UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
| [X] | Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2002 or |
| [ ] | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. |
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NU SKIN ENTERPRISES, INC. (Exact name of registrant as specified in its charter) |
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Delaware (State or other jurisdiction of incorporation) |
001-12421 (Commission File No.) |
87-0565309 (IRS Employer Identification No.) |
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75 West Center Street Provo, UT 84601 (Address of principal executive offices, including zip code) Registrant's telephone number, including area code: (801) 345-6100 |
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class
Class A common stock, $.001 par value |
Name of Exchange on which registered New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
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 the 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. |X|
Indicate by check mark whether the Registrant is an accelerated file (as defined in Rule 12b-2 of the Act). Yes |X| No |_|
Based on the closing sales price of the Class A common stock on the New York Stock Exchange on June 28, 2002, the aggregate market value of the voting stock (Class A and Class B common stock) held by non-affiliates of the Registrant was approximately $727 million. For purposes of this calculation, voting stock held by executive officers, directors, and stockholders holding more than 10% of the voting stock has been excluded.
As of February 28, 2003, 36,389,350 shares of the Registrant’s Class A common stock, $.001 par value per share, and 44,467,854 shares of the Registrant’s Class B common stock, $.001 par value per share, were outstanding.
Documents incorporated by reference. Portions of the Registrant’s definitive Proxy Statement for the Registrant’s 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the Registrant’s fiscal year end are incorporated by reference in Part III of this report.
TABLE OF CONTENTS
| PART 1 | -1- |
| ITEM 1 | BUSINESS | -1- |
| General | -1- |
| Our Product Divisions | -1- |
| Nu Skin | -2- |
| Pharmanex | -3- |
| Big Planet | -5- |
| Sourcing and Production | -7- |
| Research and Development | -8- |
| Geographic Sales Region | -9- |
| Distribution | -11- |
| Competition | -15- |
| Intellectual Property | -16- |
| Government Regulations | -16- |
| Employees | -19- |
| Available Information | -19- |
| Risk Factors | -20- |
| ITEM 2 | PROPERTIES | -31- |
| ITEM 3 | LEGAL PROCEEDINGS | -32- |
| ITEM 4 | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | -32- |
| PART II | -33- |
| ITEM 5 | MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS | -33- |
| ITEM 6 | SELECTED FINANCIAL DATA | -35- |
| ITEM 7 | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | -37- |
| ITEM 7A | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | -51- |
| ITEM 8 | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | -51- |
| ITEM 9 | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | -72- |
| PART III | -72- |
| ITEM 14 | CONTROLS AND PROCEDURES | -72- |
| PART IV | -73- |
| ITEM 15 | EXHIBITS FINANCIAL STATEMENTS SCHEDULE AND REPORTS ON FORM 8-K | -73- |
| SIGNATURES |
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FORWARD LOOKING STATEMENTS
THIS ANNUAL REPORT ON FORM 10-K, IN PARTICULAR “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” AND “ITEM 1. BUSINESS,” INCLUDE “FORWARD-LOOKING STATEMENTS” WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE STATEMENTS REPRESENT OUR EXPECTATIONS OR BELIEFS CONCERNING, AMONG OTHER THINGS, FUTURE REVENUE, EARNINGS, GROWTH STRATEGIES AND OTHER FINANCIAL RESULTS, NEW PRODUCTS, FUTURE OPERATIONS AND OPERATING RESULTS, AND FUTURE BUSINESS AND MARKET OPPORTUNITIES. WE WISH TO CAUTION AND ADVISE READERS THAT THESE STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE EXPECTATIONS AND BELIEFS CONTAINED HEREIN. FOR A SUMMARY OF CERTAIN RISKS RELATED TO OUR BUSINESS, SEE “ITEM 1. BUSINESS – RISK FACTORS” BEGINNING ON PAGE 20.
In this Annual Report on Form 10-K, references to “dollars” and “$” are to United States dollars. Nu Skin, Pharmanex, “6S Quality Process” and Big Planet are our trademarks. The italicized product names used in this Annual Report on Form 10-K are product names and also, in certain cases, our trademarks.
PART I
ITEM 1. BUSINESS
General
Nu Skin Enterprises is a leading, global direct selling company. We develop and distribute premium-quality, innovative personal care products and nutritional supplements, which are sold worldwide under the Nu Skin and Pharmanex brands. Technology and distributor business services and a line of home care products are marketed under the Big Planet brand. We are one of the largest direct selling companies in the world with 2002 revenue of $964 million and a global network of approximately 566,000 active independent distributors. Approximately 28,000 of our active distributors have achieved executive distributor status under our Global Compensation Plan. Our executive distributors play an important leadership role in our distribution network and are critical to the growth and profitability of our business. We currently operate in more than 30 countries throughout Asia, the Americas and Europe.
We develop and market branded consumer products that we believe are well suited for direct selling. Our distributors market and sell our products by educating consumers about the benefits and distinguishing characteristics of our products and by providing personalized customer service. Through dedicated research and development, we continually develop and introduce new products and enhance our existing line of products to provide our distributors with a differentiated portfolio of premium products. We are able to attract and motivate high-caliber independent distributors because of our focus on developing innovative products, our attractive global compensation system and our advanced technological distributor support.
Our Product Divisions
We have three product divisions: Nu Skin, which offers personal care products; Pharmanex, which offers nutritional products; and Big Planet, which offers distributor related business services and
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home care products, which currently include an environmentally-friendly line of cleaning products and a water filtration system.
Presented below are the U.S. dollar amounts and percentages of revenue from the sale of Nu Skin, Pharmanex and Big Planet products and services for each of the years ended December 31, 2000, 2001, and 2002. This table should be read together with the information presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which discusses the costs associated with generating the aggregate revenue presented:
Revenue by Product Category
(in millions)(1)
| Year Ended December 31, 2000 |
Year Ended December 31, 2001 |
Year Ended December 31, 2002 |
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|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Product Category |
$ |
% |
$ |
% |
$ |
% | |||||||
| Nu Skin | 441.7 | 50.2 | 423.7 | 47.8 | 470.6 | 48.8 | |||||||
| Pharmanex | 383.8 | 43.6 | 396.3 | 44.8 | 439.0 | 45.5 | |||||||
| Big Planet | 54.3 | 6.2 | 65.6 | 7.4 | 54.5 | 5.7 | |||||||
| Total | 879.8 | 100.0 | 885.6 | 100.0 | 964.1 | 100.0 | |||||||
| (1) | In 2002, over 85% of our sales were transacted in foreign currencies that are converted to U.S. dollars for financial reporting purposes at weighted average exchange rates. Foreign currency fluctuations negatively impacted reported revenue by 1% in 2002 compared to 2001, and 9% in 2001 compared to 2000. |
Nu Skin. Nu Skin is our original product line and offers over 100 premium-quality personal care products in the areas of daily skin care, advanced skin treatments, ethnobotanical personal care and other advanced products.
Our strategy is to leverage our network marketing distribution model to establish Nu Skin as an innovative leader in the personal care market. We are committed to continuously improving and evolving our product formulations to incorporate innovative and proven ingredients while excluding those that we believe are detrimental to consumers. For example, we recently introduced Clear Action Acne Treatment System to treat the full spectrum of cosmetic effects that breakouts can have on the skin. Other examples include our Perennial Intense Body Moisturizer, a rich lotion that helps skin retain moisture as it faces the adverse effects of harsh cold or dry climates, and Epoch Baby, an “ethnobotanical” line of baby products based on the traditional use of plants by indigenous cultures. Our educated distributor force provides consumers with detailed information and instruction about our Nu Skin products and guidelines for using the products most effectively, thereby enabling us to bring more sophisticated ideas and technologies to market.
Nu Skin offers products individually and in comprehensive product sets that include a variety of products in each product line. The following table summarizes the current Nu Skin product line by category. Revenue percentages in the table are for the year ended December 31, 2002:
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| Category |
Description |
Selected Products | |||
|---|---|---|---|---|---|
|
Daily Skin Care 44% of Nu Skin division revenue |
Our premier line of daily skin care products consists of cleansers, toners and moisturizers, Nutricentals products fortified with topically applied nutrients uniquely position this line. | Night Supply Nourishing Cream NaPCA Moisturizer Enhancer Celltrex Ultra Perennial Intense Body Moisturizer |
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| Advanced Skin Treatments
21% of Nu Skin division revenue | Our advanced skin treatments are formulated to help prevent and reverse the signs of aging and environmental stress as well as treat breakouts on the skin. | Nu Skin 180º Anti-Aging Skin Therapy Tru-Face Line Corrector Galvanic Spa System Clear Action Acne Treatment System | |||
| Ethnobotanicals
7% of Nu Skin division revenue | Our Epoch line is distinguished by the inclusion of ingredients used by indigenous cultures. In addition, we contribute a percentage of our proceeds from Epoch sales to charitable causes. | Epoch Baby Glacial Marine Mud Ava Puhi Moni Shampoo Ice Dancer Leg Gel Fire Walker Foot Cream | |||
| Other — Advanced Products
28% of Nu Skin division revenue | Our personal care portfolio also includes daily use products such as hair care and color cosmetics. | DailyKind Mild Shampoo FreeFall Detangling Spray Nutriol Hair Fitness Prep Sunright Lip Balm Nu Colour Skin Beneficial Tinted Moisturizer | |||
Pharmanex. We currently offer approximately 50 Pharmanex nutritional products. We are committed to providing our customers with high-quality, standardized and scientifically substantiated nutritional supplements. Pharmanex nutritional supplements include our flagship LifePak line of micronutrient and phytonutrient supplements, which we currently sell in all of our major markets. LifePak sales accounted for 19.7% of our total revenue and 43.2% of Pharmanex revenue in 2002. We also offer a line of targeted Pharmanex nutritional supplements, weight management products and other specialty products. We design Pharmanex nutritional products to promote healthy, active lifestyles and general well-being when used in conjunction with proper diet and exercise.
We believe that direct selling is a more effective method of marketing high-quality nutritional supplements than traditional retailing channels because our distributors are able to educate consumers about the benefits of our nutritional supplements and to differentiate the quality and benefits of our products from those offered by competitors. Our strategy is to further expand our nutritional supplement business by continuing to introduce new, innovative products based on extensive research and development. To further extend our research capability, we have recently completed the build-out of a
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research center in Shanghai, China. This approximately 12,000 square foot facility will house Pharmanex research scientists and is one of three research and development centers (Shanghai, Beijing, and Provo) in the Pharmanex division. Our product development efforts are focused in the area of anti-aging and other health issues related to nutrition. We avoid the use of stimulants, such as ephedra related products, and anabolic steroids (and precursors) in our products. Any ingredients that are proven conclusively to have any long-term addictive or harmful effects are not considered for product development, even if the short-term effects may be desirable.
We are continuously looking for ways to help our distributors market our products more effectively. In 2002, we completed the acquisition of a company with exclusive rights to a patented laser-based scanning tool that can measure the level of carotenoids (a powerful antioxidant). We believe we are the first nutritional company to make available a non-invasive tool that will measure the level of tissue antioxidant carotenoids after regular nutritional supplementation. We made a limited number of these scanners available to our top distributors in the United States in February 2003, and anticipate making more of them available to other distributors during 2003 as we complete our development of a final production model. We currently plan to lease the scanners to our distributors at a monthly lease rate of $199 per month. We are currently evaluating the scanner for potential introduction in international markets in 2004, subject to favorable results in the U.S. and compliance with applicable regulations in foreign markets.
We use our “6S Quality Process” to standardize our nutritional supplements and provide a consistent level of the desired active compounds in our products. We believe that this 6S Quality Process enhances our ability to provide consumers with safe, effective and consistent products. The 6S Quality Process generally involves the following steps:
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Selection. Conducting a scientific review of research and databases in connection with the selection of potential products and ingredients, and determining the authenticity, usefulness and safety standards for potential products and ingredients. |
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Sourcing. Investigating potential sources, evaluating the quality of sources and performing botanical and chemical evaluations where appropriate. |
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Structure. Determining the structural profile of natural compounds and active ingredients. |
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Standardization. Standardizing the product dosage of its biologically relevant active ingredients. |
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Safety. Assessing safety from available research and, where necessary, performing additional tests such as microbial tests and chemical analyses for toxins and heavy metals. |
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Substantiation. Reviewing documented pre-clinical and clinical trials and, where necessary and appropriate, initiating studies and clinical trials sponsored by Pharmanex. |
Following our acquisition of First Harvest International, LLC, Pharmanex began selling a Vitameal dehydrated food product. Vitameals are a highly nutritious food product used for emergency food supply. We also provide a convenient way for distributors to donate Vitameal products they purchase from us to relief organizations for use in humanitarian relief. This initiative is maintained under the Nourish the Children trademark.
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The following table summarizes the current Pharmanex product lines by category. Revenue percentages in the table are for the year ended December 31, 2002:
| Category |
Description |
Selected Products | |||
|---|---|---|---|---|---|
| Micronutrient Supplements
43% of Pharmanex division revenue |
Our LifePak family of daily supplements is designed to provide a beneficial mix of nutrients including vitamins, minerals and antioxidants. |
LifePak LifePakWomen LifePakPrime LifePakTrim LifePakTeen |
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Targeted Nutritional Solutions 35% of Pharmanex division revenue | Our self-care dietary supplements contain consistent levels of botanical ingredients that are designed to provide consumers with targeted wellness benefits. |
ReishiMax Cortitrol Cholestin CordyMaxCs-4 TeGreen97 BioGingko27/7 ImmuneFormula | |||
| Weight Management
13% of Pharmanex division revenue |
Our Body Design line of weight-management products was created to capitalize on the sports fitness market as well as to create a presence in the growing weight management category. | Overdrive FibreNet CraveEase Body Design meal replacement products |
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| Other — Specialty Products
9% of Pharmanex division revenue | Our portfolio of other nutritional products includes healthy drinks and other specialty wellness products. | SplashC Appeal AloeDrink | |||
Big Planet. Big Planet technology products are designed to allow our distributors and their customers to “power their businesses” with products that generate commissionable distributor sales volume. These products include individual, personalized distributor websites that grant customers easy and convenient access to information about our products and services. We host these websites for our distributors and provide content with relevant product and business information. Distributors also have the ability to configure their individual websites to customize their marketing efforts and to conduct e-commerce activities across our product lines, by seamlessly integrating their sites and online ordering capabilities with our websites and back-end fulfillment systems. Online orders placed by a customer are credited to the appropriate distributor and are automatically routed through our electronic ordering system, and products are shipped by us directly to the customer. We believe this web-based approach greatly simplifies and enhances the ordering experience for our distributors and their customers while at the same time helping to reduce our overall operating costs. Other Big Planet products designed to enhance distributor activity include online business tools, which help our distributors to monitor their sales activity, as well as set up meetings, communicate with their sales organizations and conduct electronic-based marketing efforts.
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Other Big Planet technology products and services designed to generate commissionable sales for distributors include our Internet access and website hosting, domestic and international long distance telecommunications services, and personal 800 numbers. Our Internet services include web hosting and Internet access offered to our customers in the United States through more than 3,000 local dial-up access sites. In Japan and Taiwan, we offer Internet access through third-party Internet service providers who co-brand their services with Big Planet. We also offer an affiliate online shopping website called the Big Planet Mall (www.bpmall.com).
We believe our Big Planet “power your business” products help to attract a new, more technologically sophisticated demographic of distributors to our business. We believe that a significant number of these individuals are people who would not ordinarily be attracted to a more conventional direct sales business. Our experience indicates that upon joining our business, many distributors attracted by our Big Planet products and services will also begin to purchase and distribute our Nu Skin and Pharmanex products, which offer comparatively high levels of commissionable sales volume. In this way, we believe Big Planet helps to drive revenue for our other product lines.
Our strategy for Big Planet has been to expand the Big Planet product mix to include higher margin products and improve margins on its key technology products. For example, Big Planet recently entered the home-care market and will continue to develop and offer products in this segment going forward. Products in this segment will include environmentally-friendly cleaning products and air and water filtration systems. As of January 1, 2003, Big Planet, under the Ecosphere brand, will take responsibility for the Pharmanex water filtration product. Water and air filtration are future development categories for Big Planet under the Ecosphere brand.
Since 2000, we have incubated a small professional employer organization that provides small to mid-sized businesses with outsourced payroll administration, benefits administration, risk management and human resources services. We do not plan to market the professional employer organization service through our distributors or actively expand this business in the foreseeable future.
The following table summarizes the current Big Planet product lines by category. Revenue percentages in the table are for the year ended December 31, 2002:
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| Category |
Description |
Selected Products | |||
|---|---|---|---|---|---|
| Internet Services
42% of Big Planet division revenue |
Our Internet service products include dial-up Internet access, web hosting and other Internet tools and services. | Business Center (U.S.) Personal Website (Japan) Global Web Page (other) ISP for US - by Qwest ISP for Japan - by Nifty |
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| Telecommunications
16% of Big Planet division revenue | We offer competitively-priced telecommunications services and enhanced telecommunication services. | Simplify Home Simplify One Qwest | |||
| Home Care
2% of Big Planet division revenue | Our current home care offering includes such products as laundry detergent, all purpose and glass and mirror cleaners. | Ecosphere Laundry Ecosphere Dish Ecosphere Surface Ecosphere Glass & Mirror | |||
| Professional Employer Organization (PEO)
40% of Big Planet division revenue | Our professional employer organization provides small to mid-sized businesses with outsourced payroll administration, benefits administration, risk management and human resources services. | PEO | |||
Sourcing and Production
Nu Skin. In order to maintain high product quality, we acquire our ingredients and products from suppliers that we believe are reliable, reputable and provide us with ingredients and products we believe to be of high quality. For approximately ten years, we have acquired ingredients and products from one unaffiliated supplier that currently manufactures approximately 45% of our Nu Skin personal care products. Our contract with our major supplier is for a one-year term that automatically renews for an additional one-year term unless either party terminates the contract. We maintain a good relationship with our supplier and do not anticipate that either party will terminate the contract in the near term. We also have ongoing relationships with secondary and tertiary suppliers who supply almost all of our remaining products and ingredients. We believe that, in the event we are unable to source any products or ingredients from our major supplier, we could produce or replace those products or substitute ingredients from our secondary and tertiary suppliers without great difficulty or significant increases in our cost of goods sold.
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Due to Chinese government restrictions on the importation of products, we established our own manufacturing facility in Shanghai, China in 2001. At this facility, we currently manufacture our personal care products sold through our retail stores in China. A small portion of the output from this facility is exported to our other markets.
Pharmanex. Substantially all of our Pharmanex nutritional supplements and ingredients, including LifePak, are produced or provided by third-party suppliers that we consider to be among the best suppliers of these products and ingredients. We currently rely on two unaffiliated suppliers, one of which supplies 41% and the other of which supplies 26% of our Pharmanex nutritional supplements. We believe that, in the event we were unable to source any products or ingredients from these suppliers or our other current suppliers, we could produce or replace these products or substitute ingredients without great difficulty or significant increases in our cost of goods sold. We also maintain an extraction and processing facility located in Zhejiang Province, China, where we currently produce the extracts for our TeGreen 97 and ReishiMax products.
To help ensure the quality of Pharmanex products, we have implemented an extensive quality control process designed to maintain tight quality controls through all stages of development, including the sourcing of raw materials and the manufacturing and packaging of our products. During investigations of potential sources of botanical raw materials, we conduct analyses of samples from each potential source. Suppliers are chosen based on the quality and concentration level of the active ingredients present in the source. We also maintain close working relationships with the manufacturers of our products and their quality control departments to implement quality assurance programs that meet our requirements. We regularly check and monitor their compliance with these programs. Our selection and retention of manufacturers is driven by their ability to meet our strict quality control criteria.
Big Planet. Other than web hosting, email, online distributor tools and Big Planet Mall, nearly all of the Big Planet services and products we offer are currently contracted or sourced from unaffiliated third-parties pursuant to contractual arrangements. For example, we have contracted with Qwest Communications to provide long distance telephone and Internet access services. By acting as a reseller of these services, we are able to avoid the large capital deployment and investment that would be required to build the infrastructure necessary to provide these services. However, our profit margins and ability to deliver quality services at competitive prices depend upon our ability to negotiate and maintain favorable terms with our third-party providers. Distributors receive commissions based on our gross margin on each sale of Big Planet products or services, including monthly recurring service charges, or based on the commission received by us with respect to products sold directly by third-party vendors to our distributors and customers. In addition to the online business tools we have developed internally, we source complementary tools from third-party vendors to enhance our suite of distributor tools. We also source and manufacture our home-care products through various third-party vendors.
Research and Development
We continually invest in our research and development capabilities. Our research and development expenditures were approximately $9 million in 2000 and were approximately $7 million in each of 2001 and 2002. The majority of our recent research and development activity has been directed towards our Pharmanex products. Much of our Pharmanex research to date has been conducted in China, where we benefit from a very low cost labor pool that enables us to conduct research and clinical trials at a much lower cost than we would incur in the United States. We recently opened a laboratory adjacent to our office complex in Provo, Utah, which houses both Pharmanex and Nu Skin research facilities and technical personnel. Because of our commitment to product innovation, we will continue to commit significant resources to research and development in the future. Research and development costs are expensed as incurred.
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We believe that we are one of the few nutritional supplement companies in the United States that has a research and development program modeled after the pharmaceutical industry. We believe that this research and development capability provides us with an important competitive advantage in the industry. We employ approximately 75 scientists at our dedicated research and development centers in Shanghai, China and Beijing, China and at our Provo, Utah offices. We also have working relationships with other independent scientists including an advisory board comprised of recognized authorities in various related disciplines. In addition, we evaluate a significant number of product ideas presented to us by outside sources.
We have established collaborative arrangements with two prominent universities and research institutions in China: Shanghai Medical University and Beijing Medical University. The staffs of these institutions include scientists with expertise in natural product chemistry, biochemistry, pharmacology and clinical studies. Our research and development center in Shanghai coordinates and validates our collaborative efforts with these institutions. We also occasionally collaborate with other major universities in the United States and other countries. Some of the university research centers that we have worked with include UCLA, the Rippe Center for Clinical Lifestyle Research, Columbia University, the University of Kansas, the University of Hong Kong School of Medicine and Taiwan Academia Sinica.
For product development support in our Nu Skin personal care line, we have established an aggressive licensing strategy and rely on an advisory board comprised of recognized authorities in various disciplines as well as an in-house staff of research and marketing professionals. We also have entered into an agreement with the Stanford University Medical Center for directed research and clinical trials of Nu Skin products and materials. These activities are conducted at the Nu Skin Center for Dermatological Research at Stanford University's School of Medicine. This center focuses on scientific investigation, dermatology research, product development and clinical trials. We believe our strategic alliances provide important access to innovative product concepts. We recently entered into a development agreement with Cosmix Molecular Biologicals GmbH, a pharmaceutical research group in Germany, to strengthen our ingredient portfolio in key cosmetic categories.
Geographic Sales Regions
For information on revenue for each of the geographic regions in which we operated for the years ended December 31, 2000, 2001, and 2002, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 17 to our consolidated financial statements.
North Asia. The North Asia region currently consists of our markets in Japan and South Korea. Japan is our largest market with revenue of approximately $530 million in 2002. According to the World Federation of Direct Selling Associations, the direct selling channel in Japan generated sales of approximately $22.8 billion of goods and services in 2000, making Japan the second largest direct selling market in the world. Despite our revenue growth in Japan, the overall size of the direct selling channel in Japan has been negatively impacted over the last several years by economic conditions. Substantially all of our Nu Skin personal care products and a majority of our Pharmanex nutritional supplements, including LifePak, our leading multi-vitamin and mineral supplement, are available in the Japanese market. We have introduced a number of our Big Planet technology products and services into Japan including Internet service offered through a third-party provider, personalized websites, computers and online business tools. According to the World Federation of Direct Selling Associations, the direct selling channel in South Korea generated sales of approximately $2.9 billion of goods and services in 2001. Our revenue in this market was approximately $64 million in 2002. We currently offer the majority of our Nu Skin personal care products and approximately one-half of our Pharmanex nutritional supplements in South Korea.
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Southeast Asia. Our Southeast Asia region currently consists of the markets in Taiwan, Hong Kong, Singapore, Thailand, the Philippines, New Zealand, Australia, Malaysia and our retail operation in China. Taiwan is the largest market in this region with revenue of approximately $79 million in 2002. Nu Skin Taiwan is one of the largest direct selling companies in Taiwan. According to the World Federation of Direct Selling Associations, the direct selling channel in Taiwan generated approximately $1.2 billion in sales of goods and services in 2000, and approximately three million people (over 10% of Taiwan's population), are estimated to participate in direct selling. We offer most of our Nu Skin personal care products and approximately one-half of our Pharmanex nutritional products, including LifePak, in Taiwan. We currently offer Big Planet branded Internet service in Taiwan through a third-party provider and a limited number of our other Big Planet products.
In December 2000, we commenced operations in Singapore. We offer Nu Skin products and a limited number of Pharmanex products, including LifePak, in this market. In addition, we expanded operations into Malaysia in November 2001. Because Malaysian law requires our Malaysian affiliate to be 70% locally-owned, we have entered into a shareholders' agreement with local partners that allows us to manage the day-to-day operations of the local affiliate, with veto control over all major decisions. In addition, we have entered licensing and distribution agreements with the local affiliate pursuant to which we sell products and receive license fees based on total sales to distributors in this market. The opening of Singapore and Malaysia has contributed significantly to our growth in Southeast Asia. In 2002, revenue from Singapore and Malaysia was approximately $64 million.
A significant component of our growth strategy is to continue to enter into and expand new markets, particularly China. China has restrictions that prevent us from operating our direct sales business model in China. Therefore, we have adopted a retail sales model to expand our operations in China in which an employed sales force sells products through fixed retail locations. We rely on this employed sales force to market and sell products at the various fixed retail locations supported by modest advertising and promotional efforts.
In January 2003, we significantly increased the number of retail locations we operate to 100 stores. In addition, we introduced our Nu Skin-branded products to the market. Our retail model in China is largely based upon our ability to attract customers to our retail stores, to educate them about our products, and to obtain repeat purchases from these customers. All product sales are transacted within our retail stores. Our employed sales force earns base pay and related benefits, as well as a commission based upon their personal sales efforts. While our distributor leaders from other markets are able to introduce customers and sales people to our stores, their promotional efforts are significantly limited due to the restrictions on direct selling in this market.
As a result of its admission to the World Trade Organization, China has agreed to establish regulations regarding sales away from fixed retail locations by December 2004. If we view these new regulations to be an enhancement to our retail business model, we may revise our business model in China to alter our remuneration plan for our employed sales force, incorporate the use of a non-employee sales force and/or limit our reliance on retail stores. Subject to appropriate changes in direct selling laws, we believe that China could become one of the largest direct selling markets in the world over the next five to seven years. Our operations in China are subject to a complex political and regulatory environment and we have been subject to significant regulatory scrutiny since expanding our operations in January 2003. See "Government Regulation" for more information on these regulatory issues.
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North America. The North America region consists of our markets in the United States and Canada. According to the World Federation of Direct Selling Associations, the direct selling channel in the United States generated sales of approximately $26.7 billion of goods and services in 2001, making the United States the largest direct selling market in the world. In 2002, we generated approximately $137 million in revenue in the United States. Substantially all of our Nu Skin personal care products, our Pharmanex nutritional supplements and our Big Planet products and services are available in the United States. As of December 31, 2002, we had 2,176 executive distributors in the United States, which accounted for 81% of the total executive distributors within North America. Our strategy for the United States market is to focus on initiatives centered around Pharmanex and Nu Skin products, such as the scanner, to help drive sales of Pharmanex and Nu Skin products and increase the number of distributors promoting and distributing our products.
Other Markets. Our Other Markets currently consist of the markets in Europe, Central America and Brazil. We currently distribute products in 17 countries in Europe, including the United Kingdom, Ireland, France, Germany, Belgium, the Netherlands, Luxembourg, Spain, Portugal, Italy, Austria, Poland, Sweden, Iceland, Norway, Finland and Denmark. In 2002, our revenue from our European markets was approximately $26 million. The majority of our Nu Skin personal care products and several of our Pharmanex products, including LifePak, are sold in Europe. We also distribute a limited number of Big Planet products in the European market. We have additional small operations in Brazil, Mexico and Guatemala. According to the World Federation of Direct Selling Associations, the direct selling channel in Brazil generated sales of approximately $2.5 billion of goods and services in 2001. Approximately 25% of our Nu Skin personal care products have been introduced in Brazil, along with 15 locally produced products.
In the first quarter of 2002, we acquired a controlling interest in a small direct selling company in Poland. We believe that the direct selling model utilized by this company can be developed into a model that will help us compete in less developed economies throughout the world, including our current markets in Latin America and potential new markets in Eastern Europe, which we believe will be among the fastest growing direct selling regions in the world over the next several years.
Distribution
Overview. The foundation of our sales philosophy and distribution system is network marketing. Except in China, we currently sell substantially all of our products through independent distributors who are not our employees. Our distributors purchase products from us for resale to consumers and for personal consumption. Because of the nature of our Big Planet products and services, distributors buy a limited number of our Big Planet products for resale but primarily act as independent sales representatives for our products and receive a commission on product sales from us.
We believe that network marketing is an effective vehicle to distribute our products because:
| • | distributors can educate consumers about our products in person, which we believe is more effective for premium-quality, differentiated products than using television and print advertisements; |
| • | direct sales allow for actual product testing by potential customers; |
| • | there is greater opportunity for distributor and customer testimonials; and |
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| • | as compared to other distribution methods, our distributors can provide customers higher levels of service and attention by, among other things, following up on sales to ensure proper product usage and customer satisfaction and to encourage repeat purchases. |
Our revenue is highly dependent upon the number and productivity of our distributors. Growth in sales volume requires an increase in the productivity of distributors and/or growth in the total number of distributors. As of December 31, 2002, we had approximately 566,000 active distributors of our products and services. An active distributor is a distributor who has purchased products for resale or personal consumption during the previous three months. Approximately 28,000 of these active distributors had achieved "executive level" status. Executive level distributors are the distributors who are most seriously pursuing the direct selling opportunity and must achieve and maintain specified personal and group sales volumes for a required period of time. Once a distributor becomes an executive level distributor, the distributor can begin to take full advantage of the benefits of commission payments on personal and group sales volume. As of each of the dates indicated below, we had the following number of executive distributors in the referenced regions:
Total Number of Executive Distributors by Region
| Region |
1998 |
1999 |
2000 |
2001 |
2002 | ||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| North Asia | 17,311 | 14,601 | 14,968 | 16,891 | 17,668 | ||||||
| Southeast Asia | 5,091 | 3,419 | 3,044 | 4,540 | 6,536 | ||||||
| North America(1) | -- | 2,547 | 2,632 | 2,419 | 2,693 | ||||||
| Other Markets | 379 | 438 | 737 | 989 | 1,018 | ||||||
| Total | 22,781 | 21,005 | 21,381 | 24,839 | 27,915 | ||||||
| (1) | North America was not part of our operations until March 1999 when we terminated our license agreement with one of our private affiliates, thereby acquiring its North American operations. |
On a monthly basis, we evaluate a limited number of distributor requests for exceptions to the terms and conditions of the Global Compensation Plan, including volume requirements. While our general policy is to discourage exceptions, we believe that the flexibility to grant exceptions is critical in retaining distributor loyalty and dedication.
Sponsoring. We rely on our distributors to recruit and sponsor new distributors of our products. While we provide product samples, brochures, magazines and other sales materials at cost, distributors are primarily responsible for recruiting and 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 a network marketing structure. Persons that a distributor sponsors are referred to as “downline” or “sponsored” distributors. If downline distributors also sponsor new distributors, they create additional levels in the structure, but their downline distributors remain in the same downline network as their original sponsoring distributor.
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Sponsoring activities are not required of distributors and we do not pay any commissions for sponsoring new distributors. However, because of the financial incentives provided to those who succeed in building a distributor network that consumes and resells products, we believe that many of our distributors attempt, with varying degrees of effort and success, to sponsor additional distributors. People are often attracted to become distributors after using our products and becoming regular customers. Once a person becomes a distributor, he or she is able to purchase products directly from us at wholesale prices. 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, which obligates the distributor to abide by our policies and procedures.
Global Compensation Plan. We believe that one of our key competitive advantages is our Global Compensation Plan. Under our Global Compensation Plan, distributors are paid consolidated monthly commissions in the distributor’s home country, in local currency, for their own product sales and for product sales in that distributor’s downline distributor network across all geographic markets. Because of restrictions on direct selling in China, our sales employees within China do not participate in the Global Compensation Plan, but are compensated according a retail sales model established for that market. Additionally, while distributor leaders are compensated for sales activity of preferred customers and sales employees in China, sales in China do not accrue to satisfy applicable sales volume requirements within the Global Compensation Plan.
Commissions on our Nu Skin and Pharmanex products can reach approximately 58% of an individual product’s wholesale price. However, on a global basis, commissions on these products have averaged approximately 40% to 43% of product revenue over the past ten years. We believe that our commission payout as a percentage of total sales is among the most generous paid by major direct selling companies. Commissions are paid on the sales of Big Planet products and services as a percentage of our gross margins on those products. For Big Planet products and services purchased directly from our third party vendors by our distributors or customers, the commission is based on the total commission Big Planet receives from third parties with respect to those sales. Accordingly, the commissions paid to distributors of Big Planet products and services are less as a percentage of revenue than for our Nu Skin and Pharmanex products.
High Level of Distributor Incentives. Based upon management’s knowledge of our competitors’ distributor compensation plans, we believe that the Global Compensation Plan is among the most financially rewarding plans offered to distributors by leading direct selling companies. Currently, there are two fundamental ways in which our distributors can earn money:
| • | through retail markups on sales of products purchased by distributors at wholesale; and |
| • | through a series of commissions on product sales. |
Each of our products 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-sales taxes. As a distributor’s business expands from successfully sponsoring other distributors into the business who in turn expand their own businesses, a distributor receives a higher percentage of commissions. An executive’s commissions can increase substantially as downline distributors achieve executive status. In determining commissions, the number of levels of downline distributors included in an executive’s commissionable group increases as the number of executive distributorships directly below the executive increases.
Distributor Support. We are committed to providing high-level support services tailored to the needs of our distributors in each market. We attempt to meet the needs and build the loyalty of
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distributors by providing personalized distributor services and by maintaining a generous product return policy. Because the majority of our distributors are part-time and have only a limited number of hours each week to concentrate on their business, we believe that maximizing a distributor’s efforts by providing effective distributor support has been, and will continue to be, important to our success.
Through training meetings, annual conventions, web based messages, distributor focus groups, regular telephone conference calls and other personal contacts with distributors, we seek to understand and satisfy the needs of our distributors. We provide walk-in, telephonic and computerized product fulfillment and tracking services that result in user-friendly, timely product distribution. Several of our walk-in retail centers maintain meeting rooms, which our distributors may utilize for training and sponsoring activities. Because of our efficient distribution system, we do not believe that most of our distributors maintain a significant inventory of our products.
Technology and Internet Initiatives. We believe that the Internet has become increasingly important to our business as more consumers communicate online and purchase products over the Internet as opposed to traditional retail and direct sales channels. As a result, we have committed significant resources to enhancing our e-commerce capabilities and the abilities of our distributors to take advantage of the Internet. In Japan, approximately 23% of our sales during 2002 occurred over the Internet. In addition, we have introduced a global web page that allows a distributor to have a personalized website through which he or she can sell products in many of our more than 30 global markets.
Rules Affecting Distributors. We closely monitor regulations in each market as well as the activity of distributors to ensure that our distributor activities comply with local laws. Our published distributor policies and procedures establish the rules that distributors must follow in each market. In addition, we generally participate in local direct selling associations and agree to abide by the policies required of those associations. We also monitor distributor activity to ensure that our distributors enjoy a level playing field and that distributors are not disadvantaged by the activities of another. We require our distributors to present products and business opportunities ethically and professionally. Distributors further agree that their presentations to customers must be consistent with, and limited to, the product claims and representations made in our literature. Even though sponsoring activities can be conducted in many countries, our distributors may not conduct marketing activities outside of those countries in which we currently conduct business, and further they may not export for sale products from one country to another.
Distributors must represent to us that their receipt of commissions is based on retail sales and substantial personal sales efforts. We must produce or pre-approve all sales aids used by distributors such as videotapes, audiotapes, brochures and promotional clothing. 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 us. Distributors may not use our trademarks or other intellectual property without our consent.
Except in China, products generally may not be sold, and our business opportunities may not be promoted, in traditional retail environments. We have made an exception to this rule by allowing some of our Pharmanex products to be sold in independently owned pharmacies and drug stores meeting specified requirements. 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 a manner to attract the general public into the establishment to purchase products.
In order to qualify for commission bonuses, our distributors generally must satisfy specific requirements including achieving at least 100 points, which is approximately $100, in personal sales volume per month.
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In addition, individual markets may have requirements specific to that country based on regulatory concerns. For example, in the United States, distributors must also:
| • | document retail sales or customer connections to established numbers of retail customers; and |
| • | sell and/or consume at least 80% of personal sales volume. |
We systematically review reports of alleged distributor misbehavior. If we determine that one of our distributors has violated any of our distributor policies or procedures, we may terminate the distributor’s rights completely. Alternatively, we may impose sanctions such as warnings, probation, withdrawal or denial of an award, suspension of privileges of a distributorship, fines, withholding commissions until specified conditions are satisfied or other appropriate injunctive relief. Except in China, our distributors are independent contractors who may terminate their distributorship at any time.
Product Guarantees. We believe that we are among the most consumer-protective companies in the direct selling industry. While the regulations and our operations vary somewhat from country to country, we generally follow a similar procedure for product returns. For 30 days from the date of purchase, our product return policy allows a retail customer to return any Nu Skin or Pharmanex product to us directly or to the distributor through whom the product was purchased for a full refund. After 30 days from the date of purchase, the end user return privilege is in the discretion of the distributor. Our distributors, however, can return unused products directly to us for a 90% refund for one year. Our experience with actual product returns has averaged less than 5% of annual revenue through 2002.
Payment. Distributors generally pay for products prior to shipment. Accordingly, we carry minimal accounts receivable. Distributors typically pay for products in cash, by wire transfer or by credit card. Cash, which represents a significant portion of all payments, is received by order takers in the distribution centers when orders are personally picked up by one of our distributors.
Competition
Nu Skin and Pharmanex Products. The markets for our Nu Skin and Pharmanex products are highly competitive. Our competitors include manufacturers and marketers of personal care and nutritional products, pharmaceutical companies and other direct selling organizations, many of which have longer operating histories and greater name recognition and financial resources than we do. We compete in these markets by emphasizing the innovation, value and premium quality of our products and the convenience of our distribution system. While we believe 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.
Big Planet Products and Services. The markets for our Big Planet products and services are highly competitive. Many of our competitors for these products and services have much greater name recognition and financial resources than we do. We compete in this market by offering convenient access to a variety of technology, Internet and telecommunications services and products at competitive prices with a high level of customer service. The market for technology and telecommunication products is very price sensitive, and many products are offered by our competitors with little or no margin. We rely on our ability to acquire quality and reliable services from vendors at prices that allow our distributors to sell services at competitive prices and still generate attractive commissions.
Direct Selling Companies. We also compete with other direct selling organizations, some of which have a longer operating history and higher visibility, name recognition and financial resources than we do. The leading direct selling companies in our existing markets are Avon and Alticor (Amway). We
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compete for new distributors on the strength of our multiple business opportunities, product offerings, Global Compensation Plan, management strength and appeal of our international operations. In order to successfully compete in this market and attract and retain distributors, we must maintain the attractiveness of our business opportunities to our distributors.
Intellectual Property
Our major trademarks are registered in the United States and in each country where we operate or have plans to operate, and we consider our trademark protection to be very important to our business. Our major trademarks include Nu Skin, Pharmanex, Big Planet and LifePak. In addition, a number of our products are based on proprietary technologies and formulations, some of which are patented or licensed from third parties. We also rely on trade secret protection to protect our proprietary formulas and know-how. Our business is not substantially dependent on any single licensed technology from any third party.
Government Regulation
Direct Selling Activities. Direct selling activities are regulated by various federal, state and local governmental agencies in the United States and foreign countries. These laws and regulations are generally intended to prevent fraudulent or deceptive schemes, often referred to as “pyramid” schemes, that compensate participants for recruiting additional participants irrespective of product sales, use high pressure recruiting methods and/or do not involve legitimate products. The laws and regulations in our current markets often:
| • | impose cancellation/product return, inventory buy backs and cooling off rights for consumers and distributors; |
| • | require us or our distributors to register with governmental agencies; |
| • | impose reporting requirements; and |