Nu Skin Enterprises Inc. Q4 2008 Earnings Call Transcript

Feb. 6.09 | About: Nu Skin (NUS)

Nu Skin Enterprises Inc. (NYSE:NUS)

Q4 2008 Earnings Call

February 6, 2009 11:00 am ET

Executives

Scott Pond – Director of Investor Relations

Truman Hunt – President, Chief Executive Officer

Ritch N. Wood – Chief Financial Officer

Joseph Chang – Chief Scientific Officer

Analysts

Olivia Tong - Bank of America/Merrill Lynch

Timothy Ramey - D. A. Davidson & Co.

Douglas Lane - Jefferies & Co.

Amy Greene - Avondale Partners LLC

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2008 Nu Skin earnings conference call. My name is [Jeri] and I’ll be your operator for today. (Operator Instructions) I would now like to turn the call over to Mr. Scott Pond, Director of Investor Relations. You may proceed sir.

Scott Pond

Thank you Jeri. We appreciate all of you joining us today. With us are Truman Hunt, President and Chief Executive Officer; Ritch Wood, Chief Financial Officer; and Joe Chang, Chief Scientific Officer.

During this call comments may be made that include some forward-looking statements. These statements involve risks and uncertainties and 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 these risks.

In addition, during this call certain financial numbers may be discussed that differ from comparable numbers contained in our financial statement. We believe that these non-GAAP financial numbers assist management and investors in evaluating and comparing period-to-period results in a more meaningful and consistent manner. Please refer to our investor portion at nuskinenterprises.com for a reconciliation of these non-GAAP numbers.

With that I’ll turn the time now over to Truman.

Truman Hunt

Thanks Scott and good morning everyone. We appreciate you joining us on the call today. As our release this morning indicates we had a strong fourth quarter which helped us post record revenue for 2008.

During the fourth quarter we generated revenue of $318 million, a 4% improvement over the prior year period with earnings per share of $0.23 compared to $0.09 in 2007. Now as the release indicates our fourth quarter earnings include unusual charges in both 2007 and 2008. In 2007 we had a fourth quarter restructuring charge of $0.17 while fourth quarter earnings for 2008 were negatively impacted by $0.12 of foreign currency translation losses. So on an apples-to-apples basis, our earnings per share would have increased 35% during the quarter improving it from $0.26 to $0.35 per share.

We are very pleased with this progress which reflects three years of work to get our operating margin above 10%, and which represents a 230 basis point improvement year-over-year. We’re really pleased as well with our top line for the quarter and again delighted with the progress we’re making on profitability.

Our success can largely be attributed to the positive momentum in our skin care business as well as ongoing business transformation initiatives which are translating to good distributor energy around the world. Nu Skin personal care sales increased 27% year-over-year in the quarter with the Galvanic Spa continuing to be the star of our skin care line up.

Two years ago in the fourth quarter of 2006 Galvanic sales were about $5 million globally. And in the fourth quarter we just finished Galvanic sales rose to over $50 million. So we really have hit a home run here with this product. One of the reasons for the success of the Galvanic is that it’s a perfect direct selling product. Our distributors can easily demonstrate the benefits of the Galvanic Spa which helps them recruit both customers and distributors.

In fact, our distributors typically introduce the Galvanic through a personalized, half face demonstration and at the end of that demonstration the customer can easily see immediate benefits in the appearance of their skin. And of course once they see the great results they’re typically eager to start using the Galvanic Spa on the other half of the face as well. The Galvanic also has several consumable companion products which encourage ongoing purchasing.

We’d indicated during the year that the introduction of the Galvanic Spa in China would be the stimulus for getting to even on a year-over-year basis in the fourth quarter. This proved to be the case as the introduction of Galvanic to sales leaders in China led to a significant improvement in China’s revenue trend. The positive introduction of Galvanic in the fourth quarter also bodes well for the roll out of Galvanic to consumers in China during the first quarter of this year.

Adding to the energy of the Galvanic Spa we also launched Galvanic Spa Facial Gels that incorporate our exclusive AgeLoc technology during the fourth quarter in the U.S. and as well as in Europe. We’ll begin the global roll out of AgeLoc later this year as we introduce AgeLoc in a daily use skin care system at our October Global Distributor Convention. This proprietary AgeLoc technology takes our product portfolio to an entirely new level.

Today, competitive products address the signs and symptoms of aging such as wrinkles and discoloration. We believe Nu Skin now has a distinct competitive advantage as we’re the only company that can offer a comprehensive skin care system that addresses not just the outward signs and symptoms of aging but also slows the actual sources of the aging process.

Following the fall 2009 launch of AgeLoc skin treatments we look to incorporate this scientific breakthrough into our nutritional line as well going into 2010. We’re extremely pleased with our product strategy and believe that we’re really in a stronger position than we’ve ever been in before from a product perspective.

We’re also generating positive results from our ongoing business transformation initiatives and are making significant improvements in operating margin and G&A levels. Our operating margin improved to 12.2% during the fourth quarter, which represents again a 230 basis point improvement when excluding 2007 restructuring charges. This helps us achieve a 10.1% operating margin for the year and is a clear indication that we’re moving profitability in the right direction.

A big contributor to the fourth quarter operating margin increase was a 130 basis point improvement in selling expenses. During the past three years we’ve worked to improve alignment between distributor and corporate growth objectives, encouraging and rewarding targeted distributor activity. The launch of what we call the Wealth Maximizer, a feature of our compensation plan in North America and Europe during 2008 proved to be very successful as average income levels for early stage distributors are up, leading to an improvement in distributor retention while overall selling expenses have been managed down slightly.

Additionally we saw our G&A expenses drop 140 basis points over the prior year, again a reflection that we’re becoming much more efficient. The decisions we’ve made over the past few years are paying dividends and we anticipate these trends will continue as we consistently seek to find new ways to improve profitability.

Looking at the distributor energy in our markets, we’re especially pleased with the momentum we continue to see in the U.S., in Europe, in South Korea and in Latin America. As these regions continue to grow rapidly, the diversity of our business continues to improve giving us a wider footprint and allowing us to become less reliant on any single market.

While we become more internationally diverse, we nevertheless remain focused on building our Japan business. As we’ve previously indicated, Japan is the final market to go through our restructuring process. We’re reconfiguring our operations there to align Japan organizationally with what we’re now doing everywhere else in the world.

This restructuring got under way just in the last month of January and will lead to charges of approximately $14 million this year, with $8 to $10 million of these charges coming in the first quarter. We believe that this restructuring in Japan will benefit our overall business as it has with similar efforts that we’ve made in other markets over the past few years. With these Japan restructuring charges we’re poised to push our operating margin to 12% over the next four years.

Now in the midst of current economic turmoil we remain committed to providing an antidote for what ails the economy by enabling people to supplement and replace income. While we’re not immune to contractions in consumer spending, the opportunity side of our equation helps to offset consumer spending contraction. So far we’re weathering the turbulent conditions well and we remain optimistic about 2009 mirroring our growth in 2008.

Let me just add anecdotally that the spirits among our sales leaders in the face of economic trends really could not be higher. At a time when many people are desperately seeking income, Nu Skin Enterprises is a source of hope and provides a real mechanism for people to provide for their families.

Now one thing that we can’t control is currency swings, which were definitely a negative factor in our reported results for the second half of 2008. But we’re in a very healthy financial position. We’re pleased with local currency results and we’ve made significant improvements in profitability.

We remain committed to shareholder value and are pleased that our board of directors has approved a 5% increase in our quarterly dividend. This represents the seventh consecutive year since instituting dividend payments that the company has raised its dividends payout.

Okay. With that, I’ll turn the time over to Ritch to go over financial specifics.

Ritch N. Wood

Thank you Truman. Good morning everyone. I’ll quickly give the local currency revenue figures for some of our major markets. In North Asia, fourth quarter revenue in Japan was 11.5 billion yen compared to 13.4 billion yen in the same quarter of 2007. Quarterly revenue in South Korea was 42.3 billion won versus 35.6 billion won in the prior year. In the Americas, the U.S. posted $50.5 million in revenue. That’s compared against $42.5 million in the prior year. Canada reported 5.3 million Canadian dollars in the quarter compared to 3.1 million in the prior year. And Latin America revenue was $4 million compared to $2.3 million in the prior year quarter.

And then in greater China, mainland China revenue was 117.7 million renminbi during the quarter versus 119 million renminbi in the prior year. And quarterly revenue from Hong Kong was 100.6 million Hong Kong dollars compared to 93.8 million in the same quarter last year. Taiwan revenue was 749 million NT$ compared against 775 million NT$ in 2007.

Our gross margin for the quarter was 81.7% and our gross margin remained even sequentially and approximately 30 basis points lower than the prior year. Selling expenses for the quarter were 41.6% compared to 42.9% in the fourth quarter of 2007. This improvement can be attributed to recent distributor compensation plan enhancement in many markets that more closely aligned with distributor and corporate growth objectives.

General and administrative expenses for the quarter were $88.3 million or 27.8% of sales compared to 29.2% of sales in the prior year period. The 140 basis point improvement is primarily a result of management’s transformation efforts to increase efficiency and drive improved profitability in the company.

The company’s operating margin was 12.2% for the quarter, a 240 basis point improvement over the prior year. That’s excluding restructuring charges from the prior year quarter. And during the quarter we sustained a net expense of $14.8 million in the other income expense line of our income statement. Foreign currency translation losses resulted in $12.6 million of this expense in the fourth quarter. Approximately $9 million of this foreign currency loss relates to the translation of our yen denominated debt into U.S. dollars as the yen moved from 106.35 at the end of September to 90.73 at the end of December.

The remainder of the currency loss relates to the translation of inter company balance sheet accounts into U.S. dollars at the end of the quarter. Note that these foreign currency losses are generally non-cash and gains could result when these currencies rebound. The foreign currency loss resulted in a $0.12 charge to EPS in the fourth quarter.

Since foreign currency translation has created unusual swings to EPS in the past two quarters, I’ll take a moment to try and explain our strategy as it relates to hedging. First off, we hedge our Japan revenue stream by establishing some of our debt in yen. In so doing, we’ve been able to borrow at an average coupon rate of approximately 2% and the long liability position hedges against the revenue of our Japan business. So as the yen strengthens, we pick up a benefit when exchanging our yen revenues and earnings back into U.S. dollars, which is then somewhat offset by the expense created by the stronger yen when converting our debt back into U.S. dollars.

In addition to the debt, we have established inter company yen liabilities between Nu Skin’s parent company with the Japan entity to offset foreign currency denominated inter company receivable balances between Nu Skin’s parent and many of its foreign subsidiaries. So generally when the basket of currencies move one way or the other against the U.S. dollar, the translation of foreign currency denominated liabilities and assets back to U.S. dollars offset each other.

As you are aware, however, currency movements in the past several months have been significant and unusual. The yen strengthened against the dollar, while the dollar strengthened against most other currencies. And in this case we generated a foreign currency loss on our yen denominated liabilities while also generating losses on our foreign currency receivables as well. Unless these receivables or liabilities are settled during the period, the foreign currency losses are non-cash and again will likely generate gains as the currencies rebound.

Although it’s impossible to project where our currencies will go in 2009 we don’t anticipate generating such currency losses this year. As an example, our yen debt and liabilities are currently converted on our balance sheet on December 31 at a yen-to-dollar rate of 90.73.

So hopefully this gives a bit of transparency as to what is happening with foreign currency losses and gains. It’s a bit unfortunate for us this year actually as we lost about $0.18 in foreign currency losses during the year when in 2007 we actually picked up $0.06 in foreign currency gains. Note that these losses are reported both below the operating income line and the line that we call other income and expense.

So from 2007 to 2008, we improved operating margin by 32%. We improved operating income by 42%. And we’re very encouraged about the direction of the business and the improvements in operations and particularly in profitability, and believe we’re in a good position to continue to generate improvements moving forward.

I am especially pleased that our balance sheet is strong and continues to get stronger, with debt declining and cash increasing. And as a sign of this strength and commitment to strive to improve shareholder value, we announced today that we will increase our quarterly dividend by 5%.

Our tax rate for the quarter was approximately 40%. That was compared to 43% in the prior year. During the quarter we paid $7 million of dividends and repurchased $2.5 million of company stock.

Our restructuring efforts in Japan are going very well. We expect to incur a charge of approximately $14 million of which $8 to $10 million will result in cash charges. We anticipate that the bulk of these charges will be fully incurred and completed within the first half of 2009.

As we discussed in the past, our 2008 gross margin was slightly lower than the prior year due to the shift in revenue from Japan to other lower margin markets and the increase in the sales of the Galvanic Spa unit. As we come into 2009, we’ll wrap around this issue and our gross margin should be fairly consistent with prior quarters. Also we expect distributor incentives to improve some 20 to 40 basis points from 2008 to 2009.

We reiterate the 2009 guidance that we provided in December at our investor day. Guidance includes local currency revenue growth of 3 to 5% and a projected negative foreign currency impact of about 3 to 5% to revenue. This puts our 2009 revenue in the $1.24 to $1.27 billion range. We expect 2009 earnings per share to improve 8 to 18% over 2008, or be in the $1.10 to $1.20 range. That’s excluding 2009 restructuring charges which we would anticipate being somewhere around $0.14.

For the first quarter we project revenue to be in the $290 to $300 million range with earnings per share of $0.22 to $0.24, excluding approximately $0.10 in restructuring charge. And again we would expect currency to negatively impact revenue some 3 to 5% here in the first quarter.

So with that background we’ll go ahead and open up this call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Olivia Tong - Bank of America/Merrill Lynch.

Olivia Tong - Bank of America/Merrill Lynch

Margins were a lot better than I’d expected and I understand the selling expense portion. Can you provide a little bit more color on what you’re doing to drive G&A lower?

Ritch N. Wood

Sure Olivia. Yes, I think the margin was something that we worked on for a long time so it’s really – we’re pleased with the direction that we’re moving. In terms of selling expenses, we really kicked off an effort about three years ago to analyze all the various aspects of our incentive payout. And during 2008 a number of initiatives coming out of the study were implemented in markets all over the world. Really the focus is to maximize the payout and to maximize the benefit that we receive on the payout. And just work very effectively.

Truman mentioned the Wealth Maximizer which was one of those examples. Another objective is to focus, especially in this economic time, getting money to an early executive so they can be benefited and our retention rates go up. So that works very well. In terms of actual G&A expenses we’ve reduced our headcount by 25% over the last two-and-a-half years globally. So those benefits are really starting to pay off.

We’re continuing to look for ways to refine our operating model and improve efficiency. We’ll end up – the restructuring in Japan will adjust about 40% of our headcount down and again hopefully make us quite a bit more efficient there and focused on those things which are driving the business.

Olivia Tong - Bank of America/Merrill Lynch

On the G&A it looks like, you know, you’ve been doing this for like you said about two years now but you had been sort of at this 29 to 30% steady rate for G&A as a percentage of sales. But then in Q4 you’re now sub 28%. So is there anything specific that hit Q4 more drastically than in previous quarters?

Ritch N. Wood

Not necessarily. You know our revenue was up a little bit. We only had a convention in the U.S. which was approximately $2 million but no large convention related expenses. And I think just a steady, steady improvement over time has kind of gotten us to that level in the fourth quarter.

Olivia Tong - Bank of America/Merrill Lynch

And then on retention, you mentioned the Wealth Maximizer initiative. Can you talk about retention numbers now versus say pre – before you started making some of these changes?

Ritch N. Wood

Yes. I mean I think the Wealth Maximizer has now been in place since April and June in the U.S. and in Europe. So it’s a little hard to – you know we probably don’t have enough history to declare victory. But I think our focus during these times specifically and Truman has really pointed our market managers to focus very carefully on retention of both our distributors as well as our customers in a time where the consumer is under a lot of pressure.

So we’re analyzing a number of ways to continue to try and improve retention. I would say on a year-over-year basis we’re about even today with where we were a year ago. So neither dramatic improvement nor declines in retention as compared to a year ago.

Operator

Your next question comes from Timothy Ramey - D. A. Davidson & Co.

Timothy Ramey - D. A. Davidson & Co.

Would you remind me what countries Galvanic Spas is in now or where is it not? Is it –

Truman Hunt

Galvanic Spa is virtually everywhere in the world now with the exception of Taiwan, where local regulations prevent its sale. But with introduction to consumers in China in the month of January, Galvanic Spa is virtually everywhere else in the world.

Timothy Ramey - D. A. Davidson & Co.

So that should be part of the revenue growth in 2009 versus 2008, I would guess.

Truman Hunt

Yes, we expect Galvanic to continue to definitely add to revenue growth in 2009.

Timothy Ramey - D. A. Davidson & Co.

And if you’re characterizing the growth in – I mean there’s impressive growth in the Americas and impressive growth in Europe. Was that primarily Galvanic Spa? Was it – how was nutrition doing there? Can you give us some more granularity there?

Ritch N. Wood

Yes, the growth is definitely coming on the skin care side of the equation. Nu Skin sales up 27% year-over-year in 2008. Pharmanex sales globally were down about 5 to 6% in 2008. So it’s really not surprising to us that with the spotlight being so brightly shined on the Galvanic Spa right now we would suffer a little bit of a decline in Pharmanex. But overall we’re happy with the trends.

We do focus some CRM mechanisms on retaining Pharmanex sales volume. And as you know when we introduce new products from time-to-time that the spotlight does shift from one product category to the other. That spotlight will shift back in 2010 and 2011 to the Pharmanex side of the equation when we infuse AgeLoc technology into some nutrition products. But overall the shift from Pharamanex to Nu Skin has been a good one.

Timothy Ramey - D. A. Davidson & Co.

That was actually my next question, your comment on bringing some of the AgeLoc technology to the nutrition. Can you be specific at all about what that might entail?

Ritch N. Wood

Yes. The AgeLoc technology that’s being infused into skin care products in 2009 has to do with the inhibition of an enzyme called arNOX and our scientists are hard at work preparing nutritional ingredients that generate the same result and inhibit arNOX production.

Operator

Your next question comes from Douglas Lane - Jefferies & Co.

Douglas Lane - Jefferies & Co.

I want to talk about two your bigger markets as far as driving the growth plus and minus. Japan continues to be a drag and it looks like its getting worse. Can you give us an update on the local market conditions in Japan and how you think ’09 is going to shape up vies a vie ’08? And then conversely Russia – I mean Europe in general continues to be a huge driver of growth and now is approaching 10% of sales so it’s really starting to move the needle. I’m getting mixed messages coming out of Europe so I wonder why Nu Skin is doing so well in those markets.

Ritch N. Wood

Well, let’s talk about Japan first and yes, Q4 was an accelerated decline over Q3. But I hope that people won’t read more than they really should into that because as you’ll recall we decided to start really changing the way we promote in Japan during 2009. And the accelerated decline in Q4 is really just a reflection of the fact that we didn’t engage in the same level of promotion, frankly the same types of promotion in Q4 of ’08 as we did in Q4 of ’07.

So overall we have guided to a 7 to 10% down in Japan for 2009. And we continue to believe that that’s safe guidance. So we think that things will improve there sequentially in Q1 and then going forward throughout 2009.

In Europe, you’re absolutely right. It’s just become a phenomenal market for us and it doesn’t show signs of slowing. The growth we’re seeing in Eastern Europe especially is tremendous. Russia has now caught the bug and is growing at a very rapid rate, despite the economic turbulence there. And I would say it’s just a combination of focused field leadership, really good enthusiasm among field leaders, and momentum that’s just kind of spilling from one market – one country into the next. And so you’re right, Europe has become material and will continue to become more material in 2009.

Douglas Lane - Jefferies & Co.

And is there a particular bias towards skin care or nutrition in those markets in Europe? And which of the key countries other than Russia that are driving the growth there?

Ritch N. Wood

Yes, it’s been kind of a split bias in Europe with Eastern Europe over the last couple of years being somewhat Pharmanex centric and Western Europe over the past couple of years being somewhat Nu Skin centric. But now that bias is really kind of following the global trend and we’re seeing more and more of our sales leaders focus on skin care and Galvanic in particular. It’s Galvanic that really has started Russia on a steep growth trajectory. And so we’ve seen growth on both sides of the fence, with recent attention really skewing the Nu Skin direction.

Truman Hunt

Doug, just real quick I’d just comment we have about a third of our business today coming from Northern Europe, a third coming from Central Europe and a third from Eastern Europe. The largest markets would be Germany and Hungary in terms of volumes.

Douglas Lane - Jefferies & Co.

Larger than Russia?

Truman Hunt

Yes. Certainly. Russia we’ve been in now what, two years I think so a little bit less history. Growing it’s probably our fastest growing market today is Russia, or one of the faster growing markets. But still not to the same size as some of these more established markets.

Operator

Your next question comes from Amy Greene - Avondale Partners LLC.

Amy Greene - Avondale Partners LLC

I know there’s been a fair number of questions about whether your distributors would be able to sell a $250 appliance to consumers as the economic macros continue to slow down. Are you hearing from them any resistance or increased difficulties selling the product? Or is it continuing to sell kind of across the board as strongly as it did before?

Truman Hunt

I actually spent some time last night and this morning talking to U.S. sales leaders in particular, asking that very question because as economic news just continues to worsen it’s frankly hard for me to believe that we can plow our way through this economic turbulence without really seeing some impact on the contraction consumer spending. I’ll just tell you, Amy, that the enthusiasm of our sales leaders has never been higher. And so far the fact that we’re providing a very vibrant business opportunity that enables people to supplement or replace income is outweighing the impact of contraction in consumer spending.

But we recognize very acutely that a significant part of our business is consumer business. And it’s probably unrealistic for us or anyone else to think that our consumers won’t also be impacted by the economic crunch. But we just have the natural hedge and frankly the increasingly important hedge of also providing people an income opportunity. And so far that’s offsetting consumer pressure.

Operator

This concludes the Question-and-Answer portion of your conference. I would now like to turn the call over to Mr. Scott Pond for closing remarks. You may proceed sir.

Truman Hunt

Well, this is Truman. I’ll just close by saying again and reiterating how pleased we are with the direction of our business. We continue to innovate in every area of our business and in particular in our product platform as well as our distributor compensation. We’ll work continually to reinvent ourselves. We’re seeing great progress in our business transformation efforts. And again in this uncertain economic environment when more and more people are looking for some stability, it’s a great time to be a direct seller with Nu Skin Enterprises. And as we celebrate our 25th anniversary this year we see great things ahead. Thanks for joining us.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Good day.

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