如新 (NUS) 2003 Q2 法說會逐字稿

Good morning. My name is Sylvia and I will be your conference facilitator. At this time I would like to welcome everyone to the Nu Skin Enterprises second quarter investor call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. Thank you.

Mr. Allen, you may begin your conference.

Thank you. Good morning. We appreciate all those joining us today on this conference call and listening over the Internet. With us on the call this morning are Truman Hunt, President and Chief Executive Officer; and Ritch Wood, Chief Financial Officer. Following management's discussion of the company's operations, the call will be open for questions.

As a reminder, during this conference call comments may be made which will include some forward-looking statements. These statements involve risks and uncertainties, and, as you know, actual results may differ materially from those discussed or anticipated. We encourage you to refer to a copy of our 10K, our most recent 10Q, and today's earnings release for a complete discussion of risks associated with these forward-looking statements and our business.

I will now turn the time over to Mr. Truman Hunt.

Thanks, Charlie. Good morning, everyone, and thanks for joining us this morning. Today we reported revenue of $241m for the second quarter which is $6m above our projected range. We're encouraged by stronger than expected revenue from many of our markets and earnings at the high end of our expectations at 21 cents per share which is a penny above the consensus estimate.

At the beginning of the second quarter, we articulated our top three geographic priorities. First, generating revenue growth in Japan; second, revitalizing the U.S. business; and third, stabilizing our China operations. We made good progress in each of these areas during the second quarter. After three quarters of accelerating revenue declines year over year in Japan, we stopped that trend by reporting a 6 percent revenue decline in local currency which was even with first quarter year-over-year comparisons. While our executive distributor account was down in Japan compared to prior year results, we began to see during the quarter the positive impact of distributor incentive programs that are expected to help increase our executive distributor account in Japan throughout the remainder of the year.

In addition, to these incentives, new product launches, specifically Pharmanex's Reishi/Max product and Nu Skin's Tru Face Essence product are also helping us turn the tide in Japan. We're also making important strides in the U.S. Increasing distributor activity tied to the Pharmanex BioPhotonic Scanner program drove the 37 percent revenue growth in U.S. Pharmanex revenue with Nu Skin revenue holding relatively flat for the quarter. Revenue from automatic delivery subscriptions increased 24 percent in the United States over the second quarter of 2002 which is a good sign as these customers tend to be long term in nature.

Additionally, nearly all distributor indicators are up over last year's results in the U.S. including the executive distributor account which was up 18 percent year over year. While the Scanner is key to our U.S. market development plans, fortunately other products and programs are also having a positive impact.

We performed very well in China in Q2 where we posted $5.8m in second quarter revenue, up 50 percent sequentially. We recently concluded the government's review of our business which resulted in no modifications to our current operating structure, and all of our stores in all the provinces where the stores are located are also open and functioning fully.

Although we need to continue to develop positive government relations, we're making encouraging progress in this important market. We believe we're building a strong foundation for exceptional long-term growth in China and expect to report 2003 revenue at the higher end of our $20m to $30m target range.

Now, just a few quick highlights from other markets. South Korea revenue was down 21 percent during the quarter in local currency. This is a market that is really struggling economically and there's little consumer confidence in the new government there. These factors are negatively impacting the entire retail environment and the direct selling industry. However, revenue was up 10 percent sequentially and we expect that the year-over-year revenue decline in the third quarter will be about half that of the second quarter.

In September at our annual distributor conference in Seoul we'll implement some new distributor incentives and compensation plan modifications and launch several new products which we think will be very well received by our distributor force there. We're hopeful that this effort will stabilize the market.

You will also note in our release that we've divided what was our Southeast Asia region into two regions, greater China and South Asia-Pacific. In greater China, which includes mainland China, Taiwan and Hong Kong, the SARS epidemic negatively impacted revenue in the quarter. It's hard to tell to what extent revenue was impacted, but as the crisis ended in late May we definitely saw a rebound through the end of the quarter.

It's also fair to note that the 2002 comparison is a bit tough because in Q2 in 2002 our results were positively impacted by activity precipitated by our announcement of plans to expand into China.

Other than Malaysia and Singapore, our South Asia-Pacific markets reported strong revenue during the second quarter. In local currency, Thailand was up more than 85 percent and Australia and New Zealand posted an 11 percent revenue gain. However, the 50 percent decline in Malaysia and Singapore more than offset the growth elsewhere. But Singapore and Malaysia have also trended much better recently and we expect these markets to post improving sequential results in the third quarter.

Now, shifting to our product divisions, Nu Skin's 6 percent revenue decline was due primarily to decreased revenue in Japan, South Korea, Singapore and Malaysia. However, on a positive note, Nu Skin had an important product introduction with Tru Face Essence, an advanced skin firming product which was launched in Japan in late March and continues to perform very well. We actually sold through our inventory level in just six weeks and unfortunately missed most of May and June sales of this product. But we're back in stock as of about 10 days ago and the product is selling very well. We're also moving forward with plans to roll Tru Face Essence out in Taiwan and South Korea in September.

Pharmanex posted 3 percent revenue growth during the second quarter driven by the Scanner in the United States, the introduction of Reishi/Max and solid ADP growth in many of our markets around the world. In addition, several of our immune products enjoyed stronger sales in markets affected by SARS. The Scanner remains central to our Pharmanex strategy and we're working to refine our marketing plan to leverage the Scanner in many of our markets around the world by the end of the year.

Big Planet's revenue was negatively impacted in the second quarter by our focus on higher margin Pharmanex and Nu Skin products and by a decline in revenue from the Professional Employer Organization. We've been given board approval to complete the sale of the PEO which is expected to be completed during the third quarter.

Additionally, we're shifting the Big Planet telecommunications business from a provider relationship to an agency relationship effective August first. While these steps will negatively impact revenue by approximately $5m during the quarter, profitability overall will improve.

Now, with that, let me ask Ritch Wood to provide more details on our financial results.

Thank you, Truman. Good morning, everyone. Let me quickly provide the local currency sales figures from our major geographies. Japan revenue for the quarter was 16.3b yen versus 17.3b yen last year. South Korea was 17.6b won versus 22.3b won in 2002.

In Greater China, revenue from Taiwan during the quarter was 651m NT dollars versus 682m NT dollars last year, while Hong Kong revenue was 42m Hong Kong dollars versus 44m Hong Kong dollars last year. And China revenue was 48.3m renminbi during this quarter. In South Asia, the combined U.S. dollar revenue for Malaysia and Singapore was $8.7m versus $16.8m in the second quarter of '02. Our U.S. market generated $29.4m of revenue in the second quarter compared to $32.5m in 2002. Second quarter revenue in Europe was $8.3m compared to $6.5m in the second quarter of 2002.

The company's gross margin improved approximately 100 basis points compared to second quarter, 2002, results. The year-over-year improvement in gross margins related to the company's continued emphasis on promoting higher margin products as well as the strengthening of the Japanese yen versus the U.S. dollar. Distributor incentives as a percent of revenue were up over the prior year period due to lower Big Planet revenue as well as some special initiatives and incentives designed to reward new distributor leadership, particularly in Japan and in the United States.

Selling, general and administrative expenses increased $2.9m compared to the prior year period because of the strengthening of the Japanese yen which added about $1.6m year over year to reported results and incremental expenses associated with our business in China. Consequently, operating margin for the quarter was down approximately 170 basis points from second quarter, 2002, results. The company posted a $1m gain in other income during the quarter due to the fluctuations of the Japanese yen.

With the continued shift in Big Planet revenue, we expect gross margin to improve to approximately 82 percent in the third quarter and then improve a bit more in the fourth quarter. However, we anticipate that at the same time distributor incentives as a percent of revenue will increase approximately 50 to 70 basis points by the end of the year. The company's second quarter cash position increased by $9.8m to $113.7m as a result of $18.6m of cash flow generated from operations during the quarter. The company paid $5.6m in dividends and repurchased $2.3m of company stock during the second quarter.

With the investments that we are making in China and with the Scanner and elsewhere, we are keeping a close eye on operating expenses. We're taking a close look at our cost structure to ensure our spending is focused on the most promising growth opportunities. The divestiture of the Professional Employer Organization is part of this effort. In addition, we've offered an early retirement package to eligible employees in Provo which will be concluded during this quarter. We're also evaluating all of our departments and every business function to ensure that our resources are focused on revenue driving activities.

Including the impact of lost revenue from the sale of the PEO and the change in the Big Planet telecommunications business, revenue in the third quarter is expected to be $230m to $240m. As a result of the evaluation of our cost structure, as well as the third quarter divestiture of the Big Planet PEO, we anticipate taking a $5m to $6m one-time charge during the third quarter. Earnings per share, excluding this one-time charge, are expected to be in the 20-23 cent range for the third quarter and 83-86 cents, as previously guided for the year. On a GAAP basis, earnings per share for the quarter are expected to be in the 15-18 cent range. Earnings per share for 2003 are expected to be 78 to 81 cents.

The non-GAAP projections include on an after-tax basis an estimated 2 cents per share charge related to the planned sale of PEO and an estimated 3 cents per share charge related to the early retirement program and other non-recurring employee separation charges.

With that, I'll turn the call back to Truman.

Thanks, Rich. Looking at the balance of 2003, then, we find ourselves feeling much better than we did three months ago. The world is fortunately a calmer place and we're encouraged about our prospects. Our top priority remains generating growth in Japan. As our press release indicates, to help in this effort, we're moving three regional personnel to Japan who have overseen both Japan and South Korea from Provo, including Robert Conlee, who will be the President of the North Asia region. Robert has overseen the North Asia region for the past two years from Provo, and he's very familiar with the region, having already spent five years in Tokyo for us.

Second, we need to continue the healthy growth and momentum we've seen in the United States and China. We now have about 230 BioPhotonic Scanners in use in the U.S. and we continue to make progress in refining the technology and the manufacturing process. We're putting about 15-20 of these units into the market each week, and increasing access to the Scanner is helping distributors to grow their business.

As I already indicated, during the second quarter, the regulatory review of our China operations was concluded with no changes to our current business model, and our government relations there continue to improve. Our sales growth in China, however, is centered in just a few cities and we're focused on driving growth in additional cities where we currently operate throughout the remainder of the year.

We recognize the need to stem the sales decline in South Korea, Singapore, and Malaysia. We have good managers focused on these countries and we believe these markets will post improving sequential results in the third quarter. By focusing more corporate resources on our strategic priorities, we believe we can more consistently grow our active and executive distributor accounts, establish solid revenue growth and continue to improve profitability.

Our spending will be in three key areas. Number one, development of distributor leadership and retention of distributors; number two, product development and marketing, marketing support of new products and distributor tools; and number three, creation of a successful emerging market business model.

We need to refine a business model that's more viable than our current model in developing economies, and in furtherance of this effort we're launching a new business approach in Brazil later this year, which is one of the largest direct selling markets in the world. And we're pleased to have with us supervising that effort our newly appointed general manager in Brazil, Jhou Maggioli [ph], who formerly was President of Avon Brazil and really built Avon to be what it is down in that important South American region. We're committed to figuring out a better way to do business in Brazil and other developing economies.

OK. With that, we would like to open the call for questions.

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Again, if you wish to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Doug Lane from Avondale Partners.

Yes, hi. Good morning, everybody.

Hey, Doug.

Looking at North Asia, which has both Japan and Korea in it, it looks like that is where, I guess, the sharpest sequential decline was in your executive distributorship, going from 16,600 to almost 16,300 in the second quarter. Given the programs that you've talked about on this call, both in Japan and Korea, when should we look for sequential improvement, do you think, in that executive distributorship count? Is that something we could see as soon as the third quarter or do you think it's going to take a couple quarters to really work that through?

No, Doug. We think that you'll see sequential improvement in Q3. Remember that at the end of Q1, we talked about the impact of our China opening in Q1 and the fact that a lot of our distributor leaders had frankly taken their eye off the ball in their home markets. That was certainly the case in both Japan and South Korea, and the dynamics we see now in those markets is positive. And in fact, as our release indicates, distributor indicators in Japan are quite positive as we've seen a real rebound in our application rate among those who are interested in becoming executives. So we think you'll see some improvement there in Q3.

That's encouraging. The other thing - you know, you broke out Greater China, which makes a lot of sense to me, to distinguish those three markets from the rest of Southeast Asia. It just makes my math a little bit more difficult, at least for this call, until I get it all figured out. But are the executive distributors in that South Asia and Pacific market - what about the stabilization there? Because we had that big growth in Singapore and Malaysia and now we're sort of going through this contraction. My sense is a lot of what you talked about in Japan and Korea - in other words, the excitement of China and then the reality of China being a slow build, not a, you know, quick kind of market to develop, might have discouraged some distributors in South Asia. So if you could just give us an update on trends there.

Yeah, that's true. China did have that impact. The fortunate thing is that with China trending the way it is currently, we believe that a lot of our distributors around the world are going to, frankly, be a little bit surprised at the degree to which China volume is showing up in their checks. And so I think that that's going to have, you know, a positive impact in the Great China region and in the South Asia region. Rich, do you want to comment on the trend there?

Yeah, I think - it's a good question, Doug. I think we'll see Taiwan and Hong Kong level off in terms of their numbers. They have contracted slightly. It's certainly been more than offset by our growth in China, which, as you noticed, we reported 1,200 executives in that market. Really, the executive growth coming forward in China will be pretty much organic. It will be driven by the local leadership there in China. So I think overall, you know, it's a good investment on the distributors' part even though it's caused us to be a little soft in our executive count in some of the other markets.

I see. OK, thank you.

You bet.

Your next question comes from Kathy Reid from Stanford Financial [ph].

Good morning. Could you please give us a little more clarity on the new compensation plan that you have for distributors in South Korea in addition to the convention that you're going to have in Seoul which should bolster local currency growth there. Just - what changes did you make to distributor incentive already in that region so that we should see improving productivity coming from them in the third quarter?

You know, what happened, Kathy, was last fall, after the new government was elected, they imposed some changes on direct selling laws generally and those changes required us to make, you know, relatively modest modifications to our compensation plan, and in many ways, the changes that were made weren't hugely material. But any change in a compensation plan tends to be disarming to distributors because they have to stop and figure out what that does to their commission flow and how they need to change the way that they're marketing the business opportunity proposition.

So, you know, it wasn't that the changes were all that hugely material, but in the intervening months we have spent quite a bit of time working with our Korean leadership, both corporate and distributor leadership, and we have decided to implement some modifications to our comp plan that, again, aren't enormous in nature, but will be better designed to promote the way they want to do the business in South Korea. And, you know, given the fact that we developed these changes now with distributor leadership in tow and they're fully endorsing the changes, we think that's going to have a calming affect on the market.

OK, great. And just the past week we saw some earthquakes in Japan. Did any of that have any affect on your business?

No.

OK, great. And lastly, just - what are you budgeting your currencies at for the rest of the year?

Let me respond to that, Kathy, if I can. This is Ritch. Real quick, we've got the Japanese yen at approximately 120 going forward.

Is that just the second half or the third quarter?

That's for third and fourth quarters. And the others - you know, we don't see a lot of change happening from where they're at, you know, the ranges that they're in right now. You know, we don't see a ton of change, so...

OK, great. Thank you.

You're welcome.

Your next question comes from Bill Steele from Banc of America.

Thanks, good morning. I was hoping you would maybe touch on the cost savings that you will get from the employee retirement program that you're implementing.

Sure, Bill. This is Ritch.

Hi, Ritch.

Hi. You know, we are seeing a number of opportunities where we think we can invest some money and really drive some growth, some growth initiatives that Truman has addressed in his call. We don't see this as a cost-cutting measure but more a realignment of these costs into some initiatives that we believe can grow some revenue. So we don't expect to see, you know, SG&A numbers decline significantly. We're going to put some of this money back into our distributor incentives to develop some leadership. We're going to put some into our development of an emerging market model. We're going to put some into research and development, the rollout of the Scanner, not only to further roll that out in the U.S. but to roll that into some of our foreign markets. And so that's where the dollars are going to be allocated.

And that makes sense. How quickly do you think you could generate the cost savings for redeployment?

We anticipate that most of these cost savings will be completed in the third quarter. You know, we've debated on whether we roll this out over a long period of time or whether we take the charge and get it done with. We anticipate that most of the cost savings initiatives will be complete during the quarter, during the third quarter, and then reinvesting those dollars even beginning the end of this quarter and into the coming quarters.

OK. And, Ritch, while I have you on the phone, cash flow from operations was down about 41 percent. Can you kind of tell me what you think cash flow will be for the full year, because your first half was pretty weak.

That's right. We anticipate our cash flow increasing. It was approximately $20m this quarter. Would anticipate that increasing both Q3 and Q4, and cash from operations being somewhere in the $80m to $90m range for the year.

And have you made any changes to your cap ex budget?

No. Still approximately $25m to $30m for the year.

OK. And then the last question is what were the changes that you made in the incentive program in Japan in the second quarter?

Well, we did two things. We actually are running an incentive this year, Bill, for executives to quality for a trip out of Japan, which they're excited about, and that's costing some money. But we also put in place an incentive that rewards the creation of new executives. And basically it's a bonus that we're paying out to new executives that is above and beyond our normal compensation plan.

And these would be temporary, it sounds like.

Yes.

OK, great. Thank you.

You bet.

Your next question comes from Pria Orey [ph] from Banc of America Securities.

Hi, my question has been answered. Thank you.

Thank you. Your next question comes from Alice Longley from CSFB.

Hi, good morning.

Hi, Alice.

Good morning.

Hi. A question about sales, I guess, in the third and fourth quarter. It looks like even taking Big Planet out of comparisons that you're expecting sales to be down a little bit in the third quarter. And could you tell us what you're looking for for North Asia in dollars?

Sure. You know, just to remind you that in Q3 and Q4, we'll lose about $5m from our Big Planet, you know, restructuring in the third quarter and about $6m compared to the previous year in the fourth quarter.

For Japan, let me just talk in percentage terms. We anticipate that Japan, which was down 6 percent year over year in the second quarter, will improve to being down about 4 percent or so in the third quarter, and, you know, we mentioned that Korea would also be cut in half. On a U.S. dollar basis - let me just pull that up real quick. We anticipate probably somewhere in the $140m to $150m range in Q3 for North Asia, and, you know, improving to $150m to $160m in Q4 for those two markets.

At this time, I would like to remind everyone - if you would like to ask a question, please press star, then the number one on your telephone keypad. You have a follow-up question from Alice Longley from CSFB.

Similarly, what do you expect the executive distributor count to be in North Asia in the third and fourth quarter and on a year-over-year basis, not sequentially. I think you were down 12 percent in the second quarter?

That's right. That will begin to improve. As you recall, our numbers in Japan, particularly last year in the second quarter, were very high. In fact it was the all-time high for the year. And so we would anticipate closing that gap as we go forward. I think we can probably expect or plan to add about 1,000 executives in Q3 to where we're at in Q2 right now.

OK. And then my other question is on the distributor incentive percentage. It looks like you expect it for the year to hit maybe 41 percent? Could you - is that right?

That's correct, yes.

And then where would you anticipate it being for next year? Is it going to stay - this is sort of built on a former question. Is it going to go back to 40 percent or are we going to stay with 41 percent?

No, I think we'll stay with 41 percent. The primary reason for the shift, again, Alice, is this move away from Big Planet revenue which paid very little or no commission. And so as we’ve made that shift, it's created this increase in our distributor incentive. So it will stay pretty close to the 41 percent going forward.

Where would you expect gross margins to be for both years?

We anticipate, as we mentioned, it moving to about 82 percent and probably picking up another 30 to 40 basis points in the fourth quarter. It should hold at about that level, between 82 and 82.5 percent into the next year.

OK, thank you very much.

You're welcome.

Your next question comes from Chris Ferrara [ph] from Merrill Lynch.

Good morning.

Hi, Chris.

I was just wondering. Would you guys be able to give just a little bit of color on why you're sending people over to Japan? Is it just to get more focused on the market specifically?

Yeah. You know, all of the personnel we're sending over, Robert Conlee and Alex Jerhan [ph] and Courtland Pierson [sp], have all spent a number of years in the market. And as you know, Robert was essentially Vamu San's [ph] right hand manager for five years and so he's very familiar with the market. And, you know, it's really - we're really pleased with the dynamic we see, Chris, when we put our regional managers out into the market. I mean frankly, you know, we like having Corey [ph] on the ground in Shanghai. It's just a tremendous benefit to the business there to have him there making decisions real time rather than trying to communicate overnight. And so, you know, we've decided to put Robert and Alex and Courtland back into the market where they can just focus more time and energy on a real-time basis to grow the business there.

Got it. I also wanted to ask you - maybe you could reconcile something for me. I think you guys said U.S. sales were $29.4m, down from $32.5m, down about $3m. Now, when Pharmanex was up 37 percent and Nu Skin was about flat and Big Planet as a whole was only down, I guess, $800,000, about 6 percent if my numbers are right - am I missing a piece of the U.S., why it was down [inaudible]something that is if not in those three divisions?

Yeah, let me just give a little clarification on that, Chris. Big Planet was actually down $2m approximately in the telecommunications business, about $2m in the PEO business year over year, and then there was about a $1.4m FAS 133 loss that comes through our revenue line reported in North America that would have hit as well [inaudible].

Big Planet has also declined more in the U.S. than it has outside the U.S. where we're generating some Big Planet sales in Japan and Taiwan in particular and now they're making up some of that decline.

And we should mention, too, that those sales in the foreign markets are all very profitable sales and fit within the model of the other businesses.

Got it. Thank you.

Yep.

At this time there are no further questions. Gentlemen, are there any closing remarks?

No. Just quickly, thank you, again, for joining us this morning, and as always, Ritch, Charlie or I would be happy to address any questions that you have. Thanks. Have a good day.

Thank you for participating in the Nu Skin Enterprises second quarter investor call. You may now disconnect.