Nu Skin Enterprises, Inc. (NUS) Earnings Call Transcript & Summary

Great. Well, thank you, everyone, for joining. I'm Mark Astrachan, Stifel's household and personal care, beverages and broadband retail analyst. We're pleased to welcome Nu Skin Enterprises to Stifel's Cross Sector Insight Conference. With us today, we have Chief Financial Officer, Mark Lawrence; and from Investor Relations, Taylor Henderson. Today's presentation and fireside chat comes at an interesting time, given the coronavirus pandemic and its impact on consumer demand and unemployment levels. Historically, Nu Skin's direct-selling model has provided an opportunity for self-employment selling products across the company's personal care and nutrition businesses. Timing is also noteworthy as it comes ahead of a major new product launch cycle scheduled for the fourth quarter of this year. So Mark is going to offer a few opening comments, then we'll proceed with Q&A. And as a reminder, for folks joining, you can either e-mail me directly or you can submit questions via the webcast link. So with that, Mark, thank you again for joining us, and the floor is yours.

Great. Thank you, Mark, and thanks, Stifel, for hosting us. And my best wishes to everyone out there in the virtual world, that hopefully, everyone is staying healthy and happy during these interesting times in which we operate. I'll give a brief background. Nu Skin is roughly a 35-year-old company. We are based in Provo, Utah. We focus on innovative beauty and wellness products, and our split is roughly 60% personal care products and 40% nutrition. We operate in approximately 50 markets globally with a very strong footprint in Asia. We utilize a direct-selling model where we have over 1.1 million customers and approximately 50,000 sales leaders who sell our beauty and wellness products. Traditionally, we have a healthy balance sheet with strong cash flows and pay a healthy dividend. We came off a bit of a tough year in 2019, where our Chinese business was a bit challenged, where we declined in revenue, 7% in constant currency, and that came after 2 strong years. We grew 3% in 2017, and we grew 18% in 2018, and we look forward to returning to growth in the fourth quarter of this year. As Mark mentioned, we have a really healthy product launch coming up, where we have a Hero Product called Boost that will be introduced in the fourth quarter. And historically, when we launched these Hero Products, we get a nice increase in sales leaders, we get a nice increase in customers, and we get a nice boost in revenue that generally carries on into the following year. So with that, Mark, I'll open it up to questions, and you can lead us wherever you would like to.

Great. Well, thanks for that introduction, Mark. So maybe to start with the most recent past. So first quarter results were definitely better than I think many folks were expecting. Maybe walk us through a bit of kind of what happened in the quarter, why the business was so insulated relative to what was going on in the world and maybe touch on whether there were any surprises? Or maybe what was most surprising to you all as the quarter evolved?

Yes, for sure. So as we're all aware, we live in a really interesting time. And when I was giving Q1 guidance, the coronavirus had impacted China, and we felt pretty confident that it would likely be impacting the other parts of Asia, Korea, Japan, Southeast Asia, areas in which we operate and have a very strong foothold. And we built our guidance assuming that. What happened is we guided $480 million to $510 million in revenue and $0.23 to $0.33 of EPS. And we delivered $518 million in revenue, so we had a very healthy beat, and $0.36 of EPS, also beating the high end of that range. Where the growth or the over expectations came from was Asia generally performed better than we expected. So China recovered or was less impacted than we expected, and Korea, Japan and Southeast Asia all performed in line or slightly better than our expectations. And then what performed a little bit worse than our expectations was Europe, the U.S. and Latin America, where we hadn't contemplated that coronavirus will become a global pandemic. The nice thing is that the overachievement in the Asian markets offset the underachievement in some of the other markets that we hadn't contemplated to be affected. And we were able to give annual guidance and then keep our annual guidance, which, again, is, I think, somewhat rare in today's world.

Yes. And as you think about the business today, so I want to ask first, to be kind of related to it. So I think part of what was mentioned on first quarter results was percent of business done digitally and via subscription. So maybe touch a bit on how that has helped broadly and how you think about that as a provider of greater visibility onto your ability to guide to full year and maintain full year results.

Yes. Thank you, Mark. That's a really good question, and really an important question. As I mentioned, 2019 was a relatively tough year for us. And part of the reason was the Chinese government instituted a period, an observation period, early in 2019 were restricted meetings for direct-selling companies. And that really accelerated an effort that we had started a couple of years before to digitize our business. We realized that we needed to modernize our business. We needed to digitize our business. And so we brought in a new leadership team from -- to lead our IT organization, the leader of which came from AWS. And we took all of our core infrastructure, and we put it in the cloud using AWS. And then in China, we used the Aliyun Alibaba platform and moved our China business also into the cloud. This created a lot of agility for us and really prepared us as we learn through 2019 how to operate our business digitally and reduce our dependence on in-person meetings. Today, more than 80% of our revenue is conducted via our digital properties and more than 60% of our business is done via subscription. I think both of those things insulate us a little bit from what happened in COVID. Our sales leaders are used to working remote, and we've now provided them with the tools that enable them to build their business with these digital tools.

And so if you're thinking about the whole full year guidance, without giving an update on where things are, what are the key things then that we should be focused on, since it's obviously hard for investors to look beyond what you had said about the percentage of your business being done digitally and subscription, in terms of kind of where we are? Because it certainly seems like from the outside in that if the world is gradually reopening, therefore you should have more visibility. And so that coupled with what you said about digital, the subscription would then result in increased confidence?

Yes. There's a couple of things which we should highlight inside of that question. One is I think the world's permanently a different place. How permanent the work remote environment is, we will see. But if you're a believer in the gig economy, like I am, more and more people are going to want either a side gig or a permanent gig that's different than in traditional employment. They want to work when they want to work, how they want to work and get paid according to what they do. Our gig opportunity is very attractive now. It always has been attractive, but it's maybe particularly more attractive now considering that some of the other popular side gigs are a little bit less attractive, such as driving Uber or some of the other side gigs that would put you more in the public eye and exposed to virus and more public settings. Also with more and more people working remote, they have more time in front of their computers. They have more time not commuting and more opportunity to be building their business with the digital tools that we've been giving them. So there are a number of tailwinds that help us as the new world starts to evolve. And as things open up, all of the digital tools that we've talked about only are additive to the way that we've always built our business. So if group meetings begin to happen again that will be additive to the new digital tools, and the reach of our sales leaders is much broader than it ever has been. The digital reach, I think all of us can think about our number of Facebook friends versus the number of friends that we could invite or would want to invite over to our house for dinner. Our digital reaches are just a little bit broader than that personal reach.

That's helpful. I guess maybe this will involve putting your storyteller hat on or your [indiscernible] psychic hat on a little bit. But how then does the changes that you just talked about in terms of pandemic evolution of the business impact what had been the traditional business, which is in-person meetings, holding very large conventions? And how do you think about the way this business will look in the future? And what potentially it has as an impact?

Yes. This is something that I think is going to evolve over time. Our business in direct selling, in general, I think, is always going to be relationship-based. I think that's one of the beauties of this business. There is something great about trying a product or buying a product from somebody that you know and trust. And so I think that element of our business is always going to exist. The great thing about what we're all learning in this digital world is that we can still have those relationships but we don't necessarily need to be in the same room together. We don't all need to be in the same conference center together or in a big arena. We can build those relationships and share what we're doing via social media, via broadcast tools. A normal product cadence for us in one of these Hero Products would be to introduce this product in a large convention, maybe with 10,000 to 15,000 people there or introduce it through a series of multiple large group meetings of 5,000 people. In this year's case, considering the environment we're in, we held large broadcasts with our top sales leaders and they were interactive. People were able to have working prototypes on hand in various markets that they could touch and feel, and they were also able to see and experience it virtually as we shared the product ideas, the product concepts, accepted their feedback, made modifications to the product and to its consumables just as if we were on a large conference. And many people provided feedback that they actually were able to interact significantly better online than they would have if they were sitting on the top deck of a large conference center.

So as you think about the new products, so maybe we use that as a bridge to the pending innovation. So you've talked a bit about $100 million in sales in a launch period as being a reasonable expectation, which is what the prior big Hero Product LumiSpa had when it was introduced in 4Q '17. So maybe just very broadly walk us through the puts and takes to the launch plan, both for Boost and the Nutricentials product and then touch on how you've thought about trying to forecast the introduction given what you just said about the changes in the introduction.

Yes, that's great. Our last Hero Product was LumiSpa, we introduced in Q4 of 2017. That product generated roughly $100 million of incremental revenue. And I think the word incremental revenue is important here. The actual sales of the product were about $130 million. But we're making an assumption that about $30 million of that cannibalized other products. So we talk about it as about $100 million of incremental sales. We are following the same process that we followed for LumiSpa with the introduction of Boost. Boost is a device product. It uses a microcurrent and a consumable to provide bounce and brightness to the skin. The feedback on the concepts and the prototypes and the working units that we've given to our markets around the world has been very positive. And so we believe that the customer uptake of that product is going to be similar to LumiSpa. The only hedge that we're putting on that is because of the situation in 2019 and its impact on sales leaders, we are entering 2020 with a lower sales leader count than we entered 2017 when we launched LumiSpa. Nevertheless, we think it's going to be a strong product launch. It has -- the product has solid gross margins in line with our average gross margin, and we look forward to that. In addition to Boost, we are also launching a new skin care line called Nutricentials that we believe is targeted towards the millennials. It will be -- also, again, it won't be as big as the Boost launch, but we believe that it will be a well-received product line priced in a range that makes sense for millennials. A little bit different pricing than some of our high-end anti-aging skin care lines.

That's great. And in thinking about the sales leaders and customers, just in general. So you mentioned the lower count. So those have trended a bit lower in recent quarters, although I think the sequential change from 4Q to 1Q is less impactful than historically seen between that period. But maybe talk about how you think about those 2 components as drivers of the business on a go-forward basis. So that would be some overall level. And then how to think about it with the new product introductions, as you mentioned. So does that mean then that you're anticipating that the fewer sales leaders' customers are more productive? Or do you anticipate an acceleration of those trends through the year?

Yes. Customers and sales leaders, I'll start with customers. When Ritch Wood became the CEO just a little over 3 years ago and he brought me in, I came from Amazon. I spent my entire career in Silicon Valley. And Ritch -- and Ryan became the President of the company, and Ryan had been a market president in Korea and in China, has been with the company for 20 years and really understands what the field and the customers are asking for. We decided to make an increased focus on customers, and not take our eye off those sales leaders because that's, of course, the lifeblood and the economic engine of what we do, but really focus on customers. And that resonated really well with me, again with my background coming from Amazon and the desire to delight customers. We have been, in my opinion, very successful in keeping our customer numbers relatively stable in spite of the challenges with meetings and COVID that affect our ability to recruit and retain sales leaders. And so I think that's the first area where I think we have a really solid base of active customers who love and use and consume our products. Sales leaders were negatively impacted in 2019, largely due to the lack of meetings and largely in China. But what we've seen in the past is when we have these periods where we introduce new Hero Products, in order for someone to participate in the introduction of that product, they have to qualify. And that qualification process generally leads to a buildup of sales leaders. And the way it works for us in our business is generally someone comes into the business by being a customer. They tried our products, they like our product, they use our product and then they evolve into a sharer. And that would be somebody who shares the product with other customers and brings other customers into the business. Only after they become a customer and a sharer of the product do they decide, at that point, that they potentially want to build a team. And as they build a team and they have more products they share, they qualify as being a sales leader. So while our sales leader numbers have been impacted by our ability to hold meetings, our customer numbers have been strong, and many of those customers are sharing the product, and they are part of that economic engine which we talk about.

Got it. That's very helpful. I want to shift again a bit and talk more narrowly about the specific countries and categories. So China is distantly your largest market trends here, earlier points have been a bit weaker in recent quarters coming out of that 100-day review on, not of your business, but of the industry in general, January 2019. So how do you think about expectations on a go-forward basis? I know you had mentioned on the most recent earnings call that you were seeing gradual signs of improvement. So what does this mean? And how should we think about that business, especially as historically, I think trends begin to improve somewhere after 4 or 5 quarters of weakness?

Yes. That's a great question. And it's an important question. It's usually the lead question people want to know about. China makes up about 30% of our sales, it has over the last couple of years. As we've talked about on the call, Mainland China has declined for a couple of quarters -- or a few quarters now as a result of the 100-day ban on business meetings early in 2019. The thing is, we continue to believe in our long-term opportunity in China. We have a deep understanding of that market. We've been there for a very, very long time. We were just starting to see things open up and return more to a normal cadence in Q4 of '19 when COVID hit and really shut everything down. We anticipate that in-person meetings will continue. But we're also confident that our leaders will continue to adapt to the changing environment. And I think we're better positioned now, in 2020, than we certainly were at the start of 2019 with all the digital tools that we have developed. We mentioned that we are seeing gradual improvements in that business, and we expect that trend to continue. In fact, we believe we will return China to growth this year. Not for the total year, but certainly inside of this year, we believe Q4 will be a growth quarter for us. And we always look for the blessing in disguise or the learning from tough times. And I think we can look back and say the biggest takeaway from 2019 was a realization of how dependent we had become on in-person meetings and an acceleration to reduce that dependency and really through our digital tools. So I'm really happy with where we are from a progression perspective. And I'm pretty excited to see China and the recovery that they're on right now.

And within that expectation for return to growth in 4Q, how much of that is innovation-driven?

Yes. For us, the Chinese market is a really important one from a device perspective. They are the biggest consumer of our beauty devices, which were rated the #1 beauty device system in the world. And China is a big consumer of that. So China will play a big part in the launch of the Boost product, and we anticipate good results therefrom China in that launch.

Okay. In general, in China, we've seen your U.S. multi-level direct-selling competitors also underperformed since the 100-day period beginning of last year. Maybe just talk a bit about the state of the industry there and when the expectations would be for the industry, the category to return to growth? Does that happen as well around fourth quarter? Does it happen sooner? Does it happen later? And maybe you can talk about your business within the broader context.

Yes. When we think about our business, we generally think about the fact that we're mostly in control of our own destiny. So I think the Boost launch will lead to an increased excitement level amongst our sales leaders and increased excitement level among our customers. And the digital tools that we've developed will enable that to happen more efficiently than in the past. So I think we can operate and grow independently of whether the industry grows in China or not. I think it will be great if the world shifts back again to where we can have more in-person meetings, but I think we're prepared to operate even if it doesn't. And I can't speak to whether the other competitors or people in our industry are equally prepared. But I think the opportunity -- as I mentioned, the opportunity in China is very large. It's a market that we love and appreciate and that we know very well. We're always going to be compliant with anything that's asked of us from the Chinese government, and we look to continue to operate there and, again, as mentioned, return to growth.

Okay. And back to one of the earlier questions. So visibility-wise in China, what percent of the business would be digital and subscription-driven?

Yes. Our digital revenue and our subscription revenue doesn't vary very much by market. So we are currently north of 80% of our revenue is done digitally. And subscriptions, again, make up about 60% of our revenue. That 60% subscription number has remained steady for some period of time, extended period of time. And the digital property number just continues to improve.

Okay. Just lastly on China. So in thinking about the evolution to digital or e-commerce in that market. It seems like you're looking at other household personal care categories that there's been pretty substantial acceleration in e-commerce business or just e-commerce as a percentage of total sales. How should we think about that for your business in time as well as what the push model historically has been about those conventions? So it would seem like further acceleration to digital subscription relative to what you had just mentioned. And how does that impact then the business going forward?

Yes. This is something that we think about often. In my opinion, when Amazon does well or Alibaba does well or more people are shifting their consumer habits to being online, I think that speaks well for direct selling, especially the way we're doing direct selling digitally. We still have a leg up, I think, in that we start with the relationship. So you're not buying something cold online. But as more and more people around the world get more and more comfortable buying online, I think they'll become even more comfortable buying online from a friend. And so I think those trends also to move in our favor.

Okay. That's great. So shifting a bit to your other business, which is your manufacturing business, which was acquired in recent years, is 5% of the business growing faster than total. I think for somebody who maybe hasn't paid as close attention to Nu Skin in recent years and came back and looked at it, they'd be surprised that you are in that business today. So maybe talk us through the rationale for doing that, and where you see that over the next 3 to 5 years, and then whether that includes more M&A within that category.

This is an area where we don't talk about a lot, but you'll hopefully hear more from us on this segment. About 2 years ago, we acquired 3 manufacturing companies. They're all very close to our Provo headquarters. We acquired a personal care manufacturer, a nutrition manufacturer and a packaging company. And so why did we do it? There's actually a number of reasons why we acquired these companies. And it actually did create some confusion because the P&L of these manufacturing companies is different than our core Nu Skin P&L, and I'll talk about that in a second. The first reason we did it is really to speed up our pace of innovation. That was one of the goals that Ritch had when he took the CEO role. I think that's part of the reason why I came in as the CFO is really trying to speed up the pace of innovation in a 35-year-old company and really increase the pace in which we operate. Having manufacturers within 20 miles of our headquarters allows our Ph.D. scientists, when they have a product, to take that product, and in many cases, put it in their car and drive it over to factory and see if they can do small batch testing. It really speeds up the pace of innovation. The other area of a reason why we did it is these manufacturing companies, only about 15% of what they produce comes to Nu Skin. The other 85% goes everywhere else and that everywhere else is companies that are really founded by influencers. So think about some of the largest influencer brands that you may be familiar with and there's a decent chance that we manufacture for them. They also manufacture over-the-counter products that are sold on Amazon, sold in Walmart, Target, Costco, et cetera. And they're growing faster than our core business. So we are now able to participate in some of these high-growth markets that we wouldn't be able to participate in as a direct-selling company. And lastly, their U.S. profit and U.S. profit, for us, comes at a very, very low tax rate, considering that the rest of our profit is generated overseas at a higher tax rate. So those are really the reasons why we've done it. I think we're super happy with this segment. Again, it makes up about 5% of our revenue, but growing faster than core Nu Skin. And maybe most importantly, the profitability of these manufacturing partners is right in line with Nu Skin profitability. Their P&L looks different because their gross margins are significantly lower than the core Nu Skin gross margin that's about 78%. The gross margins of our manufacturers sits around 25% to 35%, but they carry no selling expense. And so that offsets the large selling expense that Nu Skin has, and ultimately, their profitability is accretive to the overall business.

That's great. I think we have hit our half an hour mark. So with that, I really appreciate it. Thank you all for joining us today. Mark, Taylor, thank you both for participating.