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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
For the fiscal year ended December 31, 1997
------------------------------
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 001-12421
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.
As of March 5, 1998, the aggregate market value of the voting stock (Class
A and Class B Common Stock) held by non-affiliates of the Company was
$648,847,604. For purposes of this calculation, voting stock held by officers,
directors, and corporate affiliates has been excluded.
As of March 5, 1998, 11,830,104 shares of the Company's Class A Common
Stock, $.001 par value per share, 70,280,759 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.
Portions of the Company's 1997 Annual Report (the "1997 Annual Report") to
security holders to be furnished to the Securities and Exchange Commission (the
"Commission") pursuant to Rule 14a-3(b) in connection with Registrant's 1998
Annual Meeting of Stockholders scheduled to be held on or about May 5, 1998 (the
"1998 Annual Meeting"), are attached hereto as Exhibit 13, and are incorporated
herein by reference into Parts II and IV of this Annual Report on Form 10-K
(this "Report").
Portions of the Company's Definitive Proxy Statement (the "Proxy
Statement") to be filed with the Commission pursuant to Regulation 14A in
connection with the 1998 Annual Meeting are incorporated herein by reference
into Part III of this Report.
Certain Exhibits filed with the Company's Registration Statement on Form
S-1 (Registration No. 333-12073), as amended on Post Effective Amendment No. 1
to the Company's Registration Statement filed on September 3, 1997 (Registration
No. 333-12073), and Company's Annual Report on Form 10-K for the year ended
December 31, 1996 are incorporated herein by reference into Part IV of this
Report.
NU SKIN ASIA PACIFIC, INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I........................................................................ 1
ITEM 1. BUSINESS.................................................... 1
ITEM 2. PROPERTIES..................................................41
ITEM 3. LEGAL PROCEEDINGS...........................................42
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........43
PART II.......................................................................43
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.................................43
ITEM 6. SELECTED FINANCIAL DATA.....................................43
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.........................43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................43
PART III......................................................................44
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..........44
ITEM 11. EXECUTIVE COMPENSATION......................................44
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................44
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............44
PART IV.......................................................................45
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K....................................................45
PART I
ITEM 1. BUSINESS
General
Nu Skin Asia Pacific, Inc. ("Nu Skin Asia Pacific" or the "Company"), is a
network marketing company involved in the distribution and sale of premium
quality, innovative 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, Thailand
and the Philippines, where the Company currently has operations, and in
Indonesia, Malaysia, the People's Republic of China ("PRC"), Indonesia,
Singapore and Vietnam, where Nu Skin operations have not 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, health solutions and botanical supplements.
The Company was incorporated in Delaware on September 4, 1996. On November
20, 1996, the stockholders (the "Original 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")
(together the "Original Subsidiaries") 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"). As a result of the
Reorganization, each of the Original Subsidiaries became a wholly-owned
subsidiary of the Company. 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, Nu Skin Thailand, and Nu Skin Philippines, Inc. ("Nu
Skin Philippines") 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.
In November 1996, the Company and certain Original 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"). In addition, in December 1996, the Company, NSI and certain of
NSI's affiliates offered to qualifying NSI independent distributors and
employees, in non-underwritten offerings (the "Rule 415 Offerings", and together
with the Underwritten Offerings, the "Offerings") certain options and shares of
Class A Common Stock pursuant to Rule 415 under the Securities Act of 1933, as
amended (the "1933 Act").
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
provides 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 who
are licensed to the Company pursuant to agreements between NSI and the Company's
Subsidiaries. On February 27, 1998, the Company entered into a Stock Acquisition
Agreement with the Stockholders of NSI and certain affiliates of NSI to acquire
all of the capital stock of NSI and certain affiliates of NSI. See "Recent
Developments."
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.
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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. References to "yen" and "(Y)" are to Japanese yen, and
references to "won" are to South Korean won. References to "baht" are to Thai
baht. References, if any, to the "NT$" are to New Taiwanese dollars and
references, if any, to the "HK$" are to Hong Kong dollars.
Note Regarding Forward-Looking Statements
Certain statements made herein under the captions "Business-Country
Profiles," and "Risk Factors," are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). In addition, when used in this Report the words or phrases "will likely
result," "expects," "intends," "will continue," "is anticipated," "estimates,"
"projects," "Management believes," "the Company believes" and similar
expressions are intended to identify "forward-looking statements" within the
meaning of the Reform Act.
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 of each country in which the Company operates
and financial results of the Company. These forward-looking statements involve
risks and uncertainties and are based on certain assumptions that may not be
realized. Actual results and outcomes may differ materially from those discussed
or anticipated. The forward-looking statements and associated risks set forth
herein relate to the: (i) proposed NSI Acquisition, (ii) expansion of the
Company's market share in its current markets; (iii) Company's entrance into new
markets (iv) development of new products and new product lines tailored to
appeal to the particular needs of consumers in specific markets; (v) stimulation
of product sales by introducing new products; (vi) opening of new offices,
walk-in distribution centers and distributor support centers in certain markets;
(vii) promotion of distributor growth, retention and leadership through local
initiatives; (viii) upgrading of the Company's technological resources to
support distributors; (ix) obtaining of regulatory approvals for certain
products, including LifePak; (x) stimulation of product purchases by inactive
distributors through direct mail campaigns; (xi) retention of the Company's
earnings for use in the operation and expansion of the Company's business; (xii)
development of brand awareness and loyalty; (xiii) enhancing of the Company's
Global Compensation Plan; (xiv) diversifying of the Company's revenue base and
markets, (xv) seeking of cost reductions from vendors; and (vxi) establishment
of local manufacturing.
All forward-looking statements are subject to known and unknown risks and
uncertainties, including those discussed under the caption "Risk Factors"
herein, that could cause actual results to differ materially from historical
results 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 further
advise readers that the important factors listed under the caption "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 views
or statements expressed with respect to future periods. Important factors and
risks that might cause such differences include, but are not limited to (a)
factors related to the Company's reliance upon independent distributors of NSI,
(b) fluctuations in foreign currency values relative to the U.S. dollar, (c)
adverse economic and business conditions in the Company's markets, especially
South Korea and Thailand, (d) the possibility the proposed NSI Acquisition may
not be consummated, (e) the potential effects of adverse publicity, including
adverse publicity regarding the Company and other direct selling companies in
South Korea and the Company's other markets, (f) the potential negative impact
of distributor actions, (g) seasonal and cyclical trends, (h) variations in
operating results, (i) government regulation of direct selling activities in the
PRC, Malaysia and other existing and future markets, (j) government regulation
of products and marketing, (k) import restrictions, (l) other regulatory issues,
including regulatory action against the Company or its distributors in any of
the Company's markets and particularly in South Korea, (m) the Company's
reliance on certain distributors, (n) the potential divergence of interests
between distributors and the Company, (o) management of the Company's growth,
(p) the effects on operations of the NSI distributor equity program, (q) the
introduction of the Scion product line in the Philippines and Aloe-mx in Japan,
(r) market acceptance in South Korea and other markets of LifePak and LifePak
Trim, the Company's core IDN nutritional supplements, (s) the acceptance of new
distributor walk-in centers in Japan, Thailand and Taiwan, (t) acceptance of
modifications to the Company's sales compensation plan in the Philippines, (u)
the Company's ability to renegotiate or adjust vendor relationships, (v) the
Company's ability to establish local manufacturing capability, (w) risks
inherent in the importation, regulation and sale of personal care and
nutritional products in the Company's markets, (x) the Company's ability to
successfully enter new markets such as Poland and Brazil and introduce new
products in addition to
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those already referenced above, (y) the Company's ability to manage growth and
deal with the possible adverse effect on the Company of the change in the status
of Hong Kong, (z) the potential conflicts of interest between the Company and
NSI, (aa) control of the Company by the Original Stockholders, (bb) the
anti-takeover effects of dual classes of common stock, (cc) the Company's
reliance on and the concentration of outside manufacturers, (dd) the Company's
reliance on the operations of and dividends and distributions from the
Subsidiaries, (ee) taxation and transfer pricing issues, (ff) the potential
increase in distributor compensation expense, (gg) product liability issues, and
(hh) competition in the Company's existing and future markets.
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. The Company disclaims any obligation or intent
to update any such factors or forward-looking statements to reflect future
events or developments. See "Risk Factors."
Recent Developments
On February 27, 1998, the Company entered into a Stock Acquisition
Agreement (the "Acquisition Agreement") with the stockholders of NSI and certain
affiliates of NSI (the "NSI Stockholders") to acquire (the "NSI Acquisition")
all of the capital stock of NSI and certain affiliates of NSI (the "Acquired
Entities"). The consideration to be paid by the Company to the NSI Stockholders
will consist of shares of Series A Preferred Stock, par value $.001 per share,
of the Company (the "Series A Preferred Stock") in an amount determined as set
forth below, the assumption of the Acquired Entities' S Distribution Notes (as
defined below) payable to the NSI Stockholders in the amount of approximately
$180 million (taking into account the Acquired Entities' S Distribution Notes as
of December 31, 1997 and as of the closing date of the NSI Acquisition) and,
contingent upon NSI and the Company meeting certain earnings growth targets, up
to $25 million in cash per year over the next four years. In addition, the
Acquisition Agreement provides that if the Acquired Entities' S Distribution
Notes do not equal or exceed $180 million, the Company will pay each NSI
Stockholder in cash or in the form of promissory notes the difference between
(i) $180 million and (ii) the aggregate principal amount of the Acquired
Entities' S Distribution Notes multiplied by each NSI Stockholder's proportional
ownership interest in the outstanding capital stock of NSI. The Acquisition
Agreement provides that the number of shares of Series A Preferred Stock to be
delivered to the NSI Stockholders shall be determined by dividing $70 million by
the average closing price of the Class A Common Stock for the 20 consecutive
trading days ending five trading days prior to the closing of the NSI
Acquisition.
Collectively, the NSI Stockholders and their affiliates own beneficially
all of the outstanding shares of the Class B Common Stock. In addition, several
of the NSI Stockholders are directors and/or executive officers of the Company.
Effective as of December 31, 1997, NSI contributed certain assets relating
to the right to distribute NSI products in the United States to Nu Skin USA,
Inc. ("Nu Skin USA"), a newly created corporation wholly owned by the NSI
Stockholders, in exchange for all of the common stock of Nu Skin USA. The Nu
Skin USA common stock was then distributed to the NSI Stockholders. In addition,
effective as of December 31, 1997, NSI and the other Acquired Entities declared
distributions to their then existing stockholders (consisting solely of the NSI
Stockholders) that included all of such Acquired Entities' previously earned and
undistributed S corporation earnings through such date (the "Acquired Entities'
S Corporation Distribution"). As of December 31, 1997, such Acquired Entities'
aggregate undistributed S corporation earnings were approximately $136.2
million. The Acquired Entities' S Corporation Distribution was distributed in
the form of promissory notes due December 31, 2004 and bearing interest at 8.0 %
per annum (the "Acquired Entities' S Distribution Notes"). The Acquired
Entities' S Corporation Distribution Notes are held entirely by the NSI
Stockholders. In addition, the Acquired Entities will declare distributions to
then existing stockholders that include all of such Acquired Entities'
previously earned and undistributed S corporation earnings through the date of
closing of the NSI Acquisition. As discussed above, the obligation to repay the
Acquired Entities' S Distribution Notes to the NSI Stockholders will be assumed
by the Company in connection with the NSI Acquisition.
The Acquired Entities consist of NSI, Nu Skin International Management
Group, Inc., ("NSIMG") and the NSI affiliates operating in Europe, Australia and
New Zealand, including Nu Skin Europe, Inc.; Nu Skin U.K., Ltd.(domesticated
-3-
in Delaware under the name Nu Skin U.K., Inc.); Nu Skin Germany, GmbH
(domesticated in Delaware under the name Nu Skin Germany, Inc.); Nu Skin France,
SARL (domesticated in Delaware under the name Nu Skin France, Inc.); Nu Skin
Netherlands, B.V. (domesticated in Delaware under the name Nu Skin Netherlands,
Inc.); Nu Skin Italy, (SRL) (domesticated in Delaware under the name Nu Skin
Italy, Inc.); Nu Skin Spain, S.L. (domesticated in Delaware under the name Nu
Skin Spain, Inc.); Nu Skin Belgium, N.V. (domesticated in Delaware under the
name Nu Skin Belgium, Inc.); Nu Skin Personal Care Australia, Inc.; Nu Skin New
Zealand, Inc.; Nu Skin Brazil, Ltda. (domesticated in Delaware under the name Nu
Skin Brazil, Inc.); Nu Skin Argentina, Inc.; Nu Skin Chile, S.A. (domesticated
in Delaware under the name Nu Skin Chile, Inc.); Nu Skin Poland Spa.
(domesticated in Delaware under the name Nu Skin Poland, Inc.); and Cedar
Meadows, L.C. The NSI Stockholders continue to own as private entities the NSI
affiliates operating in the United States, Canada, Mexico, Guatemala and Puerto
Rico, including Nu Skin USA, Inc.; Nu Skin Canada, Inc.; Nu Skin Mexico S.A. de
C.V. (domesticated in Delaware under the name Nu Skin Mexico, Inc.); Nu Skin
Guatemala, S.A. (domesticated in Delaware under the name Nu Skin Guatemala,
Inc.); and Nu Skin Puerto Rico, Inc. (collectively, the "Retained Entities").
The following chart illustrates the organizational structure of the
Company and the Retained Entities immediately after the NSI Acquisition.
[Organizational Chart]
-4-
Through its acquisition of NSI, the Company will obtain ownership and
control of the Nu Skin trademarks and tradenames, the Nu Skin Global
Compensation Plan, distributor lists and related intellectual property and
know-how (collectively, the "Intellectual Property"). The Company, through NSI,
intends to continue to license the Intellectual Property and, through NSIMG,
intends to continue to provide management support services to the Acquired
Entities on substantially the same terms as existed prior to the NSI
Acquisition. In connection with the NSI Acquisition, the Company anticipates,
through NSI and NSIMG, entering into new agreements with Nu Skin USA, Inc. and
revised agreements with the other Retained Entities on terms substantially
similar to its agreements with the Acquired Entities, pursuant to which NSI will
continue to license the Intellectual Property and the exclusive right to sell Nu
Skin personal care and nutritional products in the United States, Canada,
Mexico, Guatemala and Puerto Rico to the Retained Entities and NSIMG will
continue to provide management support services to the Retained Entities.
Upon completion of the NSI Acquisition, the Company and its subsidiaries
will own and distribute Nu Skin products in 18 markets worldwide. The Company
will also hold the rights to all future Nu Skin markets.
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, 1995, 1996 and 1997. 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," incorporated herein by reference to the Company's 1997 Annual
Report, sections of which are filed herewith as Exhibit 13, which discusses the
costs associated with generating the aggregate revenue presented. The Company
did not commence operations in the Philippines until February 1998.
Year Ended December 31,
-----------------------------------------
COUNTRY 1995 1996 1997
- -------- --------- --------- ---------
(dollars in thousands)
Revenue:
Japan.................... $ 231,540 $ 380,044 $ 599,375
Taiwan................... 105,415 154,564 168,568
South Korea(1)........... -- -- 74,207
Thailand(2).............. -- -- 22,834
Hong Kong................ 17,046 17,037 21,267
Year Ended December 31,
-----------------------------------------
1995 1996 1997
--------- --------- ---------
Active Distributors(3)(4):
Japan.................... 147,000 215,000 297,000
Taiwan................... 75,000 91,000 86,000
South Korea(1)........... -- 57,000 21,000
Thailand(2).............. -- -- 11,000
Hong Kong................ 14,000 14,000 15,000
------- ------- -------
Total.............. 236,000 377,000 430,000
------- ------- -------
- ------------------
(1) The Company commenced operations in South Korea in February 1996.
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(2) The Company commenced operations in Thailand in March 1997. (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.
-6-
The following table sets forth certain estimated economic and demographic
data in each of the Company's markets for the years presented. 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. In addition, the following data does not
reflect the economic decline that commenced in certain of the Company's markets
in 1997. The listed data was not available from the referenced source as of
March 5, 1998.
1996 1996 GDP 1996 GDP Real GDP
Population (in billions per capita Growth
Country (in millions) of $) (in $) 1996/1995 (%)
- ------- ------------- ------------ ----------- -------------
Japan............... 125.5 $4,575.2 $36,456 3.6%
Taiwan.............. 21.5 270.5 12,583 5.6
South Korea......... 45.3 497.6 10,984 6.9
Hong Kong........... 6.3 158.7 25,108 4.6
Thailand............ 61.8 185.0 2,993 6.7
Philippines......... 72.0 83.2 1,156 5.5
- -----------
Source: World Information Services; Country Data Forecasts, March 1997.
Japan. The Company, through its subsidiary Nu Skin Japan, commenced
operations in Japan in April 1993. According to the World Federation of Direct
Selling Associations ("WFDSA"), the direct selling channel in Japan generated
sales of approximately $30 billion of goods and services in 1996, making Japan
the largest direct selling market in the world. Management believes that as many
as six million people are involved in direct selling businesses in Japan. Direct
selling is well-understood in Japan and is governed by detailed government
regulation. See "Risk Factors--Government Regulation of Direct Selling
Activities" and "--Government Regulation of Products and Marketing; Import
Restrictions."
A great deal of the Company's success to date can be directly attributed
to the growth of its Japanese business in recent years. Significant revenue was
recognized from the outset of the Company's operations in Japan due to the
immediate attention given to the market by leading NSI distributors from around
the world. Japan has continued to post strong financial results for the Company,
with revenue increasing by approximately 58% in U.S. dollars and 75% in local
currency for 1997 compared to 1996 and by approximately 64% in U.S. dollars and
90% in local currency for 1996 compared to 1995. Management believes that the
increase from 1996 to 1997 was primarily the result of the growth in executive
distributors in Japan during this period and the increasing demand for IDN
products, which accounted for 38% of revenue for the period. Furthermore, given
the size of the direct selling market, management believes that there is still
significant opportunity for revenue growth in this market. However, a variety of
factors including, without limitation, economic conditions in Asia generally and
Japan specifically may hinder revenue growth. As of December 31, 1997, Nu Skin
Japan offered 68 of the 90 Nu Skin personal care products and 15 of the 40 IDN
products, including LifePak and LifePak Trim, the core IDN nutritional
supplements. Nu Skin Japan also offered 4 popular skin lightening products, 7
additional face care products, and Aloe-mx, an Aloe vera-based nutritional drink
designed specifically for Japanese consumers.
In support of the Company's growth strategy, Nu Skin Japan intends to (i)
focus on internal country development by supporting the recently opened Fukuoka
walk-in center and considering 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 Nu Skin personal care and IDN products,
(iv) enhance corporate support of distributors by upgrading information
technology resources, (v) expand warehousing and distribution support
facilities, and (vi) continue to build brand name recognition through
sponsorship from time to time of major events such as the NBA Supergames in 1997
and the Nippon Yacht Squadron in the America's Cup 2000 Regatta.
Taiwan. The Company, through its subsidiary Nu Skin Taiwan, commenced
operations in Taiwan in January 1992. According to the WFDSA, the direct selling
channel in Taiwan generated approximately $1.7 billion in sales of goods and
-7-
services in 1996, of which approximately 43% were nutritional products.
Approximately two million people (approximately 10% of the population) are
estimated to be involved in direct selling. Because a large percentage of its
population is involved in direct selling activities, the Taiwan government
regulates direct selling activities to a significant extent. For example, the
Taiwan government has enacted tax legislation aimed at ensuring proper tax
payments by distributors on their transactions with end consumers. See "Risk
Factors--Government Regulations of Direct Selling Activities" and "--Government
Regulation of Products and Marketing; Import Restrictions."
Revenue growth in Taiwan has averaged 41% per year since the commencement
of operations in 1992. The Company believes that the 1997 increase in sales was
primarily due to (i) the opening of walk-in centers in various Taiwanese cities,
(ii) increased distributor training and recognition, and (iii) increased product
offerings. The Company believes that Nu Skin Taiwan was the largest direct
selling company in Taiwan in 1997. As of December 31, 1997, Nu Skin Taiwan
offered 72 of the 90 Nu Skin personal care products and 11 of the 40 IDN
products.
In support of the Company's growth strategy, Nu Skin Taiwan intends to (i)
capitalize on the size of the nutritional supplements market by locally sourcing
LifePak to more competitively price this core IDN product and expanding the
current product offerings in Taiwan to include additional Nu Skin personal care
and IDN products, (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. According to the WFDSA, the
direct selling channel in Hong King generated approximately $78 million in sales
of goods and services in 1995. Hong Kong represents an important market in the
structure of the Asian region because it serves as the location of the Company's
regional office and is an important base of operations for many of the Company's
most successful distributors, whose downline distributor networks extend into
other Asian markets. As of December 31, 1997, Nu Skin Hong Kong offered 86 of
the 90 Nu Skin personal care products and 18 of the 40 IDN products.
Hong Kong became a Special Administrative Region (SAR) of the PRC
effective July 1, 1997. Although the Company has not perceived any material
impact resulting from the integration, further integration of the Hong Kong
economy and political system with the economy and political system of the PRC
could have an impact on the Company's business in Hong Kong. See "Risk
Factors--Possible Adverse Effect on the Company of the Change in the Status of
Hong Kong."
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. Macau represents the smallest of the Company's
markets in population with just under 500,000 residents. 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, (ii) capitalize on the size of the nutritional supplements
market by promoting the premium LifePak nutritional supplement, (iii) expanding
the current product offerings in Hong Kong to include additional Nu Skin
personal care and IDN products, and (iv) 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. According to the WFDSA, the direct
selling channel in South Korea generated approximately $1.8 billion in sales of
goods and services in 1996. South Korea's direct sales legislation, which went
into effect in July 1995, requires companies to comply with numerous provisions,
such as local registration, reporting of certain operating results and
dissemination to distributors of certain information regarding the laws. Nu Skin
Korea was among the first foreign-owned firms to register and begin operations
under the new direct selling legislation. See "Risk Factors--Government
Regulations of Direct Selling Activities" and "--Government Regulation of
Products and Marketing; Import Restrictions."
Management believes that Nu Skin Korea was one of the largest direct
sellers in the country during this time period. As of December 31, 1997, Nu Skin
Korea offered 52 of the 90 Nu Skin personal care products and 1 of the 40 IDN
-8-
products. Additionally, Nu Skin Korea offered various shades of Nu Colour
MoistureShade Liquid Finish designed specifically for Korean consumers.
The Company had sales in South Korea of approximately $122 million and $74
million for 1996 and 1997, respectively. The Company believes that the revenue
decline in South Korea during the second half of 1997, although partially
reflective of the business cycle experienced by the Company in other new
markets, was primarily the result of other factors specific to South Korea.
These other factors include a general collapse of the South Korean economy,
volatility in the South Korean won and activities by the South Korean government
and campaigns by a coalition of consumer protection and trade organizations
against producers of luxury and foreign goods, in general, and certain network
marketing companies, in particular, that resulted in negative media attention.
Management believes that the media attention has negatively impacted the
business environment generally. See "--Potential Effects of Adverse Publicity."
Additionally, the recent economic decline in South Korea has resulted in reduced
consumer spending on foreign goods. Further, the devaluation of the Korean won
has suppressed reported U.S. dollar revenues.
In support of the Company's growth strategy, Nu Skin Korea intends to (i)
engage in the local manufacturing of certain products to alleviate concerns
about the high level of goods being imported into South Korea by the Company,
(ii) engage in targeted promotional and public relations activities designed to
address concerns regarding the current business environment for direct selling
companies, (iii) promote the development of local distributor leadership,
including focused training efforts, compensation plan modifications and the
introduction of distributor productivity programs, and (iv) build the local
distributor support infrastructure.
Thailand. The Company, through its subsidiary, Nu Skin Thailand, commenced
operations in Thailand on March 13, 1997. According to the WFDSA, direct sales
in 1996 totaled $800 million in Thailand, making it the fourteenth largest
direct selling market worldwide. The Company's opening in Thailand was supported
by more than 200 of NSI's highest ranking distributors, many of whom are from
Taiwan and other Asian markets. As of December 31, 1997, Nu Skin Thailand
offered 31 of the 90 Nu Skin personal care products and none of the IDN
products. Initial revenue growth in the first half of 1997 slowed dramatically
in the second half of 1997 due primarily to economic turmoil in Thailand which
led to a significant devaluation of the Thai baht and a general slowdown in
consumer spending for foreign goods.
In Thailand, the Company intends to (i) systematically introduce
additional Nu Skin personal care products including locally sourced products at
a value price, (ii) promote the Company's brand image through public relations
efforts, including the endorsement of Nu Skin personal care products by the
1995-1996 Miss Thailand, and (iii) train new distributors in the most effective
methods of marketing the Company's products and in becoming effective leaders
within NSI's global distributor compensation plan (the "Global Compensation
Plan") framework.
Philippines. The Company, through its subsidiary Nu Skin Philippines,
commenced operations in the Philippines on February 4, 1998. The opening was
supported by over 150 of NSI's highest ranking distributors. Nu Skin Philippines
currently offers 26 of the 90 personal care products, none of the IDN products
and 11 personal care products that are manufactured in the Philippines under the
brand name Scion. The locally produced Scion personal care product line is
priced to appeal to a broader demographic segment of the population than Nu Skin
premium products. The Company intends to focus on establishing a stable
distributor base prior to implementing product line enhancements. In addition,
the Company also has implemented an enhancement to the Global Compensation Plan
to provide greater incentives for distributors at low executive levels in this
country with relatively low per capita income.
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 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.
-9-
The Company has the right to be the exclusive distributor of NSI products
in Indonesia, Malaysia, the PRC, Singapore and Vietnam. The Company believes
that these countries collectively represent significant markets for future
expansion; however, no assurance can be given that Nu Skin operations will ever
be commenced in these counties. Generally, the Company, as a matter of policy,
does not announce the timing of its opening of new markets.
There are, however, significant risks and uncertainties associated with
the Company's expansion into these countries. 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 generally
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 assurance can be given that the
Company will be able to obtain necessary regulatory approvals to commence
operations in these new markets, or that, once such approvals are obtained, the
Company and NSI, upon which the Company is largely dependent for product
development assistance, will be able to successfully reformulate Nu Skin
personal care and IDN product lines in any of the Company's new markets to
attract local consumers. Given existing regulatory environments and economic
conditions, the Company's entrance into Singapore and Vietnam is not anticipated
in the short to mid-term. See "Risk Factors--Entering New Markets" and
"--Government Regulation of Products and Marketing; Import Restrictions."
The following table sets forth certain estimated economic and demographic
data in each of the countries for which the Company has an exclusive license but
in which the Company has not commenced Nu Skin operations. 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 intends to operate, no assurance can be given that economic or
population data in a particular country will indicate what the Company's results
of operations, if any, will be in that country.
1996 1996 GDP 1996 GDP Real GDP
Population (in billions per capita Growth
Country (in millions) of $) (in $) 1996/1995 (%)
- ------- ------------- ------------ ----------- -------------
Indonesia.............. 197.4 $224.5 $1,137 7.8%
Malaysia............... 20.5 97.2 4,751 8.2
PRC.................... 1,236.0 808.2 654 9.7
Singapore.............. 3.0 93.2 30,771 7.0
Vietnam................ 76.3 26.1 342 9.3
- -------------------
Source: World Information Services; Country Data Forecasts, March 1997.
Indonesia. Although historically not open to foreign investment
opportunities, in the mid 1990's, Indonesia experienced an emphasis on
deregulation and private enterprise and an average annual growth in GDP of 6%
from 1985 to 1994. The Indonesian Direct Selling Association reports that there
are 750,000 participants in direct selling in the country. During the latter
part of 1997, Indonesia experienced a significant devaluation in its local
currency and significant economic turmoil. Due to these recent factors,
management believes that immediate expansion into this market is not in the
Company's best interest.
Malaysia. According to the WFDSA, more than $760 million in goods and
services were sold through the direct selling channel in Malaysia in 1996. There
are currently numerous direct selling companies operating in Malaysia. 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. See "Risk
Factors--Potential Negative Impact of Distributor Actions" and "--Potential
Effects of Adverse Publicity." Management is continuing to evaluate the time
frame in which it will reapproach the Malaysian market.
-10-
PRC. With the PRC's large population and the Company's success in the
neighboring and Chinese-speaking countries of Hong Kong and Taiwan, management
believes that the PRC may be an attractive market for the Company. However, the
PRC has proven to be a particularly difficult market for foreign corporations
due to its extensive government regulation and historical political tenets, and
no assurance can be given that the Company will be able to establish operations
in the PRC. The Company believes that entering the PRC may require the
successful establishment of a joint venture enterprise with a Chinese partner
and the establishment of a local manufacturing presence. These initiatives would
likely require a significant investment over time by the Company. The Company
believes that the PRC national regulatory agency responsible for direct selling
periodically reviews the regulation of multi-level marketing. Management is
aware of recent media reports in the PRC reporting an increasing desire on the
part of senior government officers to curtail or even abolish direct selling and
multi-level marketing activities. These views may lead to changes in applicable
regulations. The Company believes that PRC regulators are currently not issuing
direct selling or multi-level marketing licenses and may take action restricting
currently licensed direct selling businesses. The Company is actively working on
these and other issues including joint ventures and potential marketing
alternatives related to possible Nu Skin operations in the PRC. It is not known
when or whether the Company will be able to implement in the PRC business models
consistent with those used by the Company in other markets. 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 in the PRC 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, the uncertainties of enforcement of existing
legislation and laws, and potential revisions of existing laws could have an
adverse effect on the Company's proposed business in the PRC. See "Risk
Factors--Entering New Markets."
Singapore. In Singapore, relatively high levels of GDP per capita indicate
that the country enjoys strong consumer buying power and a dynamic market
structure similar to, yet smaller than, Hong Kong. Although direct selling
activities are permitted, currently network marketing is not allowed in
Singapore. Accordingly, the Company's entrance into Singapore is not anticipated
in the short to mid-term. See "--Government Regulation--Regulation of Products
and Marketing; Import Restrictions."
Vietnam. The Company believes that there is little or no direct selling
activity in Vietnam. However, the country is moving towards a market-based
economy and has recently adopted a freely convertible currency. The Company
anticipates that the increase in free enterprise will help to develop the direct
selling channel. However, given existing regulatory, environmental and economic
conditions, the Company's entrance into Vietnam is not anticipated in the short
to mid-term.
Southeast Asian and South Korean Economic Crisis
During 1997, economic and in some cases political conditions in Southeast
Asia and South Korea continued to decline. The region currently labors under
declining stock and currency markets, mounting bad bank debt, bankruptcies
involving some of its largest business enterprises, excess capacity, decreasing
demand for foreign goods and political unrest. These conditions are most
significantly reflected in the Company's operating results in South Korea and
Thailand. The Company has announced initiatives in each of its existing markets
to promote and sustain growth. These initiatives include increasing the local
production of products, supplementary product offerings with more moderately
priced goods, and enhancing the sales compensation plan to provide for greater
commission payouts at lower qualifying levels. No assurances can be given that
these initiatives will be successful. See " --Country Profiles" herein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-- Outlook" incorporated herein by reference to the Company's 1997
Annual Report, sections of which are filed herewith as Exhibit 13.
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 and personal
consumption. Pursuant to the Global Compensation Plan, products are sold
exclusively to or through independent distributors
-11-
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. See "--Relationship with NSI."
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 directly to a consumer 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 for resale and 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 approximately 42% of revenue from commissionable sales over the last
eight years. Because the Company licenses the right to use the Global
Compensation Plan from NSI, the structure of the plan, including commission
rates, is largely under the control of NSI. See "Risk Factors--Increase in
Distributor Compensation Expense."
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 primarily relies on
NSI to enforce distributor policies and procedures. There can be no assurance
that the productivity or number of distributors will be sustained at current
levels or increased in the future. See "Risk Factors--Reliance Upon Independent
Distributors of NSI." Furthermore, the Company estimates that, as of December
31, 1997, approximately 300 distributorships worldwide comprised NSI's Hawaiian
Blue Diamond and Blue Diamond executive distributor levels, which are NSI's two
highest executive distributor 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. See "Risk Factors--Reliance on
Certain Distributors; Potential Divergence of Interests between Distributors and
the Company."
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
-12-
as their original sponsoring distributor. See "Risk Factors--Reliance on Certain
Distributors; Potential Divergence of Interests between Distributors and the
Company."
Sponsoring activities are not required of distributors. However, because
of the financial incentives provided to those who succeed in building a
distributor network that consumes and resells products, 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, Hong Kong and the
Philippines, 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. In South Korea and
Thailand, distributors are not required to purchase a starter kit.
Global Compensation Plan. Management believes that one of the Company's
key competitive advantages is the Global Compensation Plan, which it licenses
from NSI. Distributors receive higher levels of commissions as they advance
under the Global Compensation Plan. The Global Compensation Plan is seamlessly
integrated across all markets in which Nu Skin personal care and IDN products
are sold, which allows distributors to receive commissions for global product
sales, rather than merely local product sales. 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. Outside of the Company's markets, NSI currently has
affiliated operations in the U.S., the United Kingdom, Puerto Rico, Canada,
Australia, New Zealand, Ireland, Germany, France, the Netherlands, Belgium,
Italy, Spain, Austria, Portugal, Mexico and Guatemala. Allowing distributors to
receive commissions at the same rate for sales in foreign countries as for sales
in their home country 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, which is
frequently the case under the compensation plans of the Company's major
competitors. 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. See "--Relationship with
NSI."
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 approximately 42% of revenue from
commissionable sales over the last eight years. See "Risk Factors--Increase in
Distributor Compensation Expense."
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.
-13-
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 distributorship
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,
----------------------------------------------
Executive Distributors 1993 1994 1995 1996 1997
------ ------ ------ ------ ------
Japan............................ 2,459 3,613 4,017 10,169 15,756
Taiwan........................... 1,170 2,093 3,014 5,098 4,342
South Korea...................... -- -- -- 4,675 898
Thailand......................... -- -- -- -- 308
Hong Kong........................ 275 377 519 541 641
Total...................... 3,907 6,083 7,550 20,483 21,945
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 make appropriate
recommendations to NSI.
Distributor Support. The Company is committed to providing high level
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
-14-
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. See "Risk Factors--Potential Negative Impact of Distributor
Actions."
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 typically pay for products in cash, by wire transfer, and by credit
cards. 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.
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. See "--Relationship with NSI" and "Risk
Factors--Relationship with and Reliance on NSI; Potential Conflicts of
Interest." NSI markets 90 different personal care and 40 different nutritional
products, of which 85 and 24, respectively, were available in at least one of
the Company's current markets as of December 31, 1997. 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 as well as a line of
11 personal care products which are produced locally in the Philippines. In
addition to products, the Company
-15-
offers a variety of sales aids, including items such as starter kits,
introductory kits, brochures, product catalogs, videotape and personal care
accessories. See "Risk Factors--Product Liability."
The following chart indicates how many of the Nu Skin personal care and
IDN products were available as of December 31, 1997, in each of the Company's
current markets.
Nu Skin Personal Care and IDN Product Offerings
Total Products Offered
Products ---------------------------------------------
Offered by Hong South
Product Categories/Product Lines NSI Japan Taiwan Kong Korea Thailand
--------------------------------------------------------
Nu Skin Personal Care:
Facial Care.............................. 20 14(1) 13 18 13 10
Body Care................................ 12 10 9 12 9 9
Hair Care................................ 14 13 13 14 12 10
Color Cosmetics.......................... 13 13 13 13 8(2) -
Specialty................................ 31 18 24 29 10 2
-- -- -- -- -- --
Total................................ 90 68 72 86 52 31
== == == == == ==
Nutritional Supplements.................. 17 7 4 4 1 -
Nutritious and Healthy Snacks............ 7 3 4 6 - -
Sports and Fitness Nutritional Products.. 1 - - - - -
Health Solutions......................... 3 - - - - -
Botanical Supplements.................... 8 4 3 8 - -
-- -- -- -- -- --
Total................................ 40 15 11 18 1 -
== == == == == ==
- ------------------
(1) In Japan, the Company also sells 11 locally sourced personal care products.
(2) In South Korea, the Company also sells one locally sourced color cosmetic
product.
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, 1995, 1996 and 1997.
Revenue by Product Category
Year Ended Year Ended Year Ended
December 31, 1995 December 31, 1996 December 31, 1997
----------------- ----------------- -----------------
$ % $ % $ %
Product Category --------- ------ --------- ------ --------- ------
Nu Skin Personal care..$ 303,387 84.6% $ 493,609 72.8% $ 569,156 63.9%
IDN.................... 23,959 6.7 138,593 20.4 272,402 30.6
Sales aids............. 31,263 8.7 46,394 6.8 48,990 5.5
--------- ------ --------- ------ --------- ------
Total............$ 358,609 100.0% $ 678,596 100.0% $ 890,548 100.0%
========= ====== ========= ====== ========= ======
Nu Skin Personal Care Products
The Company's current Nu Skin 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 90 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. See "Risk Factors--Government Regulation of
Products and Marketing; Import Restrictions."
-16-
The Nu Skin 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, 1997:
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. In addition, Nu Skin Japan also offers a line of
four popular skin lightening products and seven additional facial care products
designed particularly for Japanese consumers.
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. Nu Colour
was introduced in South Korea during 1997. The Nu Colour line consists of 13
products with 105 SKU's including MoistureShade Liquid Finish (10),
MoistureShade Pressed Powder (8), Blush (9), Eye Shadow (10), Mascara (2),
Eyeliner (7), Lip Liner (10), Lipstick (32), DraMATTEics Lip Pencils (6), Lip
Gloss, Creme Concealer (5), Finishing Powder and Brow Pencil (4).
Specialty Products. Epoch is 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 Herbal Bath, Emulsions and
Firewalker Foot Cream. Epoch was launched in August 1996 in Hong Kong, in
October 1996 in Taiwan, in February 1997 in Japan and in December 1997 in South
Korea and Thailand. Nu Skin Korea and Nu Skin Thailand currently offer only one
Epoch product, Glacial Marine Mud. 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.
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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, Japan, Taiwan, South Korea and
Thailand. At present, Sunright Lip Balm is not available in Japan. Currently,
Sunright Prime Pre & Part Sun Moisturizer and Sunright Lip Balm are not
available in Taiwan and South Korea. Nu Skin Thailand currently offers only one
Sunright product.
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, AP-24 Anti-Plaque Breath Spray and the recently introduced
AP-24 Whitening Flouride Toothpaste. These products are currently available in
Hong Kong and Taiwan. The AP-24 oral health care products for kids are designed
to make oral care fun for children and includes 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 40 products in the following
lines: nutritional supplements, nutritious and healthy snacks, sports and
fitness nutritional products, health solutions and botanical supplements. 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 Nu Skin personal care category, each of the Subsidiaries, except Nu
Skin Thailand, markets a variety of the IDN products offered by NSI. Nu Skin
Korea currently offers only one IDN product, LifePak. In the United States, the
IDN division is an official licensee of the U.S. Olympic Committee. In South
Korea, LifePak is the official nutritional supplement of the Korean Olympic
Committee
The Company believes that the nutritional supplement market is expanding
in Asia because of changing dietary patterns, a health-conscious population and
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 believes 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. See "Risk
Factors--Government Regulation of Products and Marketing." 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 and LifePak Trim, the core IDN
nutritional supplements, are 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 24% of the Company's revenue in Japan. LifePak was launched in
Taiwan, Hong Kong and South Korea in October 1996, January 1997 and August 1997,
respectively.
-18-
Additional nutritional supplements include: Vitox, which incorporates beta
carotene and other important vitamins for overall health; Metabotrim, which
provides B vitamins and chromium chelate; Optimum Omega, a pure source of omega
3 fatty acids; Image HNS, an all-around vitamin and antioxidant supplement; and
Optigar Q, a blend of co-enzyme Q10 and deodorized garlic. The Company also
offers FibreNet, FibreNet Plus and Diene-O-Lean as a part of its nutritional
supplement offerings. 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 supplements, LifePak and
LifePak Trim, NSI introduced LifePak Women and LifePak Prime. These products
address the more specific nutritional needs of women and the aging generation.
Also launched by NSI were Life Essentials, a lower cost, more general
nutritional supplement, and Nightime Complex with Melatonin, a sleep aid. The
Company is currently evaluating the feasibility of introducing these nutritional
supplements into its markets.
Nutritious and Healthy Snacks. As part of the Company's mission to promote
a healthy lifestyle and long-term wellness, IDN includes Fiberry Fat-Free Snack
Bars and Appeal Lite, a nutritional drink containing chelated minerals and
vitamins. The Company also offers Breakbars and Pocket Fuel, nutritious snacks
which provide carbohydrates, protein and fiber. In addition, the Company offers
a number of other nutritional drinks. 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. Aloe-mx, a nutritional aloe vera beverage drink, was specifically
produced for the Japanese market and introduced in October of 1997.
Sports and Fitness Nutritional Products. 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. Amino Build is a low
fat high protein drink mix that is designed to replace nutrients before and
after workouts. ProGRAM-16 protein bars are designed to provide nutritional
support for individuals seeking optimal performance during high-intensity
effort.
Health Solutions. IDN products include customized supplementation
addressing the specialized interests of health conscious individuals. These
supplements include Cartilage Formula which contains an advanced blend of
glucosamine to help maintain normal structure and function of healthy joints,
Eye Formula which contains significant levels of beta-carotene, vitamins C and E
to help maintain the normal structure and function of healthy eyes, and St.
John's Wart Complex which provides a balanced formula to support general health
and emotional well-being.
Botanical Supplements. 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).
-19-
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 has averaged less than 3.5% of annual revenue through
1997.
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, Nu Skin personal care products do not contain 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 Nu Skin personal
care product lines has been their gender neutral positioning. This product
positioning substantially expands the size of the traditional skin and hair care
market. NSI's IDN product lines have 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.
-20-
Production. Although the Company is investigating the possibility of
manufacturing certain products within specific markets, virtually all of the
Company's products are currently 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 2000. 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 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. See "Risk
Factors--Reliance on and Concentration of Outside Manufacturers."
Relationship With NSI
As of March 5, 1997, approximately 98% of the combined voting power of the
outstanding shares of Common Stock was held by the shareholders of NSI and their
affiliates. As a result, when acting as stockholders of the Company, these
shareholders of NSI and their affiliates will consider the short-term and
long-term impact of all stockholder decisions on the consolidated financial
results of NSI and the Company. See "Risk Factors--Relationships with and
Reliance on NSI; Potential Conflicts of Interest." In addition, the Company has
entered into distribution, trademark/tradename license, licensing and sales, and
management services agreements (the "Operating Agreements") with NSI and NSIMG,
summary descriptions of which are set forth below. Such summaries are qualified
in their entirety by reference to the Operating Agreements in effect and as they
may be amended from time to time. In the future the Company may enter into
amendments to the Operating Agreements or additional agreements with NSI or
NSIMG. 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. See "Risk Factors--Relationship with and Reliance on
NSI; Potential Conflicts of Interest."
The South Korean Operating Agreements differ in various minor ways from
the Company's other Operating Agreements. With the exception of the minor
modification of certain terms, the Operating Agreements described below will
remain in effect following consummation of the NSI Acquisition.
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 Nu Skin personal care and IDN products
and sales aids in the Company's markets. Nu Skin Japan, Nu Skin Taiwan, Nu Skin
Korea, Nu Skin Thailand and Nu Skin Philippines 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 Nu Skin personal care and IDN products in its respective
country. The
-21-
following discussion summarizes the terms of the Regional Distribution Agreement
and the Wholesale Distribution Agreements for each of the Subsidiaries, other
than the Wholesale Distribution Agreement for Nu Skin Korea, which is discussed
below.
The Company has the right to purchase any Nu Skin personal care or IDN
products, subject to unavailability due to local regulatory requirements. See
"--Government Regulation." 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, through its subsidiary Nu Skin Hong Kong, purchases virtually
all of its products from NSI. 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. See "Risk Factors--Currency Risks."
The Company is responsible for paying for and obtaining government
approvals and registrations necessary for importation of Nu Skin personal care
and IDN 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. See
"Risk Factors--Government Regulation of Products and Marketing; Import
Restrictions."
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. See "Risk Factors--Product Liability."
The Company is prohibited from selling Nu Skin personal care and IDN
products outside of the countries for which it has an exclusive distribution
license, except that the Company may sell certain Nu Skin personal care and IDN
products to NSI affiliates in Australia and New Zealand. In addition, the
Company is prohibited from selling products which directly or indirectly compete
with Nu Skin personal care and IDN 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 Nu Skin
personal care and IDN products without restriction but may not manufacture
products which compete directly or indirectly with Nu Skin personal care and IDN
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 using its business
model in Indonesia, Malaysia, 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 substantially similar to
those described below.
-22-
Trademark/Tradename License Agreements. The following discussion
summarizes the terms of the Trademark/Tradename License Agreements for each of
the Subsidiaries. Pursuant to the Trademark/Tradename License Agreements, NSI
has granted to each Subsidiary an exclusive license to use in its market the Nu
Skin and IDN trademarks, the individual product trademarks used on Nu Skin
personal care and IDN 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 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. The following discussion summarizes the terms of the
Licensing and Sales Agreement for each of the Subsidiaries, other than the
Licensing and Sales Agreement for Nu Skin Korea where the intercompany
agreements are modified to comply with local regulations.
The Licensing and Sales Agreements include 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. 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. The 42% figure has been set on the
basis of NSI's experience over the past eight 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.
See "Risk Factors--Potential Increase in Distributor Compensation Expense."
-23-
In addition to payments to local distributors, the Company is generally
responsible for distributor support and relations within Japan, Taiwan, Hong
Kong, South Korea, Thailand and the Philippines. 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. See "Risk
Factors--Government Regulation of Direct Selling Activities."
Management Services Agreements. The following discussion summarizes the
terms of the Management Services Agreements which each of the Subsidiaries have
entered into with NSIMG. Pursuant to the Management Services Agreements, 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. See "Management--Executive Compensation."
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