NU SKIN ENTERPRISES  52 51 NU SKIN ENTERPRISES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY NOTE 2. SUMMARY OF SIGNIFICANT  ACCOUNTING POLICIES Nu Skin Enterprises, Inc. (the “Company”) is a leading, global direct selling com- pany that develops and distributes premium-quality, innovative personal care products and nutritional supplements and technology and telecommunications products and services. The Company distributes products throughout the world. The Company’s operations are divided into four segments: North Asia, which consists of Japan and South Korea; North America, which consists of the United States and Canada;  Southeast Asia, which consists of Australia, Hong Kong (including Macau), New Zealand, the PRC (China), the Philippines, Singapore, Taiwan and Thailand; and Other Markets, which consists of the Company’s markets in Brazil, Europe, Guatemala and Mexico (the Company’s subsidiaries operating in these countries are collectively referred to as the “Subsidiaries”). The Company was incorporated on September 4, 1996 as a holding company. As discussed in Note 3, the Company completed the NSI Acquisition on March 26, 1998. Prior to the NSI Acquisition, each of the acquired entities elected to be treated as an S corporation.  As discussed in Note 4, the Company completed the Pharmanex Acquisition on October 16, 1998, which enhanced the Company’s involvement with the distribution and sale of nutritional products. As discussed in Note 5, on March 8, 1999, Nu Skin International, Inc. (“NSI”) a subsidiary of the Company, terminated its distribution license and various other license agreements and other intercompany agreements with Nu Skin USA, Inc. (“Nu Skin USA”). Also, in March 1999, through a newly formed wholly-owned subsidiary, the Company acquired selected assets of Nu Skin USA. In May 1999, the Company acquired Nu Skin Canada, Inc., Nu Skin Mexico, Inc. and Nu Skin Guatemala, Inc. (collectively, the “North American Affiliates”). As discussed in Note 6, the Company completed the Big Planet Acquisition on July 13, 1999, which enabled the Company to provide marketing and distribution of technology-based products and services. CONSOLIDATION: The consolidated financial statements include the accounts of the Company and the Subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. USE OF ESTIMATES: The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America required management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include reserves for product returns, obsolete inventory and taxes. Actual results could differ from these estimates. CASH AND CASH EQUIVALENTS: Cash equivalents are short-term, highly liquid instruments with original maturities of 90 days or less. INVENTORIES: Inventories consist primarily of merchandise purchased for resale and are stated at the lower of cost, using the first-in, first-out method, or market. The Company had reserves for obsolete inventory totaling $13,600,000, $7,200,000 and $2,800,000 as of December 31, 1998, 1999 and 2000, respectively. PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost and depreciated using the straight-line method over the following estimated useful lives: OTHER ASSETS: Other assets consist primarily of deferred tax assets, deposits for noncancelable operating leases, distribution rights, goodwill and long-term intangibles acquired in the NSI Acquisition (Note 3), the Pharmanex Acquisition (Note 4) and the Furniture and fixtures 5–7 years Computers and equipment 3–5 years Leasehold improvements Shorter of estimated useful life or lease term  Vehicles 3–5 years Expenditures for maintenance and repairs are charged to expense as incurred. Big Planet Acquisition (Note 6). The goodwill and intangible assets and distribution rights asset are being amortized on a straight-line basis over their estimated useful lives ranging from 4 to 20 years. The Company assesses the recoverability of long-lived assets by determining whether the amortization of the balance over its remaining life can be recovered through undiscounted future operating cash flows attributable to the assets. REVENUE RECOGNITION: Revenue is recognized when products are shipped and title passes to independent distributors who are the Company’s customers. A reserve for product returns is accrued based on historical experience. The Company generally requires cash or credit card payment at the point of sale. The Company has determined that no allowance for doubtful accounts is necessary. Amounts received prior to shipment and title passage to distributors are recorded as deferred revenue. In December 1999, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The implementation of SAB 101 did not significantly impact the Company’s revenue recognition policies.  RESEARCH AND DEVELOPMENT: The Company’s research and development activities are conducted primarily through its Pharmanex division. Research and development costs are expensed as incurred. INCOME TAXES: The Company has adopted Statement of Financial Account- ing Standards No. 109 (“SFAS 109”), Accounting for Income Taxes. Under SFAS 109, the liability method is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. NET INCOME PER SHARE: The Company computes earnings per share under Statement of Financial Accounting Standards No. 128 (“SFAS 128”), Earnings per Share. SFAS 128 specifies the computation, presentation and disclosure requirements for earnings per share data. SFAS 128 also requires the presentation of both basic and diluted earnings per share data for entities with complex capital struc- tures. Diluted earnings per share data gives effect to all dilutive potential common shares that were outstanding during the periods presented. FOREIGN CURRENCY TRANSLATION: Most of the Company’s business operations occur outside of the United States. Each Subsidiary’s local currency is considered the functional currency. Since a substantial portion of the Company’s inventories are purchased with U.S. dollars in the United States and since the Company is incorporated in the United States, all assets and liabilities are translated into U.S. dollars at exchange rates existing at the balance sheet dates, revenues and expenses are translated at weighted average exchange rates, and stockholders’ equity is recorded at historical exchange rates. The resulting foreign currency translation adjustments are recorded as a separate component of stockholders’ equity in the consolidated balance sheets, and transaction gains and losses are included in other income and expense in the consolidated financial statements. FAIR VALUE OF FINANCIAL INSTRUMENTS: The fair value of financial instruments including cash and cash equivalents, accounts receivable, related parties receivable, accounts payable, related parties payable and notes payable approximate book values. The carrying amount of long-term debt approximates fair value because the applicable interest rates approximate current market rates. Fair value estimates are made at a specific point of time, based on relevant market information. STOCK-BASED COMPENSATION: The Company measures compen- sation expense for its stock-based employee compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and provides pro forma disclosures of net income and net income per share as if the fair value based method prescribed by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), Accounting for Stock-Based Compensation, had been applied in measuring compensation expense (Note 14). REPORTING COMPREHENSIVE INCOME: The Company has adopted Statement of Financial Accounting Standards No. 130 (“SFAS 130”), Reporting Comprehensive Income. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources, and it includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities. The statement