如新 (NUS) 2005 Q4 法說會逐字稿

Good afternoon. My name is Emarkis and I will be your conference facilitator. At this time, I would like to welcome everyone to the Nu Skin Enterprises fourth-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 session. (OPERATOR INSTRUCTIONS). Thank you. Mr. Allen, you may begin your conference.

Thank you. Good afternoon, everyone. We appreciate all those joining us today on this conference call and listening over the Internet. With us on the call today are Truman Hunt, President and Chief Executive Officer and Ritch Wood, Chief Financial Officer.

As a reminder, during this conference call, comments may be made which include some forward-looking statements. These statements involve risk 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 in our SEC filings for a complete discussion of risks associated with these forward-looking statements and our business. In addition, during this call, certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements prepared in accordance with Generally Accepted Accounting Principles, referred to by the Securities and Exchange Commission as non-GAAP financial measures. We believe that these non-GAAP financial measures assist management and investors in evaluating and comparing period-to-period results of operations in a more meaningful and consistent manner. Please refer to the investor portion of the Company's Web site, NuSkinEnterprises.com, to find our fourth-quarter press release containing a reconciliation of these measures. I will now turn the time over to Truman.

Thanks, Charlie, and good afternoon, everyone. We have important issues to discuss with you today so thanks for joining us. I wanted to take a minute and talk about what's happening in our major markets and then turn to the progress we're making in our business transformation effort.

Today we reported a 4% increase in annual revenue over 2004 with our fourth-quarter revenue roughly even with the prior year, excluding the impact of currency but declining 5% over the prior year in reported results as a result of a weaker yen. Fourth-quarter earnings of $0.22 per share versus '04 earnings of $0.31 a share were primarily the result of currency swings that reduced revenue and gross margin as well as a higher effective tax rate that Ritch will review in his remarks.

While we have made good progress over the last few years, these results for the fourth quarter are not satisfactory. We can do better. So I want to be as clear as possible today with respect to the issues that have impeded our growth recently, as well as let you know as clearly as possible what we're doing to address those issues. First I will address our businesses in Japan, China and the U.S. then give you an update on the business transformation effort we initiated in November.

So, let's begin with Japan. There are two factors that have negatively impacted our operation in the second half of 2005. The first was changes to our compensation plan that were implemented in 2005 and the second factor was a lesser than hoped for response to our scanner initiative. Now, we have cited compensation plan changes a few times in the last year as a reason for soft results. Consequently, while this may not seem to be the case, we're actually always very cautious about changing our compensation plan. Our modifications are almost always based on the desire to get more money to the front end of our plan for those who are actively building the business to enable those early participants to generate a higher level of income and consequently enjoy more staying power in the business. With that objective in mind, in 2005, we implemented changes to our compensation plan in Japan after those same changes had proven successful in the United States, Southeast Asia and Europe. But as we assessed Japan in retrospect now, we believe that the compensation plan change in 2005 had unanticipated impacts and was the single most significant cause of our decline in the second half of 2005. Consequently, we are implementing revisions to the plan that will be announced in our March Japan convention that will correct the impact of last year's changes.

In addition to fixing the compensation plan, we also need to generate a better distributor response to our growth drivers. We have cited the regulatory differences in Japan that prevent us from using the scanner exactly as we use it in the United States but the advent of the S2 BioPhotonic scanner, which we have announced, also caused us to seize S1 manufacturing and stop qualification campaign that had distributors working to qualify for an S1 scanner lease. And that factor also muted the impact of the scanner launch in Japan in 2005.

So at our March convention in Japan, in addition to the compensation plan enhancements, we'll also be launching the next generation S2 scanner along with the new scanner business model. The S2, as we've discussed, is a significantly improved version of the scanner and it really is what we hoped the original scanner would be.

The new scanner business model is designed to provide our aggressive business builders with easier and quicker access to the scanner. Previously, you will recall we've leased scanners for about $300 a month and paid a $10 bonus to distributors for securing a new auto ship customer. Going forward, the more functional but lower-cost S2 will lease for about $200 a month and will be made available first to distributors who are actively building a business. And those distributors who reach monthly productivity requirements will also have the lease cost waved. At same time, the S1 scanner leases will be reduced to about $100 a month. So both of the scanners -- both the S1 and the S2 will be more available to the sales force.

Japan will also launch this year the Nu Skin ProDerm Skin Analyzer. We're seeing a lot of energy and enthusiasm for this device already, which has been beta tested in the U.S. over the past few months. Like the BioPhotonic scanner, ProDerm is an easy calling card for our distributors to use and evokes a similar consumer response. Skeptical consumers who have been conditioned by marketing hype for years want to know whether the products they use are actually making a difference. ProDerm addresses this need, just as the BioPhotonic scanner does. ProDerm is also a unique and proprietary tool that we developed entirely in-house so this tool will provide a nice competitive differentiator going forward.

In addition to our tools, we'll also be launching our g3 nutrition drink at the March convention, which will help fuel an improved scanner impact. And Japan is also considering the best way to incorporate the appeal of the LifePak Nano story, which we launched in the U.S. in the fourth quarter into their product mix during 2006. So we feel that we're doing everything possible to address the issues that have impacted us in Japan over the last couple of quarters.

Now turning to China, the delay in implementation of the direct selling regulations obviously took a toll on our business in 2005. We also made in that market some compensation changes in preparation for the new regulations and to bring our overall payout to the sales force there in line with global levels. The month-to-month improvement in key indicators during the fourth quarter was encouraging and seemed to signal a bottoming out of the decline. But with respect to the licensing process, our application has been submitted and we remain patient with the process and optimistic about the future of direct selling in China. Our focus in China today is to maintain positive government relations and strengthen our operations in preparation for licensing. We expect, again, the government to begin issuing direct selling licenses within the next few months.

Now as in China, the S2 scanner and the launch of ProDerm will also be growth drivers in China in 2006. We are developing a very impressive group of sales leaders in China who are really comparable to the quality of sales leaders we enjoy in our other major markets. In 2004, we had only a couple of these sales leaders qualify for our highest level of recognition and in 2005, we will actually have a few dozen people qualify at our highest level. As I get to know them, I'm confident that we are developing a caliber of leader in China who will enable us to grow the business there in the future.

Okay, onto the United States. As the release indicates, the U.S. had a solid fourth quarter and really had a solid 2005. The advent of the S2 scanner also slowed Pharmanex growth in the U.S. as S1 promotions slowed. But the October global convention was a success. LifePak Nano has been well-received. Our Photomax service has also been well-received by the sales force and by consumers. So the U.S. is set to continuous growth as the S2, ProDerm and Photomax enhancements come online during 2006.

Now before I talk about our business transformation process, let me just briefly highlight a couple of other markets. First of all, South Korea posted its eighth consecutive quarter of year-over-year revenue growth and is on track to continue its impressive growth rate. We are really doing very well in that market. Europe and South America also continue to perform well during the fourth quarter and with respect to new markets, we're moving forward with our plans to open Russia in the second quarter and continue to believe we'll see good demand in that rapidly growing direct selling market.

Okay, let's move now to the broader theme of business transformation. Over the past few years, we've made good progress, positioning ourselves to achieve our objective of becoming the world's leading direct selling company. But we're now stepping back and evaluating our strategic direction and our organizational structure to determine what we need to do to put ourselves in better shape to grow. This transformation process is enabling us to clearly identify the competitive advantages that we either enjoy now or will enjoy in the future and is also helping us by identifying how to leverage those advantages to create a leadership position in the direct selling world. And it's also highlighted how our organization needs to change to better serve the needs of our distributors.

As the release indicates, our transformation objectives are threefold. First, to align our corporate efforts and our resources with the direction and needs of our sales leaders. We're transitioning from what historically has been a somewhat complex matrix organization to being an organization that is designed first and foremost around the needs of our distributors. We're becoming much more process oriented, we're restructuring our organization around fundamental aspects of our business that we frankly have not organized around in the past. Let me give you an example of that.

One of our transformation teams is restructuring an organization to focus entirely on what we have labeled as the distributor's success process. This group will be responsible for the creation and global implementation of strategies to improve sponsorship, product consumption and retailing as well as the development of sales leadership. We have never actually had one organization that was entirely focused and entirely accountable for this process, which is really the essence of our business. So this step alone is going to be a meaningful improvement in our organization.

Second, we're also focused on simplifying and clarifying our growth initiatives in each of our geographic markets. We produce a lot of ammunition for our sales force to use in their business building efforts and I think often we produce too much ammunition, which leads to distributor confusion about what they should use and how they should best use our various products.

In each geographic market, we need to be much more clear than we are today about what we're going to support as growth initiatives. Unfortunately, when I pick up our product catalogs and our marketing materials around the world, it is not clear to me whether we expect distributors to design their efforts around our product A or product B. So within each of our product categories and within each geographic market, we're going to be clearer and more aligned with our field leaders about our growth opportunities and growth stories so that we can reduce confusion and reduce the friction that is caused by lack of clarity.

Third, we're committed to streamlining our organization to enable us to invest in growth and to maintain profit levels. Our 2006 budgets call for about $30 million of investment in initiatives that just simply didn't exist in 2005. These initiatives include China and Russia expansion, the S2, ProDerm, additional money allocated to distributor compensation, additional development of Photomax services, improvement of physical facilities in Japan, and brand enhancement campaigns in Japan and China that we have not done in the past. So we are committed to doing our best to maintain profitability while spending on these growth initiatives. That's a bit of a challenge but as Ritch will review in a moment, we feel like we're in a position to take steps to do that. So beginning in the next few days and developing over the remainder of the quarter, a new organization will begin to take shape that I personally am very excited about. I currently have 12 people who report directly to me and in the coming weeks, this number will be reduced to six. And we will have for the first time in our organization global heads of our product development efforts, our distributor success efforts, our corporate strategy and development process as well as other key processes. I have no doubt that our business transformation is going to make us a better company and put us in a much better position to serve the needs of our sales force. Though this transformation is not easy, when we are through, it will dramatically change the way we do business and it will result in a release of new energy throughout our entire organization that will benefit us even in the short term.

So with that, let me turn the time over to Ritch before I make some concluding remarks.

Thank you, Truman. I'll first provide the local currency revenue figures from our major geographies. So starting in North Asia, fourth-quarter revenue in Japan was 15.5 billion yen, that's compared to 16.5 billion yen in the fourth quarter of 2004. Quarterly revenue in South Korea was 25.1 billion won versus 19.6 billion won during the prior year. In greater China, mainland China revenue was 183 million Renminbi during the quarter; that's versus 220 million Renminbi in the prior-year period. And revenue from Taiwan during the quarter was 748 million NT dollars versus 796 million NT dollars last year. Hong Kong revenue was 81.1 million Hong Kong dollars; that's versus $93.0 million Hong Kong dollars in the fourth quarter of 2004. And in the South Asia-Pacific region, our newest market, Indonesia, contributed positively, posting $2.3 million U.S. during the quarter.

In North America, the United States generated $40 million in revenue and 4 million of that revenue was from convention sales to non-U.S. distributors who attended our international convention in October. Europe revenue was 11.6 million versus 11.0 million in the same quarter in 2004. And finally, Latin America revenue was $2.1 million for the quarter compared to 1.5 million in the same quarter of 2004. And again, just as a reminder, all this data as well as revenue for the markets that I did not mention can be found on the investor section of our corporate Web site, so I would invite you to visit there as well.

Our fourth-quarter gross margin was 82.4% compared to 83% in the prior year. Gross margin was negatively impacted by a weaker Japanese yen as well as increased amortization expense from an increased number of Pharmanex S1 scanner units.

Selling expenses as a percent of revenue were 42.4% compared to 43% in the prior-year period and this improvement over the prior year is largely attributed to the short-term Japanese sales incentive enhancements that we placed during the fourth quarter of 2004.

General and administrative expenses as a percent of revenue were 30.6% compared to the prior year of 29.1%, primarily due to a lower revenue number. And as you'll note, the level of dollars spent in G&A was essentially even this year with the prior year.

Fourth-quarter operating margin was 9.4% compared to 10.9% in the prior year and the Company's tax rate increased to 40.7% in the fourth quarter. This increase was due primarily to the reversal of some benefits taken for the permanent investment of China earnings taken earlier in the year and as China earnings fell in the latter half of the year, those had to be reversed out. So, the lower revenue and the increased effective tax rate are really the cause of the decline in earnings for the quarter.

Interest expense for the fourth quarter was $1.3 million. We paid dividends of $6.5 million, we repurchased $5.5 million in Company stock and we repaid back $12.1 million in debt and then invested $6.6 million in capital improvements during the quarter. Cash from operations then for the quarter was $39.2 million.

For 2005, the whole year, the Company generated $121.3 million in cash from operations. We paid dividends of 25.4 million. We repurchased $24.6 million of Company stock. We paid $17.1 million in debt and invested $30.9 million in capital improvements.

As disclosed in our earnings release, we're modeling the yen at 118 to the dollar for 2006. That's compared to 110 average yen rate to the dollar in 2005. This weakening, just to try and quantify this for you, the weakening of the yen represents a reduction of estimated 2006 revenue of approximately $40 million. That's the consequence of the swing from 110 to 118. And so that's reflected in the guidance that we provide here. Overall for 2006, we're projecting revenue to be 1.14 billion to 1.20 billion. And this forecast estimates that Japan will be down approximately 3 to 5% in local currency for the first half of the year and then approximately even for the second half of the year as we gain traction with some of the initiatives that Truman has spoken about. The U.S. is expected to grow 8 to 10% for the year and China is expected to be up at least 10% for 2006 over 2005 and most of that growth will be back-end loaded.

This revenue modeling of 1.14 to 1.20 billion is estimated to result in earnings per share of approximately $0.90 to $0.96. Note that this includes -- this $0.90 to $0.96 -- includes approximately $0.08 per share of stock option expense not recorded, as you know, in our 2005 results. And this guidance also excludes the 30 to $40 million of restructuring charges, which I will discuss in a little more detail in just a second here. So including the restructuring charges, our earnings per share are expected to be $0.55 to $0.69 in 2006.

We estimate gross margins for 2006 to be in the 82.5 to 83% range and distributor incentives to be in the 42.2 to 42.7% range. And then we anticipate that the Company's tax rate will be in the 37 to 38% range in 2006.

In terms of cash outlays, we anticipate spending approximately 40 to $45 million in capital expenditures. Just to give you maybe some of the key categories there, approximately $10 million in scanners, approximately $10 million in maintenance CapEx, another $10 million in image enhancements and miscellaneous sort of things -- ProDerm, for example, and then 10 to $15 million in manufacturing facilities.

For the first quarter, we're expecting revenue of 263 to $270 million, again, based on a yen rate of about 118 to the dollar. And our earnings per share of $0.13 to $0.15. Now, on the earnings line, note that we have $0.02 estimated stock option expense in this year's numbers, again, not included in the prior-year number and a $0.04 to $0.05 charge related to convention expenses in Japan, which will be held in March of this year and was not included in the prior-year results. And then including the restructuring charge, which we anticipate will be mostly in the first quarter, we expect to show a loss of $0.12 to $0.22 based on the size of that restructuring charge.

With that sort of modeling behind us, let me just take a moment to address some of the restructuring efforts in a little bit more detail. As mentioned in our release we anticipate a total charge of about 30 to $40 million and that will be again primarily taken in the first quarter 2006. Approximately half of the charge will be a non-cash expense related to the impairment of the book value of our S1 scanners. It is our desire to launch and market the much improved S2 scanners, which will initially begin to launch in some of the markets at the end of the first quarter. And these new S2 units cost about one-third of the original unit, approximately $2000 per unit. They're much more mobile, they're faster, they're easier for a sales rep to use and so we want to launch those in as aggressive fashion as we can. We anticipate releasing approximately 5,000 new S2 scanner units into the market during 2006. And again, that's a capital investment of approximately $10 million.

In addition to the non-cash expense associated with the scanners and restructuring, we anticipate approximately 10 to $15 million of cash expenses associated with severance and approximately $5 million of expenses associated with other streamlining initiatives, office closures and the like. The savings from these restructuring efforts will be significant. We anticipate approximately 25 to $30 million in savings from these restructuring efforts once they have been fully implemented. Those are annual savings.

And at the same time, we expect to reinvest a substantial amount of these savings, as Truman mentioned earlier, into growth initiatives in Japan, China and Russia. And specifically, we expect to add approximately $15 million in Japan, which would include building brand and image enhancement activities, including improvement of physical facilities, promotions and enhancements and some enhancements to the compensation plan.

In China, we will add about 5 million to increase and improve our infrastructure and promotional expenses, again, building out in advance of the launch of our full business model there. And we will spend about $5 million to launch our business into Eastern Europe by opening Russia for operations in April. So we believe these investments will provide a solid return to us in the coming years.

This business transformation is focused upon improving our processes. It will truly change the way we are structured and operate at the corporate level. In fact, we have a dozen of our key managers working closely to help us develop our plan through this restructuring effort. We've made great progress and we believe that we'll be able to complete the effort in the first quarter and, therefore, we anticipate that substantially all the restructuring charge will be realized in the first quarter of 2006. So with that, I will turn the call back to Truman.

Thanks, Ritch. Before taking some questions, let me just conclude by stating that we believe we are doing all the right things and all that we can do to grow the business. We have conventions that are coming up in the first half of the year in Japan and Korea and greater China. We are investing in our largest market, Japan, with physical facility improvements and compensation plan enhancements and some brand promotion that Ritch has talked about. We're putting our compensation plan issues behind us in markets where compensation plan changes have hurt. We are improving access to our differentiating tools. We're making -- creating some room for an aggressive rollout of our S2 scanner on our balance sheet. We're introducing ProDerm, which will help to reinvigorate our Nu Skin product category which has taken a hit over the last couple of years. We're launching new products in our healthy living category that are synergistic with and augment our Measurable Difference marketing theme. We see some upside in Photomax, which continues to grow at a nice pace.

We continue to believe that there's tremendous upside in China and that China is really more of a timing issue than anything else. We are optimistic about Russia, which will be our most meaningful new market since we started business in China now over three years ago. And we are excited about the impact of our business transformation and this represents a significant overhaul of our organization and I am just really excited about the prospect of getting more aligned with our sales force, simplifying our business and really focusing on our growth initiatives and streamlining our business so that we can invest in these growth initiatives and also maintain our profit levels.

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

(OPERATOR INSTRUCTIONS). Kathleen Reed.

Good afternoon. Can you basically just talk about at your analyst meeting on November 30 of last year, what are the basic issues or things that you think have changed on how you are viewing '06? It appears in addition to just the rate of the yen, 118 that you're now using, that you're now expecting your second half of 2006 for Japan to be flat as opposed to I think before it was up slightly positive so that for the full year, you were going to be kind of flat in local currency and now it appears that Japan is going to be down.

Yes, Kathy, I would say that the biggest change really from our November outlook is that as we assess the way the business developed in Japan in '05, we have concluded that the impact from the compensation plan change in '05 was simply more profound than we thought it would be. And as we assess what's going on in the business there, we believe that's the primary factor that has negatively impacted us there.

In addition to the scanner and our inability to use the scanner exactly as we do in other markets and then a subsequent introduction of the S2, which slowed S1 promotion, that we knew in November. I think what has changed a little bit is that we underestimated the impact from these compensation plan changes and that's what we are fixing in March.

Okay. So can you just remind us a little bit more about what you actually changed in terms of compensation for '05? Because I think in the third quarter and fourth quarter of '04, you have like a doubling of compensation expense in Japan because you wanted to slowly change the compensation plan. And I think it got changed to reward people for more ADP purchases. So now, when you're going to make changes, are you just going to put it back to the way it was so that they're -- that doesn't seem to coincide with the launch of the new scanner.

Well, right. And whenever we get into compensation plan discussions, we can spend an hour talking about this in great detail and it's kind of confusing to do where we can't diagram it on a whiteboard. But basically we did augment the compensation plan at the end of '04 to prepare the sales force there for the transition that we wanted to make in '05 with the compensation plan modification. Essentially what we did was take a little bit of money from the front end of our compensation plan and reallocate it to aggressive business builders. It was really just a reallocation of front-end money more than anything else. And it drove some good behavior but overall, we saw that the erosion that it caused from those who in our business have just been kind of steady -- described as kind of steady eddy distributors who aren't necessarily aggressively building a business but are happy to be making 3, 4, $500 a month, those are the people who were hurt by the compensation plan change in '05. So we're not going back to exactly the same compensation structure but we are reallocating front-end dollars again towards these steady eddy distributors who are happy to be maintaining checks in the 3, 4, $500 range and that's the target audience for the changes that we will be making in March and April.

Okay, and then on your savings from your business realignment plan, it also appears like those got dramatically increased on the savings side from the previous estimate of 10 to 15 to now 25 to 30. Is part of that -- and it doesn't seem like you're getting any savings I think from the write-down of the S1 scanner. So what other areas are you planning that significant improvement in?

You know, Kathy, we will get savings from the write-down of the S1 scanner. Obviously, the amount on our books there versus what's going to be on the books for the new scanner will be more. So we I'll probably realize some 5 to $8 million of additional savings and amortization expense. That's part of the reason that number jumped up. But I think as we have been very thorough in analyzing our organization, we found -- we've tried to find everything possible in terms of what we can do to streamline our operation. And I think we have been more successful at finding savings than what we had anticipated when we spoke of this in November before we had really launched our restructuring efforts.

Okay, and then just finally on Russia, can you tell us what the business model is going to look like there since you're going to launch in April? If it's going to be more like your Latin American business model where you pay more for products as opposed to recruiting?

No, the business model in Russia will look very much how it looks in the United States and Europe. We are finding that most of our distributor leaders who are working in Russia come from those two markets and so we wanted to have a consistent -- a business model that they are familiar with.

Joe Norton.

Sorry to ask another question about the compensation issue, but I'm just not -- when you say that it benefits some and it hurts others, is what's going on that the people that it impacts negatively are leaving, you're seeing attrition there? Or does it just affect their sales levels?

Well, it's both. But what has been more troubling -- the most troubling factor is that we're seeing attrition of those people. And we're happy to have them as distributors even if they aren't aggressive business builders and so we're going to reallocate some front-end dollars to those folks.

Okay, so can you tell us what the rep trend in Japan was for the quarter?

It was down about 6%. It was really in line with our (multiple speakers)

Sales growth. Okay. And then I'm sorry, Ritch, I think at the end, you said about the savings. Will we see the full impact of the 25 to 30 million in '06?

No, no. Obviously, the restructuring efforts will be mostly in place by the end of the first quarter with some kind of trickling in throughout the year. So, the benefits will kind of phase in throughout (technical difficulty) and I would anticipate should be fully phased in in terms of the run rate by probably the third quarter of this year.

Let me just give you specific details that you asked on the Japan numbers if I can real quick, Joe. Executives were down 6% and actives were down 3%.

Okay. And then finally, I just wanted to -- on the China outlook, should we continue to see sort of negative rep trends and sales trends in the first and second quarter of '06 or how are you guys thinking about that?

As I think as I do my modeling, clearly, year-over-year, there will be a negative trend in the first two quarters of the year. If you recall last year it was the third quarter when we started to dip. But I think sequentially, typically, the first quarter is going to be a slower quarter because of the Chinese New Year holiday. So we would anticipate being somewhat level or close to level with fourth quarter, you know, sequentially fourth quarter to first quarter and then see sequential improvement throughout the year.

Okay, got it. And then just finally, on the inventory balance, it seems like that was up pretty significantly on a days basis. Can you just give any color on what was going on with that?

Yes, I think the number one issue is the fact that our sales slowed a little bit and so that caused that days in inventory to jump. But we will see our inventory balance probably come down a little bit in the coming quarters and get back in line here quickly. You know, you build off your forecast and we had forecast higher levels of sales in the fourth quarter. As those were a little bit lower, that obviously impacts your days in sales.

Doug Lane.

Good afternoon. Ritch, can we go through the economics of the scanner here? It seems like they've changed a lot now with the information today. If I remember right, you used to be -- old scanner 1 was designed to be kind of profit neutral, now it's got with the write-off of the S1's, and they're still in the field. How many S1's are still in the field by the way?

We have about 4,000 in the field today and maybe, Doug, let me try and simplify it as much as I can.

Today we have about $1 million a month in lease revenue coming from the old scanners and about $1 million a month in amortization expense. Going forward, that lease revenue is going to come down somewhat because we have got other models developed and likewise, the amortization expense will come down. And I think going forward, we will have probably about a one-to-one ratio between lease rate and the cost of sales as well. So, I'm not sure the model changes a lot. Effectively, we have a zero gross margin on the lease and the amortization of the units and that will continue to be pretty close to the case going forward.

So it won't be a write-off to zero, it's just a partial write-off?

That's right. It won't be a full write-off because some of those units will continue -- the S1 units will continue to be used and leased at a lower rate going forward.

Okay, and when you say -- you are including the S2 in this analysis, which looks like if that's amortized on three years, that becomes a profit generator?

Yes, you are exactly correct.

So, even with the write-off, the model is going to be now a slight loss on the S1, a slight profit on the S2's and a net wash?

That's it.

All right. Thank you. How much do you have modeled in for Russia sales this year?

We're kind of looking at about $1 million a month I think in our early modeling here. I believe that's probably a conservative estimate.

And can you --

Would be the latter part of April.

And can you give us an update on Latin America and what your strategy will be there for a broader rollout of your business in Latin America?

We're taking a hard look at Latin America as we evaluate all of our unprofitable markets actually. And I think what we're going to see is a little bit of a scale-back in Brazil to bring our overhead really a little bit more in line with our revenue level while we really focus some investment on Mexico, which has shown good results over the last couple of years and where we have a really good core of leadership and a lot of leadership energy. So, we are in the process of redesigning our Mexico business actually to keep the growth going there while we scale back a bit in Brazil.

Okay. And finally, in China do you know of any companies that have been granted a direct selling license yet?

No I don't believe that anyone has yet.

Okay, thank you.

Olivia Tong.

On your '06 outlook, it looks the gross margin and selling expenses are sort of coming in in line. so I assume that most likely the sales and also G&A that are slightly below your expectations -- on G&A, is that pretty much just a scale loss from sales or are there other things that we should know about?

No, it's exactly the scale loss from sales. You know, in fact, we actually had the U.S. convention that we held this year. In the prior year, we had a Japan convention. The delta between those two was about $2 million of additional expense this year. Immediately, as we saw sales slow a little bit, we were able to cut our expenses back a little bit in the fourth quarter. But the percentage of sales issue is completely sales driven, you know, a lower sales number.

Got it. On Russia, you had said about a million per month that's in your early modeling and you thought that might be conservative. Just wondering why you think that might be conservative, because I'm looking at Indonesia which is where you just entered. And that's sort of like, I think you said 2.3 million for the quarter? So it looks like your Russia target is obviously above that. And what are you seeing to sort of get you to that 1 million a month target?

Russia is just a larger direct selling market and growing at a much more rapid pace. And what we see there are our competitors flourishing and doing very well. So we're much more optimistic about Russia than we were about Indonesia.

Got it. And then on your three largest markets, can you talk about the sales targets? U.S., you have a pretty big acceleration expected in '06. What's driving that? And then Japan and China, are you hearing anything different from the distributors as far as what they have said before on their expectations for maybe the scanner or the ProDerm or anything like that?

The growth initiatives in all three of those markets are largely the same. The launch of the S2, which our sales force continues to be enthusiastic about. It's the launch of ProDerm, which is a very exciting tool for our sales force to use and the first of its kind measurement tool in the skin care industry. We continue to rollout new products in China and Japan in particular. And it's those three things.

Olivia, if I can jump in on the rate of growth. The U.S. actually had a nice year this year, growing 7, 7.5%. So we kind of anticipate that carrying forward. We're confident that China is turning the corner and moving in the right direction. So to get to a 10% growth rate would be somewhere in the $110 million or $115 million range this year. And then again, I gave detail already on Japan. So that's a little bit more detail in terms of how we model them out.

Got it. Turning to restructuring. The countries and divisions, have they been notified? And if so, can you give an idea on sort of where you expect to see rationalizations?

Well we haven't announced any office closures yet so our people have not yet been notified of that. Most of the headcount issues are going to happen in Provo, however, here in our home office, where as I indicated my direct reports are basically going to be cut in half. And for the first time, we're going to appoint global heads of our product development effort and our distributor management effort essentially. And as we bring those organizations together, we're just looking for ways to identify and eliminate redundant functions and redundant processes.

Ilias Papazachariou.

Do you expect an incremental revenue contribution from the March convention in Japan?

Typically, in Japan, we don't necessarily have a lot of products to launch right at the convention. They kind of roll out over the end of the month and the coming months. So we don't anticipate a big push in revenue from that convention but rather excitement surrounding the initiatives with the initiatives rolling out in Q2 and going forward.

Is there going to be a transitional period and implementation of the new compensation plan in Japan?

There will be some transition but that transition expense is baked into the numbers that Ritch has given you.

Okay. I was wondering if you could give us an update on the regulatory environment in Japan about ProDerm. Are you aware of any specific restrictions at this point?

No, the regulatory environment really hasn't changed from how it's been. It's basically status quo with the scanner and with ProDerm in Japan.

In terms of the new scanner in the U.S., have you been able to retain a license with no restrictions?

We're still working on that and I think there's a high likelihood of that happening in the next 30 to 60 days.

Scott Van Winkle.

Hi, several questions. First on the restructuring, what is the magnitude of the headcount reduction percentage? You know, the percentage of full-time employees that are going to be getting severance. And second, any changes to your co-packing relationship involved in this restructuring?

The magnitude of the headcount I will just characterize really more in terms of our labor burden. It represents about 10% of our labor budget here in Provo.

I'm sorry, I don't understand the co-packing issue, Scott, help me.

Any of your external manufacturers making any changes there to try and save on cost of goods sold?

No, we are actually identifying the whole supply chain as an area where we think we can be a lot more effective going forward, but it would not impact so much our vendors right now.

It's also -- the supply chain is a little bit of a longer-term issue than just 2006. But our goal is to take 15 to $20 million out of our supply chain within the next three years.

And on the beta test you're running in the U.S. on ProDerm, anything you can throw us out there, any positives, negatives, things you had to change, go back, rework, anything like that?

The positives are just that the field has reacted very positively to the ability to simply assess and evaluate people's skin. There's kind of a similar dynamic as we experienced with the BioPhotonic scanner. People are curious how they stack up against a population database and how they stack up based on various factors. So, ProDerm is measuring wrinkles, pore size, skin tone, and texture and just very good feedback. We even have some dermatologists who are using it and they love it in their practice because it's a very high-quality camera that enables them to take almost microscopic images of a person's face and be able to talk about these various skin characteristics.

Negatives, you know, we're still playing a little bit with the output from the device, exactly what we want the output to be. Should we boil down the test to a numerical factor as we do with the scanner or should we simply measure these for skin elements and let the scale speak for itself? You know really not a lot of negatives. We're just kind of fine-tuning the output of the device more or less.

Are there any early results you can share as to what happens to distributor productivity when this is put in their hands?

Well one of the things it does for sure is just redirect distributor attention to the Nu Skin category. Pharmanex has really enjoyed the spotlight with the launch of the scanner over the last couple of years. And so the fact that distributors now have something as compelling as ProDerm to talk about will drive Nu Skin volume just based on that alone.

But what we're also trying to do is reduce consumer confusion about what products they should be using. Today when you flip through our product catalog, we find that consumers don't know which products to pull out of that catalog and adopt in their skincare regimen. So ProDerm will also play a very important role in minimizing that confusion and basically prescribing a skincare regimen based on that person's skin characteristics.

Would you expect any material change in the mix of business between Pharmanex and Nu Skin this year?

I think that in the United States we're going to see both categories grow. And I think that outside of the United States, you know, it's hard to say but both Pharmanex and Nu Skin enjoyed good growth initiatives this year. I just think Nu Skin is going to be getting a lot more attention than it has the past couple of years. So just given the fact that it now has a device that competes with the scanner, I think you'll see perhaps a little more Nu Skin growth than you will Pharmanex growth.

Okay, on another subject, we read a story a couple of weeks ago about your intent to open some stores in Thailand. Is that correct? And what's the plan there? Is it something you're seeing in China that you're going to extrapolate in other Asian markets?

It is a little bit of a similar dynamic. I mean, it's a test program in Thailand now and really relates to this notion of getting more aggressive in terms of image enhancement and brand promotion. We're finding that these storefronts are inexpensive to build and to operate in many of the Asian environments and the emerging economy environments. And they play a very handy role where people are more hesitant in those environments to invite people into their homes or to go into other people's homes to do business. It's just a convenient gathering spot. These people like the ability to pick up product as opposed to have product shipped to them and helps us promote the image of our brands in the fashion that we would like to.

Kathleen Reed.

Thanks. Also it seems in your new expectations for '06 or at least you had a sentence in there for your China forecast that you expect growth of at least 10% and I think before on your analyst day you said 10 to 20. Should we read anything into that or you're leaning more towards the bottom end of that range or should we not read anything specific into that language?

Yes, I don't think you should read anything specific into that language, Kathy. We're just trying to be conservative about China right now.

Okay. And then on the Photomax for initiatives for Big Planet, was most of that 8 million all in the U.S.?

Yes, a little bit of it is in Europe but 98% of it is U.S.

Okay do you have a growth target for that for '06?

We're actually anticipating that that business will grow by probably 40 to 50% in the current year.

Wow. And is it in other countries or is it going to be rolled out to other regions or is that primarily where it has been adopted?

We anticipate Photomax being relevant in 2006 only in the United States and Europe.

Okay. Just finally, I believe you had a Pharmanex plant in China that was supposed to come online in the fourth quarter. Can you just give us an update on that? And I think there's a second one coming in '06?

The Pharmanex plant that went online in the fourth quarter is producing Pharmanex products just for China. And the second plant that is currently in the design phase will begin construction in the next few months and will be designed for exporting of Pharmanex products from China. And it's part of our strategy to take 15 to $20 million out of our supply chain in the next couple of years.

And then we'll probably come online latter part of '07.

Latter part of '07. Thank you very much.

David [Plantz].

Hi, gentlemen. Just to ask you, I came in slightly late and missed your opening lines on China and I was hoping if you've already detailed it, please tell me so, but can you outline exactly how the licensing is going at sort of the national and then regional and what your timeframe is for the sort of ultimate door-to-door work?

Sure. Let me give a little more color on the licensing process. We submitted our license, our application, to the Shanghai officials on the first day we could, which was December 1. And the licensing process was slowed a little bit by two factors. One was that people weren't really clear and the government wasn't really clear on what the physical presence or the service center requirement was going to be on a province to province basis. And then all of us who are applying for licenses also had to wait for clarity on where to deposit the financial deposit that's required in order to even apply for a direct selling license.

So, perhaps the confusion that exists today is that now that the applications have gone from the municipalities and the provinces to Beijing, the issue is whether the ninety-day clock that is built into the licensing time line will start running as of December 1, which is the day we and others submitted applications initially or whether that ninety days starts running from the time our applications hit Beijing. So that is I think the only confusion right now that remains in the licensing process is that.

And we would anticipate consequently that licenses will start to be issued in the next couple of months and what we are hearing is that, given the fact that Avon Products has had kind of a temporary license in a couple of cities, that they will likely be licensed the soonest and the first and then other licenses will follow.

At this time, sir, you have no further questions.

Okay. Thank you all for joining us today and as always we stand by ready to answer whatever questions we can and look forward to speaking with you and appreciate your support. Thanks very much.

This concludes today's conference. You may now disconnect.