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Nu Skin Enterprises (NYSE:NUS)

Q2 2014 Earnings Call

August 06, 2014 11:00 am ET

Executives

Scott Pond - Director of Investor Relations

M. Truman Hunt - Chief Executive Officer, President and Director

Ritch N. Wood - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

John A. Faucher - JP Morgan Chase & Co, Research Division

Olivia Tong - BofA Merrill Lynch, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Rommel T. Dionisio - Wedbush Securities Inc., Research Division

Frank A. Camma - Sidoti & Company, LLC

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

Mark Sigal - Canaccord Genuity, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 Nu Skin Enterprises Earnings Conference Call. My name is Glenn, and I will be your operator for today. [Operator Instructions]

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today, Mr. Scott Pond. Please proceed.

Scott Pond

Thanks, Glenn. We appreciate you joining us. With me in the room are Truman Hunt, President and Chief Executive Officer; Ritch Wood, Chief Financial Officer; and Joe Chang, Chief Scientific Officer.

Just a reminder, during the call, comments may be made that include forward-looking statements. These statements involve risks and uncertainties, and actual results may differ materially from those discussed or anticipated. We encourage you to refer to today's earnings release and our SEC filings for a complete discussion of these risks. Also during this call, certain financial numbers may be discussed that differ from comparable numbers obtained in our financial statements. We believe these non-GAAP financial numbers assist management and investors in evaluating and comparing period-to-period results in a more meaningful and consistent manner.

I will now turn the time over to Truman.

M. Truman Hunt

Thanks, Scott. Hello, everyone. We appreciate you joining us today. While our business generally performed in line with our guidance for the second quarter, lower-than-expected results from the China LTO in June resulted in second quarter revenue of $650 million, which was obviously lower than our guidance. When we guided the quarter at the beginning of May, we were just a few days in the resumption of corporate promotional activities in China, which included accepting new sales leader applications and holding corporate-sponsored promotional meetings.

At the time, our China team felt that a $100 million estimate was a conservative forecast for the June limited time offer of our Tru Face Essence Ultra skincare serum. We were disappointed with the results for the LTO that came in at about 50% of our expectations. We believe this was largely due to the lack of business promotional mediums and the suspension of applications, which impacted the ability of our sales force to build momentum in the months leading up to the LTO.

Otherwise, our local-currency revenue results were largely in line with guidance, with the Americas performing well, up 18% in local currency, EMEA up 14% in local currency, SCA up slightly against the tough comp and North Asia in line, although Korea's continued strength was offset obviously by a soft quarter in Japan, where we were going up against a tough comp in the previous year.

With respect to earnings, obviously, Venezuela currency issue was significant during the quarter. We adopted the SICAD II exchange-rate, which took the bolivar exchange rate to about 50:1, creating a $46 million currency charge, $21 million of which was attributed to the first quarter and $25 million of which was recognized in the second quarter. The significant step up in the tax rate for the second quarter was directly tied to the Venezuela issue, which Ritch will explain here in a moment. Just to note, to protect profitability and reduce exchange risks, we're making significant price adjustments in Venezuela as you might suspect.

We also took a significant charge in the quarter to address inventory risks in China. As you know, we deferred the launch of the TR90 weight management product to get as more time to train on the program and to enable the market to absorb the inventory, which was purchased in the first LTO. We were forecasting a very substantial TR90 LTO in China in 2014, and we're building inventory accordingly. But the results of the June LTO in China led us to conclude that we'd likely have difficulty successfully executing a large LTO of TR90 in the second half of this year. This resulted in the conclusion that we'll likely bump up against some product expiry dates on TR90 inventory, with built up in anticipation of the large LTO this year.

Our production schedules are such that we typically need to make commitments for inventory well in advance of our planned LTO events. So we made inventory commitments last fall for TR90 based on the more than $300 million in sales we generated in the global LTO in Greater China in the fall of 2013. The change in plans this quarter and resulting forecast leads us to take the inventory charge of $50 million in the second quarter.

So with those factors, I want to focus my comments today on 2 issues of significant strategic importance. The first question is the question of why this year's regional LTOs have generated less than the projected response, and the second is the question of our prospects in China now going forward. With respect to the response to the regional LTOs this year, clearly, TR90 has underperformed against our forecast. This is a result of several factors, but overall, we feel that it's much more a reflection of our product strategy in the weight management category generally and less a reflection of the LTO sales mechanism itself.

TR90 is a very effective way to change body composition. As we explained in the past, most weight loss programs lead to the loss of muscle mass. In fact, research shows that in many programs, as much as 50% of weight loss when dieting comes from the loss of muscle. This is not good. And particularly, as we age, when lean muscles seem to evaporate overnight. TR90 is designed to maximize fat loss, not weight loss. But this orientation requires education. Many consumers are used to looking at one measurement only, and that's the measurement on the bathroom scale, to determine whether their weight management program is working. So this requires a shift in consumer thinking, and it's a shift that takes time and education.

The training associated with this different and better approach to weight management is an execution issue for us that requires more time and more attention. In addition, the weight management category has different dynamics than other product -- other products in the anti-aging category. In our product launch process, you'll recall that we normally LTO a product and then take it off the market for a period of months. This is challenging with weight management because people don't want to disrupt their regimen.

Consequently, in many of the markets, we decided to launch TR90 on a full-time basis rather than LTO it this year. So that reduced the urgency to buy in the LTO and muted the response to the LTOs a bit in regions, for example, in Southeast Asia. But all that considered, we're encouraged by the data. Those who follow the TR90 program get great results. It's the right way to transform body composition, and we continue to expect that TR90 will be a very significant contributor to our revenue going forward.

Now turning to China, it's great to be back in business now, although we're not yet back to full promotional activities. Every month we take steps to get back up to full speed. For example, promotional meetings since May has still been corporate-sponsored. As we move into the third quarter, we anticipate allowing individual China sales leaders to begin to host their own meetings and, for example, we're also recommencing corporate events, such as the expo events, which we've been holding on a quarterly basis. And we held our first expo in China on August 1 and 2, just last week, which went really well.

When we guided the second quarter in early May, we didn't guide for the remainder of the year because we didn't know how soon China would respond to the resumption of promotional activities. Remember that the sales leader qualification process in China can take up to 4 months. So the rebuild in the sales leader base takes some time.

May showed improvements over April, as we start to accept new sales leader applications, and we're seeing continued stabilization in key indicators since May, and believe the business is firming and sales leaders are gaining confidence in getting back to work. Although the LTO didn't meet our expectations, we saw positive signs in the business in June and July, and believe that these trends will continue.

We recently held a very successful convention for the Greater China region in Hong Kong. This event attracted more than 25,000 people who attended the event and we felt very positive about the convention and believe that our sales leaders in the region continue to be enthusiastic about the future.

So clearly, the media reports early in the year were damaging to the environment, but overall, we haven't seen anything in China that leads us to believe that the market's potential is spoiled or lost. In fact, direct selling companies continue to thrive. And in our interaction with government officials, we believe that they are willing to be fair with us and with the industry to maintain a level playing field for legitimate direct selling companies. We see the recent direct selling license grant in Wenzhou, for example, as a reflection of the government's disposition towards us. So our hopes remain high and we look forward to executing our plans to grow the business in China in a healthy way.

Now with those thoughts, Ritch will provide a little more color on the results and outlook for the remainder of the year.

Ritch N. Wood

Thank you, Truman. And good morning, everyone. Sales for the quarter declined 3% in dollar terms and 1% in constant currency. Revenue for the quarter was $50 million short of our guidance, and this miss related directly to the LTO in China, where we forecast $100 million, but only achieved approximately $50 million in the LTO. Outside of the LTO, the forecast for the business was accurate.

During the quarter, we took an inventory charge, as Truman mentioned, of $50 million, specifically related to TR90 and associated LTO products in China. While inventory levels for other products in China have increased due to the reset of our business there, we anticipate that we'll be able to sell through these products before the product shelf life expires. And while inventory balances around the world are slightly higher due to the build of inventory, particularly for the TR90 launch this year, we also believe that we'll be able to work through this inventory as well.

Historically, we have not incurred material inventory write-offs, and we will continue to apply all of our best practices to carefully work through the issues as they develop in the future as we have in the past. The write off in China is a result of unusual circumstances. Overall, we believe our inventory balances will continue to decrease in the next several quarters and will move back in line with historical level of inventory turns.

So while we reported gross margin for the quarter 76% without this $50 million inventory charge, gross margin would have been a solid 83.7% that's compared to 83.4% in the prior year. We anticipate that our gross margin will remain in the 83.5% to 84% range in the back half of 2014.

Selling expenses for the quarter decreased to 43.6%, a 70 basis point improvement over the prior year. The reduction in selling expenses reflects a lower number of sales leaders qualifying for promotional sales incentives compared to the prior year, particularly in China.

General and administrative expenses for the quarter as a percentage of revenue were 24% compared to 22.1% in the prior year. While we've been able to reduce the dollar amount of expenses from previous levels, the lower revenue has caused a percentage of this expense to be higher in the current period. So we'll continue to manage our overhead carefully and protect profit margin levels, while adequately supporting our ability to grow the business going forward.

We incurred a loss of $21.1 million in the other income expense line compared to a $1.2 million loss in the prior year. This loss resulted in a change to the way we account for Venezuela now as a highly inflationary economy. During the quarter we adopted the SICAD II exchange rate, which is approximately VEB 50 to $1. By revaluing our balance sheet for Venezuela, we incurred a total foreign currency charge of approximately $46 million, of which $21 million should have been recorded in the first quarter to reflect the conversion of assets at the SICAD I rate, which is approximately 10 [ph], and the balance of approximately $25 million in the current quarter at the SICAD II rate.

The total of these foreign currency expenses are recorded in the other income expense line item below the operating income line on the income statement. However, due to the size of the adjustment in the first quarter, the company will restate the first quarter 10-Q.

Our income tax rate for the second quarter was 42% compared to 34.4% in the prior year. The income tax rate in the quarter is higher due to the foreign currency charge in Venezuela, for which a tax-deductible expense is not allowed until profit is realized in the country. Our tax rate is projected to be 36% in the third quarter, and 38% in the fourth quarter. And by the way, the tax expense would have been around 35.8% in the third quarter without -- or in the second quarter without that Venezuelan expense.

During the quarter, we paid $20.4 million of dividends. We had no stock repurchases during the quarter, which keeps our remaining authorization at $370 million at the end of the quarter and note that we're limited by our loan covenants that restrict our use of cash for stock repurchases. We're reviewing our current capital structure, while evaluating a change to our debt structure and covenants that would allow us to have more flexibility as we move forward into the future.

We now have a couple of months under our belts to evaluate our Mainland China trends and business there, since we began accepting sales leader applications the beginning part of May. While our business activities are still limited, as Truman mentioned, we have seen the business stabilizing and feel that we have enough visibility to provide guidance for sales in the back half of the year. We anticipate that our Q3 revenue will be in the $620 million to $640 million range.

Our expectation for the business this year is quite typical of what we generally see as a normal sequential trend in our core business, and excluding LTO sales from a Q2 to a Q3. Generally, our Q3 is about equal or slightly softer than Q2, due primarily to the vacation periods throughout many of our markets during July and August. This year, we would then anticipate that our Q4 sales will increase from Q3, also a similar to our normal trend. And we estimate revenue for the fourth quarter in the range of $650 million to $675 million.

We forecast a negative impact of 2% from foreign currency fluctuations in both of these 2 quarters. We estimate earnings per share to be in the $0.90 to $0.95 range for the third quarter and $1 to $1.05 in the fourth quarter. And just for comparative purposes, I remind you that we recorded $207 million in LTO sales in the third quarter of 2013 and $353 million of LTO sales in the fourth quarter of 2013.

These large sales events in the prior year make for really difficult comparisons here in 2014. So our focus going forward is to generate sequential improvements. And we believe that there are product pipeline and business plans that set us up to have a really good year in 2015.

With those comments, we'll now open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of John Faucher with JPMorgan.

John A. Faucher - JP Morgan Chase & Co, Research Division

Ritch, I guess I understand the sequential changes that you guided to in the back half of the year, but I guess my counter to that would be, you saw sales sequentially decline in Q2, when I think historically they've moved up from Q1 to Q2. Given the historical risk when we see sales momentum decelerate at the direct seller, I guess, why isn't this a little more of a warning here? And what gives you confidence that the sequential fall off in Q2 signals something a little different than normal seasonality? And then the second question would be just sort of what's the holdup on the balance sheet issue? It seems as though from what you're saying, one relatively small piece of debt is holding up your entire balance sheet. And I guess I'm sort of wondering what's causing the delay on that.

Ritch N. Wood

Yes, no problem. Thanks, John. Yes, from Q1 to Q2, the primary decline was due to our Greater China region, which declined $50 million or so from the quarter. And that's really a reflection of the fact that our China business was in decline through April. Since that point in time, sales in mainland China have stabilized and increased a little bit month to month, which gives us confidence as we guide the back half of the year that things are stabilized there, and that's what's reflected in our guidance, that essentially Q2 was the low watermark for Greater China. As it relates to our balance sheet, I think our focus here is to make sure that we do a capital structure going forward that really fits our needs and ensures that we are set up for several years to come, that it's not just a quick strategy put in place, that needs to be refixed again, but rather we get the right partners in place and we do this in a way that's going to be really meaningful and supportive of our goals and objectives here in the next several years. And so that process takes a little bit longer, but certainly, we're anxious to get that moving forward and completed, and would hope to do that by the time we release our earnings in Q3.

John A. Faucher - JP Morgan Chase & Co, Research Division

Okay, and one follow-up on that, is there anything in terms of where your cash is currently located that's precluding you from doing anything in terms of dealing with this debt? Are you having trouble getting access to cash? What's the status there?

Ritch N. Wood

Yes, generally our cash is fully available, with the exception of Venezuela. There are some timing issues throughout some of our markets in Asia where you declare a dividend and then you can remit the dividend back to corporate headquarters. But even in -- especially our larger markets like China, we can get money out through back-to-back loans. So yes, it really is not a cash issue, having the cash tied up overseas.

Operator

And your next question comes from the line of Olivia Tong with Bank of America.

Olivia Tong - BofA Merrill Lynch, Research Division

Truman, your prepared comments seemed relatively sanguine about China, and you talked about the Expo last week. Can you quantify what you mean by it went well? Maybe, can you -- to follow-up on John's question, can you give us an idea of a normalized quarterly or monthly run rate for China? And to follow up on that, what are you hearing from your on-the-ground management and executive leaders? Do you -- is there something that needs to be done more drastically to reengage some of the lost distributors? Are the ones that have left, are they disgruntled? Do they feel like they had the wool pulled over their eyes? Or do they feel like, "Hey, we just got into a little bit of bad luck?"

M. Truman Hunt

Well, obviously, Olivia, a lot of the feedback that we would provide on this point is anecdotal in nature because it's based primarily just on our interaction with the sales leaders we interact with. And based on events, such as the Greater China convention which we held recently, which attracted a lot of people, and where we saw an awful lot of enthusiasm. Generally, I would say that our top sales leaders, who are the ones who interact with the most, are quite stable in the way that they're looking at the business, and in fact, often, we find ourselves being lectured by them that, "Hey, this is just the way it is in China. And it's the way you all need to get used to doing business here essentially. And so in many respects, they end up being less surprised about the ups and downs there than we are, perhaps. The August Expo was the first one we've held since beginning of the year. And so it was nice to see a good response, both in terms of sales and in terms of new sales leader applications, which I think it's fair to say, Ritch, I think, surprised the 2 of us a little bit on the upside. And so it gave us confidence that there's still a lot of energy in the market and that we have the ability to drive the business forward. I would say too, however, that the other factor that has probably muted sales a little bit and probably limited the response to the June LTO was the fact that last year's LTO of TR90 was huge. And if we had to do it over again, we'd dial it back in size because we put a lot of inventory in the market and in the channel, and I think that our sales leaders are working through that inventory. That likely muted the response to the June LTO a bit. But as I said, I mean, when we look at the environment, when we look at the psyche of our sales leaders, our management team, when we talk to government officials, we don't believe that there has been a fundamental shift in the prospects of the environment and the prospects for the market, the potential for the market. So we remain optimistic that China will continue to grow from a direct selling perspective. We believe the government's committed to maintaining a level playing field for all direct selling companies. And I think the recent license grant that we received was a positive indication, with respect to their disposition towards us right now.

Olivia Tong - BofA Merrill Lynch, Research Division

If I could follow up on margins. Do you have a sense for what the costs will be to sort of stabilize this business? How much of the cut in the second half in margins is due to loss leverage versus an expectation that you're going to have to potentially reinvest a bit to rebuild the distributor base? Do you have to add more infrastructure or management, et cetera, to get this stabilized? Because it looks like you're looking for about, let's call it a high-300, low-400 basis point hit to margins in the second half, if my estimates are correct.

Ritch N. Wood

Yes, our margins should be in the 14.5% to 15.5% in the back half of the year. Those margins don't necessarily reflect a significant increase in spending to try and reengage the sales force and so forth. It essentially requires us to continue to manage carefully our overhead and focus our dollars around those events that are going to be most important in engaging the sales leaders. So yes, I don't anticipate that we're having to spend to really reengage the market. It's a matter of, really, I believe, getting the activities back in place in China. Allowing the promotional activities to begin working in a way that we can begin growing our sales leader numbers.

Operator

Your next question comes from the line of Bill Schmitz with Deutsche Bank.

William Schmitz - Deutsche Bank AG, Research Division

When I look at guidance, it seems like, if there was $560 million of LTO sales from the year ago, you're kind of guiding the sales down like 20% from that $560 million. So it seems like it's not just lapping, and tell me if my math is right, but you're not just sort of assuming that there's no pull forward after the LTO, but you're also going to have sort of like a base business decline on top of that. So can you just talk about kind of how you built the guidance and the level of conservatism that you applied to it? And then if there's any change in the subscription levels or anything else that made your forecasting so accurate historically, because you had like a decent chunk of sales obviously already sort of taken care of.

Ritch N. Wood

Yes, that's a great question, Bill, in terms of how we're trying to view the business going forward. And I think the primary difference between last year and this year, in addition to the LTO, is just a reset in the number of sales leaders we have in Greater China. That number being down substantially from where it was in the back half of last year. So it's -- I think the best way for us to look at the business, it's tough to compare it on a year-over-year basis because of the fact that it's just a completely different number of sales leaders pushing forward. I think, generally, the subscription revenue around the world in our other markets there's been very little change, but it's the base of sales leaders in China. You'll notice in my guidance going forward, I have our Greater China region showing a slight improvement in Q3 versus Q2, which to us indicates that the sales leader count has kind of hit the bottom and is starting to come back. That would be consistent with the way we see the business trending kind of June, July and here in the beginning of August. So to us, really, the accurate comparison is to look on a sequential basis going forward, as opposed to try and monitor the business versus where it was at last year.

William Schmitz - Deutsche Bank AG, Research Division

Great, and can you remind me the executive and regular distributor levels, is that the average for the quarter? Is that the number at the quarter end?

Ritch N. Wood

Yes. The active number is anybody who purchased during the 3 months. The sales leader number is the number at the end of the quarter.

William Schmitz - Deutsche Bank AG, Research Division

Okay. All right, got you. Because the first quarter, obviously, there was probably a lot of people who were there in the first few weeks of January before everything kind of came to a head in China is my guess, so that number is partly -- artificially right?

Ritch N. Wood

Exactly right. The low point was really April. So it was still declining as we came into the second quarter, at which point May firms began to firm up.

William Schmitz - Deutsche Bank AG, Research Division

Got you. Now can you just talk about the innovation pipeline in the back half of the year? I know you did an expo, I was wondering if you were tempted to do a convention. And my question is, what did you guys talk about at the expo? Because it sounds like Tru Face probably got to a later start than you guys envisioned, is that fair? Because we kind of heard that in some of the checks. And so maybe like will the subsequent periods be better month by month on the Tru Face Essence, but also just kind of like what the folks are talking about in these expos and then maybe whether or not you might want to do a convention to make sure that momentum on the ramp base isn't decelerating.

M. Truman Hunt

Well as we mentioned, Bill, we just held a Greater China convention in Hong Kong a few weeks ago. And so that event was executed very effectively with high levels of energy and enthusiasm. And in fact, if you had attended it, you'd never even know that there's been a disruption in the China business actually, because the energy level was so high. The response to the June LTO was lighter than we expected, obviously. But we offered a subsequent LTO in July of the same product, the Tru Face Essence Ultra product, which actually generated a higher response the second time around than it did the first time around. And so we're actually hearing from our team and feeling optimistic that TFEU can be a good catalyst for sales in the second half of the year and that, again, the muted response to the first LTO was not a reflection of the product itself, but just a reflection of the fact that we have sales leaders who are still selling through inventory and getting their own cash levels back up. So the second half of the year, you're going to see us focusing on TFEU from a sales momentum perspective in China, along with all of the other products that are currently offered. And then beginning next week, we actually start our cycle with respect to the 2015 launches, and we'll have sales leaders from around the world gathered for a, what we call our Opportunity Summit, which kicks off the sales cycle for the products being launched next year, which we're very excited about. We have big products in the pipeline in both skin care and nutrition, and feel like we have good ammunition to use in 2015 to renew growth.

William Schmitz - Deutsche Bank AG, Research Division

Right. And then if I can sneak in one more quick one. How about the air filtration system and the water filtration system, that's been sort of whispered, is that still on the docket?

M. Truman Hunt

It's still being evaluated. They're not small ticket items. And so we want to be very careful about these categories because we don't want to find ourselves in another inventory crunch carrying a big-ticket item that is a big-ticket inventory item that we have a hard time moving. So we're being cautious in this category. But both categories are still being evaluated.

Operator

Your next question comes from the line of Rommel Dionisio with Wedbush Securities.

Rommel T. Dionisio - Wedbush Securities Inc., Research Division

Truman, on your new provincial license in China -- and congratulations on getting that by the way, could you just update us as to where you are now in terms of the, how much of the region is -- of the China region is addressable market at this point, with the licenses you have in place? And perhaps -- I know it's tough reading tea leaves with the Chinese government, but how close you may be with the remainder of the country, in terms of getting provincial licenses?

M. Truman Hunt

Yes, as I recall, the number of licenses issued so far is in the 19 to 20 range, which we feel puts us -- gives us coverage of about 2/3 of the country in terms of the real target market of the country. So still room to expand, but making good progress with our footprint.

Operator

Your next question comes from the line of Frank Camma, with Sidoti.

Frank A. Camma - Sidoti & Company, LLC

Just a couple of quick questions. Obviously, just to hit on one on China real quick, several years back, Japan was obviously a great market for you, and then you had some negative media attention there, and it has since abated over time. Just wondering, do you draw any parallels to what's going on in China right now? And does that like concern you that you might have a repeat here?

M. Truman Hunt

Well, Frank, I wouldn't say that Japan has faded because of media attention. I mean, it's true that there's been some negative media attention there, but the direct selling channel has contracted, as you know, over the course of the last 15 years by about 35%, and we have actually fared better than the channel has, as we've picked up market share through last year against the channel generally. Japan suffers from a lot of things. I mean, it's a tough consumer environment anymore. They imposed the new consumer tax, April 1, that stifled, we think, consumer appetite for spending. China is just a different ballgame. I mean, there's just so much more room to develop that economy than where Japan has been over the last 20 years, that I think that that's a really a difficult comparison to draw. And of course, we continue to keep an eye on the channel generally, and the success of other companies and trends of other companies, and we don't see anything happening there yet that would signal some kind of a secular turn in direct selling's potential in China. We -- I mean it's, China is still not even close to being the world's largest direct selling market, and it will become that in the next 5 years.

Frank A. Camma - Sidoti & Company, LLC

Okay. The other question is on TR90. Obviously, you took the internal write-down on inventory, and you had mentioned that the successful launch last year was maybe a little bit too heavy on the sales force. I was just wondering, are you concerned about any returns that might be in excess of your historical patterns? And do you have reserves in place for that?

Ritch N. Wood

Yes. Thanks, Frank, for that question. I'll take that. The returns level was about 3.5% in the second quarter, compared to about 3.5% in the first quarter. It's slightly higher in terms of where we were the last 2 quarters of last year, which was in the 2.5% range. But from a dollar side, we actually see the dollars coming down. We don't see returns issues increasing at this point in time. So we analyze that every quarter and do our best to estimate where sales are going, what the inventory balances are, as I mentioned, kind of in my comments, we believe that we'll be able to sell through the inventory that we have, and that we'll see that inventory converting to cash here in the next few quarters.

Frank A. Camma - Sidoti & Company, LLC

Okay, great. There's only one more. I'd just like to ask, on the new product lineup that you had discussed for next year, the specifically what I'm talking about is on the personal care side. Are they -- any chance you might switch the schedule around, like move it up? Or would you still be launching that towards the back end of the year? Any thoughts there?

M. Truman Hunt

Yes, that's the product that we've -- we codenamed Bespoke, which maybe that's the name that you're looking for there. It's codenamed Bespoke because it's essentially a customized approach to developing individual skincare regimens. This product involves a piece of hardware that obviously has a manufacturing timeline associated with it. We also, as you know, do our global sales leader convention every other year. And so we won't move that forward, obviously. That will still be in the back half of next year, and that will be the event around which both of these products will be launched.

Operator

Your next question comes from the line of Mark Astrachan with Stifel.

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

What was the Greater China sales leader number at the end of July?

Ritch N. Wood

We actually don't have that, Mark, until about the 10th of the month when we have complete sort of records, of who qualified and who didn't.

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

Got it, okay. Any sort of color you can give directionally on that, at least relative to the movement through the second quarter? I mean is it higher or lower than what we saw at the end of June?

Ritch N. Wood

I think what we feel like is happening is that the pipeline is beginning to fill, as it relates to sales leaders. It's, as we mentioned -- Truman mentioned, in his comments, it's a several month qualification process for somebody to actually qualify as a sales leader. So the fact that we started taking applications in May, those first group of sales leaders will qualify here in the third quarter, and generally, closer to the end of the third quarter. So it's going to take a little time to build that back and that's what we've reflected in our guidance. But we liked the underlying indicators that we're seeing. The pipeline's filling, the sponsoring of new customers is improving. Those sort of indicators generally will lead to a stronger sales leader base going forward. And so that's what we're basing our comments on.

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

Got you, okay. And then tax rate expectations, has there been any change in profitability in the market or region that would account for the expected increase in tax rate?

Ritch N. Wood

No. And I should have addressed that more clear in my comments, so thanks for asking it, Mark. But basically the tax rate is the same. The only impact is this Venezuelan impact. And frankly, as Venezuela begins to become profitable and earn profits, then we'll actually get a benefit from the expense that we've taken down there. So no outside of the ordinary tax rate issues in this quarter other than Venezuela.

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

Got you, okay. And then just lastly, if you could talk sort of directionally about the impact, if any, on your business, from changes imposed by the Chinese government?

M. Truman Hunt

Yes, the result of the investigation, which as you know, was completed a few months ago, actually, resulted in very few changes to our model. It was mostly a product-related issue, where they found that non-products not registered for the direct sales channel were leaking into that channel. And so they haven't required any changes to our business model. We continue to work as a team and work cooperatively with the government, to figure out what we need to do to maximize our potential in the long run, but they didn't mandate any changes to the business model nor ask us to make any.

Mark S. Astrachan - Stifel, Nicolaus & Company, Incorporated, Research Division

What about in terms of the direct selling industry, sort of broadly, that you may or may not have to conform to?

M. Truman Hunt

Well, I mean, I don't think that we're going to be granted any exceptions to the regulatory framework, if that's what you're asking. I think we, like other companies there, are all going to be subject to the same regulatory framework. I also, just from a color commentary perspective, don't think that the government is -- has a strong appetite for modifying the existing regulatory framework in a short term either. I think they continue to evaluate the industry globally and industry trends in market and will be prudent and measured, as they might modify the regulatory framework going forward. But I wouldn't expect that in the short term.

Operator

And your next question comes from the line of Scott Van Winkle with Canaccord Genuity.

Mark Sigal - Canaccord Genuity, Research Division

It's Mark Sigal for Scott. Were existing sales leaders who stepped away from the business in China permitted to come back in May without the formal requalification?

M. Truman Hunt

Yes, we have offered a welcome back program that was -- that involved the qualification process less restrictive than the 4-month qualification period.

Mark Sigal - Canaccord Genuity, Research Division

Okay, and can -- based on the numbers you saw, can you talk about how that reengagement rate trended versus internal expectation?

M. Truman Hunt

Well I think that's one of the reasons our China team would cite the lower-than-expected response to the June LTO is that they didn't get the response to the welcome back program at the same level they had hoped and projected. And so the stabilization that we're seeing and key indicators here that we've referred to this morning is more a reflection of new entrants into the business than necessarily a recovery of former sales leaders.

Mark Sigal - Canaccord Genuity, Research Division

Okay. And then on the softer LTO, understanding the softer reengagement and the inventory issues, did you hear any pushback on the LTO process itself or anything that causes you to maybe reevaluate timing and proximity to a global LTO or anything of that nature?

M. Truman Hunt

Yes, we have -- we've learned a lot through this last LTO cycle, and we will make modifications to our LTO strategy going forward. One of the things that we've learned is that it's probably less likely that we will do regional LTOs in between the global LTO and the local launch. We think that now having gone through this last cycle, that's one of the takeaways. And so you'll definitely see us modify our LTO mechanism. But we've learned from it every time we've done it over the course of the last 5 years. So every time we execute a product launch, we're learning, and we'll get better with the next one.

Mark Sigal - Canaccord Genuity, Research Division

Okay. And then lastly, I know it might be a little early to be looking towards the next global LTO, but given how big last year's was and the channel issues that we've seen subsequent, is there a new sweet spot, if you were over $500 million last year in terms of orders of magnitude, are you targeting maybe something half that for the next major cycle? Or how are you viewing that?

M. Truman Hunt

I think that's an issue that we'll address later in the year. And as we continue to refine our thinking and continue to learn from this year's experience, I don't know, Mark, that we're ready to go out and say the ideal LTO is going to be excised next year. I mean, we're not quite there. But one thing we know for sure is that we're not going to maximize the size of an LTO just because we can. I mean, we're definitely going to be strategic, more strategic than we've been in the past in terms of how much product we put into any given market in connection with any LTO.

And let's conclude the call with one additional thought. I want to thank you, again, for joining us this morning.

As we look forward today, it's fair to say that we see some significant challenges, but fortunately, most of those are in the rearview mirror. And we're encouraged by what we see ahead. We see generally improving trends in many of our key markets. We see our financial picture improving, as inventory level start to come down and cash begins to rise. We see a loyal foundation of strong Nu Skin sales leaders around the world who frankly couldn't be more committed to their business, which obviously bodes well for ours, and who share our vision of becoming the world's leading direct selling company.

In the direct selling world, Nu Skin's history reflects its repeated ability to continually renew itself and renew the vibrancy of our product lines and the business opportunity we offer. And that process continues, as I mentioned, with our first meetings with sales leaders next week to discuss the 2015 product launches in both skincare and nutrition.

We're confident that these products will capture the enthusiasm of our leaders and will represent significant innovations in our 2 key product categories. And with this step, we begin to execute, with our sales leaders, our plan to resume growth in 2015, and to keep Nu Skin Enterprises on path to reach its potential.

Thank you for joining us this morning.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

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Source: Nu Skin Enterprises' (NUS) CEO Truman Hunt on Q2 2014 Results - Earnings Call Transcript
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