== ========
Repurchase of common stock
In December 1997, the Company repurchased 1,415,916 shares of Class A
Common Stock from certain original stockholders for an aggregate price
of approximately $20.3 million. Such shares were converted from Class B
Common Stock to Class A Common Stock prior to or upon purchase, and were
repurchased in connection with the entering into of an amended and
restated stockholders agreement by the original stockholders providing
for, among other things, a one-year extension of the original lock-up
provisions applicable to such original stockholders.
During 1998, the Board of Directors authorized the Company to repurchase
up to $20.0 million of the Company's outstanding shares of Class A
Common Stock. As of December 31, 1998, the Company had repurchased
917,254 shares for an aggregate price of approximately $10.5 million.
Conversion of common stock
In December 1998, the holders of the Class B Common Stock converted 15.0
million shares of Class B Common Stock to Class A Common Stock.
12. INCOME TAXES
Consolidated income before provision for income taxes consists of income
earned primarily from international operations. The provision for
current and deferred taxes for the years ended December 31, 1996, 1997
and 1998 consists of the following (in thousands):
1996 1997 1998
-------- -------- --------
Current
Federal $ 331 $ 3,332 $ 3,695
State 32 124 3,580
Foreign 56,929 76,553 72,317
-------- -------- --------
57,292 80,009 79,592
Deferred
Federal (1,929) (24,317) (10,712)
State -- (30) (48)
Foreign (2,398) 45 947
Change in tax status (3,439) -- (6,939)
-------- -------- --------
Provision for income taxes $ 49,526 $ 55,707 $ 62,840
======== ======== ========
Prior to the Company's Reorganization and the NSI Acquisition described
in Note 1, the Subsidiaries elected to be taxed as S corporations
whereby the income tax effects of the Subsidiaries' activities accrued
directly to their stockholders; therefore, adoption of SFAS 109 required
no establishment of deferred income taxes since no material differences
between financial reporting and tax bases of assets and liabilities
existed. Concurrent with the Company's Reorganization and the NSI
Acquisition, the Company terminated the S corporation elections of its
Subsidiaries. As a result, deferred income taxes under the provisions of
SFAS 109 were established.
The principal components of deferred tax assets are as follows (in
thousands):
December 31, December 31,
1997 1998
------------ ------------
Deferred tax assets:
Inventory reserve $ 1,773 $ 5,195
Foreign tax credit 19,268 33,969
Distributor stock options and employee stock awards 6,992 6,020
Capitalized legal and professional -- 5,990
Accrued expenses not deductible until paid 7,002 10,144
Withholding tax 5,692 7,291
Minimum tax credit 3,555 869
Net operating losses -- 12,621
------------ ------------
Total deferred tax assets 44,282 82,099
------------ ------------
Deferred tax liabilities:
Withholding tax 5,692 8,871
Exchange gains and losses 1,679 3,032
NSI inventory step-up -- 11,176
Pharmanex intangibles step-up -- 11,445
Other 143 1,520
------------ ------------
Total deferred tax liabilities 7,514 36,044
------------ ------------
Valuation allowance (4,700) (12,166)
------------ ------------
Deferred taxes, net $ 32,068 $ 33,889
============ ============
The valuation allowance primarily represents a reserve against a portion
of the deferred tax asset related to foreign tax credits.
The consolidated statements of income include a pro forma presentation
for income taxes, including the effect on minority interest, which would
have been recorded if the Company's Subsidiaries had been taxed as C
corporations for all periods presented. A reconciliation of the
Company's pro forma effective tax rate for the years ended December 31,
1996, 1997 and 1998 compared to the statutory U.S. Federal tax rate is
as follows:
-30-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Year Ended December 31,
1996 1997 1998
-------- ------- -------
Income taxes at statutory rate 35.00% 35.00% 35.00%
Foreign tax credit limitation (benefit) -- 2.41 4.40
Cumulative effect of change in tax status -- -- (4.09)
Pharmanex in-process research and development -- -- 2.80
Non-deductible expenses .75 .15 .83
Other 1.26 .42 (1.94)
-------- ------- -------
37.01% 37.98% 37.00%
======== ======= =======
13. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) defined contribution plan which permits
participating employees to defer up to a maximum of 15% of their
compensation, subject to limitations established by the Internal Revenue
Code. Employees who work a minimum of 1,000 hours per year, who have
completed at least one year of service and who are 21 years of age or
older are qualified to participate in the plan. The Company matches 100%
of the first 2% and 50% of the next 2% of each participant's
contributions to the plan. Participant contributions are immediately
vested. Company contributions vest based on the participant's years of
service at 25% per year over four years. The Company's contribution
totaled $454,000, $647,000 and $829,000 for the years ended December 31,
1996, 1997 and 1998, respectively.
14. DERIVATIVE 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 certain intercompany loans of foreign currency.
The Company does not use such derivative 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
certain intercompany loans of foreign currency are recorded as other
income and expense in the consolidated statements of income.
At December 31, 1997 and 1998, the Company held foreign currency forward
contracts with notional amounts totaling approximately $51.0 million and
$46.3 million, respectively, to hedge foreign currency items. These
contracts do not qualify as hedging transactions and, accordingly, have
been marked to market. The net gains on foreign currency forward
contracts were $5.6 million and $2.6 million for the years ended
December 31, 1997 and 1998, respectively. There were no significant
gains or losses on foreign currency forward contracts for the year ended
December 31, 1996. These contracts at December 31, 1998 have maturities
through July 1999.
At December 31, 1997 and 1998, the intercompany loan from Nu Skin Japan
to Nu Skin Hong Kong totaled approximately $92.5 million and $57.3
million, respectively. The Company recorded exchange gains totaling $7.8
million and $2.2 million resulting from this intercompany loan for the
years ended December 31, 1997 and 1998, respectively.
-31-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
At December 31, 1998, the intercompany loan from Nu Skin Japan to the
Company totaled approximately $82.0 million. The Company recorded
exchange gains totaling $2.8 million resulting from this intercompany
loan for the year ended December 31, 1998. There was no loan at December
31, 1997 from Nu Skin Japan to the Company.
15. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest totaled $84,000, $251,000 and $3,731,000 for the
years ended December 31, 1996, 1997 and 1998, respectively. Cash paid
for income taxes totaled $18,133,000, $73,905,000 and $77,271,000 for
the years ended December 31, 1996, 1997 and 1998, respectively.
Noncash investing and financing activities
For the year ended December 31, 1996, noncash investing and financing
activities were as follows: (1) $86.5 million distribution to the
stockholders of the Initial Subsidiaries (Note 1). (2) $1.2 million of
additional paid-in capital contributed by the stockholders of the
Initial Subsidiaries in exchange for shares of Class B Common Stock in
connection with the termination of the Initial Subsidiaries' S
corporation status. (3) $33.0 million of additional paid-in capital and
$20.7 million of deferred compensation recorded related to the issuance
of 1,605,000 options to distributors to purchase shares of Class A
Common Stock. 600,000 of these options were sold to affiliated entities
in exchange for notes receivable totaling $12.4 million (Note 11).
For the year ended December 31, 1997, noncash investing and financing
activities were as follows: (1) $87.1 million distribution to the
stockholders of the Acquired Entities (Note 1). (2) Adjustment to the
distributor stock options to reallocate 120,000 options initially
allocated to affiliated entities and a related reduction in the notes
receivable of $3.2 million (Note 11).
For the year ended December 31, 1998, noncash investing and financing
activities were as follows: (1) $37.6 million distribution to the
stockholders of the Acquired Entities (Note 1). (2) Purchase of Acquired
Entities for $70.0 million in Preferred Stock and $6.2 million in
long-term notes payable. Net assets acquired totaled $90.4 million and
assumed liabilities totaled $171.3 (Note 3). (3) $25.0 million in
contingent consideration issued to the NSI Stockholders. $8.8 million of
the contingent payment was recorded as an increase in intangible assets
and $16.2 million of the contingent payment was recorded as a reduction
of stockholders' equity (Notes 3 and 5). (4) Purchase of Pharmanex for
$77.6 million in Class A Common Stock and $0.2 million in cash. Net
assets acquired totaled $3.6 million and assumed liabilities totaled
$34.0 million (Note 4).
16. SEGMENT INFORMATION
During 1998, the Company adopted Statement of Financial Accounting
Standards No. 131 ("SFAS 131"), Disclosures about Segments of an
Enterprise and Related Information. As described in Note 1, the
Company's operations throughout the world are divided into three
reportable segments: North Asia, Southeast Asia and Other Markets.
Segment data includes intersegment revenue, intersegment profit and
operating expenses and intersegment receivables and payables. The
Company evaluates the performance of its segments based on operating
income. Information as to the operations of the Company in each of the
three segments is set forth below (in thousands):
-32-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Year Ended December 31,
1996 1997 1998
------------ ------------ ------------
Revenue
North Asia $ 502,381 $ 673,582 $ 665,523
Southeast Asia 336,783 412,524 320,606
Other Markets 266,368 314,048 294,947
Eliminations (343,894) (446,732) (367,582)
------------ ------------ ------------
Totals $ 761,638 $ 953,422 $ 913,494
============ ============ ============
Year Ended December 31,
1996 1997 1998
------------ ------------ ------------
Operating Income
North Asia $ 88,347 $ 117,302 $ 89,075
Southeast Asia 52,224 46,195 19,385
Other Markets 4,134 19,684 46,994
Eliminations (7,538) (2,961) 785
------------ ------------ ------------
Totals $ 137,167 $ 180,220 $ 156,239
============ ============ ============
December 31,
1997 1998
------------ ------------
Total Assets
North Asia $ 104,488 $ 167,867
Southeast Asia 176,570 110,518
Other Markets 211,663 500,299
Eliminations (87,717) (172,251)
------------ ------------
Totals $ 405,004 $ 606,433
============ ============
Information as to the Company's operation in different geographical
areas is set forth below (in thousands):
Revenue
Revenue from the Company's operations in Japan totaled $380,044,
$599,375 and $654,168 for the years ended December 31, 1996, 1997 and
1998, respectively. Revenue from the Company's operations in Taiwan
totaled $154,564, $168,568 and $119,511 for the years ended December 31,
1996, 1997 and 1998, respectively. Revenue from the Company's operations
in the United States (which includes intercompany revenue) totaled
$252,111, $301,217 and $280,115 for the years ended December 31, 1996,
1997 and 1998, respectively.
Long-lived assets
Long-lived assets in Japan were $11,001 and $20,242 as of December 31,
1997 and 1998, respectively. Long-lived assets in Taiwan were $3,087 and
$2,466 as of December 31, 1997 and 1998, respectively. Long-lived assets
in the United States were $55,557 and $213,856 as of December 31, 1997
and 1998, respectively.
-33-
Nu Skin Enterprises, Inc.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
17. COMMITMENTS AND CONTINGENCIES
The Company is subject to governmental regulations pertaining to product
formulation, labeling and packaging, product claims and advertising and
to the Company's direct selling system. The Company is also subject to
the jurisdiction of numerous foreign tax authorities. These tax
authorities regulate and restrict various corporate transactions,
including intercompany transfers. The Company believes that the tax
authorities in Japan and South Korea are particularly active in
challenging the tax structures and intercompany transfers of foreign
corporations. Any assertions or determination that either the Company,
or the Company's distributors is not in compliance with existing
statutes, laws, rules or regulations could potentially have a material
adverse effect on the Company's operations. In addition, in any country
or jurisdiction, the adoption of new statutes, laws, rules or
regulations or changes in the interpretation of existing statutes, laws,
rules or regulations could have a material adverse effect on the Company
and its operations. Although management believes that the Company is in
compliance, in all material respects, with the statutes, laws, rules and
regulations of every jurisdiction in which it operates, no assurance can
be given that the Company's compliance with applicable statutes, laws,
rules and regulations will not be challenged by foreign authorities or
that such challenges will not have a material adverse effect on the
Company's financial position or results of operations or cash flows.
18. SUBSEQUENT EVENTS
In February 1999, the Company announced its intent to acquire Big
Planet, Inc., certain assets of Nu Skin USA, Inc. and the Company's
remaining affiliates in Canada, Mexico and Guatemala for approximately
$40.0 million in cash, $14.5 million in a three-year note and the
assumption of certain liabilities. The assets to be acquired from Nu
Skin USA, Inc. include approximately 620,000 shares of the Company's
Class A Common Stock (Note 11). The Company concluded the Nu Skin USA,
Inc. transaction in March 1999 and anticipates closing the remaining
transactions within 90 days.
The acquisition of Big Planet, Inc. is expected to be accounted for by
the purchase method of accounting. The acquisition of Nu Skin USA, Inc.
and the Company's remaining affiliates in Canada, Mexico and Guatemala
is expected to be accounted for by the purchase method of accounting,
except for that portion of these affiliated entities under common
control of a group of stockholders, which portion will be accounted for
in a manner similar to a pooling of interests.
-34-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Nu Skin Enterprises, Inc.
In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated balance sheets and the related consolidated statements
of income, of stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of Nu Skin Enterprises, Inc. and its
subsidiaries at December 31, 1997 and 1998, and the results of their operations
and their cash flows for the years ended December 31, 1996, 1997 and 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of the Acquired Entities
(Note 3), which statements reflect total assets of $127.0 million at December
31, 1997, and total revenue of $265.0 million and $308.9 million for the years
ended December 31, 1996 and 1997, respectively. Those statements were audited by
other auditors whose report thereon has been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for the Acquired
Entities, is based solely on the report of the other auditors. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the report of other auditors provide a reasonable basis for the
opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Salt Lake City, Utah
February 17, 1999
-35-
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Common Stock
The Company's Class A Common Stock is listed on the New York Stock
Exchange ("NYSE") and trades under the symbol "NUS." The following table is
based upon information available to the Company and sets forth the range of the
high and low sales prices for the Company's Class A Common Stock for the
quarterly periods during 1997 and 1998 based upon quotations on the NYSE.
1997
--------------------------
Quarter Ending High Low
-------------- ------ ------
March 31, 1997 $30.88 $23.00
June 30, 1997 $28.25 $23.63
September 30, 1997 $27.19 $19.31
December 31, 1997 $24.44 $16.00
1998
--------------------------
Quarter Ending
--------------
March 31, 1998 $25.75 $15.75
June 30, 1998 $28.69 $15.50
September 30, 1998 $19.25 $10.19
December 31, 1998 $25.63 $10.31
The market price of the Company's Class A Common Stock is subject to
significant fluctuations in response to variations in the Company's quarterly
operating results, general trends in the market for the Company's products and
product candidates, economic and currency exchange issues in the foreign markets
in which the Company operates and other factors, many of which are not within
the control of the Company. In addition, broad market fluctuations, as well as
general economic, business and political conditions, may adversely affect the
market for the Company's Class A Common Stock, regardless of the Company's
actual or projected performance.
The closing price of the Company's Class A Common Stock on March 5, 1999
was $18.50. The approximate number of holders of record of the Company's Class A
Common Stock and Class B Common Stock as of March 5, 1999 was 949. This number
does not represent the actual number of beneficial owners of shares of the
Company's Class A Common Stock because shares are frequently held in "street
name" by securities dealers and others for the benefit of individual owners who
have the right to vote their shares.
The Company has not paid or declared any cash dividends on its Class A
Common Stock and does not anticipate doing so in the foreseeable future. The
Company currently anticipates that all of its earnings, if any, will be retained
for use in the operation and expansion of its business. Any future determination
as to cash dividends will depend upon the earnings and financial position of the
Company and such other factors as the Company's Board of Directors may deem
appropriate.
-36-