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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------------
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ______________ to ______________
Commission file number 333-12073
Nu Skin Asia Pacific, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 87-0565309
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
75 West Center Street, Provo, Utah 84601
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (801) 345-6100
-------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
Class A Common Stock New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
As of March 3, 1997, the aggregate market value of the voting stock held by
non-affiliates of the Company was $339,777,427.
As of March 3, 1997, 11,723,011 shares of the Company's Class A Common
Stock, $.001 par value per share, 71,696,675 shares of the Company's Class B
Common Stock, $.001 par value per share, and no shares of the Company's
Preferred Stock, $.001 par value per share, were outstanding.
NU SKIN ASIA PACIFIC, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I ......................................................................1
ITEM 1. BUSINESS..................................................1
ITEM 2. PROPERTIES...............................................34
ITEM 3. LEGAL PROCEEDINGS........................................35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......35
PART II .....................................................................36
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS......................................36
ITEM 6. SELECTED FINANCIAL DATA..................................37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS......................39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..............47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE......................47
PART III .....................................................................48
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......48
ITEM 11. EXECUTIVE COMPENSATION...................................51
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT...............................................56
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...........59
PART IV .....................................................................62
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.................................................62
PART I
ITEM 1. BUSINESS
General
Nu Skin Asia Pacific, Inc., a Delaware corporation founded in September
1996 (the "Company"), is a network marketing company involved in the
distribution and sale of personal care and nutritional products. The Company is
the exclusive distribution vehicle for Nu Skin International, Inc. ("NSI") in
the countries of Japan, Taiwan, Hong Kong (including Macau), South Korea and
Thailand, where the Company currently has operations, and in Indonesia,
Malaysia, the Philippines, the People's Republic of China ("PRC"), Indonesia,
Singapore and Vietnam, where operations have not yet commenced. The Company's
products are specifically designed for the network marketing distribution
channel. The Company markets its personal care products under the trademark "Nu
Skin" and its nutritional products under the trademark "Interior Design
Nutritionals" (IDN). The Nu Skin personal care product lines include facial
care, body care, hair care and color cosmetics, as well as specialty products
such as sun protection, oral hygiene and fragrances. The IDN product lines
include nutritional supplements, weight management products and nutritious
snacks, sports nutrition products and botanicals.
In Japan, Taiwan and Hong Kong, the Company currently offers most of NSI's
personal care products and approximately one-third of NSI's nutritional
products. In South Korea and Thailand, the Company currently offers one-third of
NSI's personal care products and none of the nutritional products. The Company
intends to expand its product offerings with existing NSI products and to
introduce new products tailored to specific markets.
The Company was incorporated on September 4, 1996. On November 20, 1996,
the stockholders of Nu Skin Japan Company, Limited ("Nu Skin Japan"), Nu Skin
Taiwan, Inc. ("Nu Skin Taiwan"), Nu Skin Hong Kong, Inc. ("Nu Skin Hong Kong"),
Nu Skin Korea, Inc. ("Nu Skin Korea") and Nu Skin Personal Care (Thailand), Inc.
("Nu Skin Thailand") contributed their shares of capital stock to the capital of
the Company in a transaction (the "Reorganization ") intended to qualify under
Section 351 of the Internal Revenue Code of 1986, as amended (the "Code"), in
exchange for shares of the Company's Class B Common Stock, par value $.001 per
share (the "Class B Common Stock"). Prior to the Reorganization, all of the
outstanding shares of such companies were held by these stockholders (the
"Original Stockholders"). As a result of the Reorganization, each of the
above-listed companies became a wholly-owned subsidiary of the Company.
In November 1996, the Company and certain selling stockholders sold a total
of 10,465,000 shares of the Company's Class A Common Stock, par value $.001 per
share (the "Class A Common Stock," and, together with the Class B Common Stock,
the "Common Stock "), in underwritten public offerings (the "Underwritten
Offerings"). The Company issued and sold 4,750,000 shares of Class A Common
Stock as part of this transaction. In December 1996, in non-underwritten
offerings (the "Rule 415 Offerings," and, together with the Underwritten
Offerings, the "Offerings") pursuant to Rule 415 of the Securities Act of 1933,
as amended (the "1933 Act"): (i) NSI offered to qualifying NSI distributors
options (the "Distributor Options") to purchase 1,605,000 shares of Class A
Common Stock; (ii) the Company offered 1,605,000 shares of Class A Common Stock
to be issued upon the exercise of the Distributor Options; (iii) the Company
offered to its employees 109,000 shares of Class A Common Stock in connection
with the awarding of employee stock bonus awards; and (iv) NSI and certain of
its affiliates offered 1,250,000 shares of Class A Common Stock to their
employees as stock bonus awards. The 1,605,000 shares of Class A Common Stock
underlying the Distributor Options are held by the Company for issuance upon the
exercise of the Distributor Options. The Distributor Options are expected to
become exercisable in January 1998 and will remain exercisable until December
31, 2001. In November and December 1996, the Company made stock bonus awards to
certain of its employees for an aggregate of 109,000 shares of Class A Common
Stock and in January 1997 the Company made additional stock bonus awards to
certain of its employees for an aggregate of 41,959 shares of Class A Common
Stock. The shares of Class A Common Stock underlying each of these stock bonus
awards will be issued to the recipient of the award at a rate of 25% per year
commencing in November, 1997, subject to certain restrictions. In January 1997,
the Company also issued and sold 8,011 shares of Class A Common Stock to three
foreign individuals pursuant to Regulation S under the 1933 Act. As of March 3,
1997, the Original Stockholders and certain of their affiliates beneficially
owned shares of Common Stock having approximately 98.4% of the combined voting
power of the outstanding shares of Common Stock.
NSI, founded in 1984 and based in Provo, Utah, is engaged in selling
personal care and nutritional products and, together with its affiliates,
comprises one of the largest network marketing organizations in the world. NSI
has provided, and continues to provide, a high level of support services to the
Company, including product development, marketing and other managerial support
services. Since distributor agreements are entered into between NSI and
distributors, all of the distributors who generate revenue for the Company are
distributors of NSI. Because of this fact, the Company cannot control who
becomes a distributor.
When used in this Annual Report on Form 10-K and in future filings by the
Company with the Securities and Exchange Commission (the "Commission"), in the
Company's press releases and in oral statements made with the approval of an
authorized executive officer, the words or phrases "will likely result,"
"expects," "intends," "will continue," "is anticipated," "estimates," "projects"
and similar expressions are intended to identify "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include plans and objectives of management for future
operations, including plans and objectives relating to the products and the
future economic performance and financial results of the Company. The
forward-looking statements and associated risks set forth herein relate to: (i)
the expansion of the Company's market share in its current markets; (ii)
Company's entrance into new markets; (iii) development of new products and new
product lines tailored to appeal to the particular needs of consumers in
specific markets; (iv) stimulation of product sales by introducing new products;
(v) opening of new offices, walk-in distribution centers and distributor support
centers in certain markets; (vi) promotion of distributor growth, retention and
leadership through local initiatives; (vii) upgrading of the Company's
technological resources to support distributors; (viii) obtaining of regulatory
approvals for certain products, including LifePak; (ix) stimulation of product
purchases by inactive distributors through direct mail campaigns; and (x)
retention of the Company's earnings for use in the operation and expansion of
the Company's business. All forward-looking statements are subject to certain
risks and uncertainties, including those discussed under the caption "Certain
Business Considerations and Risk Factors" herein, that could cause actual
results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward- looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
under the caption "Certain Business Considerations and Risk Factors" could
affect the Company's financial performance and could cause the Company's actual
results for future periods to differ materially from any opinions or statements
expressed with respect to future periods in any current statements. Factors and
risks that might cause such differences include, but are not limited to,
factors related to the Company's reliance upon independent distributors of NSI,
the potential effects of adverse publicity, the potential negative impact of
distributor actions, government regulation of direct selling activities,
government regulation of products and marketing, other regulatory issues, the
Company's reliance on certain distributors, the potential divergence of
interests between distributors and the Company, the Company's entering new
markets, managing the Company's growth, the possible adverse effects on the
Company of a change in the status of Hong Kong, the Company's relationship with
and reliance on NSI, potential conflicts of interest between the Company and
NSI, control of the Company by the Original Stockholders, the anti-takeover
effects of dual classes of common stock, the adverse impact on the Company's
income of the Distributor Option program, the allocation and vesting of the
Distributor Options, the potential decrease in the number of Distributor
Options available, product returns, restrictions on the resale of the shares of
Class A Common Stock underlying the Distributor Options, regulatory and
taxation risks, the Company's reliance on and the concentration of outside
manufacturers, the Company's reliance on the operations of and dividends and
distributions from the Subsidiaries, taxation and transfer pricing, the
potential increase in distributor compensation expense, seasonal and cyclical
trends, variations in operating results, product liability issues, market
conditions and competition, the Company's operations outside the U.S., currency
risks, import restrictions, duties and regulation of consumer goods, the
anti-takeover effects of certain charter, contractual and statutory provisions,
dilution and the absence of Company dividends. In light of the significant
uncertainties inherent in forward-looking statements, the inclusion of any such
statement should not be regarded as a representation by the Company or any
other person that the objectives or plans of the Company will be achieved.
Unless otherwise noted, references to "Nu Skin Asia Pacific" or the
"Company" mean Nu Skin Asia Pacific, Inc., including the Subsidiaries. The
"Subsidiaries" means Nu Skin Japan, Nu Skin Taiwan, Nu Skin Hong Kong , Nu Skin
Korea and Nu Skin Thailand, collectively. Until September 30, 1994, the
Company's fiscal year ended on September 30 of each year. As of October 1, 1994,
the Company changed its fiscal year end to December 31 of each year, beginning
with the fiscal year ended December 31, 1995.
Nu Skin(R), Interior Design Nutritionals(TM), IDN(R), a logo consisting of
an image of a gold fountain with the words "Nu Skin" below it, and a logo
consisting of the stylized letters "IDN" in black and red are trademarks of NSI
which are licensed to the Company. The italicized product names used in this
Annual Report on Form 10-K are product names and also, in certain cases,
trademarks and are the property of NSI. All other tradenames and trademarks
appearing in this Annual Report on Form 10-K are the property of their
respective holders.
In this Annual Report on Form 10-K, references to "dollars" and "$" are to
United States dollars, and the terms "United States" and "U.S." mean the United
States of America, its states, territories, possessions and all areas subject to
its jurisdiction, and references to "yen" and the yen sign are to Japanese yen,
and references to "won" are to South Korean won.
Country Profiles
The following table sets forth the Company's revenue and the total number
of active distributors for each of the countries in which the Company operated
for the years ended December 31, 1994, 1995 and 1996. This table should be
reviewed in connection with the information presented under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," which discusses the costs associated with generating the aggregate
revenue presented.
Country Year Ended December 31,
1994 1995 1996
(dollars in thousands)
Revenue:
Japan................... $172,960 $231,540 $380,044
Taiwan.................. 79,219 105,415 154,564
South Korea(1).......... -- -- 122,337
Hong Kong............... 10,880 17,046 17,037
-------- -------- --------
Total(2).......... $263,059 $354,001 $673,982
======== ======== ========
Active Distributors(3)(4):
Japan................... 106,000 147,000 215,000
Taiwan.................. 53,000 75,000 91,000
South Korea(1).......... -- -- 57,000
Hong Kong............... 11,000 14,000 14,000
-------- -------- --------
Total............. 170,000 236,000 377,000
======== ======== ========
- ---------------------------
(1) The Company commenced operations in South Korea in February 1996.
(2) Operating expenses have increased with the growth of the Company's
revenue. However, as a percentage of revenue such expenses have
declined due to improved operating leverage. In addition, total revenue
does not include sales of certain products to NSI affiliates in
Australia and New Zealand of $1.4 million, $4.6 million and $4.6
million in 1994, 1995 and 1996, respectively.
(3) The term "Active Distributors" includes only those distributors who
purchased products from the Company during the three months ended as of
the date indicated.
(4) Numbers are rounded to the nearest thousand.
The following table sets forth certain estimated economic and demographic
data in each of the Company's markets. Although the Company believes that the
following table provides a useful basis for evaluating the relative size and
growth of the economies and populations of the countries in which the Company
operates, no assurance can be given that economic or population data in a
particular country will indicate what the Company's results of operations will
be in that country.
1995 Real GDP
Population 1995 GDP 1995 GDP Growth
Country (in millions) (in billions of $) per capita (in $) 1995/1994 (%)
- ------- -------------- ------------------ ----------------- -------------
Japan......... 125.3 $4,645.5 $37,672 0.9%
Taiwan........ 21.2 259.9 13,403 6.1
Hong Kong..... 6.2 144.3 26,442 5.0
South Korea... 44.9 446.4 11,422 8.1
Thailand...... 60.7 162.7 3,033 8.6
- ---------------------------
Source: World Information Services; Country Data Forecasts, March 1996.
Japan. The Company, through its subsidiary Nu Skin Japan, commenced
operations in Japan in April 1993. Network marketing activities and the sale of
the Company's products are subject to significant government regulation in
Japan. To date, the Company has experienced significant growth in Japan, where
revenue increased 34% in 1995 compared to 1994 and 64% in 1996 as compared to
1995. Nu Skin Japan currently offers 52 of the 89 NSI personal care products and
10 of the 36 IDN products, including LifePak, the core IDN product.
Additionally, Nu Skin Japan offers 11 personal care products that are
manufactured in Japan and are specifically targeted to the Japanese market.
In support of the Company's growth strategy, Nu Skin Japan intends to (i)
focus on internal country development by opening offices in additional Japanese
cities, thereby increasing consumer awareness and enhancing the Company's image,
(ii) expand development capacity to develop more products that are particularly
suited to the Japanese market, (iii) continue to expand the current product
offerings in Japan to include additional NSI products, such as FibreNet and the
MHA Product System, which were recently introduced in Japan, and (iv) enhance
corporate support of distributors by upgrading information technology resources.
Taiwan. The Company, through its subsidiary Nu Skin Taiwan, commenced
operations in Taiwan in January 1992. The Taiwanese government regulates direct
selling activities to a significant extent. For example, the Taiwan government
recently enacted tax legislation aimed at ensuring proper tax payments by
distributors on their transactions with end consumers. Revenue growth in Taiwan
has averaged 59% on an annualized basis since 1993.
In support of the Company's growth strategy, Nu Skin Taiwan intends to (i)
capitalize on the size of the nutritional supplements market by promoting the
recently introduced LifePak product and expanding the current product offerings
in Taiwan to include additional NSI products, in particular FibreNet, which,
subject to regulatory approval, is scheduled for introduction in Taiwan by the
end of 1997, (ii) focus more resources on product development specifically for
the Taiwan market, and (iii) enhance corporate support of distributors by
upgrading information technology resources.
Hong Kong. The Company, through its subsidiary Nu Skin Hong Kong, commenced
operations in Hong Kong in September 1991. Nu Skin Hong Kong currently offers 81
of the 89 NSI personal care products and 13 of the 36 IDN products.
In February 1995, Macau, a Portuguese colony scheduled to become an SAR of
the PRC in 1999, was opened as a new market. Revenue figures for Macau are
combined with those of Hong Kong. The Company's Macau office operates under the
direction of Nu Skin Hong Kong.
In support of the Company's growth strategy, Nu Skin Hong Kong intends to
(i) promote distributor growth, retention and leadership development through
local initiatives such as a recently opened "distributor business center," which
provides offices for distributors to rent, at cost, from which they can conduct
business, (ii) seek regulatory approvals for the introduction of LifePak; which
is not yet available in Hong Kong, and (iii) stimulate purchases from inactive
distributors through direct mail campaigns.
South Korea. The Company, through its subsidiary Nu Skin Korea, commenced
operations in South Korea in February 1996. Nu Skin Korea currently offers 34 of
the 89 NSI personal care products and none of the IDN products.
In support of the Company's growth strategy, Nu Skin Korea intends to (i)
continue to add products from NSI's personal care product line to stimulate new
sales, (ii) seek regulatory approvals for the introduction of IDN products,
(iii) continue to develop an infrastructure to support a rapidly growing
distributor base, including, but not limited to, adding additional walk-in
centers in major South Korean cities, and (iv) promote the development of local
distributor leadership.
Thailand. The Company, through its subsidiary Nu Skin Thailand, commenced
operations in Thailand on March 13, 1997. Nu Skin Thailand currently offers 26
of the 89 personal care products and none of the IDN products.
In Thailand, the Company intends to focus on establishing a stable
distributor base prior to implementing growth strategies through product line
enhancement.
New Market Opportunities
The Company has developed a low cost, disciplined approach to opening new
markets. Each market opening is preceded by a thorough analysis of economic and
political conditions, regulatory standards and other business, tax and legal
issues. Prior to a market opening, the Company's management team, in conjunction
with NSI support personnel, local legal counsel and tax advisors, works to
obtain all necessary regulatory approvals and establish facilities capable of
meeting distributor needs. This approach, combined with NSI's global distributor
compensation plan (the "Global Compensation Plan"), which motivates distributors
to sponsor and train other distributors to sell products in new markets, has
enabled the Company to quickly and successfully open new markets.
The Company, as a matter of policy, does not announce the timing of its
opening of new markets. The Company is the exclusive distributor of NSI products
in Indonesia, Malaysia, the Philippines, the PRC, Singapore and Vietnam. The
Company believes that these countries collectively represent significant markets
for future expansion. There are, however, significant risks and uncertainties
associated with this expansion. The regulatory and political climate in these
potential markets is such that a replication of the Company's current operating
structure cannot be guaranteed. For example, Malaysia has governmental
guidelines that have the effect of limiting foreign ownership of direct selling
companies operating in Malaysia to no more than 30%. In addition, because the
Company's personal care and nutritional product lines are positioned as premium
product lines, the market potential for the Company's product lines in
relatively less developed countries, such as the PRC and Vietnam, remains to be
determined. Modifications to each product line may be needed to accommodate the
market conditions in each country, while maintaining the integrity of the
Company's products. No assurances can be given that the Company will be able to
make such modifications. Given existing regulatory environments and economic
conditions, the Company's entrance into Singapore and Vietnam is not anticipated
in the short to mid-term.
Distribution System
Overview of Distribution System. The foundation of the Company's sales
philosophy and distribution system is network marketing. Under most network
marketing systems, distributors purchase products for retail sale or personal
consumption. Pursuant to the Global Compensation Plan, products are sold
exclusively to or through independent distributors who are not employees of the
Company or NSI. Distributors contract directly with NSI, and NSI makes such
distributors available to the Company through Licensing and Sales Agreements.
Network marketing is an effective vehicle to distribute the Company's
products because (i) a consumer can be educated about a product in person by a
distributor, which is more direct than the use of television and print
advertisements; (ii) direct sales allow for actual product testing by a
potential consumer; (iii) the impact of distributor and consumer testimonials is
enhanced; and (iv) as compared to other distribution methods, distributors can
give customers higher levels of service and attention, by, among other things,
delivering products to a consumer's home and following up on sales to ensure
proper product usage and customer satisfaction, and to encourage repeat
purchases. Under most network marketing systems, independent distributors
purchase products either for resale or for personal consumption.
Direct selling as a distribution channel has been enhanced in the past
decade due to advancements in communications, including telecommunications, and
the proliferation of the use of videos and fax machines. Direct selling
companies can now produce high quality videos for use in product education,
demonstrations and sponsoring sessions that project a desired image for the
Company and the product line. Management believes that high quality sales aids
play an important role in the success of distributor efforts. For this reason,
NSI maintains an in-house staff of video production personnel and video and
audio cassette duplication equipment for timely and cost-effective production of
sales materials. These facilities and expertise are available for the Company's
use. Management is committed to fully utilizing current and future technological
advances to continue enhancing the effectiveness of direct selling.
NSI's network marketing program differs from many other network marketing
programs in several respects. First, the Global Compensation Plan allows NSI
distributors to develop a seamless global network of downline distributors.
Second, NSI's order and fulfillment systems eliminate the need for distributors
to carry significant levels of inventory. Third, the Global Compensation Plan is
among the most financially rewarding plans offered to distributors by network
marketing companies, and can result in commissions to distributors aggregating
up to 58% of a product's wholesale price. On a global basis, commissions have
averaged 42% of revenue from commissionable sales over the last seven years.
Because the Company licenses the right to use the Global Compensation Plan from
NSI, the structure of the plan, including commission rates, is under the control
of NSI.
The Company's revenue is directly dependent upon the efforts of
distributors. Growth in sales volume requires an increase in the productivity of
distributors and/or growth in the total number of distributors. Because the
distributors have contracted directly with NSI, the Company has no control over
who becomes a distributor and little or no control over the level of sponsorship
of new distributors. There can be no assurance that the productivity or number
of distributors will be sustained at current levels or increased in the future.
Furthermore, the Company estimates that, as of December 31, 1996, approximately
325 distributorships worldwide comprised NSI's Hawaiian Blue Diamond and Blue
Diamond executive distributor levels ("Executive Pin Levels"), which are NSI's
two highest Executive Pin Levels and, together with their extensive downline
networks, account for substantially all of the Company's revenue. Consequently,
the loss of such a high-level distributor or another key distributor, together
with a group of leading distributors in such distributor's downline network, or
the loss of a significant number of distributors for any reason, could adversely
affect the Company's results of operations.
Sponsoring. The Company relies solely on NSI distributors to sponsor new
distributors. While the Company provides, at cost, product samples, brochures,
magazines and other sales materials, distributors are primarily responsible for
educating new distributors with respect to products, the Global Compensation
Plan, and how to build a successful distributorship.
The sponsoring of new distributors creates multiple levels in the network
marketing structure. Persons whom a distributor sponsors are referred to as
"downline" or "sponsored" distributors. If downline distributors also sponsor,
they create additional levels in the structure, but their downline distributors
remain part of the same downline network as their original sponsoring
distributor.
Sponsoring activities are not required of distributors. However, because of
the financial incentives provided to those who succeed in building a distributor
network, the Company believes that most of its distributors attempt, with
varying degrees of effort and success, to sponsor additional distributors.
Generally, distributors invite friends, family members and acquaintances to
sales meetings where Company products are presented and where the Global
Compensation Plan is explained. People are often attracted to become
distributors after using Company products and becoming regular retail customers.
Once a person becomes a distributor, he or she is able to purchase products
directly from the Company at wholesale prices for resale to consumers or for
personal consumption. The distributor is also entitled to sponsor other
distributors in order to build a network of distributors and product users.
A potential distributor must enter into a standard distributor agreement
with NSI which obligates the distributor to abide by NSI's policies and
procedures. Additionally, in all countries except Japan, a new distributor is
required to enter into a product purchase agreement with the Company's local
subsidiary, which governs product purchases. In Japan, Taiwan and Hong Kong,
distributors are also required to purchase a starter kit, which includes NSI's
policies and procedures, for between $55 and $85, which essentially represents
the cost of producing the starter kit, and active distributors are required to
pay the Company an Annual Materials Fee ("AMF") of up to $35 to cover the cost
of newsletters, magazines and updates that are mailed regularly to them. In
South Korea, due to local regulations, distributors are not required to purchase
a starter kit, and active distributors are not required to pay an AMF.
Global Compensation Plan. Management believes that one of the Company's key
competitive advantages is the Global Compensation Plan, which it licenses from
NSI. The Global Compensation Plan is seamlessly integrated across all markets in
which NSI products are sold. This seamless integration means that the Company's
distributor base has global reach and that the knowledge and experience resident
in current distributors can be used to build distributor leadership in new
markets. By entering into international sponsoring agreements with NSI,
distributors are authorized to sponsor new distributors in each country where
NSI or the Company has operations. These countries currently include the U.S.,
the United Kingdom, Puerto Rico, Canada, Taiwan, Hong Kong (including Macau),
Japan, South Korea, Thailand, Australia, New Zealand, Ireland, Germany, France,
the Netherlands, Belgium, Italy, Spain, Mexico and Guatemala. This allows
distributors to receive commissions at the same rate for sales in foreign
countries as for sales in their home country. This is a significant benefit to
distributors because they are not required to establish new distributorships or
requalify for higher levels of commissions within each new country in which they
begin to operate. Under the Global Compensation Plan, a distributor is paid
consolidated monthly commissions in the distributor's home country, in local
currency, for product sales in that distributor's global downline distributor
network. Current and future distributor lists have been licensed by NSI to the
Company, pursuant to Licensing and Sales Agreements.
The Global Compensation Plan allows an individual the opportunity to
develop a business, the success of which is based upon that individual's level
of commitment, time, enthusiasm, personal skills, contacts, and motivation. For
many, a distributorship is a very small business, in which products may be
purchased primarily for personal consumption and for resale to relatively few
customers. For others, a distributorship becomes a full-time occupation.
High Level of Distributor Incentives. Based upon its knowledge of network
marketing distributor compensation plans, the Company believes that the Global
Compensation Plan is among the most financially rewarding plans offered to
distributors by network marketing companies. There are two fundamental ways in
which distributors can earn money: (i) through retail markups, for which the
Company recommends a range from 43% to 60%; and (ii) through a series of
commissions on product sales, which can result in commissions to distributors
aggregating up to 58% of such product's wholesale price. On a global basis,
however, commissions have averaged 42% of revenue from commissionable sales over
the last seven years.
Each product carries a specified number of sales volume points. Commissions
are based on total personal and group sales volume points per month. Sales
volume points are essentially based upon a product's wholesale cost, net of any
point of sale taxes. As a distributor's retail business expands and as he or she
successfully sponsors other distributors into the business who in turn expand
their own businesses, he or she receives a higher percentage of commissions.
Once a distributor becomes an executive, the distributor can begin to take
full advantage of the benefits of commission payments on personal and group
sales volume. To achieve executive status, a distributor must submit a
qualifying letter of intent and achieve specified personal and group sales
volumes for a four-month period of time. To maintain executive status, a
distributor must generally also maintain specified personal and group sales
volumes each month. An executive's commissions increase substantially as
multiple downline distributors achieve executive status. In determining
commissions, the number of levels of downline distributors that can be included
in an executive's group increases as the number of executive distributorships
directly below the executive increases.
As of the dates indicated below, the Company had the following number of
executive distributors.
Total Number of Executive Distributors
As of December 31,
----------------------------------------
1992 1993 1994 1995 1996
Executive Distributors ----------------------------------------
Japan..................... -- 2,459 3,613 4,017 10,169
Taiwan.................... 551 1,170 2,093 3,014 5,098
South Korea............... -- -- -- -- 4,675
Hong Kong................. 164 275 377 519 541
----- ----- ----- ----- ------
Total.............. 715 3,904 6,083 7,550 20,483
===== ===== ===== ===== ======
On a monthly basis, the Company and NSI evaluate requests for exceptions to
the Global Compensation Plan. While the general policy is to discourage
exceptions, management believes that the flexibility to grant such exceptions is
critical in retaining distributor loyalty and dedication. In each market,
distributor services personnel evaluate each such instance and appropriate
recommendations are made to NSI.
Distributor Support. The Company is committed to providing a high level of
support services tailored to the needs of its distributors in each market. The
Company meets the needs and builds the loyalty of its distributors with
personalized distributor service, a support staff that assists distributors as
they build networks of downline distributors, and a liberal product return
policy. Because many distributors have only a limited number of hours each week
to concentrate on their Nu Skin business, management believes that maximizing a
distributor's efforts through effective support of each distributor has been and
will continue to be important to the success of the Company.
Through training meetings, annual conventions, distributor focus groups,
regular telephone conference calls and personal contacts with distributors, the
Company seeks to understand and satisfy the needs of each distributor. The
Company provides walk-in, telephonic and computerized product fulfillment and
tracking services that result in user-friendly, timely product distribution. In
addition, the Company is committed to evaluating new ideas in technology and
services, such as automatic product reordering, that the Company can provide to
distributors. The Company currently utilizes voicemail, teleconferencing and fax
services. Global Internet access (including Company and product information,
ordering abilities and group and personal sales volume inquiries) is anticipated
to be provided to distributors in the future. Each walk-in center maintains
meeting rooms which distributors may utilize in training and sponsoring
activities.
Rules Affecting Distributors. NSI's standard distributor agreement,
policies and procedures, and compensation plan contained in every starter and/or
introductory kit outline the scope of permissible distributor marketing
activities. The Company's distributor rules and guidelines are designed to
provide distributors with maximum flexibility and opportunity within the bounds
of governmental regulations regarding network marketing. Distributors are
independent contractors and are thus prohibited from representing themselves as
agents or employees of NSI or the Company. Distributors are obligated to present
the Company's products and business opportunity ethically and professionally.
Distributors agree that the presentation of the Company's business opportunity
must be consistent with, and limited to, the product claims and representations
made in literature distributed by the Company. No medical claims may be made
regarding the products, nor may distributors prescribe any particular product as
suitable for any specific ailment. Even though sponsoring activities can be
conducted in many countries, distributors are prohibited from conducting
marketing activities outside of countries in which NSI and the Company conduct
business and are not allowed to export products from one country to another.
Distributors must represent that the receipt of commissions is based on
substantial efforts. Exhibiting commission statements or checks is prohibited.
Sales aids such as videotapes, promotional clothing, pens, stationary and other
miscellaneous items must be produced or pre-approved by the Company or NSI.
Distributors may not use any form of media advertising to promote products.
Products may be promoted only by personal contact or by literature produced or
approved by the Company. Generic business opportunity advertisements (without
using either the Company or the NSI names) may be placed in accordance with
certain guidelines in some countries. NSI logos and names may not be permanently
displayed on physical premises. Distributors may not use NSI trademarks or other
intellectual property of NSI without NSI's consent.
Products may not be sold, and the business opportunity may not be promoted,
in traditional retail environments such as food markets, pharmacies and
drugstores. Nor may business be conducted at conventions, trade shows, flea
markets, swap meets, and similar events. Distributors who own or are employed by
a service-related business such as a doctor's office, hair salon, or health
club, may make products available to regular customers as long as products are
not displayed visibly to the general public in such a way as to attract the
general public into the establishment to purchase products.
Generally, distributors can receive commission bonuses only if, on a
monthly basis (i) the distributor achieves at least 100 points (approximately
U.S. $100) in personal sales volume, (ii) the distributor documents retail sales
to at least five retail customers, (iii) the distributor sells and/or consumes
at least 80% of personal sales volume, and (iv) the distributor is not in
default of any material policies or procedures.
NSI systematically reviews alleged reports of distributor misbehavior. If
NSI determines that a distributor has violated any of the distributor policies
or procedures, it may either terminate the distributor's rights completely or
impose sanctions such as warnings, probation, withdrawal or denial of an award,
suspension of privileges of a distributorship, fines or penalties, withholding
commissions until specified conditions are satisfied, or other appropriate
injunctive relief. Distributor terminations based on violations of NSI's
policies and procedures have aggregated less than 1% of the Company's
distributor force since inception. Distributors may voluntarily terminate their
distributorship at any time.
Payment. Distributors generally pay for products prior to shipment.
Accordingly, the Company carries no accounts receivable from distributors.
Distributors pay for products in one of several ways. Cash, which represents a
large portion of all payments, is received by order takers in the distribution
center when orders are personally picked up by a distributor. In addition, in
Japan cash is sent through the mail using a postal cash envelope. The Company
also accepts payment through the use of credit cards. This method of payment is
very popular in Hong Kong and Taiwan and is expected to increase in popularity
in South Korea. Another form of payment utilized in Japan is a Tososhin card,
which is essentially a distributor credit card utilized to place orders. Bank
wire transfers are also popular throughout Asia, particularly in Japan.
Product Summary
The Company offers products in two distinct categories: personal care
products, marketed under the trademark "Nu Skin," and nutritional products,
marketed under the trademark "Interior Design Nutritionals" (IDN). The Company
is entitled to distribute NSI products in specified Asian countries pursuant to
a Regional Distribution Agreement. NSI markets 89 different personal care and 36
different nutritional products, of which 81 and 17, respectively, were available
in the Company's current markets as of December 31, 1996. Nearly all products
sold by the Company are purchased from NSI, with the exception of a line of 11
personal care products which are produced locally in Japan. In addition to
products, the Company offers a variety of sales aids, including items such as
starter kits, introductory kits, brochures, product catalogs, videotape and
personal care accessories.
The following chart indicates how many of the NSI personal care and IDN
products available as of December 31, 1996, in each of the Company's current
markets.
Personal Care and IDN Product Offerings
Total Products Offered
Products
Offered Hong South
Product Categories/Product Lines by NSI Japan Taiwan Kong Korea
Personal Care:
Facial Care............................................ 20 10(1) 13 18 10
Body Care.............................................. 12 9 8 12 7
Hair Care.............................................. 14 13 13 13 12
Color Cosmetics........................................ 13 10 10 13 -
Specialty.............................................. 30 10 16 25 5
-- -- -- -- ---
Total........................................... 89 52 60 81 34
== == == == ==
IDN:
Nutritional Supplements................................ 14 4 2 1 -
Weight Management Products and Nutritious Snacks....... 10 1 3 4 -
Sports Nutrition....................................... 4 1 - - -
Botanicals............................................. 8 4 3 8 -
--- --- --- --- ---
Total........................................... 36 10 8 13 -
== == === == ===
- ---------------------------
(1) In Japan, the Company also sells 11 locally sourced facial care products.
Presented below are the dollar amount and percentage of revenue of each
of the two product categories and other sales aid revenue for the years ended
December 31, 1994, 1995 and 1996.
Revenue by Product Category
Year Ended Year Ended Year Ended
December 31, 1994 December 31, 1995 December 31, 1996
$ % $ % $ %
Product Category
Personal care................ $ 241,188 91.2% $ 303,387 84.6% $ 493,609 72.8%
Nutritional.................. 5,464 2.1 23,959 6.7 138,593 20.4
Sales aids................... 17,788 6.7 31,263 8.7 46,394 6.8
Total................ $ 264,440 100.0% $ 358,609 100.0% $ 678,596 100.0%
Personal Care Products
The Company's current personal care products category is divided into the
following lines: facial care, body care, hair care and color cosmetics, as well
as specialty products, such as sun protection, oral hygiene and fragrances. Each
of the Subsidiaries markets a variety of the 89 personal care products currently
offered by NSI. The Company also offers product sets that include a variety of
products in each product line as well as small, sample-size packages to
facilitate product sampling by potential consumers. The product sets are
especially popular during the opening phase of a new country, where distributors
and consumers are anxious to purchase a variety of products, and during holiday
and gift giving seasons in each market. The Company anticipates the introduction
of additional personal care products into each market, based on the likelihood
of the particular product's success in the market as well as applicable
regulatory approvals.
The personal care products offered in Taiwan and Hong Kong are
substantially the same formulations of the products offered by NSI in the U.S.
In Japan and South Korea, however, most of the products have been reformulated
to satisfy certain regulatory requirements with respect to product ingredients
and preservatives and to meet the preferences of Japanese and South Korean
consumers.
The following is a brief description of each line within the personal care
product category offered by the Company as of December 31, 1996:
Facial Care. The goal of the facial care line is to allow users to cleanse
thoroughly without causing dryness and to moisturize with effective humectants
that allow the skin to attract and retain vital water. The Company's facial care
line currently consists of 20 different products: Cleansing Lotion, Facial
Scrub, Exfoliant Scrub, Facial Cleansing Bar, Clay Pack, pH Balance Facial
Toner, NaPCA Moisturizer, Rejuvenating Cream, Celltrex (called Hylatrex in Japan
and South Korea), Intensive Eye Complex, HPX Hydrating Gel, Face Lift and
Activator (two formulas for sensitive and normal skin), Jungamals Lip Balm,
Clarifex Cleansing Scrub, Clarifex Mud, Alpha Extra Face, Nu Colour Eye Makeup
Remover, MHA Revitalizing Lotion, MHA Revitalizing Lotion with SPF 15 and
Interim MHA Diminishing Gel.
Body Care. The Company's line of body care products relies on premium
quality ingredients to cleanse and condition skin. The cleansers are uniquely
formulated without soap, and the moisturizers contain light but effective
humectants and emollients. The Company's body care line currently consists of 12
products: Antibacterial Body Cleansing Gel, Liquid Body Lufra, Body Smoother,
Hand Lotion, NaPCA Moisture Mist, Body Bar, Body Cleansing Gel, Enhancer,
Jungamals Crazy Crocodile Cleaner, Alpha Extra Body, MHA Revitalzing Body Lotion
and Dermatic Effects Body Contouring Lotion.
Hair Care. The Company's hair care line, HairFitness, is designed to meet
the needs of people with all types of hair and hair problems. Focusing on the
condition of the scalp and its impact on hair quality, the Company's hair care
products use water-soluble conditioners like panthenol to reduce build-up on the
scalp and to promote healthy hair. HairFitness includes 12 products featuring
ceregen, a revolutionary wheat hydrocolloid complex of conditioning molecules
that have been shown to have dramatic hair repair and moisture control aspects:
3 in 1 Shampoo, Moisturizing Shampoo, Balancing Shampoo, Vital Shampoo, Deep
Clarifying Shampoo, Glacial Therapy, Weightless Conditioner, Luxurious
Conditioner, Conditioning Detangler Spray, Styling Gel, Holding Spray and Mousse
(Styling Foam). The Company also carries Dermanator Shampoo and Jungamals Tiger
Tangle Tamer Shampoo.
Color Cosmetics. In the latter part of 1995, the Company introduced Nu
Colour, a new line of color cosmetics, in Hong Kong, Taiwan and Japan. The Nu
Colour line consists of 13 products with 106 SKU's including MoistureShade
Liquid Finish (10), MoistureShade Pressed Powder (8), Blush (9), Eye Shadow
(10), Mascara (2), Eyeliner (7), Lip Liner (11), Lipstick (32), DraMATTEics Lip
Pencils (6), Lip Gloss, Creme Concealer (5), Finishing Powder and Brow Pencil
(4).
Specialty Products. The Company recently introduced a product line labeled
Epoch, a unique line of ethnobotanical personal care products created in
cooperation with well known ethnobotanists. These products, which unite natural
compounds used by indigenous cultures with advanced scientific ingredients,
include Glacial Marine Mud, Deodorant with Citrisomes, Polishing Bar, LeafClean
Hand Wash, Everglide Foaming Shave Gel, Desert Breeze Aftershave, Post Shave
Lotion for Women, Infusions, Emulsions and Firewalker Foot Cream. Epoch was
launched in October of 1996 in Hong Kong and Taiwan and is currently expected to
be launched, subject to regulatory approval, in the spring of 1997 in Japan and
South Korea. Glacial Marine Mud is exclusively licensed to NSI for sale in the
direct selling channel.
Nutriol, a line of products exclusively licensed to NSI for sale in the
direct selling channel and manufactured in Europe, consists of five products:
Nutriol Hair Fitness Preparation, Nutriol Shampoo, Nutriol Mascara, Nutriol Nail
and Nutriol Eyelash. Nutriol represents a product designed to replenish the
hair's vital minerals and elements. Each Nutriol product uses
mucopolysaccharide, a patented ingredient.
The Company's line of Sunright products is designed to provide a variety of
sun screen protection with non-irritating and non-greasy products. The sun
protection line includes a sun preparation product that prepares the skin for
the drying impact of the sun, five sun screen alternatives with various levels
of SPF, and a sun screen lip balm. In the Asian market, the Company's sun care
line is currently available in Hong Kong and Japan. At present, Sunright Prime
Pre & Post Sun Moisturizer and Sunright Lip Balm are not available in Japan.
AP-24, a line of oral health care products which incorporates anti-plaque
technology designed to help prevent plaque build-up 24 hours a day, is
exclusively licensed to the Company, together with the associated trademark, for
sale in the direct selling channel under the trademark AP-24. This product line
includes AP-24 Anti-Plaque Toothpaste, AP-24 Anti-Plaque Mouthwash, AP-24 Triple
Action Dental Floss and AP-24 Anti-Plaque Breath Spray. These products are
currently available in Hong Kong and Taiwan. The Company currently intends to
launch this product line, subject to regulatory approval, in South Korea and
Japan in 1997. The AP-24 oral health care products for kids offers products
designed to make oral care fun for children, including Jungamal's Tough Tusk
Toothpaste and Jungamal's Fluffy Flamingo Floss.
The Company offers a men's and a women's fragrance under the Nu Skin
trademark Safiro. The Company also offers a Nail Care Kit.
Product Sets. The Company currently offers product sets that include a
sampling of products from a given product line. These package configurations are
intended to encourage increased product trials.
Interior Design Nutritionals
The IDN product category is comprised of 36 products in the following
lines: nutritional supplements, weight management products and nutritious
snacks, sports nutrition and botanicals. IDN is designed to promote healthy,
active lifestyles and general well-being through proper diet, exercise and
nutrition. Although less developed in the Asian market than the personal care
category, each of the Subsidiaries, except Nu Skin Korea, markets a variety of
the IDN products offered by NSI. In the United States, the IDN division is an
official licensee of the U.S. Olympic Committee.
The Company believes that the nutritional supplement market is expanding in
Asia because of changing dietary patterns, a health-conscious population and
recent reports supporting the benefits of using vitamin and mineral nutritional
supplements. This product line is particularly well suited to network marketing
because the average consumer is often uneducated regarding nutritional products.
The Company believes that network marketing is a more efficient method than
traditional retailing channels in educating consumers regarding the benefits of
nutritional products. Because of the numerous over-the-counter vitamin and
mineral supplements in Asia, the Company is confident that individual attention
and testimonials by distributors will provide information and comfort to a
potential consumer.
IDN products generally require reformulation to satisfy the strict
regulatory requirements of each Asian market. While each product's concept and
positioning are generally the same, regulatory differences between U.S. and
Asian markets result in some product ingredient differences. In addition, Asian
preferences and regulations favor tablets instead of gel caps, which are
typically used in the U.S.
The following is a brief description of each of the IDN product lines:
Nutritional Supplements. LifePak, the core IDN nutritional supplement, is
designed to provide an optimum mix of nutrients including vitamins, minerals,
antioxidants and phytonutrients (natural chemical extracts from plants). The
introduction of LifePak in Japan in October 1995 resulted in a significant
increase in revenue and currently represents approximately 22% of the Company's
revenue in Japan. LifePak was launched in Taiwan in October of 1996.
Additional nutritional supplements include: Vitox, which incorporates beta
carotene and other important vitamins for overall health; Metabotrim, which
provides B vitamins necessary to convert food to energy and chromium chelate
which has been shown to help in the body's normal metabolic process; Optimum
Omega, a pure source of omega 3 fatty acids aimed to assist cardiovascular
health; Image HNS, an all-around vitamin and antioxidant supplement; and Optigar
Q, a blend of co-enzyme Q10 and deodorized garlic. The IDN Masters Wellness
Supplement provides nutrition specifically for an aging generation. Jungamals
Children's Chewables combine natural flavors and colors and contain a unique
blend of antioxidants, chelated minerals, and vitamins specifically tailored for
children. NutriFi contains four grams of soluble and insoluble fibers per
serving in a powder that can be added to liquids and foods to supplement the
recommended daily amounts of fiber.
As an enhancement to the core IDN nutritional supplement, LifePak, NSI
recently introduced LifePak Women and LifePak Prime. These products address the
more specific nutritional needs of women and the aging generation. Also recently
launched by NSI was Life Essentials, a lower cost more general nutritional
supplement, and Nightime Complex with Melatonin, a sleep aid.
The Company also offers a number of nutritional drinks. Hot & Healthy,
unlike traditional hot drinks, is 100% caffeine-free and contains beneficial
ingredients such as Korean Panax Ginseng and grape seed extract. Splash C with
juice crystals is a healthy beverage providing significant doses of vitamins C
and E as well as calcium in each serving. Real fruit juice crystals are added to
create orange or lemon flavor.
Weight Management Products and Nutritious Snacks. As part of the Company's
mission to promote a healthy lifestyle and long-term wellness, IDN includes a
HealthTrim Lifestyle System (which includes LifePak Trim, Fiberry Fat-Free Snack
Bars and Appeal Lite, a nutritional drink containing chelated minerals and
vitamins), and instructional assessment materials with a counseling program. The
Company also offers Breakbars and Pocket Fuel, nutritious snacks which provide
carbohydrates, protein and fiber. FibreNet and Diene-O-Lean are two recent
additions to IDN's weight management system.
Sports Nutrition. To cater to health conscious individuals with active
lifestyles, the IDN Sports Nutrition System offers a comprehensive, flexible
program for individuals who desire to optimize performance on an individual
basis. The system includes LifePak, OverDrive, a sports supplement licensed by
the U.S. Olympic Committee that features antioxidants, B vitamins and chromium
chelate, GlycoBar energy bars, and SportaLyte performance drink to help supply
the necessary carbohydrates, electrolytes and chelated minerals to optimize
performance. AminoBuild is a low fat high protein drink mix that is designed to
replace nutrients before and after workouts.
Botanicals. Botanical supplements are designed for those who seek the
benefits of natural herb and plant extracts. These supplements include
Botanagar, Botanavox, Botanaflor, Botanazyme, BotanaEase, BotanaGuard,
Botanavive and Botaname. Each supplement addresses a range of issues, including:
alertness, digestive maintenance, dietary health support, regular sleep habits,
weight management and antioxidant support.
Sales Aids
The Company provides an assortment of sales aids to facilitate the sales of
its products. Sales aids include videotapes, promotional clothing, pens,
stationery, business cards, brushes, combs, cotton pads, tissues, and other
miscellaneous items to help create consumer awareness of the Company and its
products. Sales aids are priced at the Company's approximate cost and are not
commissionable items (i.e., distributors do not receive commissions on purchases
of sales aids).
Product Guarantees
The Company believes that it is among the most consumer protective
companies in the direct selling industry. For 30 days from the date of purchase,
the Company's product return policy allows a retail purchaser to return any
product to the distributor through whom the product was purchased for a full
refund. After 30 days from the date of purchase, the return privilege is in the
discretion of the distributor. Because distributors may return unused and
resalable products to the Company for a refund of 90% of the purchase price for
one year, they are encouraged to provide consumer refunds beyond 30 days. In
addition, the product return policy is a material aspect of the success of
distributors in developing a retail customer base. The Company's experience with
actual product returns to date has averaged approximately 2.0% of annual revenue
through 1996.
Product Development and Production
Product Development Philosophy. The Company is committed to building its
brand name and distributor and customer loyalty by selling premium quality,
innovative personal care and nutritional products that appeal to broad markets.
This commitment is illustrated by the Company's personal care products slogan
"All of the Good and None of the Bad" and its nutritional products slogan
"Adding Life to Years." The Company's product philosophy is to combine the best
of science and nature and to include in each of its products the highest quality
ingredients. For example, NSI avoids soaps and other harsh cleansers that can
dry and irritate skin, undesirable oils such as lanolin, elements known to be
irritating and pore clogging, volatile alcohols such as ethyl alcohol, and
conditioning agents that leave heavy residues. This philosophy has led to the
Company being one of the only personal care companies in Japan to disclose every
ingredient to consumers. This philosophy has also led to the Company's
commitment to avoid any ingredients in nutritional supplements that are reported
to have any long-term addictive or harmful effects, even if short-term effects
may be desirable. Independent distributors need to have confidence that they are
distributing the best products available in order to have a sense of pride in
their association with the Company and to have products that are distinguishable
from "off the shelf" products. NSI and the Company are committed to developing
and providing quality products that can be sold at an attractive retail price
and allow the Company to maintain reasonable profit margins.
NSI is also committed to constantly improving its evolving product
formulations to incorporate innovative and proven ingredients into its product
line. Whereas many consumer product companies develop a formula and stay with
that formula for years, and sometimes decades, NSI believes that it must stay
current with product and ingredient evolution to maintain its reputation for
innovation to retain distributor and consumer attention and enthusiasm. For this
reason, NSI continuously evaluates its entire line of products for possible
enhancements and improvements.
In addition, the Company believes that timely and strategic product
introductions are critical to maintaining the growth of independent distribution
channels. Distributors become enthusiastic about new products and are generally
excited to share new products with their customer base. An expanding product
line helps to attract new distributors and generate additional revenues.
NSI maintains a laboratory and a staff of approximately 90 individuals
involved in product development. NSI also relies on an advisory board comprised
of recognized authorities in various disciplines. In addition, NSI and the
Company evaluate a significant number of product ideas that are presented by
distributors and other outside sources. NSI believes that strategic
relationships with certain vendors also provide important access to innovative
product concepts. The Company will continue to develop products tailored to
appeal to the particular needs of the Company's markets.
Historically, one of the reasons for the success of the Company's personal
care product line has been its gender neutral positioning. This product
positioning substantially expands the size of the traditional skin and hair care
market. NSI's IDN line of products has historically been positioned to be age
neutral. However, with a substantial distributor and user base established, the
Company believes that it can further increase its market share in both the
personal care and the nutritional products categories by introducing age and
gender specific products, additional vitamin products targeted to seniors, and
personal care products targeted to either men or women.
Production. Virtually all the Company's products are sourced through NSI
and are produced by manufacturers unaffiliated with NSI. The Company currently
has little or no direct contact with these manufacturers. The Company's profit
margins and its ability to deliver its existing products on a timely basis are
dependent upon the ability of NSI's outside manufacturers to continue to supply
products in a timely and cost-efficient manner. Furthermore, the Company's
ability to enter new markets and sustain satisfactory levels of sales in each
market is dependent in part upon the ability of suitable outside manufacturers
to reformulate existing products, if necessary to comply with local regulations
or market environments, for introduction into such markets. Finally, the
development of additional new products in the future will likewise be dependent
in part on the services of suitable outside manufacturers.
The Company currently acquires products or ingredients from sole suppliers
or suppliers that are considered by the Company to be the superior suppliers of
such ingredients. The Company believes that, in the event it is unable to source
any products or ingredients from its current suppliers, the Company could
produce such products or replace such products or substitute ingredients without
great difficulty or prohibitive increases in the cost of goods sold. However,
there can be no assurance that the loss of such a supplier would not have a
material adverse effect on the Company's business and results of operations.
With respect to products purchased by the Company from NSI, NSI currently
relies on two unaffiliated manufacturers to produce approximately 70% and 80% of
its personal care and nutritional products, respectively. NSI has a written
contract with the primary supplier of the Company's personal care products that
expires at the end of 1997. An extension to such contract is currently being
negotiated. NSI does not currently have a written contract with the primary
supplier of the Company's nutritional products. The Company believes that in the
event that NSI's relationship with any of its key manufacturers is terminated,
NSI will be able to find suitable replacement manufacturers. However, there can
be no assurance that the loss of either manufacturer would not have a material
adverse effect on the Company's business and results of operations.
Relationship With NSI
As of March 3, 1997, approximately 98.4% of the combined voting power of
the outstanding shares of Common Stock was held by the shareholders of NSI. As a
result, when acting as stockholders of the Company, these shareholders of NSI
will consider the short-term and long-term impact of all stockholder decisions
on the consolidated financial results of NSI and the Company. In addition, the
Company has entered into distribution, trademark/tradename license, licensing
and sales, and management services agreements (the "Operating Agreements") with
NSI and with Nu Skin International Management Group, Inc. ("NSIMG"), a Delaware
corporation also controlled by the shareholders of NSI, summary descriptions of
which are set forth below. Such summaries are qualified in their entirety by
reference to the Operating Agreements, forms of which were filed as exhibits to
the Company's Registration Statement on Form S-1 (File No. 333-12073). In the
future the Company may enter into amendments to the Operating Agreements or
additional agreements with NSI or NSIMG. The Company intends to seek the
approval of a majority of its independent directors for any amendment to the
Operating Agreements and any new agreement which the Company believes to be of
material importance to the Company and as to which the Company and NSI or NSIMG
have conflicting interests. The Company is almost completely dependent on the
Operating Agreements to conduct its business, and in the event NSI is unable or
unwilling to perform its obligations under the Operating Agreements, or
terminates the Operating Agreements as provided therein, the Company's business
and results of operations will be adversely affected.
Distribution Agreements. The Company has entered into a regional
distribution agreement (the "Regional Distribution Agreement") with NSI, through
Nu Skin Hong Kong, pursuant to which NSI has granted to the Company the
exclusive right to sell and distribute NSI products and sales aids in the
Company's markets. Nu Skin Japan, Nu Skin Taiwan, Nu Skin Korea and Nu Skin
Thailand have each entered into wholesale distribution agreements (the
"Wholesale Distribution Agreements") with Nu Skin Hong Kong, pursuant to which
each such Subsidiary has been granted the right to sell and distribute NSI
products in its respective country.
The Company has the right to purchase any of NSI's products, subject to
unavailability due to local regulatory requirements. Purchases are made by
submission of a purchase order to NSI, which NSI must accept unless it has
insufficient inventory to fill the order. In determining whether it has
sufficient inventory to fill a given order, NSI is required to treat the Company
on a parity basis with its other affiliates.
The prices for products are governed by a price schedule which is subject
to change by NSI from time to time upon at least 30 days advance notice. NSI
pays ordinary freight and the Company pays handling, excise taxes and customs
duties on the products the Company orders. In order to assist NSI in planning
its inventory and pricing, the Company is required to provide NSI with certain
business plans and reports of its sales and prices to independent distributors.
The Company purchases virtually all of its products from NSI through Nu
Skin Hong Kong. Nu Skin Hong Kong pays for its purchases from NSI under the
Regional Distribution Agreement in U.S. dollars, while the other Subsidiaries
pay for their purchases from Nu Skin Hong Kong under the Wholesale Distribution
Agreements in their local currency. Nu Skin Hong Kong therefore bears
significant currency exchange risk as a result of purchases from NSI on behalf
of the other Subsidiaries.
The Company is responsible for paying for and obtaining government
approvals and registrations necessary for importation of NSI's products into its
markets. In addition, the Company is responsible for obtaining any government
approvals, including any filings and notifications, necessary for the
effectiveness of the Regional Distribution Agreement and the Wholesale
Distribution Agreements or for the parties performance thereunder.
NSI is generally responsible for paying for the research, development and
testing of the products sold to the Company, including any product
reformulations needed to comply with local regulatory requirements. NSI warrants
as to the merchantability of, and its title to, such products. NSI has further
indemnified the Company from losses and liability relating to claims arising out
of alleged or actual defects in the design, manufacture or content of its
products. NSI is required to maintain insurance covering claims arising from the
use of its products and to cause each Subsidiary to be a named insured on such
insurance policy. The Subsidiaries are also required to maintain insurance
policies covering the business to be conducted by them pursuant to the Regional
Distribution Agreement and the Wholesale Distribution Agreements.
The Company is prohibited from selling NSI products outside of the
countries for which it has an exclusive distribution license, except that the
Company may sell certain NSI products to NSI affiliates in Australia and New
Zealand. In addition, the Company is prohibited from selling products which
directly or indirectly compete with NSI products in any country without NSI's
prior consent, which consent will not be unreasonably withheld or delayed. The
Company may sell non-competing products without restriction.
The Company may manufacture products which do not compete with NSI products
without restriction but may not manufacture products which compete directly or
indirectly with NSI products without NSI's prior consent, which consent will not
be unreasonably withheld or delayed. Any products manufactured by the Company
carrying an NSI trademark will be subject to the Trademark/Tradename License
Agreements with NSI described below and will require the payment to NSI of
certain royalties as set forth therein. If NSI discontinues a product that the
Company would like to continue to sell, the Company may elect to manufacture the
product itself or through a third party manufacturer unless NSI has a competing
product. In this event, NSI has agreed to license the product formulation and
any associated trademarks and tradenames to the Company pursuant to the
Trademark/Tradename License Agreements described below.
When the Company determines to commence operations in Indonesia, Malaysia,
the Philippines, the PRC, Singapore or Vietnam, NSI has agreed under the
Regional Distribution Agreement to enter into new Trademark/Tradename License
Agreements and Licensing and Sales Agreements and to cause NSIMG to enter into
new Management Services Agreements, in each case substantially similar to those
described below, with the Company or subsidiaries operating in such countries.
Trademark/Tradename License Agreements. Pursuant to the Trademark/Tradename
License Agreements, NSI has granted to each Subsidiary an exclusive license to
use in its market the NSI and IDN trademarks, the individual product trademarks
used on NSI products and any NSI tradenames. Each of the Subsidiaries may thus
use the licensed trademarks and tradenames on products and commercial materials
not purchased from NSI, including locally sourced products and commercial
materials and products and commercial materials manufactured by such subsidiary
and may grant a sub-license, with the consent of NSI, for the licensed
trademarks and tradenames in its market. In addition, each Subsidiary has the
right to export such products and commercial materials into other Company
markets with NSI's consent, which consent shall not be unreasonably withheld or
delayed.
The Company pays a royalty to NSI for use of the licensed trademarks and
tradenames on products, starter and introductory kits and commercial materials
not purchased from NSI, including locally sourced products and commercial
materials and products and commercial materials manufactured by the Company. The
royalty is paid monthly and is equal to 5% of the Company's revenues from such
products and commercial materials for such month generally and a total of 8%
where NSI owns the formula or has exclusive rights in the subject market for
such products or commercial materials.
NSI has the right to inspect the premises where products using its
trademarks are manufactured in order to ensure that the products meet its
quality standards. The Company's labels, packaging, advertising and promotional
materials using NSI's trademarks must conform with NSI's published standards and
NSI has the right of prior approval. The Company is responsible for correcting
any manufacturing defects in locally sourced products or products it
manufactures that are brought to the Company's attention by NSI or otherwise.
NSI is responsible for securing and maintaining trademark registrations in
the territory covered by each Trademark/Tradename Agreement. NSI has agreed to
take such actions as the Company may reasonably request to protect its and the
Company's rights to the licensed trademarks from infringement and related claims
and has indemnified the Company from losses and liability resulting from such
claims.
Licensing and Sales Agreements. Currently, all distributor agreements are
entered into between the distributor and NSI rather than with the Company.
Therefore, the Company does not own the distributor lists or the distribution
system, the Global Compensation Plan, copyrights and related intangibles.
Consequently, each of the Subsidiaries has entered into a Licensing and Sales
Agreement with NSI which includes a license to the Company to use the
distributor lists, the Global Compensation Plan, know how, distributor system
and related intellectual property exclusively in its markets. The Company pays a
license fee to NSI of 4% of the Company's revenue from product sales (excluding
starter and introductory kits) to NSI distributors for the use of such licensed
property. The Company may not grant a sublicense for the licensed property.
The Company is required to use the Global Compensation Plan to distribute
any products, except as NSI may agree to modify the plan in accordance with
local requirements. The Company must comply with all policies implemented by NSI
under the Global Compensation Plan. This is necessary to ensure global
consistency in NSI's operations. The Company must also employ all NSI policies
relating to commissions payable to, and other relationships with, NSI
distributors.
The Company and the Subsidiaries are contractually obligated to pay a
distributor commission expense of 42% of commissionable product sales (with the
exception of South Korea where, due to government regulations, the Company
satisfies this obligation by using a formula based upon a maximum payout of 35%
of commissionable product sales). The Licensing and Sales Agreements provide
that the Company is to satisfy this obligation by paying commissions owed to
local distributors. In the event that these commissions exceed 42% of
commissionable product sales, the Company is entitled to receive the difference
from NSI. In the event that the commissions paid are lower than 42%, the Company
must pay the difference to NSI. Under this formulation, the Company's total
commission expense is fixed at 42% of commissionable product sales in each
country (except for South Korea). The 42% figure has been set on the basis of
NSI's experience over the past seven years which indicates that actual
commissions paid in a given year together with the cost of administering the
Global Compensation Plan average approximately 42% of commissionable product
sales for such year. In the event that actual commissions payable to
distributors from sales in the Company's markets vary from these historical
results, whether as a result of changes in distributor behavior or changes to
the Global Compensation Plan or in the event that NSI's cost of administering
the Global Compensation Plan increases or decreases, the Licensing and Sales
Agreements provide that the settlement of distributor commission expense between
the Company and NSI may be modified to more accurately reflect actual results.
In addition to payments to local distributors, the Company is generally
responsible for distributor support and relations within Japan, Taiwan, Hong
Kong, South Korea and Thailand. The Company has agreed to use its best efforts
to support the development of NSI's distributor network in its markets by
purchasing starter or introductory kits from NSI and selling them to potential
NSI distributors.
NSI has agreed to take such actions as the Company may reasonably request
to protect its and the Company's rights to the property licensed under the
Licensing and Sales Agreements from infringement and related claims and has
indemnified the Company from losses and liability resulting from such claims.
Both NSI and the Company are required to maintain insurance coverage adequate to
insure their assets and financial stability. NSI is responsible for ensuring
that the property licensed under the Licensing and Sales Agreements complies
with local laws and regulations, including direct selling laws.
Management Services Agreements. The Subsidiaries have entered into
Management Services Agreements with NSIMG, pursuant to which NSIMG has agreed to
provide a variety of management and support services to each Subsidiary. These
services include management, legal, financial, marketing and distributor
support/training, public relations, international expansion, human resources,
strategic planning, product development and operations administration services.
Most of NSI's senior management personnel and most employees who deal with
international issues are employees of NSIMG.
Generally, the management and support services are provided by employees of
NSI and NSIMG acting through NSIMG either (i) on a temporary basis in a specific
consulting role or (ii) on a full-time basis in a management position in the
country in which the services are required. The Management Services Agreements
do not cover the services of many of the Company's executive officers.
General Provisions. The Operating Agreements are each for a term ending on
December 31, 2016, and, after December 31, 2001, will be subject to
renegotiation in the event that members of the families of, or trusts or
foundations established by or for the benefit of the Original Stockholders on a
combined basis no longer beneficially own a majority of the combined voting
power of the outstanding shares of common stock of the Company or of NSI. Each
Operating Agreement is subject to termination by either party in the event of:
(i) a material breach by the other party which remains uncured for a period of
60 days after notice thereof; (ii) the bankruptcy or insolvency of the other
party; or (iii) entry of a judgment by a court of competent jurisdiction against
the other party in excess of $25,000,000. Each Operating Agreement to which NSI
is a party and each Operating Agreement to which NSIMG is a party is further
subject to termination by NSI or NSIMG, respectively, upon 30 days notice in the
event of a change of control of the Subsidiary party thereto and by such
Subsidiary upon 30 days notice in the event of a change of control of NSI or
NSIMG, respectively. Each Operating Agreement provides that neither party may
assign its rights thereunder without the consent of the other party. Each
Operating Agreement is governed by Utah law. Any dispute arising under an
Operating Agreement is to be settled by arbitration conducted in Utah in
accordance with the applicable rules of the American Arbitration Association, as
supplemented by the commercial arbitration procedures for international
commercial arbitration.
Mutual Indemnification Agreement. The Company and NSI have entered into a
mutual indemnification agreement pursuant to which NSI has agreed to indemnify
the Company for certain claims, losses and liabilities relating to the
operations of the Subsidiaries prior to the Reorganization and the Company has
agreed to indemnify NSI for certain claims, losses and liabilities relating to
the operations of the Subsidiaries after the Reorganization.
Competition
Personal Care and Nutritional Products. The markets for personal care and
nutritional products are large and intensely competitive. The Company competes
directly with companies that manufacture and market personal care and
nutritional products in each of the Company's product categories. The Company
competes with other companies in the personal care and nutritional products
industry by emphasizing the value and premium quality of the Company's products
and the convenience of the Company's distribution system. Many of the Company's
competitors have much greater name recognition and financial resources than the
Company. In addition, personal care and nutritional products can be purchased in
a wide variety of channels of distribution. While the Company believes that
consumers appreciate the convenience of ordering products from home through a
sales person or through a catalog, the buying habits of many consumers
accustomed to purchasing products through traditional retail channels are
difficult to change. The Company's product offerings in each product category
are also relatively small compared to the wide variety of products offered by
many other personal care and nutritional product companies. There can be no
assurance that the Company's business and results of operations will not be
affected materially by market conditions and competition in the future.
Network Marketing Companies. The Company also competes with other direct
selling organizations, some of which have a longer operating history and higher
visibility, name recognition and financial resources. The leading network
marketing company in the Company's markets is Amway Corporation and its
affiliates. The Company competes for new distributors on the basis of the Global
Compensation Plan and its premium quality products. Management envisions the
entry of many more direct selling organizations into the marketplace as this
channel of distribution expands over the next several years. The Company has
been advised that certain large, well-financed corporations are planning to
launch direct selling enterprises which will compete with the Company in certain
of its product lines. There can be no assurance that the Company will be able to
successfully meet the challenges posed by this increased competition.
Government Regulation
Direct Selling Activities. Direct selling activities are regulated by
various governmental agencies. These laws and regulations are generally intended
to prevent fraudulent or deceptive schemes, often referred to as "pyramid" or
"chain sales" schemes, that promise quick rewards for little or no effort,
require high entry costs, use high pressure recruiting methods and/or do not
involve legitimate products. In Japan, the Company's distribution system is
regulated under the "Door-to-Door" Sales Law, which requires the submission of
specific information concerning the Company's business and products and which
provides certain cancellation and cooling-off rights for consumers and new
distributors. In Taiwan, the Fair Trade Law (and the Enforcement Rules and
Supervisory Regulations of Multi-Level Sales) requires the Company to comply
with registration procedures and also provides distributors with certain rights
regarding cooling-off periods and product returns. The Company also complies
with South Korea's strict Door-to-Door Sales Act, which requires, among other
things, the regular reporting of revenue, the registration of distributors
together with the issuance of a registration card, and the maintaining of a
current distributor registry. This law also limits the amount of sponsoring
bonuses that a registered multi-level marketing company can pay to its
distributors to 35% of revenue in a given month. In Thailand, currently there
are no laws (other than general fair trade laws) directly regulating direct
selling or multi-level marketing activities.
Based on research conducted in opening its existing markets (including
assistance from local counsel), the nature and scope of inquiries from
government regulatory authorities and the Company and NSI's history of
operations in such markets to date, the Company and NSI believe that their
method of distribution is in compliance in all material respects with the laws
and regulations relating to direct selling activities of the countries in which
the Company and NSI currently operate. Even though management believes that laws
governing direct selling are generally becoming more permissive in certain Asian
countries, many countries, including Singapore, one of the Company's potential
markets, currently have laws in place that would prohibit the Company and NSI
from conducting business in such markets. There can be no assurance that the
Company will be allowed to conduct business in each of the new markets or
continue to conduct business in each of its existing markets licensed from NSI.
Regulation of Products and Marketing. The Company and NSI are subject to or
affected by extensive governmental regulations not specifically addressed to
network marketing. Such regulations govern, among other things, (i) product
formulation, labeling, packaging and importation, (ii) product claims and
advertising, whether made by the Company, NSI or NSI distributors, (iii) fair
trade and distributor practices, (iv) taxes, transfer pricing and similar
regulations that affect foreign taxable income and customs duties, and (v)
regulations governing foreign companies generally.
The Japanese Ministry of Health and Welfare ("MOHW") requires the Company
to possess an import business license and to register each personal care product
imported into the country. Packaging and labeling requirements are also
specified. The Company has had to reformulate many products to satisfy MOHW
regulations. In Japan, nutritional foods, drugs and quasi-drugs are all strictly
regulated. The chief concern involves the types of claims and representations
that can be made regarding the efficacy of nutritional products. The Company's
successful introduction of IDN products in Japan was achieved by utilizing the
combined efforts of NSI's technical staff as well as external consultants.
In Taiwan, all "medicated" cosmetic and pharmaceutical products require
registration. Non-medicated cosmetic products, such as shampoo and hair
conditioner, require no registration.
In Hong Kong, cosmetic products not classified as "drugs" nor as
"pharmaceutical products" are not subject to statutory registrations, packaging
and labeling requirements apart from the Trade Descriptions Ordinance. In Macau,
"pharmaceutical" products are strictly regulated; general products are not
subject to registration requirements.
In South Korea, the Company is subject to and has obtained the mandatory
certificate of confirmation as a qualified importer of cosmetics under the
Pharmaceutical Affairs Law as well as additional product approvals for each of
the 45 categories of cosmetic products which it imports. Each new cosmetic
product undergoes a 60-day post-customs inspection where, in addition to
compliance with ingredient requirements, each product is inspected for
compliance with South Korean labeling requirements.
In Thailand, personal care products are regulated by the Food and Drug
Association, and all of the initial NSI personal care products to be introduced
in Thailand have qualified for simplified registration procedures under Thai
law. Businesses which are more than 50% owned by non-citizens are not permitted
to operate unless they have an Alien Business Permit, which is frequently
difficult to obtain. The Company is currently operating under the Treaty of
Amity and Economic Relations between Thailand and the United States (the "Treaty
of Amity"). Under the Treaty of Amity, an Alien Business Permit is not required
if a Thailand business is owned by an entity organized in the United States, a
majority of whose owners are U.S. citizens or entities. From time to time, it
has been reported that certain Thailand government officials have considered
supporting the termination of the Treaty of Amity. The Company could face
particular difficulties in continuing operations in Thailand if the Treaty of
Amity were terminated and the Company were forced to obtain an Alien Business
Permit.
Regulation of Potential Markets. Each of the proposed new markets will
present additional unique difficulties and challenges. The PRC, for example, has
proven to be a particularly difficult market for foreign corporations due to its
extensive government regulation and the historical political tenants of the PRC
government. In order to enter the market in the PRC, the Company may be required
to create a joint venture enterprise with a Chinese entity and to establish a
local manufacturing presence, which will entail a significant investment on the
Company's part. The Company will likely have to apply for licenses on a province
by province basis and the repatriation of the Company's profits will be subject
to restrictions on currency conversion and the fluctuations of the government
controlled exchange rate. In addition, because distribution systems are greatly
fragmented, the Company may be forced to use business models significantly
different from those used by the Company in more developed countries. The lack
of a comprehensive legal system and the uncertain and sporadic enforcement of
existing legislation and laws could also have an adverse effect on the Company's
proposed business in the PRC.
The other potential new markets also present significant regulatory,
political and economic obstacles to the Company. In Singapore, for example,
network marketing is currently illegal and is not permitted under any
circumstances. Although the Company believes that this restriction will
eventually be relaxed or repealed, no assurance can be given that such
regulation will not remain in place and that the Company will not be permanently
prevented from initiating sales in Singapore. In addition, Malaysia has
governmental guidelines that have the effect of limiting foreign ownership of
direct selling companies operating in Malaysia to no more than 30%. There can be
no assurance that the Company will be able to properly structure Malaysian
operations to comply with this policy. In October of 1995, the Company's
business permit applications were denied by the Malaysian government as a result
of activities by certain NSI distributors. Therefore, the Company believes that
although significant opportunities exist to expand its operations into new
markets, there can be no assurance that these or other difficulties will not
prevent the Company from realizing the benefits of this opportunity.
Other Regulatory Issues. As a U.S. entity operating through subsidiaries in
foreign jurisdictions, the Company is subject to foreign exchange control and
transfer pricing laws that regulate the flow of funds between the Subsidiaries
and the Company as well as the flow of funds to NSI for product purchases,
management services, and contractual obligations such as the payment of
distributor commissions. In South Korea, in particular, the Company has come
under the scrutiny of regulators because of the manner in which the Company and
Nu Skin Korea implement the Global Compensation Plan. Pursuant to the Global
Compensation Plan, Nu Skin Korea currently pays commissions to distributors in
South Korea on both their local and foreign product sales. Similarly,
commissions on product sales in South Korea by other distributors are paid by
their local NSI affiliate. The Company believes that it operates in compliance
with all applicable foreign exchange control and transfer pricing laws. However,
there can be no assurance that the Company will continue to be found to be
operating in compliance with foreign exchange control and transfer pricing laws,
or that such laws will not be modified, which, as a result, may require changes
in the Company's operating procedures.
As is the case with most companies which operate in the Company's product
segment, NSI and the Company have from time to time received inquiries from
various government regulatory authorities regarding the nature of their
businesses and other issues such as compliance with local direct selling,
customs, taxation, foreign exchange control, securities and other laws. Although
to date none of these inquiries has resulted in a finding materially adverse to
the Company or NSI, adverse publicity resulting from inquiries into NSI's
operations by certain government agencies in the early 1990's, stemming in part
out of inappropriate product and earnings claims by distributors, materially
adversely affected NSI's business and results of operations. There can be no
assurance that the Company or NSI will not face similar inquiries in the future,
which, either as a result of findings adverse to the Company or NSI or as a
result of adverse publicity resulting from the instigation of such inquiries,
could have a material adverse effect on the Company's business and results of
operations.
The Subsidiaries are periodically subject to reviews and audits by various
governmental agencies, particularly in new markets, where the Company has
experienced high rates of growth. Currently, Nu Skin Korea is subject to an
audit by South Korean customs authorities, which may or may not lead to other
regulatory review. Management believes that this inquiry is the result of Nu
Skin Korea's rapid growth and the fact that it is now reportedly the largest
importer of cosmetics and personal care products in South Korea. Management
believes that other major importers of cosmetic products are also the focus of
regulatory reviews by South Korean authorities.
Based on the Company's and NSI's experience and research (including
assistance from counsel) and the nature and scope of inquiries from government
regulatory authorities, the Company and NSI believe that they are in material
compliance with all regulations applicable to them. Despite this belief, either
the Company or NSI could be found not to be in material compliance with existing
regulations as a result of, among other things, the considerable interpretative
and enforcement discretion given to regulators or misconduct by independent
distributors. In 1994, NSI and three of its distributors entered into a consent
decree with the Federal Trade Commission (the "FTC") with respect to its
investigation of certain product claims and distributor practices, pursuant to
which NSI paid approximately $1 million to settle the FTC investigation. NSI is
currently in discussions with the FTC regarding its compliance with such consent
decree and other product issues raised by the FTC. NSI recently voluntarily
agreed to recall and rewrite virtually all of its sales and marketing materials
to address FTC concerns. NSI has also offered a monetary settlement, which
proposal is currently under review by the FTC. Even though neither the Company
nor the Subsidiaries have encountered similar regulatory concerns, there can be
no assurances that the Company and the Subsidiary will not be subject to similar
inquiries and regulatory investigations or disputes and the effects of any
adverse publicity resulting therefrom. Any assertion or determination that
either the Company, NSI or any NSI distributors are not in compliance with
existing laws or regulations could have a material adverse effect on the
Company's business and results of operations. In addition, in any country or
jurisdiction, the adoption of new laws or regulations or changes in the
interpretation of existing laws or regulations could generate negative publicity
and/or have a material adverse effect on the Company's business and results of
operations. The Company cannot determine the effect, if any, that future
governmental regulations or administrative orders may have on the Company's
business and results of operations. Moreover, governmental regulations in
countries where the Company plans to commence or expand operations may prevent,
delay or limit market entry of certain products or require the reformulation of
such products. Regulatory action, whether or not it results in a final
determination adverse to the Company or NSI, has the potential to create
negative publicity, with detrimental effects on the motivation and recruitment
of distributors and, consequently, on the Company's sales and earnings.
Employees
As of December 31, 1996, the Company had approximately 900 full-time and
part-time employees. None of the employees is represented by a union or other
collective bargaining group. The Company believes its relationship with its
employees is good, and does not currently foresee a shortage in qualified
personnel needed to operate the business. Each Subsidiary is directed by an
experienced manager.
Certain Business Considerations and Risk Factors
There are certain significant risks facing the Company, many of which are
substantial in nature. Stockholders and prospective stockholders in the Company
should consider carefully the following risks and information in conjunction
with the other information contained herein.
The statements in this section that are not historical facts are
forward-looking statements. These forward-looking statements involve certain
risks and uncertainties. Actual results and outcomes may differ materially from
those discussed in this section. Factors that might cause such differences
include, but are not limited to, the risks and factors discussed below.
Reliance Upon Independent Distributors of NSI. The Company distributes its
products exclusively through independent distributors who have contracted
directly with NSI to become distributors. Consequently, the Company does not
contract directly with distributors but licenses its distribution system and
distributor force from NSI. Distributor agreements with NSI are voluntarily
terminable by distributors at any time. The Company's revenue is directly
dependent upon the efforts of these independent distributors, and any growth in
future sales volume will require an increase in the productivity of these
distributors and/or growth in the total number of distributors. As is typical in
the direct selling industry, there is turnover in distributors from year to
year, which requires the sponsoring and training of new distributors by existing
distributors to maintain or increase the overall distributor force and motivate
new and existing distributors. The Company experiences seasonal decreases in
distributor sponsoring and product sales in some of the countries in which the
Company operates because of local holidays and customary vacation periods. The
size of the distribution force can also be particularly impacted by general
economic and business conditions and a number of intangible factors such as
adverse publicity regarding the Company or NSI, or the public's perception of
the Company's products, product ingredients, NSI's distributors or direct
selling businesses in general. Historically, the Company has experienced
periodic fluctuations in the level of distributor sponsorship (as measured by
distributor applications). However, because of the number of factors that impact
the sponsoring of new distributors, and the fact that the Company has little or
no control over the level of sponsorship of new distributors, the Company cannot
predict the timing or degree of those fluctuations. There can be no assurance
that the number or productivity of the Company's distributors will be sustained
at current levels or increased in the future. In addition, the number of
distributors as a percent of the population in a given country or market could
theoretically reach levels that become difficult to exceed due to the finite
number of persons inclined to pursue a direct selling business opportunity. This
is of particular concern in Taiwan, where industry sources have estimated that
up to 10% of the population is already involved in some form of direct selling.
Since distributor agreements are entered into between NSI and distributors,
all of the distributors who generate revenue for the Company are distributors of
NSI. Because of this fact, the Company cannot control who becomes a distributor.
In addition, because distributors are independent contractors of NSI, neither
NSI nor the Company is in a position to provide the same level of direction,
motivation and oversight as either would with respect to its own employees.
Although NSI has a compliance department responsible for the enforcement of the
policies and procedures that govern distributor conduct, it can be difficult to
enforce these policies and procedures because of the large number of
distributors and their independent status, as well as the impact of certain
resale price maintenance and other regulations that limit the ability of NSI and
the Company to monitor and control the sales practices of distributors.
Potential Effects of Adverse Publicity. The size of the distribution force
and the results of the Company's operations can be particularly impacted by
adverse publicity regarding the Company or NSI, including publicity regarding
the legality of the Company's distribution system, the quality of the Company's
products and product ingredients, regulatory investigations of the Company and
its products, distributor actions and the public's perception of NSI's
distributors and direct selling businesses generally.
In 1991 and 1992, NSI was the subject of investigations by various
regulatory agencies of eight states. All of the investigations were concluded
satisfactorily. However, the publicity associated with the investigations
resulted in a material adverse impact on NSI's results of operations. The
Company has not been subject to investigations in Asia, however, the denial by
the Malaysian government in 1995 of the Company's business permits due to
distributor action resulted in adverse publicity for the Company. There can be
no assurance that the Company will not be subject to adverse publicity in the
future as a result of similar regulatory investigations, similar distributor
actions or other factors or that such adverse publicity will not have a material
adverse effect on the Company's business or results of operations.
Potential Negative Impact of Distributor Actions. Distributor actions can
negatively impact the Company and its products. For example, in October 1995,
the Company's business permit applications were denied by the Malaysian
government as the result of activities by certain NSI distributors before
required government approvals could be secured. NSI subsequently terminated the
distributorship rights of some of the distributors involved and elected to
withdraw from the Malaysian market for a period of time. The denial by the
Malaysian government of the Company's business permit application resulted in
adverse publicity for the Company. In South Korea, the Company is currently
undergoing a customs audit which was precipitated by the alleged illegal
importation by certain NSI distributors of NSI products not yet available for
sale in South Korea. Distributor activities in other countries in which the
Company has not commenced operations may similarly result in an inability to
secure, or delay in securing required regulatory and business permits. In
addition, the publicity resulting from such distributor activities and other
distributor activities such as inappropriate earnings claims and product
representations by distributors can make the sponsoring and retaining of
distributors more difficult, thereby negatively impacting sales. Furthermore,
the Company's business and results of operations could be adversely affected if
NSI terminates a significant number of distributors or certain distributors who
play a key role in the Company's distribution system. There can be no assurance
that these or other distributor actions will not have a material adverse effect
on the Company's business or results of operations.
Government Regulation of Direct Selling Activities. Direct selling
activities are regulated by various governmental agencies. These laws and
regulations are generally intended to prevent fraudulent or deceptive schemes,
often referred to as "pyramid" or "chain sales" schemes, that promise quick
rewards for little or no effort, require high entry costs, use high pressure
recruiting methods and/or do not involve legitimate products. In Japan, the
Company's distribution system is regulated under the "Door-to-Door" Sales Law,
which requires the submission of specific information concerning the Company's
business and products and which provides certain cancellation and cooling-off
rights for consumers and new distributors. Management has been advised by
counsel that in some respects Japanese laws are becoming more restrictive with
respect to direct selling in Japan. In Taiwan, the Fair Trade Law (and the
Enforcement Rules and Supervisory Regulations of Multi-Level Sales) requires the
Company to comply with registration procedures and also provides distributors
with certain rights regarding cooling-off periods and product returns. The
Company also complies with South Korea's strict Door-to-Door Sales Act, which
requires, among other things, the regular reporting of revenue, the registration
of distributors together with the issuance of a registration card, and the
maintaining of a current distributor registry. This law also limits the amount
of sponsoring bonuses that a registered multi-level marketing company can pay to
its distributors to 35% of revenue in a given month. In Thailand, currently
there are no laws (other than general fair trade laws) directly regulating
direct selling or multi-level marketing activities.
Based on research conducted in opening its existing markets (including
assistance from local counsel), the nature and scope of inquiries from
government regulatory authorities and the Company's history of operations in
such markets to date, the Company believes that its method of distribution is in
compliance in all material respects with the laws and regulations relating to
direct selling activities of the countries in which the Company and NSI
currently operates. Even though management believes that laws governing direct
selling are generally becoming more permissive in certain Asian countries, many
countries, including Singapore, one of the Company's potential markets,
currently have laws in place that would prohibit the Company and NSI from
conducting business in such markets. There can be no assurance that the Company
will be allowed to conduct business in each of the new markets or continue to
conduct business in each of its existing markets licensed from NSI.
Government Regulation of Products and Marketing. The Company and NSI are
subject to or affected by extensive governmental regulations not specifically
addressed to network marketing. Such regulations govern, among other things, (i)
product formulation, labeling, packaging and importation, (ii) product claims
and advertising, whether made by the Company, NSI or NSI distributors, (iii)
fair trade and distributor practices, (iv) taxes, transfer pricing and similar
regulations that affect foreign taxable income and customs duties, and (v)
regulations governing foreign companies generally.
The Japanese Ministry of Health and Welfare requires the Company to possess
an import business license and to register each personal care product imported
into the country. Packaging and labeling requirements are also specified. The
Company has had to reformulate many products to satisfy MOHW regulations. In
Japan, nutritional foods, drugs and quasi- drugs are all strictly regulated. The
chief concern involves the types of claims and representations that can be made
regarding the efficacy of nutritional products. In Taiwan, all "medicated"
cosmetic and pharmaceutical products require registration. In Hong Kong and
Macau, "pharmaceutical" products are strictly regulated. In South Korea, the
Company is subject to and has obtained the mandatory certificate of confirmation
as a qualified importer of cosmetics under the Pharmaceutical Affairs Law as
well as additional product approvals for each of the 45 categories of cosmetic
products which it imports. Each new cosmetic product undergoes a 60-day
post-customs inspection where, in addition to compliance with ingredient
requirements, each product is inspected for compliance with South Korean
labeling requirements. There can be no assurance that these or other applicable
regulations will not prevent the Company from introducing new products into its
markets or require the reformulation of existing products.
In Thailand, personal care products are regulated by the Food and Drug
Association, and all of the initial NSI personal care products to be introduced
in Thailand have qualified for simplified registration procedures under Thai
law. Businesses which are more than 50% owned by non-citizens are not permitted
to operate unless they have an Alien Business Permit, which is frequently
difficult to obtain. The Company is currently operating under the Treaty of
Amity and Economic Relations between Thailand and the United States. Under the
Treaty of Amity, an Alien Business Permit is not required if a Thailand business
is owned by an entity organized in the United States, a majority of whose owners
are U.S. citizens or entities. From time to time, it has been reported that
certain Thailand government officials have considered supporting the termination
of the Treaty of Amity. There can be no assurance that, if the Treaty of Amity
were terminated, the Company would be able to obtain an Alien Business Permit
and continue operations in Thailand.
Other Regulatory Issues. As a U.S. entity operating through subsidiaries in
foreign jurisdictions, the Company is subject to foreign exchange control and
transfer pricing laws that regulate the flow of funds between the Subsidiaries
and the Company, as well as the flow of funds to NSI for product purchases,
management services and contractual obligations such as payment of distributor
commissions. In South Korea, in particular, the Company has come under the
scrutiny of regulators because of the manner in which the Company and Nu Skin
Korea implement the Global Compensation Plan. Pursuant to the Global
Compensation Plan, Nu Skin Korea currently pays commissions to distributors in
South Korea on both their local and foreign product sales. Similarly,
commissions on product sales in South Korea by other distributors are paid by
their local NSI affiliate. The Company believes that it operates in compliance
with all applicable foreign exchange control and transfer pricing laws. However,
there can be no assurance that the Company will continue to be found to be
operating in compliance with foreign exchange control and transfer pricing laws,
or that such laws will not be modified, which, as a result, may require changes
in the Company's operating procedures.
As is the case with most network marketing companies, NSI and the Company
have from time to time received inquiries from various government regulatory
authorities regarding the nature of their business and other issues such as
compliance with local business opportunity and securities laws. Although to date
none of these inquiries has resulted in a finding materially adverse to the
Company or NSI, adverse publicity resulting from inquiries into NSI's operations
by certain government agencies in the early 1990's, stemming in part out of
inappropriate product and earnings claims by distributors, materially adversely
affected NSI's business and results of operations. There can be no assurance
that the Company or NSI will not face similar inquiries in the future which,
either as a result of findings adverse to the Company or NSI or as a result of
adverse publicity resulting from the instigation of such inquiries, could have a
material adverse effect on the Company's business and results of operations.
The Subsidiaries are periodically subject to reviews and audits by various
governmental agencies, particularly in new markets, where the Company has
experienced high rates of growth. Currently, Nu Skin Korea is subject to an
audit by South Korean customs authorities, which may or may not lead to other
regulatory review. Management believes that this inquiry is the result of Nu
Skin Korea's rapid growth and t