如新 (NUS) 2006 Q2 法說會逐字稿

Good morning. My name is Dorothy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Nu Skin Enterprises second 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.

At this time, I would now like to turn the conference over to Mr. Charlie Allen, Vice President of Investor Relations for Nu Skin Enterprises. Please go ahead, sir.

Thank you and good morning. 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, Ritch Wood, Chief Financial Officer, and Dan Chard, Executive Vice President of Distributor Success.

As a reminder, during this conference call, comments may be made that may include some forward-looking statements. These statements involve risks and uncertainties and, as you know, actual results may differ materially from those discussed or anticipated. We encourage you to refer to today’s earnings release and our SEC filings for a complete discussion of risks associated with the forward-looking statements in 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 accord with Generally Accepted Accounting Principles, referred to by the SEC 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. With that, I’d like to turn the time over to Truman.

Thanks, Charlie, and good morning, everyone. As Charlie indicated, in addition to Ritch Wood, our CFO, I also have with me here today Dan Chard, who is our recently appointed Executive Vice President responsible for global sales and what we call our distributor success process. Dan recently repatriated from Europe, so I’m happy to have him on the call with us today.

I’ll begin by offering a bit of perspective on the quarter, and as well as the direction of our business. As you know, our second quarter results were slightly ahead of revenue guidance and in line with earnings guidance. While we continued to face revenue declines during the quarter in Japan and China, overall we’re encouraged by the progress we’re making around the world.

In Japan, we spent the quarter implementing a series of initiatives to stem the revenue decline. In April we implemented compensation plan enhancements that have been well received, and that offset the impact of last year’s changes that contributed to the revenue decline. Then in late June we introduced our G3 nutrition drink in Japan, and demand for G3 quickly pushed it into the top high-selling products in the market for the quarter.

We’re also working to improve access to scanners in Japan. We’ve deployed about 450 S2 scanners through the end of June, and intend to put a total of 2,000 or so S2 scanners into the market by the end of the year. As we’ve expressed in the past, we believe our ability to measure the impact of our flagship products is an important differentiator between us and all other nutrition and personal care companies.

We also made strides in our brand-building campaign in Japan. This effort included a full-page ad in the world’s largest circulation newspaper called Yiomiuri Shimbun, and the campaign continues, where just anecdotal reports positive as our distributors are using our ads as tools to enhance their business-building efforts. The sales force is also pleased with a major remodel of our Tokyo walk-in center that was reopened in May and that reflects a very positive image for us. So it’s been a busy quarter in Japan. Our revenue results are slightly ahead of expectations, and with all of the energy being expended, we expect results to continue to improve in the second half of the year.

Turning to Mainland China. The continued decline during the quarter is a reflection of a confused marketplace that has impacted all direct sellers. Thankfully, that confusion will be mitigated with respect to our business, as we’re pleased to announce today that we have received official notification that our application to conduct direct selling in Mainland China has been approved. This represents a significant milestone in our efforts to become the leading direct seller in this market of enormous potential. After a decade of investment, it’s gratifying to see this day come and to be among the first foreign companies to receive the government’s stamp of approval on our business. We believe the government’s approval of our application is a reflection of several things, including our investment in the market, the strength of our government relations team, our willingness to abide by the regulations going forward, as well as our conservative business approach that’s focused on long-term success in the market. Now, this approach has contributed to our decline over the past year, as securing the license has been a higher priority than nationalizing sales. We’ll continue to pursue a fairly conservative expansion of our direct selling business model.

Just as a reminder, the new regulations enable only single-level compensation plans. So our approach will be to run a hybrid business model, where we’ll engage independent contractors at the entry stage to the business, and then employ those who demonstrate a desire and an ability to generate the higher levels of income that we’ll be able to provide to our employee sales force model.

We plan to begin conducting direct selling activities in Shanghai in the fourth quarter of this year. Then, in early 2007, we’ll proceed with the provincial licensing process and then systematically introduce our direct selling operations throughout China during the remainder of next year. Each step of the way, we’ll need to secure provincial permits and establish the required service center infrastructure, which we do not anticipate being a problem, but will just simply take a little bit of time.

Despite this conservative approach, however, we’ll be disappointed if we fail to generate significant revenue growth in 2007. And we continue to firmly believe that China will eventually rival Japan in market size for us.

Our potential in China, which we confirmed through the findings of a recent study conducted by Sino Monitor, the study revealed that 98% of our target audience in China is either positive or neutral about Nu Skin’s long-term growth prospects. Now this is an impressive number, and gives us confidence that our business in China is well positioned for growth in the years ahead.

Now, looking at our U.S. operations, while results were even with the prior year, we see healthy levels of distributor activity and enthusiasm around the S2 scanner, the ProDerm skin analyzer, as well as our Photomat digital imaging initiative. We introduced the ProDerm skin analyzer late in the quarter, actually, the last week of June, which generated renewed excitement for both the sales crew itself as well as our Nu Skin business. The S2 scanner is also just beginning to roll out, with only 180 S2’s in the market by the end of the quarter. We believe that these initiatives will lead to healthy growth in the U.S. in the second half of 2006. By the end of the year, we anticipate deploying roughly 1,500 or so S2 scanners and 2,000 ProDerm units in the United States.

We’ll also touch on one of our markets that has become a shining star for us. South Korea continues to show strong momentum and has a large market for direct selling companies. We have very capable sales leaders there, and these leaders worked together on the launch of G3 in the second quarter to make the nutrition drink the market’s top-selling product in only a manner of days. And while there is a lot of attention on Pharmanex recently with the G3 launch, both Pharmanex and Nu Skin continue to experience double-digit growth. So we expect this market to continue to enjoy healthy growth for the foreseeable future.

As I look at the business today, I’m convinced that we have the ammunition to drive healthy growth. Our foremost objective is to put into the hands of our distributor leaders the most compelling direct selling business opportunity possible. They need compelling tools to be able to attract new entrants to our business. Our measurable difference marketing theme plays an important role in this effort. Our ability to measure product impact is unequaled in the industry. The second generation scanner is a significant improvement of our original version and remains the only tool in the nutrition industry that easily demonstrates product efficacy. Going forward, we’re accelerating our efforts to get this powerful tool into more distributors’ hands and will be deploying more than 5,000 units globally by the end of the year.

Similarly, we expect great things from the Nu Skin ProDerm skin analyzer for our personal care business. This is a proprietary tool that provides a visual demonstration of the benefits of our skin care products. We plan to focus ProDerm primarily on the U.S. and Europe for the remainder of 2006, and we’ll introduce it elsewhere in 2007.

Now, in addition to refining our growth initiatives, we’re also focused on gaining better strategic alignment between the company and our distributor leaders. Where we are aligned with our field efforts, we grow. So part of our focus is on making sure that our business-building initiatives are simple and clear and well aligned with our sales force’s efforts. In the upcoming months, we’ll also be rolling out our business transformation initiative into our foreign offices. Our recent transformation efforts will refine our processes to facilitate top-line growth and enable us to better support the sales force while helping us operate more efficiently. I believe these efforts are helping us execute better and focus on what’s most important.

I can tell you from my perspective that consolidating the regional operations under Dan Chard has already improved communications between markets and the home office substantially. Through the transformation process, we’ve also spent considerable time in refining our supply chain processes, improving focus on communications and our product development efforts, and establishing a global IT strategy around the world.

While our revenue declined in Japan and China over the past year, we have some looking at the glass as half empty, I see a glass that is more than half full. We have a great business. We have an exceptional business model that puts us in a strong financial position. We have an unparalleled leadership team in our sales force that is the envy of the direct selling world. We have a robust product offering and development pipeline. We’re industry leaders in our markets around the world and are now well positioned to take advantage of significant emerging markets, including China. We have the products and tools that enable us to differentiate ourselves from the competition, and we’re refining our processes and taking steps that will enable us to grow in our major markets.

Okay, with that, let me turn the time to Ritch now to address specific financial results.

Thank you, Charlie. Good morning, everyone. I’ll give, first of all, our local currency revenue figures and just remind you that these can all be found on our corporate Website.

In North Asia, second quarter revenue in Japan was 14 billion yen, compared to 16 billion yen in the second quarter of 2005, and quarterly revenue in South Korea was 28.9 billion won versus 22.8 billion won in the prior year. In mainland China, revenue was 142 million renminbi during the quarter. That’s versus 240 million renminbi in the prior year. And revenue from Taiwan during the quarter was $752 million NT versus $768 million NT last year. Hong Kong revenue was $99 million Hong Kong, benefiting obviously from our greater China convention held there, and the $99 million Hong Kong this year was compared $83 million Hong Kong in the second quarter of 2005.

In North America, the U.S. generated $36.4 million in revenue compared to $36.8 million in the prior year period. Europe revenue was $15 million versus $11.9 million in the same quarter of 2005. And finally, Latin America revenue was $2.3 million for the quarter compared to $2 million in the same quarter of 2005.

Our gross margin for the quarter was 83%. This 30 basis point improvement is largely due to decreased scanner amortization during the current year period. Selling expenses as a percent of revenue were 43.3% compared to 41.7% during the prior year. The increase is attributed to higher selling expenses in Japan, as the market transitioned to its modified compensation plan that was implemented April 1. In addition to a slightly higher overall payout on the modified plan, we are also paying some carryover bonuses from the old plan through August, at which time these will terminate. So our selling expenses were actually slightly higher than we had anticipated as our sales leaders in Japan adopted the required behaviors to reach payoff in the modified plan a bit more quickly than we had anticipated.

General and administrative expenses as a percent of revenue were 31.3%, compared against 29% in the prior year period. However, in dollar terms, second quarter 2006 expenses totaled $88.8 million versus $89.9 million in the prior year period, and we should note that the $88.8 million in the current period included $2 million of stock option expenses not incurred in the second quarter of 2005.

Interest expense for the quarter was $1.4 million. We paid dividends of $7 million, purchased about $7.9 million in capital improvements, and repurchased $5.2 million in company stock during the quarter. The company also paid $15 million in debt. Cash from operations for the quarter came in at $10.2 million.

Through transformation efforts we have reduced our overhead by approximately $15 million in annual expenses, and as we discussed previously, some of these savings will be reinvested back into the business, in particular, key initiatives that will help drive our business forward. Our primary target for the investment will be in Japan, where we targeted slightly higher selling incentives and brand-building initiatives there. However, after including approximately $4 million in stock option expense in our general and administrative expense projections for the latter part of this year, we still anticipate to see our G&A expenses decrease from the prior year period.

We estimate gross margin to be in the 82.6% to 82.9% range for the balance of 2006, and that assumes the yen holding kind of in the 116 level. We estimate selling expenses to be approximately 43% and anticipate that our tax rate will remain in the 37.5% range, as it has the first half of the year.

Assuming a yen of 116 to the dollar, we project third quarter revenue to be $272 million to $277 million, and earnings per share, therefore, approximately $0.17 to $0.19. We continue to expect 2006 revenue to be in the $1.09 billion to $1.11 billion range, with earnings per share for the year in the $0.47 to $0.52 range, or $0.75 to $0.80 when excluding the $0.28 in restructuring and impairment charges incurred in the first quarter.

With that quick overview, let me turn the time back to Truman.

Okay. Well, operator, we’re prepared now to open the call for questions.

[Operator Instructions]. We will pause for just a moment to compile a q-and-a roster. Your first question comes from Kathleen Reed.

Good morning, and congratulations on getting your license. The first question, could you just explain a little bit why you have to start in Shanghai or why that’s your home base, and why I guess you have to begin in the fourth quarter? That’s the first question.

Sure. Thanks, Kathy. Well, as you know, Shanghai is our home office for China, and it’s where our business headquarters are. In the licensing process, we were directed to apply for a license initially where our business is based. And so that’s why the initial license is focused on the Shanghai municipality. From there, we intend to expand quickly into other provinces. And so, we’re in the process of—as you know, there are certain service center requirements in each of the provinces, and so we’re already in the process of securing the required number of service centers in Shanghai. We’ll be adding five, for example, by the end of August, which will put us in a position, then, to formally begin direct selling activities.

With respect to other areas, we anticipate adding about ten service centers in Beijing, for example, by the end of September, and another thirty or so in Guangdong by the end of October, and another twenty or so in Zhejiang and Jiangsu province by the end of November, so it’s just going to take us a little bit of time to get these service centers in place, and that’s why we’ll begin our direct selling activities in Shanghai.

Okay, great. And just looking for confirmation so I’ll understand, obtaining the national license appears to be the real hurdle, and I know you have to get a local license or just the provincial license for each province that you operate as well. What is the timetable on those, or are there any other hurdles or something different than what you’ve already obtained for the national license? Or do you think it’s a little bit more of a formality?

Well, we really think that it’s the latter. We think that securing the provincial licenses will not be a problem, but we do have to demonstrate compliance with all of the regulations including the [inaudible] and service center infrastructure. And so we don’t anticipate the provincial licenses being a problem, but we do need to get the service centers in place.

Besides Avon and yourself, has there been any other foreign companies granted a license in China?

No, our understanding is that Avon and Nu Skin are the only U.S. companies who have secure licenses to date. We understand that there are two domestic companies who have granted licenses this week, and that there’s also a small Hong Kong company that was granted a license this week.

Okay, and then moving just to Japan, can you talk a little about if there’s any changes to the regulatory environment in Japan, too, that would allow you to either market the S2 scanner any differently, or just give you any more comfort that the S2 scanner will help accelerate your sales where you have some issues with using the S1?

Well, there really haven’t been any regulatory developments in Japan that would change the application of the scanner in that market.

Okay. So I guess I’m just trying to understand, though. I know the technology is different. It’s a different, improved device. But I guess the big question is, when should we expect Japan to turn around or to turn positive? Is it much more than a seven play, I mean, it’s slow sequential improvement, or when should we see some positive year and year local currency sales growth in Japan?

As we indicated in our remarks, we do expect results to improve in Japan in Q3 and Q4 and continue to improve in Q7. Now, with respect to which quarter does Japan turn positive, we are looking at ’07 for that to happen.

Okay. And then my last question is just if you can help us—you know, your revenue in your second quarter was higher than what I was expecting, I think in your prior guidance as well. And I wondered, then, why we would expect a sequential slowdown from Q2 into 3Q? If there was something I was just missing.

Hi, Kathy, this is Ritch. I’ll follow quickly to that. It’s not uncommon for us to slow just a little bit in the third quarter, just because of the seasonality and vacation periods. Last year we actually went from $310 million down to $290 million. We don’t expect that big of a drop this year until we’ll see our year-over-year comparisons begin improving in the third quarter and then continue to improve throughout the fourth quarter is the way we see our business.

Okay. Thanks so much.

Our next question comes from Olivia Tong.

Hi, good afternoon. I want to know if you could give some color on your targets for China. You said in the past to look for the $300 million to $500 million. Is that sort of where you’re thinking nowadays and also growth rates, are you expecting a significant ramp early on and then sort of petering off after that, or a slow ramp and sort of building from that point?

Well, Olivia, we do expect China to become one of our most significant markets and to rival Japan in market size, so we’ll be disappointed if China doesn’t become a $300 million to $500 million market for us in the mid term. Now, how closely does that happen? The implementation of direct selling is really going to roll out over the next four quarters in the market, and we’re not prepared today to give a specific guidance on ’07, other than to say that we’ll be disappointed if we don’t see significant growth in ’07.

Could you remind us also what the service center requirement is? How many service centers do you need per province?

The service center requirement is to have, it’s ten, one per district in each province, which has a different number in each specific province, but for example, by the end of 2006, we anticipate having 160 stores and about 85 service centers in place. By the end of 2007, we’ll have about 170 stores and about 500 service centers in place. And let me just add a little color on the service centers. These facilities are very small. And in fact will not even be equipped to stock products for sales to the sales force. These service centers really exist for only one purpose, and that is to enable consumers or salespeople to return products in the event they want to do that. So these are very small and very inexpensive centers to operate, which is why we don’t anticipate opening them to be a big burden.

Okay, got it. And then one other question. Why are you launching ProDerm in the U.S. and Europe first, when Asia are more skin-focused markets?

Well, really for a couple of reasons. Number one is that in most of our other markets, we have a lot of other initiatives in place. And frankly, those markets aren’t calling for ProDerm here in the short term. And so the initial focus is on the United States and Europe. We anticipate really refining the device here in these markets before getting serious about launching that device in Asia specifically.

Are there any regulatory setbacks in Asia besides Japan not being able to quantify the figure that, other than that?

There are some regulatory issues with respect to ProDerm in Japan as well that may keep us from being able to provide the exact type of measurement that we anticipate the device providing in the United States. But what we do think we’ll be able to do in Japan is at least take pictures of people’s skin and be able to monitor certain characteristics of skin as people start a Nu Skin product regimen.

Okay. And then just lastly, maybe for Dan, you’ve had Distributor Success in place for a couple of months. I’m just wondering if you could give any specific examples of things you learned, any changes to processes, since implementing that position?

Yes, I think beginning February, the first phase of the transformation process dealt with our corporate organizations and aligning those behind our markets and our distributors. Since then, we’ve also put a number of organizations or changes in place to help do the same thing in the markets. The first thing we’ve done is created a Global Marketing Committee whose chief focus is to make sure that our message is aligned around the world, our message and the simplicity of how we communicate. That is critical for our distributors. So that’s one thing we’re working on in that respect is having a short-term impact. We also have a cross-regional organization representing our global markets to put together best practices and borrow on some of the initiatives that are working around the globe related to leadership development, which we see as one of our core competencies, and that has to do with how our leaders work, train, develop other leaders in our business.

And the last piece is we have put some, shortly we’ve created some structural changes internally between the distributors success organization and our IQ organization, specifically designed to bring all of the business tools for our global market that help them do their business under one organization to better align those and to give our distributors more effective tools to accelerate their business activities. So those are three examples, and we’ll be rolling out more things in the remainder of the year and into next year.

Got it. That’s helpful. Thanks very much.

Your next question comes from Doug Lane.

Hi, good morning, everybody. Can you review again on the S2’s in Japan, how many are there now and how many do you expect by the end of the year?

We have about 476 units, actually, exactly, in Japan today. We anticipate having 2,000 by the end of the year.

Okay. And how would you gauge, now that you have nearly 500 in the field, can you sort of give us an update on the distributor enthusiasm response outlook today versus maybe six months ago? Better, worse, different uses than maybe you thought, everything on track? Just some sort of characterization there just to get a feel whether, what kind of traction the S2 is getting now that you have a pretty good number in the field.

Most of the feedback so far, Doug, is anecdotal, because many of these units have only been in place for a couple of months, and in the United States, again, we only have about 180 units in place. But to me, the good news is that we’re being beat up by the field for our inability to provide them more units. So that’s really good, because that tells me that there is healthy demand for the S2. People are recognizing that it’s much more functional than the S1, much more user-friendly, much more portable. We don’t have the same, for example, the same calibration times, which are dramatically shorter. We don’t have the same restriction on having to use the unit within a certain temperature range, which creates all sorts of problems in many of our markets where temperatures are too high to run the unit reliably. So, the anecdotal feedback is good, and the fact that we can’t supply the field with S2’s quickly enough is good news.

I mean, what you say there is what you said almost a year ago when we first learned about the S2’s. I just want to make sure that that’s still on track, and if there are any other features or detriments that have arrived, have arisen in the two or three months since they’ve been rolled out here. And I guess the way, it sounds like demand is as robust as you thought it would be.

Yes, demand is as strong as we thought it would be, and there’s really—I honestly can’t point to anything that would lead me to believe that the impact of the S2 is going to be weak. And I think it’s a wonderful tool, our sales force loves it, and today can’t get it fast enough.

Okay, I think if I heard you right, you have 1,500 targeted for the U.S. by the end of the year, so the remaining 1,500 to get to the 5,000 total, is that going to be any particular region? Or just throughout the rest of your markets?

Yes, really spread out across the globe.

Okay. Can you talk a little bit about Russia, since you’ve been there now for, I think almost a full quarter, right?

Yes, we opened Russia late April or early May, and Russia contributed a modest amount of revenue in the quarter. We had a couple of operational hiccups that we were not happy about. And so the business there is really small today, but we think we see some things happening that bode well for the potential of the business there. For example, it’s interesting to me to note that the tiny little market of Israel is on fire right now and growing at a very rapid rate and is actually contributing meaningfully right now to our revenue level. And there’s a tremendous amount of interest in that market to develop the business in Russia and throughout Eastern Europe. And that was really our strategy for opening Israel in the first place, and we think that that’s going to bear some fruit in the upcoming years.

You know, you haven’t talked a lot about Russia and Eastern Europe. They are huge markets for Avon, for Oraflame, and multiple hundred million dollar potential, which I would think would be more enthusiasm on your part. Why wouldn’t you be able to get to those kind of levels over time? We talk about China, $300 million to $500 million or whatever you indicated earlier, but why would there be any less opportunity in Eastern Europe and Russia for Nu Skin?

This is Dan. We actually think there is a lot of opportunity in Eastern Europe. In fact, we’ve expanded over the last two years into Hungary and Romania, which represent very good markets for us. We’ve also developed and will be rolling out in September a test for essentially a technology that will allow us to expand into some of these smaller countries in a very low-cost way. So that will include looking at countries like Ukraine, Slovakia, Czech Republic. But we actually do see opportunities and have developed some models that will allow us to do that in a very low-cost way but realize the expansion opportunity there.

Let me add to that, Doug, just quickly, by saying that as you know, a lot of our success in any market around the world is based on our ability to secure capable field leadership. And those Eastern European markets are kind of hard to get to for most of our U.S. leaders and our Asian leaders with the language barriers and just geographic distance and what-not. So as we see our leadership ranks building in Europe with the growth of the business there, and in Israel with the growth of the business there, we will be developing leaders who are capable of really pushing the business into Eastern Europe. And so I think that our growth in those markets bodes well for the potential in Eastern Europe.

As opposed to China, where you have a pretty much ingrained leadership opportunity there, both geographically and culturally, the growth is a little fast, I guess is the way to look at it.

We have lots of leadership in the Chinese community and developing leadership in the European community.

Okay. Lastly, could you talk in China about two things? One, Amway, which is the market leader, so a very important bellwether for the market. How they are reacting to the new regulations and going from their global model into the new regulations. Have they started moving that way yet? Or are they waiting for their license to be granted? Do they still operate under the global model? Just give me an update, if you don’t mind, on how Amway’s doing there, and then also any commentary you have on Avon’s press release about their recruiting successes so far under the new direct selling license in China.

Well, to tell you the truth, Doug, we don’t have a lot of visibility about how Amway’s business is faring in China right now. I’m pretty close to those guys, but I just honestly don’t know how the transition from their historical model to the new regulations is going for them. Avon, as a public company, obviously is subject to additional disclosure requirements, and the incredible number of recruits that they had in their first period of operating as a direct selling company is really quite impressive, and I think that that bodes well for us and for other direct sellers as well.

Okay. Thank you.

[Operator Instructions]. Your next question comes from Andy Sieler.

Hi, guys. I want to follow up on that last question. Given what the growth that, or the extreme number that Avon posted, given their first couple months in China, what is your expectation in terms of getting distributors to sign up in China? And then, along those lines, could you just clarify exactly how your compensation model works and dovetails with your retail store concept there? That would be helpful, too.

Sure. Well, we are in a different position than Avon was when they secured their direct selling license. As you know, Avon has thousands of counters across the country, and I think was in a better position than we are today and other direct sellers are to just immediately satisfy the service center requirement by virtue of their highly proliferated retail model. So I would expect that, just from a raw number of recruits, our number will ramp more slowly than Avon’s has because we’re really developing from province to province over the next two or three to four quarters. But let me say, however, that I also believe that our business model is more compelling than Avon’s business model. The fact that we have the ability to engage an independent contractor at the entry level, pay them on a single-level basis, and then if they have a desire to make more income and make the business opportunity really become a full-time opportunity for them, we can transition them into employed status and begin to compensate them more generously. And so, I think that’s going to be a big competitive advantage for us.

In other Chinese communities, I think that our business model would, over the years, would reflect that we’re more potent than the more traditional single-level direct sellers are. So I think in the long term we’re going to compete very favorably with Avon, and really, I think that that’s reflected as well in the fact that Amway is considerably larger than Avon is already in that market. And Amway just simply operates with a more, a higher-octane business opportunity. So from a compensation perspective, again, we’ll engage independent contractors at the entry level, we’ll pay them on a single-level basis for their product sales to their customers, and then if they want to make the opportunity more full-time, we’ll transition them to employed status and compensate them more generously on the sales volume that they generate throughout their organization.

Okay, thanks. And then, Ritch, just wanted to follow up on the guidance that you gave for both gross margin and selling expense. Is that a full year number, or is that the third and fourth quarter sort of range?

Yes, that’s the third and fourth quarter range, Andy.

Okay. And then, I guess, how does that compare with the previous full-year range that you gave previously? I think for gross margin it was in the 82.4 to 82.5 range, and for selling expense it was 42.5 to 43.1, put you in similar levels?

Yes. A little bit higher on our gross margin, I think, than where I had projected earlier. Selling expenses will be the top end of the previous range.

And the change in gross margins just be amortization going away?

A little bit less amortization, yes, that’s primarily the change in gross margin.

Okay, thanks very much.

Your next question comes from the line of Tim Ramey.

Good morning, congratulations. On the cost reduction program, I know you mentioned that some of the savings are going to be reinvested in the business, but my question relates to the ability to bring some of those savings down to the bottom line as well as sort of maintain execution and momentum. How do you sort of, six months into the process, how do you feel about your deliverables on that term?

Well, we’re really targeting to reinvest about half of our savings into growth initiatives, and try to protect the bottom line with the remaining half of the savings. And it’s early. But so far, and this is only my perception and my gut feeling, you know any time you go through a business reorganization like we have over the course of the last nine months, there’s going to be some trauma in the organization, and some uncertainty. I think that 90% of the trauma is behind us, but we’re still only 50% into our business transformation in terms of really doing things differently and doing things primarily with our sales force, first and foremost, in mind. So, Ritch, do you want to supplement that with any comments you have on dropping savings to the bottom line versus reinvesting?

No, I think that’s a great summary, actually, and that’s really what we have targeted, Tim, is to put half of what we reduced back into, primarily Japan to really turn that business around.

Okay. And on, just the kind of the gross compensation metrics for China. Do you think that the numbers will sort out about the same as your current model with your modified model there? Or will compensation expense be higher or lower in the China model?

Yes, it will start to go down, Tim, if we don’t have to employ all the early entrants into our business, we’ll start to get some benefit. We continue to pay out approximately 50% of our sales in selling expenses in China. Obviously, since we’re only really rolling into the Shanghai municipality in the fourth quarter, the expense really won’t see too much benefit until next year, but we believe we can bring that from the 50% range down kind of into the 44% range over the next two years.

And that’s for the total corporation?

No, that’s just for China.

Just for China. Okay.

And overall, that will benefit us. Today China’s about a little less than 10% of our sales, so you can kind of figure out how that impacts the overall picture.

Okay. And then kind of with that same multi-level, or multi-year perspective in place, do you anticipate the eventual approval of multi-level there? Or is safe to change?

That’s a question that’s, frankly, just really hard to answer. We certainly hope so, and we certainly hope that over time the government will become more and more comfortable with the way the business is done everywhere in the world outside of China. And I think that will be the case. I think that direct selling is going to be a wonderful boon to China’s society, and the government will realize that an awful lot of people could make a decent living doing what we do.

Okay, thank you.

Your next question comes from the line of Scott van Winkle.

Hi, thanks. In Japan, can you quantify the increase in the compensation plan? And what was the date that that was put into place?

Yes, good morning, Scott. The plan was put into place on April 1. The core plan is paying out approximately 1.5% higher than it was a year ago in the second quarter. Really, the second and third quarter last year we paid out at a lower rate, and then we added some additional incentives in the fourth quarter that took the rate up a good 0.5% up in Japan. So today, we’re paying out 1.5% higher on the core plan than we were a year ago, and then we had another approximately 1.5% associated with these bonuses that we’re double paying up through August. Those will go away in August. Overall, we’ll see our payout around the world go to close to 43%. If you kind of look back over the years, we’re more in the 42.5%. That will be specifically because we’re trying to target some additional dollars to the front end of our compensation plan and assist early executives in kind of holding and being successful with their business.

And how does that, how is your payout in Japan, say, compared to the rest of the world excluding China?

It really puts it in line with the rest of the world. The last couple of years we’ve actually been behind in Japan as to where we were in the U.S. and in our other Asian markets. This really puts them in line, and we feel like we possibly hurt the market by underpaying just a little bit. We think this will help to stabilize and return that market to growth.

And is there any difficulty when you make changes like this with the cost orders, distributors and up lines and down lines and such?

No, really not. The plan is actually more harmonious to the other plans I think now, particularly our plan in South Korea. You know, both of those are in the same region there, and so I think this is actually seen as a positive.

Okay. And your comments on the payout in China. Didn’t you say they’re also getting kind of a retail markup? Or would they in your plan in the direct selling side, are those independent distributors going to get any kind of retail markup they can add on top?

Yes, there’s approximately a 10% retail markup.

So that’s on top of the—okay, that explains it.

That’s on top of what we pay out.

Okay. And lastly, can you talk a little bit about the smaller markets in Asia and what’s happening in those markets? Singapore, Malaysia, markets such as that?

Yes. As you know, some compensation plan changes there really had a negative impact on the market last year. We see trends improving there and sequentially things seem to have flattened out, and now returning to some growth sequentially. But the impact of those changes was negative. We haven’t taken dramatic steps to reverse the impact of those changes, as our management team’s there and our sales leaders really believe that the changes were the right thing to do, and will be in the best interest of the business in the long term, and we’re starting to see that play out a little bit right now.

Thanks, congrats, and good luck in China.

Your next question comes from the line of Rommel Dionisio.

Yes, good morning. Just two quick questions. First, I may have missed this, but in your [inaudible] comments, did you talk about Capex, and what would be the effect of the new centers in China be on that?

Very small, Rommel, in China particularly. These centers, the service centers are very, very inexpensive to put in, so it won’t materially impact our Capex. We continue to look at about $35 million to $40 million Capex for this year, and going forward would not see it changing dramatically at all.

Okay, great. And just a quick follow-up. South Korea has obviously been a very strong market for you now for several quarters, and I just wondered if you could just walk through what have been the key drivers? Is it new products, recruiting trends, what’s really been the success story there and how do you expect that to continue going forward?

It really has been a terrific market for us for the past couple of years, and just continues to be very, very strong. I think it’s a combination of factors. I think we have a great management team there who is doing a phenomenal job of aligning field efforts behind corporate initiatives. One thing that Korea seems to do better than almost any market in the world is they do a very effective job at product introductions and product marketing. And that’s reflected, really, in the strength of both brands in that market. And it’s also the one market in the world where the Nu Skin brand is still larger than the Pharmanex brand. Overall, Pharmanex is gaining. But they just do a tremendous job of field alignment and they do a tremendous job of product introductions, and certainly new products over the past couple of years have played a role, but they’re just, it’s a very strong market where we’re a market leader and growing faster than our competition is growing.

Okay. Thanks very much and good luck.

Your next question comes from the line of Alice Longley.

Hi, good afternoon. Hello?

Yes, good morning, Alice.

I actually didn’t enter on a request for questions, but would see if I could pick up on—could you go over the details of how the direct selling operation is going to be working in China, vis a vis how it works differently and other [inaudible]. I’m just looking for an update of the regulations and how they require you to change how you operate in China.

Right. Well, there are many ways that the direct selling regulations there vary from direct selling regulatory frameworks elsewhere in the world. There are a lot more disclosure requirements and reporting requirements. There are restrictions on the types of people who we can potentially recruit and bring into the business. Certainly, the physical facility requirement around the country is different than anywhere else in the world. The fact that they put constraints on compensation systems is probably the most material difference from what we face elsewhere in the world, so—

Can you detail that? What are the constraints in the compensation structure?

Well, the biggest one, Alice, is just the fact that direct selling companies will be restricted to single-level compensation programs for the time being. And so, whereas outside of China, 85% or 90% of the direct selling companies out there employ some form of tiered compensation, including all of the major companies, by the way, Avon, Amway, Mary Kay, Herbalife, Nu Skin. Tupperware, for that matter, even pays some form of multi-level compensation. Oraflame, Natura, all of us will have to operate on the same terms and in employing only single-level compensation structures. We understand that the government is kind of using us as an example right now with other companies interested in doing business in China, saying, “Do it the Nu Skin way,” which is to pay single-level compensation through the independent contractor, direct-sales model. And then if people want to make it more of a full-time opportunity, then we employ them.

You see any difference compensation between yours and Avon’s? For the single-level compensation, do you pay out a higher percentage than they do, or lower, or can you compare the two compensation structures?

You know, Alice, I’m not exactly sure what their single-level plan pays out today. So it would be difficult for me to make that comparison, but I think the biggest difference will be that we will complement our direct-selling business model with our historical employed sales force business model, and I think that will be the biggest difference.

And you, aren’t their ways in which you reward people for hiring people down more than one level if they’re full-time employees?

Well, we essentially make them managers, and they have the opportunity to manage a sales force and to make more money and to make more overrides on a quarterly basis, based on the fact that they’re starting to manage salespeople below them.

Is Amway still operating as a multi-tier, in the multi-tier compensation line? I think they did for some time.

They operate in a unique fashion in China as well. And I’m honestly not sure how their transitional model is working today, how they’re going from their traditional model to the new regulations, but we’re all transforming our businesses there to comply with the new rules, and they’ll have to do that, too.

Were they typically grandfathered for multi-tiered selling for a while? Is that true, is that now being required to be changed?

Yes, my understanding is that they operated in kind of a quasi-multilevel fashion for a period of time after 1998, and that they, like all other direct selling companies, are now transitioning their business model to comply with the new regulations.

Okay. Thank you. I’ll talk to you about this off-line.

Thanks so much.

We have a follow-up question from the line of Kathleen Reed.

Good morning. Can you give us a quick update on the proposed changes to FTC regs here in the States? I think the direct selling companies banded together and made a response. That was some time in July, and the FTC is supposed to issue some other comments in August. Can you just give us some color on what the direct selling companies would like to have the final FTC rules look like?

Sure. And in fact, I’m sure that the U.S. Direct Selling Association would be happy to provide a copy of their submission to any of you who may be interested, and we can facilitate that if you’d like to see it. But the FTC proposal would impose some restrictions on direct selling activities as they exist today in the United States, and it’s a little bit unfortunate, because our understanding is, in talking with the FTC after publication of the proposal, that they really didn’t really develop them with legitimate direct selling in mind. And so we’re now in open communication with them to try to modify their proposal to enable us to not have the same level of restrictions that the new regulations would potentially impose upon us, and I think we have a good likelihood of doing that.

Okay. But in your estimate, do you put any rules or regs from the FTC, it takes quite a long, it’s a long process. Is that pretty accurate?

Yes, our understanding is that we’re looking at a period of years here to implement any proposed regulations. We think that there will be some regulations, and we’re hopeful that at the end of the day, the regulations will be consumer protective but not overly burdensome on the way direct selling is done in the United States today.

Okay. And then these are just two quick—one, I think, is a clarification. Someone else had just asked about your restructuring for the year, and I think, Ritch, you booked $36 million in restructuring charges in your first quarter, and I don’t think there was any in the second quarter. So are we done with the restructuring plan?

Yes, we’re done with the primary one-time charges that we paid.

Okay. And are savings still, I think you said you’re going to spend half of them back in terms of investment. But are they still in the $14 million range for ’06 and the $30 million range for ’07?

Yes, that is correct.

Okay. And lastly, the Hong Kong convention? How much did you spend on that?

About $1.5 million.

Okay. And that was not also in your second quarter, you didn’t have a convention in your second quarter of ’05.

That is correct.

Okay. And are there any more conventions for the remainder of the year that would be--?

There’s a U.S. convention that’s not a large one, probably be about $1 million of expense. It will be in the fourth quarter. That’s the only other major convention we have this year.

And is that not a global one?

That one’s not our global one. Our global one will be a year from October, so it will be 15 months or so from now.

Okay.

Let me just highlight to you, Kathy, that one of the reasons why our G&A was a little bit higher this quarter than perhaps anticipated, is we did run some transformation type of expenses just through our G&A line this quarter, that hopefully we won’t have to repeat going forward.

Okay, but they’re not restructuring charges, those are—

No, we did not isolate them as restructuring charges.

Okay. Great. Thanks so much.

You have another follow-up question from Andy Sieler.

Just a follow-up on, I think, the question earlier about sequential revenue decline. I guess with the Hong Kong convention, I guess you’ve got a bump there that’s probably not to be repeated moving into the third quarter. Anything else in terms other than seasonality that’s an anomaly to drive the sequential decline?

Nothing else, Andy. And the bump in Hong Kong was really just kind of a transfer of a little bit of revenue from also Taiwan and China, who both participated in that convention as well. Yeah, nothing out of the ordinary in Q3. Should be a straightforward quarter.

Okay, thank you.

At this time there are no further questions.

Great. Thank you operator, and let me just thank you all for joining us today. In many ways, with the China license in place, it seems and feels like the start of a new business for us. So we look forward to delivering better results in the quarters and years ahead as we continue to work towards our goal of becoming the world’s leading direct selling company. Thanks for joining us today, and I look forward to talking with any of you off-line.

This concludes today’s Nu Skin Enterprises second quarter earnings conference call. You may now disconnect.