如新 (NUS) 2005 Q1 法說會逐字稿

Good afternoon. My name is Monica and I will be your conference facilitator. At this time, I would like to welcome everyone to the first-quarter earnings conference 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. (Operator Instructions). Thank you. Mr. Allen, you may begin your conference.

Thank you. Good afternoon. We appreciate all those joining us today on this conference call and listening over the Internet. With us on the call this afternoon 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 include some forward-looking statements. These statements involve risks and uncertainty, and as you know, actual results may differ materially from those discussed or anticipated. We encourage you to refer to today's earnings release and our SEC filings for a complete discussion of risks associated with these forward-looking statements and our business. I'll now turn the time over to Truman.

Thank you, Charlie. Good afternoon, everyone, and thanks for joining us today. This morning, we reported earnings per share of $0.25, which represents a 25% increase over last year and is ahead of our guidance. We also generated record first-quarter revenue of $289.4 million, which is up 10% over last year's results. We're really pleased to start off the new year with another record quarter. In fact, four of the last five quarters have been record revenue quarters for us. This quarter, we're particularly encouraged by increased revenue in all of our key geographies, especially Japan, where our local management team there is doing a good job of getting this market back on track. The launch of the Pharmanex biophotonic scanner, along with recent compensation enhancements, continue to help generate positive momentum in Japan. As we've explained over the past year, the scanner has been very effective in growing our product subscriber base. This is certainly the case in Japan, where our subscriptions were up about 47% over last year. In 2005, we will continue to stimulate growth in Japan by focusing on scanner initiatives. Currently, we have about 400 scanners leased in the market today, and we expect to have about 1000 or so leased by the end of the second quarter.

Turning to the United States, we posted solid year-over-year revenue growth of 15%, excluding sales to international distributors, which occurred at our February convention of last year in Salt Lake City. Pharmanex revenue was up 18% year-over-year, when also excluding convention sales.

During the quarter, our subscription orders in the U.S. also increased 30%, compared to the same period of last year. Recent product introductions are also having a very positive impact on our U.S. business. One of the new products being introduced in the United States is a Pharmanex product called G3. G3 is a nutrient-dense juice formulated from four fruits that are harvested from various locations in Asia that contain an exceptionally high level of antioxidants and, in particular, carotenoid antioxidants. The G3 will be very scanner-friendly. For the first time, consumers will be able to scientifically measure the benefits of this unique, nutritious drink on body chemistry. With this launch, we're entering the $8 billion per year global nutrition beverage category that is gaining more attention in both nutrition and the direct selling industries.

G3 is also strategic for us because we find that the most common reason for a person to discontinue a LifePak subscription is that they fall out of compliance with the twice-a-day regimen, resulting in an oversupply of product. And there are also some people who can't seem to get used to the notion of taking several capsules each day. So both of these problems are addressed with this G3 product as we find that G3 is easily consumed. We expect this new health drink to broaden our consumer base and enhance sales of other Pharmanex and Nu Skin products as well. G3 launches officially in the United States on May 2, and will launch in Asian markets next spring.

Now, looking to mainland China. Revenue for the quarter grew 17% year-over-year, which was essentially even sequentially. We're satisfied with these results, given that our first priority in China is to qualify for a direct selling license, which has us cautiously executing the business right now. During the quarter, as our data indicates, we saw a significant shift in revenue from Nu Skin to Pharmanex, as we introduced three Pharmanex products to the market. Initially, this introduction cannibalized Nu Skin revenue, but we believe that Nu Skin sales will level out and that both categories will grow sequentially after initial period of Pharmanex attention.

With respect to the new regulations, I want to mention that I recently returned from China after holding a series of very productive meetings with government officials. We were told that the regulations were published publicly for comment within the next six weeks or so, and still plan on being implemented by mid-year. We continue to believe that the regulations will be very beneficial to us.

Based on our current understanding, there are really three key changes that will positively impact our operations. First, you will recall that today, we have to employ all of our sales representatives. And in China, people can't have two jobs. So this presents quite a barrier to recruiting salespeople, because they have to quit their job in order to accept what amounts to an entry-level sales position. Under the new regulations, we will no longer have to hire our early entry-level sales representatives because they can join as independent contractors. So the ability to engage independent contractors at the outset of a distributorship is a very significant step forward. Additionally, we will be able to avoid employment-related expenses associated with the attrition of these entry-level sales positions.

The second benefit of the new regulations is that sales will be able to take place away from our fixed retail locations. We will still be required to maintain a network of retail stores, but under the new regulations, our distributors will be able to complete transactions away from these stores, which will obviously be helpful to our sales reps.

Third, and most importantly, the new regulations will level the playing field for all direct sellers. A few of our direct selling competitors have enjoyed certain exceptions to the restrictions on direct selling activity since 1998. The new regulations will require all companies to operate in a similar fashion, which we believe will allow us to be much more competitive.

A final issue that continues to be addressed is whether China will enable multilevel compensation in the fashion commonly employed outside of China. The government seems to be decided against doing this currently, believing that this step is possible down the road as the market becomes more accustomed to direct selling. We'd obviously prefer that the government enable multilevel compensation from the outset, as do all of our direct selling peers, inasmuch as we all employ some form of multilevel compensation. But, in any event, we're confident that we can succeed by adding a direct selling component to our existing business model. While we will be able to engage independent contractors at the outset and pay them for their sales volume, we'll also be able to continue to employ our senior-level sales leaders and provide them with a salary and labor benefits to reward them for their sales leadership. So as long as we can continue to offer meaningful income opportunities on both the distributor and sales representative fronts, we believe that we'll be able to grow our business significantly and compete favorably in this important market.

As understood in the past, companies will still go through a licensing process after the regulations are effective, and I'm happy to report that we continue to enjoy healthy relationships with the government and believe that there will be a four- to six-month licensing process for us after the regulations are announced. Based on this understanding, we are well-positioned to benefit from the new direct selling environment the new regulations will create in China.

Now, in the meantime, we've recently launched three Pharmanex products, as I indicated, and we've also installed biophotonic scanners in our stores. And we've also implemented a product subscription program in China, as well. In March, we had some 43,000 subscription orders in China, which is a rapid increase during the quarter. And our focus on securing these product subscriptions will help us to improve retention and hold volume as it is done in other markets.

In preparation for the opening of China to direct selling, we're also moving forward with our capital investments, including the opening of another 80 to 100 retail stores during the remainder of the year. The opening of new stores, including the upcoming opening in Beijing next month, will further expand our footprint. By the end of the second quarter, we will have at least one store in every province in China. In addition, we're also constructing two Pharmanex manufacturing facilities, to fulfill China demand and to also enable us to export products to other markets in the future. This will have a positive impact on our gross margins down the road.

So, overall, we continue to see mainland China becoming a very significant market for us as the playing field levels there. Even though we don't expect the new regulations to impact our 2005 operations in China, we're confident that we will be able to post approximately 25% revenue growth for the year.

Now, we're not only pleased with the performance of our key geographies, but we're also posting strong gains in other top markets. For example, our fourth-largest market is Taiwan. Now, this is a 13-year-old market for us, and yet we were able to post 23% local currency revenue growth during the quarter. Although China is contributing to the strength of this market, we've also had some successful product introductions and exceptional growth in our subscriptions, and have significantly improved retention rates, all of which are contributing to our growth in Taiwan. Monthly product subscription orders in Taiwan climbed 124%, amounting to about 45% of Taiwan's quarterly revenue. Now, some of this can be attributed to the fact that roughly 92% of all new distributors who sign up monthly come into the business having committed to an initial six-month product subscription order, which is very healthy.

South Korea is another terrific market for us. First-quarter local currency revenue in Korea increased 9% over last year, despite an economy that is struggling there. This growth is in anticipation of the upcoming introduction of the biophotonic scanner, which will certainly play a key role in helping this market continue to post healthy revenue gains.

Southeast Asia also continues to perform solidly, with year-over-year revenue growth of 5%. Singapore and Malaysia are the star markets in this region, achieving 18% and 13% growth, respectively, which is really a nice thing, because you will recall that these markets were struggling a year ago, so they are nice turnarounds.

We remain on track to open Indonesia in the third quarter of this year, and given the attention that our sales leaders are focusing on Indonesia, we believe that this market will contribute 15 to $20 million of revenue in the first year of operations. Meanwhile, in Europe, we're also seeing positive growth indicators, with new and executive distributors surpassing our quarterly targets. We were actually compelled to open an office in Hungary recently because there was so much business activity in that market, which is really just reflective of the fact that we're seeing a lot of enthusiasm in other Eastern European countries, as well. And we're now targeting Russia for an early 2006 opening.

I believe it's also worth noting the continued growth in our Latin American business. This region had an impressive 151% growth year-over-year in the first quarter, with revenue in Mexico up over 300%. This market continues to see significant increases in new and executive distributors, and it's just really satisfying, actually that we've caught a gear (ph) in Latin America after significantly restructuring our operations there.

Now, on a final note, before I turned the time to Ritch, you see in our results that our recurring revenue base continues to become a much more important part of our business. In the first quarter, global monthly product subscription orders continue to climb, and accounted for 41% of total revenue during the period. This is a 71% increase over the first quarter of last year. We're very encouraged by this growth and believe that our focus on improving retention grew our monthly product subscription program, and through other mechanisms as well, will continue to positively impact our business going forward.

Okay, with that, let me turned the time over to Ritch.

Thank you, Truman. Good afternoon, everyone. Let me provide the local currency sales figures from our major geography. First, revenue in Japan was 14.8 billion yen versus 14.7 billion yen in the first quarter of 2004. Quarterly revenue in South Korea was 20.0 billion won versus 18.5 billion won last year. In greater China, in that region, we saw revenue from Taiwan during the quarter at 699 million NT dollars and versus 569 million NT dollars the last year. And Hong Kong reached 80.4 million Hong Kong dollars versus 59.9 million Hong Kong dollars in the prior year. In China, revenue was 220.4 million RMB during the quarter versus 188.7 million RMB in the prior year quarter. In Southeast Asia and the Pacific, the combined U.S. dollar revenue from Malaysia, Singapore and Brunei was $10.8 million, up versus 8.9 million in the first quarter of 2004. Thailand posted first-quarter revenue of 226 million baht compared to 265 million baht last year.

Our U.S. market generated $33.7 million of revenue in the quarter, compared to $35.1 million in 2004. And the 2004 number included $5.8 million of revenue from purchases made by international distributors at our February 2004 global convention. First-quarter revenue in Europe was $10.9 million, compared to 8.5 million in the first quarter of 2004. And finally, Latin American revenue was $1.6 million for the current quarter, compared to 644,000 in the same quarter of 2004.

Our first-quarter gross margin was 82.8%, a 60 basis point decline compared to the prior-year result. The downward pressure is largely related to an increase in current-year amortization of additional scanner units, which we expected and which is recorded in our cost of sales.

Assuming that foreign currency rates remain fairly consistent throughout the balance of this year, we anticipate gross margins will move toward 82.5% for the remainder of the year as we roll out additional scanners, particularly in the second quarter in Japan and Korea.

Selling expenses as a percent of revenue were essentially flat with the same quarter last year, at 42.8% of revenue. We concluded the short-term distributor compensation plan enhancements in Japan in early February. This change will help selling expenses decrease a bit moving forward, and we should move towards 42.5% for the remainder of the year.

General and administrative expenses as a percent of revenue improved 160 basis points over the prior year to 30.1%. The improvement in G&A expenses is due in part to the expenses related to the global distributor convention held in the prior year -- in the first quarter of the prior year. First-quarter operating margin was 9.9%; that's up 90 basis points over the prior year. And we continued to invest in key growth initiatives, including the scanner, important developing markets such as China, Indonesia, Latin America and Europe. And even considering these investments, which we're confident will provide solid growth opportunities for our Company in the future, we still anticipate that we will be able to improve operating margins by 30 to 40 basis points over the prior year and approach approximately 11.5% for 2005.

During the first quarter, interest expense was $1.5 million. We paid dividends of 6.3 million and invested $8.8 million in capital expenditures. Cash flow from operations was $29.1 million during the first quarter. That's up from $17.4 million in the same quarter of the prior year. And we continue to analyze the best uses for our cash. We seek opportunities, first, to reinvest back into our business, primarily through new products, new tools, new markets. In addition, we will continue to evaluate using excess cash to prepay debt or repurchase stock.

In the second quarter of 2005, as we model that out, we're estimating a yen rate to the dollar of approximately 108. In local currency, we expect Japan to generate growth of approximately 2% in the second quarter and about 3% for the full year. Again, that's in local currency. We anticipate that the U.S. will post approximately 12% revenue growth for the year, and we continue to model China revenue at approximately $130 million for 2005, or approximately 25% growth.

As you recall, in 2004, we had a sequential sales surge of more than 30% from Q1 to Q2, and then some leveling off in the second half of the year. This makes our upcoming second quarter a tough comparison on a year-over-year basis in China. We expect second-quarter 2005 revenue to improve sequentially in China by 10%, and then we expect to see a higher growth rate in the third and fourth quarters on the strength of opening stores in the capital city of Beijing, as well as opening many new franchise-type stores beginning this summer. Again, we don't anticipate direct selling revenue to really be relevant for us until 2006.

So, in summary, we're increasing our 2005 revenue guidance from 1.2 billion -- it was 1.2 to 1.22 -- we're increasing that to 1.22 to 1.24 billion, and earnings per share in the range of $1.17 to $1.24. This represents anticipated revenue growth of 7.7 to 9% for the year and earnings per share growth of approximately 9 to 16%. We expect second-quarter revenue to be approximately 295 to $305 million and earnings per share to be in the $0.29 to $0.31 range.

So, with that, let me to turn the call back to Truman.

Okay, thanks, Rich. As we look forward, then, I begin by reflecting back a bit on where we've been for just a moment. It will be two years next month since Rich and I assumed our current positions, and I'm happy to report that I think we've made some good progress during this period of time. We've cleaned up a lot of nagging problems that included a major restructuring of our Big Planet division and a significant headcount reduction. We've aligned our corporate objectives and organizations globally, including replacing a number of key management positions. We have reduced shareholder overhang concerns and negotiated the elimination of a super voting class of common stock. We've increased our dividend payout annually. And we've returned 84% of excess cash flow to our shareholders. We've restructured our Board of Directors. We've reengineered our business model for emerging economies that has caused some traction. And we've placed some big debts on our scanner technology and on China development that are paying off.

I'm also pleased to note that we've made a lot of progress on our financial health, as reflected in the ratios and metrics that most of the equity research analysts use to judge financial performance. It was rewarding to note in a recent Wall Street Journal summary that these efforts were reflected in our ranking as the number-one-performing NYSE stock in the personal care category for the last one-, three- and five-year periods. But our goal is to be worthy of that same recognition five years down the road, and we still have a long way to go to accomplish our objective of becoming the world's leading direct selling company, which we measure by the level of commissions we generate for our distributor force versus our competitors. We need to be at least 2.5 times larger than we are today to realize that goal.

But at this point, I think perhaps more than at any other time in the past two years, I feel like we just need to execute on the initiatives we have in place. We recognize the need to grow Japan at a faster rate than we are currently projecting. And obviously, securing a direct selling license in China later this year is a very important step. We need to continue to grow the U.S., as we are, and we need to continue to make progress in all of our other markets. I'm confident that we are in line to accomplish these things. I'm very comfortable with our product pipeline and our efforts to continue to innovate and differentiate in our product categories as well as from a business opportunity perspective.

At our October convention later this year, you will see products and initiatives that I'm convinced will continue to propel our growth. So even though we haven't branded all of these efforts as some kind of grand business transformation plan, an effective transformation is happening, and we just need to keep executing to realize the potential of the opportunity before us. So, overall, the outlook for Nu Skin Enterprises is very positive. We are on pace to continue our record results in 2005 and beyond.

Okay, with that, let's open the call for questions.

(Operator Instructions). Doug Lane, Avondale Partners.

On the October convention, this is the global convention, correct?

Correct.

And where is that going to be held this year?

It's in Salt Lake City.

Okay, and can you give us an estimate for what the costs will be for that, just so we can get it into our quarterly forecasts?

About $5 million, Doug.

And how does that compare to the Japan convention in November of '04?

The Japan convention was also close to that. So there's not a real big discrepancy in year-over-year comps this year.

Okay, good, that works out. Can you give us -- back to China, with the announcement of Avon testings some regulations, I don't know to the extent that you get any feedback from their tests being a competitor, but because they are kind of an important step in the whole regulatory process, maybe you do get some information in this one situation. And what's the sense over there on the probability of MLM? Because it seems to ebb and flow yes, maybe or no, no way, and depending upon who you talk to, there is still some hope that the MLM will be included in the initial round of regulations. So if you could handicap that as well, that would be helpful.

Yes, well, let me tackle the test here first. Yes, I suppose that Avon's test will be interesting to all direct sellers. We will obviously keep an eye on how the market response to their tests, although I don't know that what happens to them is going to be really reflective of how we will be impacted by the regs, because they are very different than we are. But certainly we will keep an eye on it. In any event, the Avon test period we see as a step in the right direction and as an indication that the government is going to honor its commitment to open the market to direct sellers, even though they missed the December deadline.

On the probability of multilevel compensation, it's fair to say that the process is not completed. There is the chance that the government will still enable multilevel compensation. We have been told, however, to prepare for a single-level world that we will use in combination with our employment system. And, really, the government regulators have told us, Doug, that in their view, whether or not they enable multilevel compensation should not be all that relevant to us, because, in any event, we can continue to employ our higher-level sales reps. But clearly, we would prefer to operate in a multilevel environment, as all of our peers would and as the U.S. government would. And we're actually receiving a lot of support from the U.S. government just through lobbying efforts and whatnot. So that battle is not over. But I think it's certainly more likely than not that it will be a single-level world, initially.

Okay. And finally, in Japan, you made those pleas to the compensation plan. If I remember right, it was to promote or to help encourage subscription revenues and also to encourage more executive distributors to go through that qualification process. Can you give us an update on both of those fronts? You said subscription revenue is up 47% in Japan. So I guess that means it must be working. How about on the executive distributor front?

Yes, the subscription rates are up, our distributor applications are up and on the leadership development front, that indicator lags the other indicators. So we should see, going forward, our executive numbers increase, but there's just a little bit of a lag there as early-level distributors start to build their businesses first with a customer base and then they start to think about recruiting other distributors and becoming a sales leader. So we would expect improvement there going forward.

Kathleen Reed, Stanford Financial.

First question is on Japan, which was very exciting to see that it turned positive year-over-year. And I was just curious -- it seems to me that your revenue guidance for the second quarter appears somewhat conservative, given that Japan is now positive. I think you said you thought it would be up about 2% local currency in the second quarter. The scanner is picking up speed. And I just wondered -- and it sounds like, also, you are launching the scanner in Korea, and that's a positive. So since you did 10% revenue growth this quarter and you had like a 20% comp, which was very tough, I just wondered why you are only expecting revenue for this Company to be only up about 4 to 5% in your second quarter?

Well, Kathy, let me just respond to that. I appreciate your question, and I hope you are right. I hope (multiple speakers) as the business turns, we're very encouraged by the signs that we're seeing, and it was just two quarters ago that we had to bring our guidance down a little bit. So, as we go forward, we would expect that the market will continue to perform at least on track with our guidance. Hopefully, those are numbers that we can all rely very heavily on, and we think there is upside. I think if you look at our numbers for the year, this year, Japan probably is the market that provides us the opportunity for upside. And so we will continue to do everything we can to execute on our strategies there. But, yes, we do feel very positive about the way the market is turning, and really in advance of what we had anticipated earlier.

I would just add to that, Kathy, that just the reality is that Japan is a big ship to move, and that's partly what has us conservative here for the next quarter, while we see how the scanner continues to impact the market.

Second, in North America, I know you have qualified that the revenue was down year-over-year just because you booked some revenue from foreign distributors in your year-ago quarter. But, for North America at 36 million, it's now been flat sequentially for four quarters in a row. I just wondered, does it have anything to do -- are we slowing down scanner penetration in North America, or what can we do to get that number to move up from 36 million? I mean, just on an actual dollar amount? It's been 36 million for four quarters in a row.

Yes, you know, we continue to see really healthy levels of distributor activity in the United States, Kathy, and are, frankly, as surprised as you are that sales have been flat sequentially. Remember that the first quarter of each year is typically our lowest-revenue quarter of each year because of the fact that we enable distributors to take a grace month each year. So the activity in the first quarter is still healthy. And the G3 product that I discussed in my comments is really attracting a lot of attention. And I think that you're going to see some healthy dynamics in the United States as a result of that launch and some other initiatives building towards our fall convention.

Okay. What is the scanner number now? Has that maxed out, do you think, or are we still adding to that?

The number of scanners in the U.S. market is relatively flat as we divert production into other markets. And we're also in the process, frankly, of aggressively managing our scanner lease base to keep scanners productive. And we have some distributors who are making far better use of scanners than others. And because it is a costly device, we are recouping as many unproductive scanners as we have to put them in the hands of productive distributors. We continue to have a lot of demand for scanners. We still have not gone forward with any plans to install scanners in fixed locations, like, you know, we have a lot of demand for health clubs and chiropractic offices and all sorts of fixed locations. And we just haven't had the supply to satisfy that demand. But we're just trying to maximize return on scanners in the market.

The scanner manufacturing plant that went online in the fourth quarter, are all those going to Japan?

Yes.

And then finally, just with your comments on China, if the government only lets you do single-level marketing, at least initially, what would that do to your payout level that you pay your distributors? Because I think that's one of your pluses, is that you are the highest-paying direct selling company. So that's obviously -- you get to attract a high level of distributors. Do you have a new number -- instead of 43%, it would be X? And how else can you then attract -- what other marketing initiatives would you do to attract your distributors against, like, in other companies?

The benefit is not single-level versus multilevel. The benefit that we will gain through the new regulations will be the fact that we don't have to employ all our entry-level sales reps. And the cost associated with churn in that number related to unemployment costs and social benefits is fairly high. So we're in the process today of even considering adjustments to our compensation plan in China, things that we think will enhance the opportunity and also bring down our expense. We pay about 51 to 52% of our sales today in selling expenses in China. And as we move throughout the year, we'll be able to bring that number down and should be helped by the regulations to come to a point where it's really down to the 43, 44% that we see in most of our other markets.

So that 51 to 52, that includes all their unemployment insurance and these benefits you have to pay them?

That's exactly right.

And Kathy, let me add to that that you are right, it is difficult to attract high-level, high-quality sales reps with a single-level system, which is why we will complement that with an employment structure that will enable us to reward people.

Scott Van Winkle, Adams, Harkness & Hill.

A couple of questions. First, on China, can you tell me how many stores you operate currently, what you added in the quarter and a little more detail on kind of how it happens over the back half of the year -- the new stores?

We added six stores during the quarter. We're up to -- we have about 120 stores total, which doesn't sound like we're increasing our number of stores because, as stores come online and as we monitor their productivity, we're also closing stores at the same time that just aren't generating enough volume. So the net number is 120. We will add another eight to 10 this quarter. For the year, as we indicated in our remarks, we're looking at 80 to 100 new stores. So the back half of the year is obviously more heavily weighted as we implement our franchise program and start to open stores in smaller cities that will be assigned to particular distributor groups or sales reps. And we will complement that, obviously, with corporate-owned stores in the larger cities, as we start to comply with the requirement to have 10 stores per province going forward.

Okay, and you said that the scanner totals in the U.S. went relatively flat. Can you give us that number?

Yes, it's about 1300. 1300 leased scanners in the market today.

Okay, and how many new markets do you expect the scanner to go in? I know you mentioned, I believe it was Korea. How many new markets do you expect the scanner to go into this year?

Well, Japan and Korea are the big markets where the scanner is launching this year. And, in addition, we are increasing our number of scanners in Europe, and we recently got approval from the government authorities in Australia to begin to ship scanners into Australia, which we haven't done to date, which we think will be a positive there, as well.

Joe Norton, Banc of America Securities.

A couple of questions for you. Going back to China, and what you said about the publishing of the regs, I'm just -- can you clarify at all what the timeline is and where you're getting the timeline? So they are going to publish their public comment in six weeks. Is that what you said?

Yes, well, you know, I mean, we are hesitant to announce a hard timeline because it's a little bit like peering into a black box. But what we've been told by certain government officials is they anticipate publishing the regs by the end of May. And our understanding is there will be a brief comment period, 30 days, something to that effect, and then the final regulations will be effective.

Okay, but is there -- so there's a comment period, and then they -- your understanding is they would plan to finalize them shortly thereafter?

Correct.

Okay. And the test -- do you know anything more about the test with Avon? Is that in any way -- I mean, is the publishing of the regs in any way contingent upon what happens with Avon, or--? It's just a little confusing as to why, I mean, if they're running a test with Avon, why would they publish final regulations before the Avon test is finished? Or just any clarification you could give us on that would help.

Yes, well, you know, I think Avon would probably be able to comment on that better than we would. We have not heard from anyone that the regs will be based on completion of this Avon test period, so that would be a new thought to us because, we just haven't heard it. What's the purpose of the test, then? Well, from what we understand, the primary purpose of the test is to honor a commitment that was made to Avon by government officials that they would be allowed to have this kind of a test period. And it's more to honor that commitment, perhaps, than it is to consider how the regulations might further be developed.

Okay, and then just going back to the stores. Because it sounds like that's sort of how you are projecting sales growth in China. Is that correct, just sort of based on the new store openings? If that -- I mean, we had 17% growth in the first quarter, 10 -- you're saying about 10 in the second, so it implies some pretty strong growth in the third and fourth quarter. So how many stores are you planning to open in Beijing, and kind of why such -- why higher sales growth in the last half?

Yes, the opening of new stores is not directly tied to revenue growth. I mean, those two things you are not going to see move in perfect parallel because of the fact that today, some of our stores are absorbing volume from surrounding areas where we intend to open stores in the future. So as we open stores in the future, some of that volume in a city that may be benefiting from an existing store location dries up a little bit. So there's a little bit of cannibalization from existing stores. So it's not a perfectly direct correlation there as new stores come online.

What we're most anxious to do is make sure that we have a good corporate presence in all of the major cities, and then have a decent franchise presence with a little bit of a smaller store to meet the regulatory requirement of having 10 stores per province. This will also give consumers easier access to our products. So that's perhaps why our sales growth in China is a little bit more weighted to the back end of the year as these additional cities come online, but may not correlate exactly, just based on the raw number of stores.

Okay. And can you tell us how many stores you plan to open in Beijing?

I believe that the plan is to open one in the month of May. And then we will have to have 10, eventually, to comply with the regs.

Okay, and then -- (multiple speakers)

The storefront in Beijing I visited two weeks ago is actually a really nice location that will be very representative of who we are, and I like it a lot.

And then, how is the -- if you could give us the rough growth, clearly, in North Asia region is accelerating. I wonder if you could just tell us by country what you saw in Japan and Korea?

Yes, are you talking about the active distributors?

Yes, sorry.

The active distributors -- let me just pull that right now. Looks like in Japan, was about 8.3% for the year; Korea, about 20%. So it is growing very healthy. It's due really in part to two things -- increased subscription customers and increased retention of those new people that we're bringing in. So we do think that's a leading indicator for the market.

8.3% for the quarter?

That's correct.

Okay, great. And then 20% in Korea.

Right.

And then finally, just one quick one for you, Rich. When you talk about the G&A in the quarter, you said the lower percentage of sales was in part due to the convention. Was there anything else in G&A that was favorable that we should know about or that might continue?

No. Really, the rest is fairly comparable. This year's G&A includes quite a bit of scanner-related costs. It includes the opening of some new markets -- Hungary, Israel, some other smaller markets that we've opened. We do see continued expansion in China, which has increased our G&A. And even with all those investments -- by the way, we've also increased quite a bit in Latin America and Europe as we prepare to open some additional Eastern European markets. Even with those investments, we're able to make some improvement on that percentage and feel like we can continue to do that. This will be the lowest quarter in terms of operating margin in the year, and we should see some nice improvements going forward.

Chris Ferrara, Merrill Lynch.

I just wanted to ask about -- I know we've probably been through this before, but the breakout between Pharmanex and Nu Skin, and obviously, the scanner's a big Pharmanex initiative, and a lot of new products are coming out on that side of the business. But I just wanted to sort of see where you guys stand on the commitment to the Nu Skin side? Is it possible that five years from now this Company is 75% nutritional supplements and 25 personal care? Or is that sort of unrealistic and you think that it will cycle back toward more of a focus on Nu Skin in a couple of years?

Yes, that's a good question that we probably should have addressed in our remarks. The Nu Skin sales could appear alarming to some degree, because Pharmanex is moving much more rapidly, obviously. But what we've seen is that there's an initial period of time after we launch the scanner in a particular market, or in China's case, now, having launched three Pharmanex products in the first quarter, where distributor attention just flows Pharmanex's direction, and it's the new, exciting thing. Fortunately, what we've seen in other markets like the U.S., Taiwan, Hong Kong, who have had the scanner for a longer period of time is that after an initial period of Pharmanex attention, both sales in both divisions tend to trend up. That's certainly been the case in Taiwan, Hong Kong and the United States so far.

So we're not overly alarmed by this quarter's situation. You know, I will confess that we seem to have an easier time innovating on the nutrition front and really differentiating on the nutrition front than we do on the personal care front. But, over time, I don't think it's going to be 75/25; I would expected it to be more maybe 60/40, Pharmanex/Nu Skin.

Lou Paprasi, Lehman Brothers.

Hello and congratulations on the quarter. I had a question on your subscription orders. I believe you said that they accounted for 41% of sales in the quarter?

Right.

And your target, I think, for the year was 35%. Has that changed?

Yes, it's a big jump. Yes, we're obviously going to have to move up our target. I think 45% for the year is probably not unrealistic. And I think we are likely to end up with 500,000 subscribers by the end of the year. And down the road, our goal is going to be to have a million or more.

Also, in China, will the ability to employ multilevel pay levels actually be significantly beneficial to revenue as well, or just to margins?

Well, I think if we were able to employ a multilevel compensation system, yes, we would be marginally benefited from that. I think we're still going to be able to compensate people in a healthy fashion. But, yes, the better world would be for us to be able to use a multilevel system. What worries me more than anything, frankly, is not the immediate impact to revenue as long as just -- it's really more just the long-term issue of whether or not we'll be able to implement a multilevel system in the future. And I just don't want the government to get too used to the notion that we're all happy to not have a multilevel system in, because we would prefer it to be the other way.

And we should -- maybe just to mention also, we're pretty committed to paying out somewhere around 43 to 45%, whether we're doing it in a single-level fashion or a multilevel fashion. So there's not going to be a ton of savings one way or the other on our P&L. The impact will be essentially equal in terms of how much we're committed to paying out.

And I heard that there's a new bill that is being proposed by Congressman Cannon. It's supposed to allow money from health savings accounts to be spent on dietary supplements. Have you looked at this, or do you know what the impact could be on your sales?

We have looked at it, and we're very supportive of initiatives of that nature, as well as other initiatives that are trying to convince insurance companies to pay health benefits for dietary supplements. And so we will be very supportive of that and, indeed, efforts like that would be very beneficial to us.

(Operator Instructions). Chris Ferrara, Merrill Lynch.

Sorry about that. I'm still trying to learn how to work a phone. I just wanted to get back onto that line of questioning. Are new distributors coming into the business? Are you by and large gearing on Pharmanex just because of the new product initiatives that you guys have had? I mean, I would imagine it's a lion's share of new people coming into the business. Is that fair?

Yes, I think that's fair.

Yes.

And in China, specifically, I guess with -- even though you only have three products out at this point, are you seeing a big shift toward Pharmanex, and how do you think China will play out in a few years?

Well, obviously, in the first quarter, we had a big shift towards Pharmanex. And it is true, too, that when you look at our competitors' businesses there, and the Amway organization in particular, our understanding is that more than a majority of their 2 billion (technical difficulty) is in the nutrition side of the business. So there is huge upside to Pharmanex activity in China, but you will recall, too, Chris, that we have a local product line there that sells very well. We move an awful lot of units of both our Scion product line as well as our Nu Skin product line. And at the end of the day, people are still using personal care products. And so the personal care business is certainly not going to disappear in China, and as I indicated, I think after an initial period of Pharmanex attention, you are going to see both divisions grow.

Got it. And then on the comments on China when you guys -- and this isn't new, I guess you guys have said this before -- but I know the playing field gets leveled a little bit with deregulation. Is there a way to talk, I guess, more quantitatively or practically about -- we know who's got the exemptions like the legacy companies, like your Amways and your Avons and your Mary Kays, but what are they doing specifically that's different from what you're doing? And who is doing it differently? And how is that making a big difference? And I know that's sort of a lot, but any sort of clarity would be great.

Yes, it is a lot and it could be the topic of hours of conversation. You know, really, the biggest player there, obviously, is Amway, right? I mean, they are 10 times the size of I think the nearest direct selling company, almost. So, you know, and honestly, we're more worried about managing our business than figuring out exactly what they are doing. But they are running a kind of a hybrid model too, from what I understand, where they have taken advantage of their 455 exception that they secured back in 1999 and run kind of a hybrid direct selling/non-direct selling business that has obviously been very successful.

I think everyone is obviously far more familiar with what Avon is doing, because they talk about it a lot and they are a public company. But, from their perspective, I think their challenge will be to convert their existing, their thousands of franchise stores into a direct selling model, or at least figure out how to operate those businesses in parallel.

From our perspective, I think the fact that we've been running a retail model and employing sales reps actually gives us an advantage over people, because I think that's where people are going to have to head, in any event. I don't know how others will deal with the regulations. But that's how we intend to deal with them. And the fact that it's not a huge deviation from what we've been doing for the last two years, I think, gives us a little bit of a head start.

And then just from a practical standpoint, there are competitors in China right now, and not just on a product line side, but also as direct sellers, who are consummating sales away from fixed store locations and can offer superior economics to distributors that you will now be on par with upon deregulation. Is that fair?

That's correct.

Kathleen Reed, Stanford Financial.

I just have a quick follow-up. Your comments that the Pharmanex -- that you launched three new Pharmanex products in China. I guess I'm a little surprised just to hear that those products really took off and cannibalized some personal care sales, just because you are still operating in a retail format. So is it really just that they took up much more shelf space in your stores -- they were right in the front, or --?

No, I think it's just that, you know, even though we operate in a retail format, Kathy, it's still our salespeople who are out there selling the products. And with the newness of Pharmanex, they've obviously been awaiting the Pharmanex launch for some time. And they've just been excited for Pharmanex to initiate sales, and so it's just an initial distraction of the sales force. Let me say, by the way, that it's actually been quite beneficial to us that our sales in Hong Kong haven't suffered as we thought they would when we started selling Pharmanex products in China, because we knew that some Hong Kong volume was flowing into China. And there's been less cannibalization there than we would've thought.

Hong Kong Pharmanex volume, is that what you meant?

Right.

And did you say that if you were launching new Pharmanex products in your second quarter in China?

We didn't say, and you know, off the top of my head, I don't know.

I think by the end of the year, Kathy, we will have about eight Pharmanex products -- seven to eight Pharmanex products total selling in the marketplace. And those will kind of spill out over the next three quarters.

Great. And then just one final, and this is just a Rich question. Can you quantify what the impact of just running your dual compensation plan in Japan -- I think it ended in January -- so that we know that that won't reoccur?

Yes. That's exactly right. There was -- January included an extra 1.25% of sales in Japan that we paid out in these additional compensation plan enhancements. So it did go away. And so we really saw the compensation plan payout in Japan come down, particularly in March, to where we would expect it to be.

But on your fourth-quarter call, I think you said it was like $5 million, having to pay that dual comp. Do you have a dollar amount for that? Just is it like one-third of that, or--?

It's 1.25% of probably, well, January (multiple speakers)

Of one month of sales in Japan?

Yes, that's right.

Mimi Sokolowski, Sidoti & Company.

Truman, I might be missing something obvious, but if you wouldn't mind indulging me, what is it about, I guess, the alternate compensation structure that you could plan for in China that would not only reward distributors for their own activities, but would also encourage recruiting?

Well, what we would do, Mimi, and no, we don't mind indulging you.

Thank you.

But what we would do is essentially hire our sales reps who demonstrate sales leadership skills, which includes the ability to recruit and train and motivate sales representatives and base their compensation, which we would structure, again, as we do now, in a salary -- on a salary format with some bonuses that are adjusted quarterly. But doing it in a fashion that really enables the cream of the crop to still rise to the top and compensate them in a significant fashion.

Okay, and they could only get there having built the track record of net -- building their network and hiring others.

Yes, they will be elevated as they demonstrate their ability to lead sales organizations.

Okay, so could -- would it be rational to assume there might be more of a lagging impact, since they kind of have to really demonstrate their mettle before they get rewarded?

Yes, I think that's fair to say, and that's actually how our business works anyway, is that there is a little bit of a lagging impact on leadership.

Okay, so it's not more immediate than the multitiered structure, or the multitiered structure is not more immediate as far as getting rewarded?

Well, you know, the fact that we probably adjust salaries quarterly instead of monthly, as we would in our regular compensation plan, might create a little bit more of a lagging impact in an employment structure, but it's not going to be a material effect over the long run, certainly.

Jeanne Ernst, Gardner Lewis.

Just a nitpicky question about Japan. You are assuming a 108 yen. If the yen stays where it is, what effect would that have on the quarter? The coming quarter?

Yes, each point that we pick up with the yen accounts for about $1 million per quarter. So if we are to run at 106 for the second quarter, we would expect to pick up $2 million in benefit in topline revenue.

Okay, and then, just kind of following on Kathleen's question, I understand wanting to underpromise and overdeliver on a consistent basis, but is there anything in particular in the second quarter that leads you to believe that Japan would get weaker, given that you're going to have 1000 scanners versus 400?

We would have guided down even lower if we felt that were the case. I mean, I think we feel real confident in the numbers we put out, and based on the fact that the key indicators that we try and monitor with the business look very strong and healthy.

And how closely, if we look at, I guess, the 10% distributor growth was for that whole region, not just for Japan?

Yes, that's right, Japan was 8.3% with the growth in active distributors.

And how closely does that tend to predict growth in revenues?

Yes, it's not 100% parallel. And actually, it's an interesting dynamic, but if you look over the last year or two, particularly in our businesses, it's shifted a little bit. And it's primarily because we are increasing retention rates on our new distributors that are coming in. So we see that number actually kind of leading out a little bit more than we ever saw in the past. And we do think that it certainly gives us a lot of stability as we go forward. I'm not sure it ties directly to revenue growth, but it gives us more visibility and stability as we look to the future and what our business is going to do.

And then, as far as the U.S. is concerned, I consistently find that if people -- I mean obviously, it's anecdotal, and my sphere of influence is pretty small -- but there's a lot of people who just don't know what Nu Skin is in the U.S. And it seems like, in fact, I think it was Kathleen that mentioned you had spent (ph) 36 million for a while. You have this new G3 product. You have the scanner. Has there been any thought to increasing the marketing in the U.S. or doing anything different to try and vitalize the market?

Yes, it's a good question, and yes, there's a lot of those discussions going on. The reality is that in the United States, we have really laid low with our scanner initiative, because we had the FDA registration statement pending for a long period of time and wanted to stay below the radar screen. Now, we are much more comfortable and willing to engage in promotional activities. And really, the United States and North America in general just has so much more potential than what we are realizing today. That we have a lot of optimism for the future of this market.

So is there anything particular that you have planned, or you're just kind of starting to think in towards that direction, that it is an opportunity?

Yes, we don't have specific things planned today that we're prepared to talk about, but we recognize the opportunity we have here to create much more brand awareness than we currently enjoy.

Well, keep up the good work. Thanks.

Thanks very much. And with that, let's end the call. And thank you all for joining us again today, and as always, we stand by to clarify any remaining questions. Thanks, bye-bye.

Thank you. This concludes today's conference call. You may now disconnect.