Nu Skin 2010 Annual Report - Direct Selling News

estrictions on the importation of finished goods applicable to the
current scope of our business in China, we are required to manufacture
the bulk of our own products for distribution in China. Cost of
sales and gross profit may fluctuate as a result of changes in the ratio
between self-manufactured products and products sourced from
third-party suppliers. In addition, because we purchase a significant
majority of our goods in U.S. dollars and recognize revenue in local
currencies, we are subject to exchange rate risks in our gross margins.
Because our gross margins vary from product to product and are
higher in some markets such as Japan, changes in product mix and
geographic revenue mix can impact our gross margins.
Selling expenses are our most significant expense and are classified
as operating expenses. Selling expenses include distributor commissions,
costs for incentive trips and other rewards, as well as wages,
benefits, bonuses and other labor and unemployment expenses we
pay to sales employees in China. Our global compensation plan,
which we employ in all of our markets except China, is an important
factor in our ability to attract and retain distributors. We pay monthly
commissions to several levels of distributors on each product sale
based upon a distributor’s personal and group product volumes, as
well as the group product volumes of up to six levels of executive
distributors in such distributor’s downline sales organization. We do
not pay commissions on sales materials, which are sold to distributors
at or near cost. Small fluctuations occur in the amount of commissions
paid as the network of distributors actively purchasing products
changes from month to month. However, due to the size of our distributor
force of approximately 800,000 active distributors, the fluctuation
in the overall payout is relatively small. The overall payout has
typically averaged between 41% and 44% of global product sales.
From time to time, we make modifications and enhancements to our
global compensation plan in an effort to help motivate distributors
and develop leadership characteristics, which can have an impact on
selling expenses.
Distributors also have the opportunity to make retail profits by
purchasing products from us at wholesale and selling them to customers
with a retail mark-up. We do not account for nor pay additional
commissions on these retail mark-ups received by distributors.
In many markets, we also allow individuals who are not distributors,
whom we refer to as “preferred customers,” to buy products directly
from us at wholesale or discounted prices. We pay commissions on
preferred customer purchases to the referring distributors.
General and administrative expenses include:
• wages and benefits;
• rents and utilities;
• depreciation and amortization;
• promotion and advertising;
• professional fees;
• travel;
• research and development; and
• other operating expenses.
Labor expenses are the most significant portion of our general
and administrative expenses. Promotion and advertising expenses
include costs of distributor conventions held in various markets
worldwide, which we expense in the period in which they are incurred.
Because our various distributor conventions are not always held during
each fiscal year, or in the same period each year, their impact on
our general and administrative expenses may vary from year to year
and from quarter to quarter. For example, we held our global distributor
convention in October 2009 and will have another global convention
in the fall of 2011 as we currently plan to hold a global convention
every other year. In addition, we hold regional conventions and conventions
in our major markets at different times during the year.
These conventions have significant expenses associated with them.
Because we have not incurred expenses for these conventions during
every fiscal year or in comparable interim periods, year-over-year
comparisons have been impacted accordingly.
Provision for income taxes depends on the statutory tax rates in
each of the jurisdictions in which we operate. For example, statutory
tax rates in 2010 were approximately 16.5% in Hong Kong, 20% in Taiwan,
22% in South Korea, 45% in Japan and 25% in China. We are
subject to taxation in the United States at the statutory corporate
federal tax rate of 35% and we pay taxes in multiple states within the
United States at various tax rates. Our overall effective tax rate was
34.5% for the year ended December 31, 2010.
CRITICAL ACCOUNTING POLICIES
The following critical accounting policies and estimates should be
read in conjunction with our audited Consolidated Financial Statements
and related Notes thereto. Management considers our critical
accounting policies to be the recognition of revenue, accounting for
income taxes, accounting for intangible assets and accounting for
stock-based compensation. In each of these areas, management
makes estimates based on historical results, current trends and future
projections.
Revenue. We recognize revenue when products are shipped,
which is when title and risk of loss pass to our distributors. With some
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