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Nu Skin Enterprises, Inc. (NYSE:NUS)

Q1 2008 Earnings Call

May 1, 2008 11:00 am ET

Executives

Scott Pond – Director, Investor Relations

M. Truman Hunt – President, Chief Executive Officer & Director

Ritch N. Wood – Chief Financial Officer

Daniel R. Chard – Executive Vice President Distributor Success

Joseph Y. Chang Ph.D. – Executive Vice President Product Development & Chief Scientific Officer

Scott E. Schwerdt – President Americas & Europe

Analysts

Olivia Tong – Merrill Lynch

Timothy Ramey – D. A. Davidson & Co.

Scott Van Winkle – Canaccord Adams

[Nina Noel] – Sidoti & Company

Operator

Welcome to the first quarter 2008 Nu Skin earnings conference call. (Operator Instructions) I’d now like to turn the presentation over to your hose for today’s call Mr. Scott Pond, Director of Investor Relations.

Scott Pond

We appreciate you joining us on the call this morning. Joining us today are Truman Hunt, President and Chief Executive Officer, Rich Wood, Chief Financial Officer, Dan Chard, Vice President Distributor Success, Joe Chang, Chief Scientific Officer and Scott Schwerdt, President Americas, Europe and South Pacific. During this call comments may be made that include some forward-looking statements. These statements included 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 filing for a complete discussion of these risks.

In addition, certain financial numbers may be discussed today 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 of operations in a more meaningful and consistent manner. Please refer to our investor portion of the company’s website for a reconciliation of these non-GAAP numbers.

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

M. Truman Hunt

We’re very pleased to report of first quarter results and to provide some insight in to what we believe will be a banner year for Nu Skin enterprises. Based on results to date, we’re well on track to achieve the 2008 revenues earnings per share and operating margin targets that were outlined in our annual investor meeting last fall. As a reminder, we had guided to 4% revenue growth, 35% to 45% EPS growth on an operating margin of 10.5%.

As our press release indicates this morning, our first quarter revenue was $298.1 million a 9% improvement over 2007 and a record first quarter revenue level. First quarter earnings per share were $0.21 compared to $0.16 in the prior year representing a 31% improvement over the prior year. Earnings per share were negatively impacted by approximately $0.05 due to the translation of Yen denominated debt to US dollars as is reflected in the other income section of our income statement. Rich will give more color on this in a minute. But, if we were to net out the impact of foreign currency fluctuations during the quarter our bottom line would have obviously been significantly higher.

So, we’re very pleased to see the impact of our restructuring efforts over the past two years. Those efforts are reflected in our improving operating margin. The 9.2% operating margin in the first quarter will continue to improve during the year to get us to our 10.5% margin target for the year. We’re very pleased with that progress. I would note that in the fourth quarter of 2005 we generated about $60,000 of revenue per full time employee and in the first quarter of 2008 that number has increased 50% to $91,000 of revenue per employee and as we move through 2008 our earnings will better reflect the impact of restructuring because we don’t expect to face the same level of debt translation expense going forward and in fact, we may even be able to recapture some of that negative impact in Q1.

Our strong revenue results came from steady sales growth in all of our regions and in most of our individual markets the United States, South Korean and Europe led the charge with roughly 20% revenue gains and it’s encouraging to see steady progress in Southeast Asia and to also see good results in some of our newer and smaller markets including Russia, Israel, South Africa and Venezuela. We actually just opened South Africa and Venezuela in the first quarter and are off to very good starts in both of those markets. We’re also very encouraged with continued strong sales in our personal care brand. In the first quarter Nu Skin sales were up 21% over the prior year due largely to the success of our Galvanic Spa System which contributed $25 million of revenue in the quarter. Now, that compares to about $8 million of revenue in the prior year and it makes the Galvanic Spa System our largest selling item under our Nu Skin brand by quite a large margin.

Some of you may have seen the Galvanic Spa System featured on The Today Show a few weeks ago. This Galvanic Spa system is a small device that emits a very low level Galvanic current that increases the penetration of charged ingredients in to skin tissue which enhances product effectiveness and provides a spa quality skin treatment at home. The product has been extremely successful in Europe, South Korea and the US. In fact, Nu Skin sales in the US were up over 80% year-over-year in the quarter and continue very strong. The Galvanic Spa is just beginning to gain traction in some markets in particular Japan where we hope it will have a very positive impact. So, we expect that Galvanic sales will continue strong for the foreseeable future.

Our True Face Essence Ultra products is also having a very positive impact on our personal care business. This is a very potent high end skin treatment that compliments the Galvanic Spa System to maximize the effectiveness of product ingredients. The product promotes elasticity and firmness in the skin and is a reformulation of our original True Face Essence product. It’s currently sold only in the United States but will be rolling out globally beginning in the second quarter. Based on results over the last few months in the United States this product really has the potential to be a runaway success for us.

On the nutrition side Pharmanex continues steady. We have several product initiatives that are keeping distributors engaged in this side of the business. Lifepak which as you know is our core supplement as well as our weight management offering are both doing well. Next month in Japan, actually this month now, in as much as we’re in May, we’re launching our biggest selling SKU in the United States which is Lifepak Nano. This is an enhanced version of the base Lifepak formulation and has quickly become the leading supplement in the United States so we expect it to have a very positive impact in Japan as well.

Now, let me point out here that our product positioning continues to set up apart in the direct selling industry. We are uniquely capable of offering substantive products in the two most critical anti-aging categories skin care and nutrition and with more and more science highlighting how these product categories are interrelated we feel like we’re in a great place to cross sell these brands in order to maximize the share of wallet we capture from each consumer. Our product development efforts around the Arnox concept that we presented to the investor community at our investor day last fall remains on track and will be introduced more formally to our sales force this coming fall.

Now, while we’re seeing strong results in a majority of our markets, we had a tough quarter in Japan. This market remains our highest priority and frankly we were frustrated by some environmental issues that muted the impact of our growth initiatives in Japan and that interrupted the progress that we were making in the second half of last year. I want to note that we were also dealing with a difficult comparison in the first quarter due to a first quarter 2007 distributor convention we held in Japan. But, the primary challenge during Q1 was regulatory and media hostility directed at a couple of direct selling competitors that disrupted our business and that we suspect had a negative impact on the direct selling industry generally.

During the first quarter Japan regulators imposed a sanction on one of the larger companies in Japan that suspended their ability to recruit new distributors for a three month period of time. The public announcement of that cited in appropriate product claims as the primary reasons for the sanction but the publicity associated with it had a chilling effect on the environment for us and prompted us to focus some additional resources on ensuring full regulatory compliance and helping distributors understand and comply with our own strict code of conduct. Though it’s difficult to project how long this disruption will continue to impact our business, though we feel the timing of our May convention is good and we have some great ammunition to put to use in the market with the launch of Lifepak Nano and True Face Essence Ultra both top performing products globally.

I also want to make just a brief comment on China. I just spent last week in China meeting with our management team, our sales leaders and government officials and we continue to believe that China presents a huge opportunity. You’ll recall that we closed about half of our stores just in December of 2007 and trimmed our headcount significantly. The other sequential decline in our business was relatively small in comparison so we’re really very pleased with the work Andrew [Finn] and his team are doing there. In 2007 China was also a very costly market representing about a $13 million investment and we’re now operating much more efficiently which will have a very positive impact to earnings this year. We’re also looking forward to greater China’s convention coming up in just a couple of weeks which will be held in Hong Kong. So we enjoyed significant potential upside in China and we feel that we’re operating in a much more manageable investment level at this point.

Geographically we are doing extremely well in the United States, Europe, South Korea and Southeast Asia. We see accelerating growth rates in each of these markets. Just a few weeks ago we held our annual incentive trip for our top sales leaders and I can tell you that their spirits are very high. In fact, we had more trip qualifiers this year than we’ve ever had in the past. It’s particularly helpful for our sales leaders around the world to get together and to share best practices and to share good news so we were pleased to see an uptick in activity immediately following the incentive trip. That will work to continue throughout Q1 and throughout the remainder of the year. So, overall I’m confident that our sales leaders share our vision and are onboard to make 2008 a record year.

In addition to our own efforts and initiatives we’re also benefitting from a few socio economic factors. We’ve stated in the past that economic uncertainty can be beneficial to our business as people are looking for supplemental sources of income. We believe that some of our success in the United States can be attributed to this factor. Now, I know some of our peers are citing economic weakness having a negative impact on their US results but frankly this just hasn’t been the case with us so far as the need for opportunity has outweighed household budget pressure. Frankly, I would add to that, that our management team here in this market Scott Schwerdt and Justin Rose are doing a great job of executing a focused strategy that has been embraced by our sales leaders.

The weak dollar is obviously also working in our favor. This should continue to positively impact revenue in 2008 and hopefully the negative impact of our debt translation is behind us. So, add these environmental factors to our improving revenue and operation efficiencies and we’re on track for a great 2008. Finally, you’ll notice in our release that we raised revenue guidance for the year. We as a management team are committed to the plans that are in place and we’re working to deliver on business targets we outlined. We now target revenue growth of about 5% for the year and have also moved up the lower end of our EPS guidance for 2008.

With that, I’ll turn the time over to Rich.

Ritch N. Wood

Good morning everyone, I’ll quickly give the local currency revenue figures in our major markets and remind you again that these can be found on the investor section of our corporate website. In north Asia region, first quarter revenue in Japan was $11.4 billion Yen compared to $12.7 billion Yen in that same quarter of 2007. And, quarterly revenue in South Korea was $38.7 billion Won and that’s versus $31.2 billion Won in the prior year. In our greater China region, Mainland China was $119.6 million RMB during the quarter versus $136.1 million RMB during the prior year. Quarterly revenue from Taiwan was $678 million NT compared against $689 million NT last year. Hong Kong revenue was $90.6 million Hong Kong dollars compared to $81.8 million Hong Kong dollars during the first quarter of 2007. In the Americas the US posted $44.4 million in revenue compared against $37.7 million in the prior year. Canada reported $3.3 million Canadian dollars in the quarter compared to $2.8 million in the prior year. And, Latin America revenue was $2.7 million dollars compared to $2.2 million in the prior year quarter. Then finally, in the Europe region in the first quarter revenue was $22.8 million versus $18.5 million in the same period of 2007.

Our initial guidance for the first quarter you’ll recall included achieving revenue of $281 to $286 million based on a Yen rate of $112 to the dollar. The actual average exchange rate for the Yen during the quarter was about $105 and therefore we gained about $6.8 million due to the strengthening of the Yen during the quarter. Our gross margin for the quarter was 81.8% and that’s approximately 30 basis points better than the prior year period. The improvement was due mainly to a reduction in air freight during this quarter and our selling expenses as percent of revenue were 42.9%, that’s approximately 30 basis points higher than the prior year but essentially even sequentially.

General and administrative expenses for the quarter were $88.6 million or 29.7% of sales compared to $89 million or 32.5% of sales for the same quarter in 2007. This is a 280 basis point improvement and ties directly to the company’s restructuring efforts. General and administrative expenses were negatively impacted about $3.8 million by the strengthening of foreign currency during the quarter reflecting a reduction of approximately $4.2 million on kind of a constant currency basis. This is in line with our commitment to reduce G&A expenses for the year by $15 million.

The company’s operating margin was 9.2% for the first quarter represents 44% improvement over the prior year and puts us on track to achieve our 2008 operating margin range in the 10.3% to 10.9% range. Our target is right around 10.5%. We incurred a $5.8 million expense in our other income expense line on the income statement. That’s primarily related to foreign currency exchange loses and interest expense. As we’ve discussed in the past about one half of our total long term debt is denominated in Japanese Yen. We use this to hedge against our revenue. At December 31, 2007 this Yen denominated debt was converted to US dollars at the yearend exchange rate of $111.45. On March 31, 2008 the Yen closed at $99.69 and so all the Yen denominated debt was converted to US dollars at this rate. This significant strengthening of the Yen created a foreign currency loss associated with this debt of approximately $5.5 million during the quarter or approximately $0.054 per share.

Again, we utilize the ability to borrow in Japanese Yen at low interest rates. Our average coupon rate there is just about 2%, just a little over 2% and it acts as a hedge against our Japanese revenue stream. Just as a side note, the Yen closed yesterday which was the last day of April at approximately $104. This movement from $99.69 on March 31st to $104 on April 30th will create a foreign currency translation gain of about $2.3 million in our April financial statement. Since we can’t predict where the Yen will finish on May 30th, the close of our second quarter, we have not estimated any gain or loss attributed to the movement of the Yen and the translation of our Yen denominated debt in to our second quarter EPS forecast.

Our tax rate for the quarter was 37.5%. That’s in line with our historical rate and during the quarter we paid $7 million of dividends and received an additional settlement of 202,000 shares from the accelerated stock repurchase executed in the fourth quarter of 2007. Our share repurchase authorization remains at $89 million.

In our press release you will note that we increased our revenue guidance for 2008 by $20 million, actually $30 million on the bottom end and $20 million on the top side to put our annual target at $1.21 billion to $1.22 billion. This revenue guidance assumes a Yen rate of $107 to the dollar for the balance of the year. We estimate our 2008 earnings per share to be in the $1.17 to $1.22 range. Now, for the second quarter of 2008 again, with the Yen of $107, we’re projecting revenue of $303 to $308 million with earnings per share of $0.26 to $0.28. Again, I have not modeled any translation gain or loss on the Yen denominated debt in to these second quarter numbers.

So, we look forward to a very strong quarter and like the direction of our business right now. With that, we’ll open up the call up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Olivia Tong – Merrill Lynch.

Olivia Tong – Merrill Lynch

I just want to talk a little bit about your expectation for Japan going forward. Previously, I think you guys had said sort of declines would decelerate as the year progressed. First, are you still expecting that? And then also, relatively to earlier this year with all the negative media attention, do you think that that attention has gotten worse as the quarter has progressed? Or, is it easing or just it’s still present and that’s about it?

M. Truman Hunt

Well Olivia we obviously, as we indicated, were frustrated with our Japan results after making some really good progress in the third and fourth quarters of last year. With this start for the year it’s obviously going to be very difficult for us to get to the point we originally anticipated Japan being during 2008. We frankly, in our modeling, and in our guidance have not baked in much of an improvement at all in Japan for the remainder of the year. We’re modeling it as essentially consistent with first quarter results. Now, hopefully we can do better than that but we wanted to model conservatively in that regard. It’s just hard to know how long this factor is going to continue to impact our business.

With respect to the current level of media attention I don’t believe that the media attention is increasing but we have heard privately through internal sources that the government continues to scrutinize our industry carefully and it could very well be that additional press might come out related to other competitors. So, we’re just modeling the remainder of the year conservatively in Japan.

Olivia Tong – Merrill Lynch

No uplift expected from the convention exporter?

M. Truman Hunt

We do think there will be an uplift from the convention. We would expect the second quarter to be better than the first quarter for that reason. But again, in our modeling we have not modeled an improvement.

Olivia Tong – Merrill Lynch

Turning to China, I know it’s difficult to predict and there’s a lot of moving parts with the distributor model changes but it seemed like last quarter made it sound like things were sort of improving a little bit. With another double digit decline this quarter I’m just wondering if there’s anything that has changed relative to your expectations in that market?

M. Truman Hunt

We felt that way too and actually got off to a very good start in the first quarter. Interestingly enough the snow storm that hit China in the beginning of February had a negative impact on results then we add that on top of the Chinese New Year and things just slowed in China in the second month of the quarter. But, in retrospect when we consider the fact that we closed half of our stores and really cut back on our operations significantly to be down 12% for the quarter doesn’t seem that bad. So, I just spent a week there, met with a lot of our sales leaders and there’s continued enthusiasm in the market and we continue to believe that there’s a lot of upside.

Olivia Tong – Merrill Lynch

If you could sort of quantify how big of a downturn did you see in the markets where you closed stores relative to your bigger cities?

M. Truman Hunt

Dan, did we measure that?

Daniel R. Chard

No, we haven’t necessarily measured the effect. What I’d say though is that we found the closure of the stores had a far smaller impact than we would have anticipated. Our sales representatives have continued to do business there and we’ve found different ways to support them, so closing stores has not been a factor in the business slowdown.

Olivia Tong – Merrill Lynch

So if closing stores hasn’t been a factor then what sort of increased the deceleration? I understand that the New Year happened but the New Year happens every year so on an year-over-year impact your down 12 in Q1 versus 10 in Q4 and I’m wondering if you could sort of give me an idea of anything that got worse?

M. Truman Hunt

The significant changes we made in the first quarter were basically an adjustment to the way we link our sales employee program to the direct selling program. We transitioned the way a part time employee and the full time employees interact. So, consider that a change to our compensation model so there’s been some basic training in the evolution of that plan so that’s certainly part of it.

Operator

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

Timothy Ramey – D. A. Davidson & Co.

Truman, earlier you mentioned that the level of investment in China was at a more manageable level and I think you compared it to an investment level of about $13 million a year ago. Would you care to give us anymore precision on what type of number would seem more manageable?

M. Truman Hunt

Yes, we estimate currently based on Q1 results and what we’re forecasting for the remainder of the year that we’re going to take that investment down about $10 million so $3 to $4 million dollar range.

Timothy Ramey – D. A. Davidson & Co.

So it’s still likely to be in to next year before we see that as a positive contributor?

M. Truman Hunt

Yes, I mean frankly we made a lot of headway in the first quarter but we think there will still be a small investment in China this year.

Timothy Ramey – D. A. Davidson & Co.

Then in your release you mentioned fx caused a $3.8 million increase in G&A. Is that just simply your overhead structure becoming more expensive in US dollars or is there anything else there asset based that we need to think about?

Ritch N. Wood

That’s exactly what it is Tim. As we translate back all our foreign currency expenses in to US dollars with a weaker US dollar it shows to be more, a higher US dollar amount so there’s nothing related to the structure of the business that’s changed and really to be able to show a sort of decrease on an apples-to-apples basis of about $4 million on a nicely increasing revenue base is really, really, really encouraging for us and we believe that will continue throughout the year.

Timothy Ramey – D. A. Davidson & Co.

Just a question on the revenue growth in the Americas of 19%, after years of relatively unenlightening results in the US, that was a pretty nice performance. If you had to kind of desegregate that in to product excitement or distributor counts, or the economy maybe or any other basket that you were trying to segregate it in, how would you attribute the cause of that nice lift?

M. Truman Hunt

Tim, let me have Scott Schwerdt take a whack at that question because he’s the one really managing the growth not only in the Americas but in Europe and doing a terrific job of doing it.

Scott E. Schwerdt

Yes, it is quite encouraging to see our leaders as energized as they are really across the region which would be really North and South America, Europe and obviously some of the new markets South Africa. Really the key is that the leaders have really focused around a very compelling product story and that’s with the Galvanic Spa and the True Face Essence Ultra has truly come together in a unified anti aging presentation that our distributors are doing and it’s really hit critical mass in the region where everybody is really saying the same thing. The leaders are as energized as I’ve ever seen them about the business, about the company, about the product line up and certainly as Truman indicated the economic factors in the United States have certainly added some wind behind our sales as people are looking for additional sources of income and looking to our company as one of those sources. So it really falls in to those three categories and that’s one of the things we’ve really focused on in the region is to really get people united behind one story and make sure our leaders feel that great sense of appreciation partnership with the company.

Operator

Your next question comes from Scott Van Winkle – Canaccord Adams.

Scott Van Winkle – Canaccord Adams

A couple of questions, if we could dig a little further in to the [new raise] issues in Japan, I would assume at some point the pool of potential distributors is going to be larger as that business deteriorates. Is that prohibited by the media attention? Have you begun to see it? Is there a timeframe where that may be the case?

M. Truman Hunt

I think theoretically Scott, yeah you might see people involved with that company looking for alternatives but so far what we’re seeing and really the feedback that we’re getting from our sales leaders there and from our management team as well is that the attention given to that company has just negatively impacted the sponsoring environment and frankly has caused us and others to make sure that we’re really reinforcing our own strict code of compliance. I don’t think Scott that the decline perhaps in their business is going to positively impact us or anyone else.

Scott Van Winkle – Canaccord Adams

Moving on to the product side and I joined the call a couple of minute late so I apologize if you mentioned it, there’s been some weakness in direct selling of some of the antioxidant juices, I’m wondering what your outlook is on your own product. And again, I missed it if you talked about its performance during the quarter or if we’re seeing a life cycle start to play out with those products and g3 in general.

Daniel R. Chard

Our own juice g3 as you mentioned was really frankly a little bit of a surprising success to us because it was by far the most successful product launch in a long time. It quickly ramped up to be about $100 million a year business. That product and that business remains steady through Q1. I believe Scott that to the extent we see perhaps any softening on the Pharmanex side of our business and with g3 in particular it’s going to be a result of just distributor enthusiasm for what’s going on in NuSkin as opposed to any particular trend related to juice or to nutrition specifically.

Operator

Your next question comes from [Nina Noel] – Sidoti & Company.

[Nina Noel] – Sidoti & Company

Just one question, in looking at South Asia Pacific you had high single digit growth in terms of revenue and yet looking at the active sales force that’s down about 10%. How are you able to get that better productivity and why is that sales force declining?

M. Truman Hunt

It’s been largely a change in focus on product. One of the key drivers to our business is our average order size and one of the folks in South East Asia has been on our weight management product so essentially it’s a slight change in the recruiting model which as you pointed out resulted in some decline of active distributors. But, on the flip side there’s been a higher spend per distributor so that’s what accounts for the upside and the revenue.

Ritch N. Wood

That will start to change also about third quarter so part of it is a comparison of when we started shifting that focus and you’ll see in about the third quarter those numbers turning the other way.

[Nina Noel] – Sidoti & Company

Which numbers?

Ritch N. Wood

The active numbers.

Operator

There are no further questions in the queue.

M. Truman Hunt

Thank you all for joining us this morning. We appreciate your time and attention. We have our annual shareholder meeting scheduled for June 25 and we’ll be out on the road prior to that time. We look forward to meeting with any of you who may want to chat further about what’s going on around the world. Thanks very much.

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