TABLE OF
CONTENTS
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Our Product Divisions |
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Sourcing and Production |
-8- |
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Research and Development |
-10- |
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Geographic Sales Regions |
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Intellectual Property |
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Government Regulation |
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Available Information |
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ITEM 3. |
LEGAL PROCEEDINGS |
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ITEM 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
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ITEM 5. |
MARKET FOR REGISTRANT’S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES |
-38- |
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ITEM 6. |
SELECTED FINANCIAL DATA |
-41- |
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ITEM 7. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |
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ITEM 7A. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK |
-66- |
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ITEM 8. |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
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ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON
ACCOUNTING AND FINANCIAL DISCLOSURE |
-92- |
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ITEM 9A. |
CONTROLS AND PROCEDURES |
-92- |
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ITEM 9B. |
OTHER INFORMATION |
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ITEM 15. |
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
-93- |
-i-
FORWARD-LOOKING
STATEMENTS
THIS
ANNUAL REPORT ON FORM 10-K, IN PARTICULAR “ITEM 7. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” AND “ITEM 1.
BUSINESS,” INCLUDE “FORWARD-LOOKING STATEMENTS” WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE STATEMENTS REPRESENT
OUR EXPECTATIONS OR BELIEFS CONCERNING, AMONG OTHER THINGS, FUTURE REVENUE, EARNINGS,
GROWTH STRATEGIES, NEW PRODUCTS, FUTURE OPERATIONS AND OPERATING RESULTS, AND FUTURE
BUSINESS AND MARKET OPPORTUNITIES. WE WISH TO CAUTION AND ADVISE READERS THAT THESE
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE EXPECTATIONS AND BELIEFS CONTAINED HEREIN. FOR A SUMMARY OF CERTAIN
RISKS RELATED TO OUR BUSINESS, SEE “ITEM 1. BUSINESS – RISK FACTORS”
BEGINNING ON PAGE 24.
In this Annual Report on Form
10-K, references to “dollars” and “$” are to United States dollars. Nu
Skin, Pharmanex, and Big Planet are our trademarks. The italicized product names used in
this Annual Report on Form 10-K are product names and also, in certain cases, our
trademarks.
PART I
Overview
Nu
Skin Enterprises is a leading, global direct selling company with operations in
approximately 40 countries throughout Asia, the Americas and Europe. We develop and
distribute premium quality, innovative personal care products and nutritional supplements
that are sold worldwide under the Nu Skin and Pharmanex brands. We also market
technology-related products and services under the Big Planet brand. We operate through a
direct selling model in all of our markets except Mainland China (hereinafter
“China”), where we operate using a retail model with employed sales
representatives because of current regulatory restrictions on direct selling activities.
We
are one of the largest direct selling companies in the world with 2004 revenue of $1.14
billion. As of December 31, 2004, we had a global network of approximately 820,000
active independent distributors, sales representatives, and preferred customers,
approximately 32,000 of whom were executive level distributors or full-time sales
representatives. Our executive level distributors and full-time sales representatives play
an important leadership role in our distribution network and are critical to the growth
and profitability of our business. We recognized approximately 88% of our revenue in
markets outside the United States in 2004. Our Japanese operations accounted for
approximately 51% of our 2004 revenue, although this market’s contribution to our
overall revenue is lower compared to prior years as a result of our expansion into and
growth in other markets. Because of the size of our foreign operations, our operating
results can be impacted positively or negatively by economic, political and business
conditions around the world as well as foreign currency fluctuations, particularly in
Japan and other Asian markets.
We
develop and market branded consumer products that we believe are well-suited for direct
selling. Our distributors market and sell our products by educating consumers about the
benefits and distinguishing characteristics of our products and by providing personalized
customer service. Through
-1-
dedicated research and development, we continually develop and
introduce new products and enhance our existing line of products to provide our
distributors with a differentiated product portfolio. We believe that we are able to
attract and motivate high-caliber independent distributors because of our focus on
developing innovative products, our attractive global compensation plan and our advanced
technological distributor support. Our business is subject to various laws and regulations
throughout the world, in particular with respect to network marketing activities and
nutritional supplements. This creates certain risks for our business, including any
inability to obtain necessary product registrations or improper activities by our
distributors.
Our
strategy for growing our business over the last year has focused on three key areas:
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• |
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expansion
into new markets; |
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• |
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introduction
of unique tools and initiatives to motivate distributors and improve retention; and |
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• |
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development
of compelling and innovative products. |
We
continued our efforts to expand into additional new markets and grow operations in
recently opened markets. During the year, we expanded our presence in China by opening 13
new stores in 12 new provinces and 1 new municipality. We grew our revenue in China from
$38.5 million in 2003 to $105.6 million in 2004. We also introduced a limited number of
Pharmanex products into China in January 2005. We commenced operations in Israel, Brunei
and Hungary during 2004 and continue to work on commencing operations in other markets,
including Indonesia and Russia.
We
also remain committed to providing our distributors with unique tools and initiatives that
motivate distributors and help them attract and retain customers and other distributors.
During 2004, we continued to expand the use of the Pharmanex® BioPhotonic
Scanner (the “BioPhotonic Scanner”) in the United States and key international
markets including Japan. The BioPhotonic Scanner is based on a patented technology that
allows our distributors to non-invasively measure the impact of our nutritional products
on overall nutritional status. In addition, we have continued to expand and promote
product subscription programs in many of our markets that provide incentives for customers
to commit to purchase a set amount of products on a monthly basis. We believe these
subscription programs have improved customer retention and helped drive revenue growth in
many of our markets.
Compelling
and innovative products and initiatives are vital to our company because they help empower
and motivate our distributors. As a result, we continue to focus on the development and
introduction of innovative products and reformulated products in order to help grow our
business in existing markets. Our product development philosophy across all three
divisions is to develop products and related initiatives that allow customers to
“live better, longer.” Some of the products introduced in the last year include:
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• |
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MarineOmega,
a novel fish oil product containing omega-3 fatty acids; |
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• |
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TRA,
a weight management system; |
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• |
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IgG
Boost, a colostrum supplement to support immune functions; |
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• |
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Estera,
a line of supplements that focus on the nutritional needs of women; |
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• |
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Nu
Skin Tri-Phasic White, an advanced system to restore even skin color and tone; |
-2-
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• |
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Nu
Skin Polishing Peel, a cost effective, at-home alternative to microdermabrasion; and |
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• |
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Epoch
Calming Touch, a soothing “ethnobotanical” cream for rash skin conditions. |
Our Product Divisions
We
have three product divisions: Nu Skin, which offers personal care products; Pharmanex,
which offers nutritional supplements and products; and Big Planet, which offers
technology-related products and services.
Presented
below are the U.S. dollar amounts and percentages of revenue from the sale of Nu Skin,
Pharmanex and Big Planet products and services for each of the years ended December 31,
2002, 2003, and 2004. This table should be read together with the information presented in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations,” which discusses the costs associated with generating the aggregate
revenue presented:
Revenue by Product
Category
(U.S. dollars in millions)(1)
|
Year Ended December 31, | |
| |
2002 | |
2003 | |
2004 | |
| Product Category | |
$ | |
% | |
$ | |
% | |
$ | |
% | |
| |
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| Nu Skin |
|
470.6 |
|
48.8 |
|
476.2 |
|
48.3 |
|
548.1 |
|
48.2 |
|
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| Pharmanex | |
439.0 |
|
45.5 |
|
472.1 |
|
47.8 |
|
567.2 |
|
49.8 |
|
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| Big Planet | |
54.5 |
|
5.7 |
|
38.2 |
|
3.9 |
|
22.6 |
|
2.0 |
|
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| Total | |
964.1 |
|
100.0 |
|
986.5 |
|
100.0 |
|
1,137.9 |
|
100.0 |
|
| (1) |
In 2004, over 88% of our sales were transacted in foreign currencies that are
converted to U.S. dollars for financial reporting purposes at weighted-average
exchange rates. Foreign currency fluctuations positively impacted reported
revenue by 4% in 2004 compared to 2003, and also positively impacted reported
revenue by 4% in 2003 compared to 2002. |
Nu Skin. Nu Skin is our original product line and offers over 100 premium
quality personal care products in the areas of daily skin care, advanced skin treatments,
ethnobotanical, and other advanced personal care products.
Our
strategy is to leverage our network marketing distribution model to establish Nu Skin as
an innovative leader in the personal care market. We are committed to continuously
improving and evolving our product formulations to incorporate innovative and proven
ingredients. In 2004, we introduced several new products, including Nu Skin Tri-Phasic
White, Nu Skin Polishing Peel, and Epoch Calming Touch, described in the
“Overview” section above.
Our
educated distributor force provides consumers with detailed information and instruction
about our Nu Skin products and guidelines for using the products most effectively, thereby
enabling us to bring more sophisticated ideas and technologies to market. We are committed
to developing tools to help our distributors market our products more effectively. In
early 2004, we introduced the Nu Skin® Regimen
-3-
Optimizer, a proprietary
software tool powered by Big Planet technology. This program integrates decades of skin
care expertise into an easy to use, mobile product recommendation tool. This mobile tool
serves as a complement to our use of the VISIA™ Complexion Analysis System in our
distributor centers around the world. This imaging system utilizes an imaging tool
produced by a third party, and provides customers with a more in-depth analysis of their
skin in order to tailor product recommendations to their specific needs.
Our
leading product categories in the Nu Skin division are daily skin care and advanced skin
treatments. The following table summarizes the current Nu Skin product line by category:
| Category | |
Description | |
Selected Products | |
| |
|
|
|
|
| Daily Skin Care |
|
Our premium line of daily skin care products
consists of face and body products including cleansers, toners, moisturizers, specialty products and body
care. Nutricentials products fortified with topically applied nutrients uniquely position this line. |
|
Night Supply Nourishing
Cream
Liquid Body Bar
Enhancer
Celltrex Ultra Recovery Fluid
Perennial Intense Body
Moisturizer |
|
| |
|
|
|
|
| Advanced Skin Treatments |
|
Our advanced skin treatments are designed to target
specific skin care needs with ingredients scientifically proven to provide visible results for concerns
ranging from anti-aging to acne. |
|
Nu Skin 180° Anti-Aging
Skin Therapy System
Tru Face Line Corrector
Tru Face Essence
Tru Face Revealing Gel
Nu Skin Galvanic Spa System II
Nu Skin Clear Action
Acne
Medication System
Nu Skin Tri-Phasic White |
|
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| Ethnobotanicals |
|
Our Epoch line is distinguished by utilizing the traditions of indigenous cultures. Each Epoch product is formulated with botanical ingredients derived
from renewable resources found in nature. In addition, we contribute a percentage of our proceeds from Epoch sales to charitable causes. |
|
Epoch Baby
Calming Touch
Glacial Marine Mud
Ava puhi moni Shampoo
IceDancer Invigorating Leg Gel
FireWalker Moisturizing Foot
Cream
|
|
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|
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|
| Color Cosmetics |
|
Our Nu Colour cosmetics are an ideal continuation of a face care regimen. Our skin beneficial complexion products bring out the skin's natural radiance
and the wearable range of shades and blendable textures enhance natural beauty. |
|
Nu Colour Cosmetics:
Skin Beneficial Tinted Moisturizer
Bronzing Pearls
Replenishing Lipstick
Eye Makeup Remover |
-4-
| Category | |
Description | |
Selected Products | |
| |
|
|
|
|
| Scion |
|
Scion is a line of essential personal care products that provide
value-oriented solutions to meet basic grooming needs with quality ingredients. |
|
Scion Toothpaste
Scion Two-In-One Shampoo
Scion Hand and Body Wash
Scion Moisturizing Body Lotion |
|
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|
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| Other Products
|
|
Our personal care portfolio also includes daily use products such as hair care, scalp treatment and sun protection. |
|
DailyKind Mild Shampoo
FreeFall Detangling Spray
Nutriol Hair Fitness
Sunright Lip Balm
|
|
Pharmanex.
We currently offer over 100 Pharmanex nutritional products within our global
markets. We are committed to providing our customers with high-quality,
standardized and scientifically substantiated nutritional supplements. Pharmanex
nutritional supplements include our flagship LifePak line of
micronutrient and phytonutrient supplements, which accounted for 23% of our
total revenue and 46% of Pharmanex revenue in 2004. We also offer a line of
targeted Pharmanex nutritional supplements, weight management products and other
specialty products. We design Pharmanex nutritional products to promote healthy,
active lifestyles and general well being when used in conjunction with proper
diet and exercise.
We
believe that direct selling is a more effective method of marketing high-quality
nutritional supplements than traditional retailing channels because our distributors are
able to educate consumers about the benefits of our nutritional supplements and to
differentiate the quality and benefits of our products from those offered by competitors.
Our strategy is to further expand our nutritional supplement business by continuing to
introduce new, innovative products based on extensive research and development. Any
ingredients that are proven to have any long-term addictive or harmful effects are not
considered for product development, even if the short-term effects may be desirable. Our
research capability consists of research and development centers in Shanghai, China;
Beijing, China; and Provo, Utah. We have also established collaborative arrangements with
prominent research institutions and independent scientists throughout the world. Our
product development efforts are focused in the areas of anti-aging, weight management and
other nutrition issues. In 2004, we introduced several new products, including MarineOmega,
TRA, IgG Boost and Estera, described in the
“Overview” section above.
We
are continuously looking for ways to help our distributors market our products more
effectively. In 2003, we introduced the BioPhotonic Scanner, an innovative, laser-based
scanning tool based on patented technology that measures the level of carotenoids (a
powerful antioxidant) in skin tissue. We believe we are the first nutrition company to
make available a non-invasive tool that will measure the level of antioxidant carotenoids
in the skin in order to observe the effects of regular nutritional supplementation. The
BioPhotonic Scanner was first made available to our distributors in the United States,
where we currently lease over 1,400 units to distributors for use in their promotion and
sale of nutritional supplements. In late 2003, we began making the BioPhotonic Scanner
available in our walk-in centers in some of our Asian markets and expanded the program
further in 2004, including the launch of the BioPhotonic Scanner in Japan in November 2004
and the introduction of BioPhotonic Scanner lease programs in Taiwan, Hong Kong, Europe,
and certain of our markets in Southeast Asia. We have also recently placed BioPhotonic
Scanners in our retail stores in China and in our walk-in centers in Latin America. There
are regulatory uncertainties in some markets, including the U.S., with respect to the
status of the BioPhotonic Scanner as a non-medical device. For a discussion of the risks
associated with these uncertainties, please refer to the section below entitled,
“Risk Factors.”
-5-
We
have also emphasized the use of our monthly product subscription program for our Pharmanex
products. This program is particularly well-suited for Pharmanex products including the
LifePak daily supplement line, which come in ten day, fifteen day, or one-month
supply packages. We have found that our distributors are able to generate a higher
customer retention rate through the use of this program.
Pharmanex
also sells a Vitameal dehydrated food product made with a blend of enriched rice
and lentils. Vitameals are highly nutritious and designed to serve as an emergency
food supply for the home. Pharmanex also supplies Vitameal as part of a
humanitarian relief effort designed to satisfy the nutritional needs of children at risk
of starvation. We have implemented a program that provides a convenient way for
distributors to donate Vitameal products they purchase from us to relief
organizations for use in humanitarian relief. This initiative is maintained under the
Nourish the Children trademark. In the past 34 months, our distributors have provided over
20 million meals to starving children through this program. Almost 2 million of these
meals were distributed in Southeast Asia to children affected by the tsunami that hit in
late December 2004.
The
following table summarizes the current Pharmanex product lines by category:
| Category | |
Description | |
Selected Products | |
| |
|
|
|
|
| Micronutrient Supplements |
|
Our LifePak family of daily supplements is designed to provide a beneficial mix of nutrients including vitamins, minerals and antioxidants. |
|
LifePak
LifePak Women
LifePak Prime
LifePak Trim
LifePak Teen
LifePak Kosher |
|
| |
|
|
|
|
| Targeted Nutritional Solutions
|
|
Our self-care dietary supplements contain consistent levels
of botanical ingredients that are designed to provide consumers with targeted wellness benefits. |
|
Tegreen 97
ReishiMax GLp
MarineOmega
Cholestin
CordyMax Cs-4
Cortitrol
BioGingko 27/7
IgG Boost
Estera Women |
|
| |
|
|
|
|
| Weight Management
|
|
Our TRA ephedra-free
line of weight management products was created to capitalize on the growing weight management category. TRA supplements are
complementary to any diet program that is currently on the market. |
|
OverDrive
FibreNet
TRA |
|
| |
|
|
|
|
| Other - Specialty Products
|
|
Our portfolio of other nutritional products includes
healthy drinks and other specialty wellness products. |
|
Splash C
Appeal
AloeDrink
|
|
-6-
Big Planet. Big Planet offers high technology products and services that are
currently centered around three product categories: business tools, digital photography
and home care. We evaluate emerging trends in technology and develop products that are
designed to capitalize on these trends while being easy to use. This allows us to provide
compelling and innovative products designed specifically for non-technical people, an
underserved market due to the common complexities of high-tech products. For example, in
2004 we introduced BP Internet Security, an advanced, yet easy-to-use Internet
security software product for home and small business computers, which addresses the
escalating threat of Internet security issues.
Our
Big Planet business tools products and services are designed to enable our distributors to
create and maintain an online business presence and to increase their productivity by
leveraging technology in the management of their direct selling activities. These products
include individual, personalized distributor websites that grant customers easy and
convenient access to information about our products and services. We host these websites
for our distributors and provide content with relevant product and business information.
Distributors may also configure their individual websites, customizing their marketing
efforts and conducting e-commerce activities across our product lines. Other Big Planet
products designed to enhance distributor activity include Internet access, advanced
telecommunication products, online business tools, which help our distributors to monitor
their sales activity, as well as set up meetings, communicate with their sales
organizations and conduct electronic-based marketing efforts.
Our
current development focus centers around digital photography. We believe that the
convergence of trends in digital cameras, mass storage and the Internet offers a unique
opportunity to provide a line of products and services that make it easy for consumers to
preserve, organize, share and enjoy their precious photographic memories. In 2004, we
introduced several new products in this category including: Photo Saver CD, a
service in which we scan traditional photographs and slides, converting them to a digital
form and storing them on a CD; Movie Magic DVD and Picture Show DVD, services
that translate digital photos into personalized movies and/or slide shows on a DVD
utilizing pictures and music selected by the customer. In 2005, we plan to introduce a
digital photo website, Photomax.com, which will make it easy for consumers to view,
organize and share digital pictures online.
We
target some investment at our Ecosphere line of home care products designed to
improve the personal environment by cleaning it and protecting it from potentially harmful
contaminants. This product line is developed primarily for our Asian markets and includes
water purification and surface cleaning products.
-7-
The
following table summarizes the current Big Planet product lines by category:
| Category | |
Description | |
Selected Products | |
| |
|
|
|
|
| Business Tools
|
|
Advanced tools and services
that help distributors and consumers establish an online presence and manage their business. |
|
Global Web Page
BP Mall
ISP for U.S. — by Qwest
ISP for Japan — by Nifty
BP Internet Security |
| |
|
|
|
|
| Ecosphere
|
|
A line of home care products to improve the personal environment. |
|
Water Purifier
Filtering Showerhead
Surface Wipes |
|
| |
|
|
|
|
| Digital Photography
|
|
A line of digital photography
services designed for non-technical consumers. |
|
Picture Show DVD
Movie Magic DVD
Photo Saver CD
Photomax Website
|
|
Sourcing and Production
Nu
Skin. In order to maintain high product quality, we acquire our ingredients and
contract production of our proprietary products from suppliers that we believe are
reliable, reputable and deliver us high quality materials and services. For more than ten
years, we have acquired ingredients and products from one primary supplier that currently
manufactures approximately 41% of our Nu Skin personal care products. Our contract with
this supplier is for a one-year term that automatically renews each year for an additional
one-year term unless either party terminates the contract. We maintain a good relationship
with our supplier and do not anticipate that either party will terminate the contract in
the near term. We also have ongoing relationships with secondary and tertiary suppliers
who supply almost all of our remaining products and ingredients. We believe that, in the
event we are unable to source any products or ingredients from our major supplier, we
could produce or replace those products or substitute ingredients from our secondary and
tertiary suppliers without great difficulty or significant increases in our cost of goods
sold. Please refer to the section below entitled, “Risk Factors” for a
discussion of risks and uncertainties associated with our supplier relationships as well
as the sourcing of raw materials and ingredients.
In
2001, we established our own manufacturing facility in Shanghai, China where we currently
manufacture our personal care products sold through our retail stores in China. A small
portion of the output from this facility is exported to our other markets. As needed, this
facility could be expanded or other facilities could be built in China to provide
manufacturing capabilities for our other markets as a back-up to our major supplier in
addition to our secondary and tertiary suppliers.
The
identification of bovine spongiform encephalopathy (“BSE”, commonly known as
“mad cow disease”) in one cow in the United States in late 2003 has generally
not impacted our ability to import our personal care products into our international
markets, except for a small number of products in South Korea. In addition, China
suspended the importation of any finished goods or bulk cosmetic products from the United
States that do not contain a “BSE-free” certification. Since substantially all
of our personal care products sold through our retail stores in China are produced in our
Shanghai facility, we were able to easily address this issue by accelerating the local
manufacturing of the small number of products we were still exporting in bulk to China.
-8-
Pharmanex.
Substantially all of our Pharmanex nutritional supplements and ingredients,
including LifePak, are produced or provided by third-party suppliers that
we consider to be among the best suppliers of these products and ingredients. We
currently rely on two suppliers for the majority of our Pharmanex products, one
of which supplies approximately 38% and the other of which supplies
approximately 26% of our Pharmanex nutritional supplements. We believe that, in
the event we were unable to source any products or ingredients from these
suppliers or our other current suppliers, we could produce or replace these
products or substitute ingredients without great difficulty or significant
increases in our cost of goods sold. Please refer to the section below entitled,
“Risk Factors” for a discussion of certain risks and uncertainties
associated with our supplier relationships as well as the sourcing of raw
materials and ingredients.
We
also maintain a facility located in Zhejiang Province, China, where we produce herbal
extracts for our Tegreen 97, ReishiMax GLp and other products for sale globally.
We recently completed the build-out of a new manufacturing facility in Zhejiang Province
where we will produce the Pharmanex nutritional supplement products for sale through our
retail stores in China. We are in the process of building a new herbal extract plant
adjacent to this facility which will replace the existing herbal extract facility. We are
also currently planning to build a nutritional supplement manufacturing facility in China
for export, which is scheduled to be on-line by the end of 2006.
Prior
to 2004, substantially all of our Pharmanex revenue was generated from products that were
encapsulated in gel capsules produced with bovine materials. In late 2003, BSE (mad cow
disease) was identified in one cow in the United States, prompting a few countries,
including Japan and South Korea, to suspend importation of nutritional supplements
encapsulated with bovine-based gelatin produced in the United States. In addition, Japan
enacted a prohibition on the sale of such products in the country after February 16, 2004.
In response, we converted some gelatin encapsulated products into an all porcine-based
gelatin form, and switched to tablet form for other products, including LifePak for
the Japanese market. Following the implementation of these measures in early 2004, except
in the U.S., substantially all of our Pharmanex revenue in 2004 was generated from
products that are encapsulated in porcine-based gel capsules or from tablet products.
Substantially all of our nutritional supplement products for sale in the U.S. continue to
utilize bovine-based gel capsules.
To
help ensure the quality of Pharmanex products, we have implemented an extensive quality
control process designed to maintain tight quality controls through all stages of
development, including the sourcing of raw materials and the manufacturing and packaging
of our products. During investigations of potential sources of botanical raw materials, we
conduct analyses of samples from each potential source. Suppliers are chosen based on the
quality and concentration level of the active ingredients present in the source. We also
maintain close working relationships with the manufacturers of our products and their
quality control departments to implement quality assurance programs that meet our
requirements. We regularly check and monitor their compliance with these programs. Our
selection and retention of manufacturers is driven by their ability to meet our strict
quality control criteria.
Since
the initial introduction of the BioPhotonic Scanner in 2003, we have relied on a
third-party manufacturer to produce them. In December 2004, we opened a plant in Shanghai,
China where we self-manufacture BioPhotonic Scanners. This facility will allow us to
produce sufficient BioPhotonic Scanners to support recent launches in Japan and China, and
to support the needs for future launches in other markets.
Big
Planet. Other than web hosting, digital photography services, and online
distributor tools, nearly all of the Big Planet services and products we offer are
currently contracted or sourced from unaffiliated third parties pursuant to contractual
arrangements. By contracting to provide these services or by acting as a commissioned
agent for these services, we are able to avoid the large capital deployment and
-9-
investment
that would be required to build the infrastructure necessary to provide these services.
However, our profit margins and ability to deliver quality services at competitive prices
depend upon our ability to negotiate and maintain favorable terms with our third-party
providers. In connection with our Big Planet digital photography services, we are
developing our own internal infrastructure for these services.
Research and Development
We
continually invest in our research and development capabilities. Our research and
development expenditures were approximately $7 million in 2002, approximately $6 million
in 2003 and approximately $8 million in 2004. The majority of our recent research and
development activities have been directed towards our Pharmanex products. Much of our
Pharmanex research to date has been conducted in China, where we benefit from a very
educated, low cost labor pool that enables us to conduct research and clinical trials at a
much lower cost than we would incur in the United States. We also have a laboratory
adjacent to our office complex in Provo, Utah, which houses both Pharmanex and Nu Skin
research facilities and technical personnel. Because of our commitment to product
innovation, we will continue to commit significant resources to research and development
in the future.
We
believe that we are one of the few nutritional supplement companies in the United States
that has a research and development program modeled after the pharmaceutical industry. We
believe that this research and development capability provides us with an important
competitive advantage in the industry. We employ approximately 125 scientists at our
dedicated research and development centers in Shanghai, Beijing and Utah.
In
order to provide high quality, standardize products, we utilize our unique 6S Quality
Process® in our development and sourcing activities. We believe that this
6S Quality Process enhances our ability to provide consumers with safe, effective and
consistent products. The 6S Quality Process involves the following steps:
| |
• |
|
Selection. Conducting a scientific review of research and databases in connection
with the selection of potential products and ingredients, and determining the
authenticity, usefulness and safety standards for potential products and ingredients. |
| |
• |
|
Sourcing. Investigating potential sources, evaluating the quality of sources
and performing botanical and chemical evaluations where appropriate. |
| |
• |
|
Structure.
Determining the structural profile of natural compounds and active ingredients. |
| |
• |
|
Standardization.
Standardizing the product dosage of its biologically relevant active ingredients.
|
| |
• |
|
Safety. Assessing safety from available research and, where necessary,
performing additional tests such as microbial tests and chemical analyses for toxins and
heavy metals. |
| |
• |
|
Substantiation. Reviewing documented pre-clinical and clinical trials and,
where necessary and appropriate, initiating studies and clinical trials sponsored by
Pharmanex. |
We
also have working relationships with other independent scientists, including a scientific
advisory board comprised of recognized authorities in various related disciplines, and we
evaluate a significant number of product ideas presented to us by outside sources. Our
Pharmanex division also establishes collaborative arrangements with prominent
universities and research institutions in the United States, Europe, and Asia. The staffs
of these institutions include scientists with expertise in natural product
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chemistry,
biochemistry, pharmacology and clinical studies. Some of the university research centers
that we have worked with include UC Davis, UC Los Angeles, Vanderbilt University, Tufts
University, Columbia University, the University of Kansas, the University of Hong Kong
School of Medicine and Taiwan Academia Sinica.
For product development support of our Nu Skin personal care line, we have established an
aggressive licensing strategy and rely on an advisory board comprised of recognized
authorities in various disciplines as well as an in-house staff of research and marketing
professionals. We also have entered into an agreement with the Stanford University Medical
Center for directed research and clinical studies involving Nu Skin products and
materials. These activities are conducted at the Nu Skin Center for Dermatological
Research at Stanford University’s School of Medicine. This center focuses on
scientific investigation, dermatology research, product development and clinical trials.
We believe our strategic alliances provide important access to scientific developments
that can lead to innovative product concepts.
Geographic Sales Regions
We
currently sell and distribute our products in 40 markets, and we operate a direct selling
model in each of our markets except China. Our operations are divided into five geographic
regions: North Asia, Greater China, North America, South Asia/Pacific and Other Markets.
The following table sets forth the revenue for each of the geographic regions for the
years ended December 31, 2002, 2003 and 2004:
Revenue by Region
(U.S. dollars in millions)
|
Year Ended December 31, | |
|
2002 | |
2003 | |
2004 | |
| |
| |
| North Asia |
|
$ 597.1 |
|
62% |
|
$ 612.8 |
|
62% |
|
$ 640.1 |
|
56% |
|
| Greater China | |
104.9 |
|
11 |
|
135.5 |
|
14 |
|
229.8 |
|
20 |
|
| North America | |
142.7 |
|
15 |
|
127.6 |
|
13 |
|
145.7 |
|
13 |
|
| South Asia/Pacific | |
91.1 |
|
9 |
|
75.8 |
|
8 |
|
81.8 |
|
7 |
|
| Other Markets | |
28.3 |
|
3 |
|
34.8 |
|
3 |
|
40.5 |
|
4 |
|
| | |
$ 964.1 |
|
100% |
|
$ 986.5 |
|
100% |
|
$ 1,137.9 |
|
100% |
|
North
Asia. The following table provides information on each of the markets in the North
Asia region including the year it was opened, 2004 revenue, and the percentage of our
total 2004 revenue for each market:
| (U.S. dollars in millions) |
Year Opened |
2004 Revenue |
|
Percentage of
2004 Revenue |
|
| |
|
|
|
|
|
|
|
| Japan |
|
1993 |
|
$
574.4 |
|
51% |
|
South Korea
|
|
1996 |
|
$
65.7 |
|
5% |
|
Japan
is our largest market globally, accounting for approximately 51% of our revenue in 2004.
Distributors and customers can purchase products via telephone or in any of three walk-in
centers in Japan. Most of our orders in Japan, however, come through monthly product
subscription programs and via the Internet, making our product ordering process efficient
and improving customer retention. We also operate distributor business consultation
centers in Tokyo and Osaka for the use of distributors in conducting business. We
currently offer most of our Nu Skin and Pharmanex products for sale in Japan and a limited
number of Big Planet products. In addition, all three product divisions offer a limited
number of locally developed products sold exclusively in our Japanese market. In November
2004, we
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launched the BioPhotonic Scanner into Japan and began leasing them to some of our
key distributor leaders. We currently lease over 200 BioPhotonic Scanners to distributor
leaders in Japan, and plan to expand this program throughout 2005. We have also recently
implemented modifications to our compensation plan in this market to promote increased
participation in our monthly product subscription program as well as sponsorship and
executive distributor development.
In
South Korea, we currently offer most of our Nu Skin and Pharmanex products and a limited
number of Big Planet services. We also made the BioPhotonic Scanner available in our
walk-in centers in this market in January 2005, and plan on offering short-term
BioPhotonic Scanner leases to our top performing executive distributors. Products are
available through two walk-in centers in this market in addition to phone, Internet, and
monthly product subscriptions. The South Korean market has been subject to difficult
economic and geopolitical conditions during the last two years that have impacted the
industry overall. However, we enjoy strong local support from our distributor leaders who
remain dedicated to our products and business plan in South Korea and we have successfully
grown our business there during this difficult period.
Greater
China. The following table provides information on each of the markets in
the Greater China region including the year that sales of Nu Skin products began, 2004
revenue, and the percentage of our total 2004 revenue for each market:
| (U.S. dollars in millions) |
Year Opened |
2004 Revenue |
|
Percentage of
2004 Revenue |
|
| |
|
|
|
|
|
|
|
| China |
|
2003 |
|
$
105.6 |
|
9% |
|
| Taiwan |
|
1992 |
|
$
82.8 |
|
7% |
|
Hong Kong
|
|
1991 |
|
$
41.4 |
|
4% |
|
In
Hong Kong and Taiwan, we operate our global direct selling business model utilizing our
global compensation plan. In Hong Kong, we have a product showcase where distributors can
purchase products, a distributor business center where distributors can conduct business,
and a warehouse to store products. The vast majority of sales in Hong Kong are transacted
at our product showcase. In Taiwan, we operate four distributor walk-in centers where
products can be ordered and picked up along with a warehouse that ships the majority of
product orders to distributors and customers. In each of these markets we conduct frequent
training meetings for the sales force, quarterly seminars of a larger scale, and large
conventions every 12 to 18 months. In Hong Kong, our conventions are regional conventions
due to the proximity of Hong Kong to China.
We
currently offer a robust product offering of the majority of our Nu Skin and Pharmanex
products in Hong Kong and Taiwan, and only limited Big Planet products and services. In
recent years, we have begun to place significant focus in Hong Kong and Taiwan on our
monthly product subscription program for distributors and customers. The majority of our
revenue in these markets now comes from such orders, which has lead to improved retention
of customers and distributors and has streamlined the ordering process. In addition, in
late 2004 we began leasing BioPhotonic Scanners to our distributors in these two markets,
and we currently lease approximately 250 BioPhotonic Scanners to distributor leaders
there.
We
currently do not operate under our global direct selling business model in China as a
result of regulatory restrictions on direct selling activities in this market.
Consequently, we have developed a retail s