如新 (NUS) 2004 Q3 法說會逐字稿

Good morning. My name is Keena, and I'll be your conference facilitator. At this time, I'd like to welcome everyone to the Nu Skin Enterprises third-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 period. (Operator Instructions). Thank you. Mr. Allen, you may begin your conference.

Thank you. 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, Chief Executive Officer, Ritch Wood, Chief Financial Officer. Following management's discussion of the Company's operations, the call will be open for questions.

As a reminder, during this conference call, comments may be made which include some forward-looking statements. These statements involve risks and uncertainties, and as you know, actual results may differ materially and adversely from those discussed or anticipated. We encourage you to refer to a copy of our most recent filings with the Securities and Exchange Commission and today's earnings release for a complete discussion of risks associated with these forward-looking statements and our business. During this call, certain financial performance measures may be discussed that differ from comparable measures contained in our financial statements prepared in accordance with Generally Accepting Accepted Accounting Principles, referred to by the Securities and Exchange Commission as non-GAAP financial measures. We believe that these non-GAAP financial measures assist management and investors in evaluating and comparing from period to period results of operations in a more meaningful and consistent manner. Please refer to the investor portion of the Company's website at www.NuSkinEnterprises.com, where you'll find our third-quarter press release containing reconciliation of these matters. At this time, I'll now turn the call over to Truman Hunt.

Good morning, everyone. Thanks for joining us today. This morning, we reported third-quarter revenue of $283.3 million, which is a 13 percent improvement over last year's results. Earnings per share for the quarter were 29 cents, which is a 53 percent increase, including the onetime charge Q3 2003 EPS, or 26 cents per share excluding the onetime charge. These results are a bit ahead of the anticipated results we announced on October 4th, as our managers did a good job of managing expenses in the quarter.

As we indicated a couple of weeks ago, we saw revenue increases in virtually all of our markets, with the exception of Japan and New Zealand. Overall revenue growth was driven by significant year-over-year gains in Mainland China, as well as strong results throughout the rest of Greater China. We also continued to see healthy growth in our U.S. business and in the Southeast Asia-Pacific region. And our Europe and Latin American businesses also posted very encouraging third-quarter results. You'll note that our revenue growth was also driven by a 25 percent increase in our active distributor count, and a 13.5 percent increase in our executive distributor number.

You'll find the details for the quarter in our press release and Ritch will address some specifics in a moment. But I'd really like to spend my time this morning talking primarily about what we see happening in China and in Japan.

As you know, we've been anticipating having a little better visibility on the direction of the new China direct selling regulations by now. These regulations continue to evolve, but are still expected to be in place by the end of this year. However, as we've also indicated a couple weeks ago, as opposed to the beginning of 2005, we now anticipate that the government will begin to issue direct selling licenses by mid 2005.

As we have also indicated this revised timeline, heightened government and media attention on the direct selling industry, as well as our focus on sales force training and retention, has slowed our growth rate, even though we're still showing significant year-over-year growth. Our first priority in China is to manage our operations to maintain positive government relations in order to maximize the likelihood of receiving a direct selling license in 2005. We're balancing this primary objective with initiatives that will keep our sales force engaged and enthusiastic in the meantime, including new product launches, geographic expansion throughout China, and the launch of the Pharmanex product portfolio, as well as the BioPhotonic Scanner in early 2005.

Now recently, we've noticed an analyst report as well as continued media reports that really typify, we think, the confusion regarding the state of the new regulations in China. I'd like to briefly offer our perspective on these reports. First of all, I want to make it clear that the new direct selling regulations should be very positive for our Company. The challenge today is the regulatory ambiguity we've faced due to the fact that we are a large direct selling company operating a unique retail-based business model today that many people easily confuse with our direct-selling business model. But having clarity on the regulations and putting all foreign and domestic direct sellers on a level playing field will be a positive step for us and for the rest of the industry. Frankly, the fact that we'll do more than $100 million in revenue in our second year of operations in China after generating $38 million of revenue in our first year shows the potential for this market, particularly because we've done this with a very restricted business model.

Now let me highlight a few items of interest in the new regulations. The first misperception I've seen circulating relates to the idea that no multilevel compensation plans will be allowed in China. This misconception seems to stem from a proposed 25 to 30 percent cap on the commission level direct sellers will be authorized to pay. Now, the mere fact that there is a proposed cap suggests otherwise. If the Chinese government intended to prohibit multilevel compensation, they would have no reason to impose a cap on commissions to begin with. And as currently worded, this cap would also be based on the retail sales price, not the wholesale price, to a distributor. So if you factored in a typical retail margin, a 25 percent cap, for example, would represent about a 35 percent cap on sales commissions on a wholesale basis. This is the same cap under which we've successfully operated in South Korea, and it's a much higher level than is currently paid out under our major competitors' compensation plans around the world.

So this cap on commission payout, if it ends up being the definitive regulation, is not going to be a definitive factor in determining the success of multilevel versus single-level compensation plans in China. In fact, when you look at the relative sizes, for example, of Amway's business in China, at about $2 billion a year with 130 stores versus Avon's business in China at about one-tenth that size in more than 5,000 stores, one would have to conclude that the multilevel compensation programs have been far more successful in the China market. And this is not just the case in China.

When one considers other Chinese markets, such as Taiwan, Hong Kong, Singapore, and Malaysia, as well as the non-Chinese Asian markets of Japan and South Korea., it's pretty easy to see in each of these cases that multilevel compensation structures are far and away more successful than single-level compensation structures or highly diluted multilevel compensation structures.

Now another misconception with respect to the China regulations has to do with the number of stores that the government is likely to require of direct sellers. It's our understanding that this issue is yet to be finalized. But the real issue the regulators are trying to address is providing consumers with locations where they know where to seek reimbursement for product returns. We understand that the regulations may require at least one store in at least ten cities in each of the 34 provinces and municipalities in China, or a minimum of 340 stores, in order to do business throughout China. Until all of these stores are built, direct sellers will only be able to conduct direct selling activities in the cities in which the stores are located.

Now, this is also not going to be a significant barrier to success for us. We're already operating in 120 stores throughout China in most of the major cities, and we're prepared to open an additional 30 new cities in the next six months or so. And so, we're also prepared to open additional stores if this is what is required. So again, we don't see this store requirement as being a significant barrier to our success in China.

So there's much inaccurate information about the direct selling regulations in China that's filtering through the investment community. Those of you who are interested in our complete take on the new regulations should plan to intend our investor day presentation in New York City on November 16th, where we'll be joined by Corey Lindley, our China-based president of the Greater China region, who will provide greater insight into the current state of direct selling in China and provide our view of what the industry is likely to look like in the short and the long terms.

Suffice it to say that today, given our historical success in Chinese markets throughout Asia, our initial success with a limited business model and product offering, as well as the success of our competitors in China today, we're optimistic that we'll perform exceptionally well in China when the playing field is level for all direct selling companies.

Now, just a few thoughts on Japan. The most significant reason for our slowdown in this market is the fact that we've had to be patient with the introduction of the BioPhotonic Scanner. Not since early 2003, when we launched our True Face Essence product in Japan, have we had a really strong growth initiative in this market. As you know, the BioPhotonic Scanner has driven very good growth results in the U.S. and is starting to have very positive impacts elsewhere. We had hoped to have introduced the scanner into Japan sooner, but unfortunately, it took us longer than anticipated to clear regulatory hurdles.

Finally, we're now five weeks away from launching a scanner lease program in Japan. By December first, we'll have about 100 scanners in the hands of our field leaders in Japan. And by February 1st, we'll begin rolling out 100 to 200 scanners per month to additional field leaders. In addition, as we indicated earlier this month, we're implementing enhancements to our compensation plan in Japan that have proven very successful in the United States, Taiwan, Hong Kong, Singapore, and Malaysia. So together with the scanner launch, we believe that Japan will see a renewed growth in 2005. While we're only modeling slight growth, due largely to the fact that we need to stem a decline, I know that I, and other members of our management team, will be very disappointed if we don't see a much better performance in Japan by the second half of 2005.

As we also noted previously, the Q3 decline in Japan was a result of a decrease in personal care sales. This is the same concern we had in the United States in the early days of the scanner launch here. So we're focusing marketing efforts to try to mitigate the extent of this impact in the upcoming quarters.

For example, during our Japan convention in November, we'll launch several new products, including a Nu Skin whitening system that we expect to be a top-selling product in Japan. And we're also starting from an early date to include Nu Skin products in our retention programs and really pushing Nu Skin products in our monthly subscription programs.

But in the United States, we continue to see our business improve nicely. We posted year-over-year revenue growth in our core business at 26 percent with Pharmanex revenue up 43 percent in the third quarter. Pharmanex obviously continues to be the focus of U.S. activity. But as our release indicates, the personal care business also grew 8 percent during the quarter, demonstrating that we can grow both sides of the business at the same time.

Now just a quick word on some of our other markets. Hong Kong continues to grow at a very rapid rate. And encouragingly, our fourth-largest market, Taiwan, is showing healthy renewed growth. Some of this growth is obviously attributable to enthusiasm for China. But we believe that a significant percentage of the business growth there is just healthy, organic growth stemming from successful marketing and retention programs. Nowhere is that progress more evident than in Hong Kong, where we are the largest direct seller in the market currently, and where our retention rates have more than doubled in the past 12 months. We're now implementing the successful retention mechanisms that have had such a positive impact in Hong Kong elsewhere in other markets, and we're seeing very good early results.

It's also worth noting our revenue growth in Singapore and Malaysia. A year ago, these markets, you'll recall, were in decline. But we've been successful in turning these markets, again, due in large part to the retention focus and our emphasis on automatic subscription programs. Add this success to our recent opening of Brunei, and our combined revenue from Singapore, Malaysia, and Brunei was up 15 percent over last your.

As you know, we've also been investing in Latin American. Although we're still very small there, we are seeing a significant improvement in our results in Mexico, in particular. Revenue is up 35 percent over last year, and new distributors are up more than 400 percent. We've made a number of enhancements to our business in Mexico, and feel that we've distilled a business model that can be exported throughout other Latin American countries, as well as into other developing economies. We've been investing in Latin America about $2 million per year, and we believe that this investment will pay off, and that the market will be operating profitably by the end of 2005, with revenue of at least double the current revenue level.

We're moving forward with our expansion plans in Eastern Europe and South Asia. In 2005, we anticipate opening both Russia and Indonesia. And although Israel is not a top direct selling market, we hope to develop strong distributor leadership in Israel, which will open in two weeks. And this leadership, we hope, will help to make Eastern Europe a good market for us. Now, let me ask Ritch to provide some financial highlights as well as comment on our forecast for the fourth quarter and for 2005.

Thank you, Truman. Good morning, everyone. I'll provide the local currency revenue figures from our major geographies. Third-quarter revenue in Japan was 15.5 billion yen versus 16.8 billion yen for the same quarter of 2003. Quarterly revenue in South Korea was 18.3 billion won versus 17.9 million won in 2003. In Greater China, revenue from Taiwan during the quarter was 716 million NT dollars versus 610 million NT dollars last year. While Hong Kong revenue was 98 million Hong Kong dollars versus 48 million Hong Kong dollars in the prior year.

Note that sales in the current quarter in Hong Kong benefited by approximately 15 million Hong Kong dollars of sales at the Greater China convention. In Mainland China, revenue was 221 million RMB during this quarter versus 89 million RMB in the third quarter last your. Combined third-quarter revenue for Malaysia, Singapore and the newly opened Brunei market was $10.5 million compared to $9.1 million for the same period in 2003. Thailand posted revenue during the quarter of 255 million baht compared to 247 million baht last year.

The U.S. market generated $33.6 million in revenue during the second quarter compared to 27.8 million in the third quarter of 2003. Third-quarter revenue in Europe was $8.7 million versus $7.5 million for the same quarter of 2003.

And finally, Latin American revenue was $1 million for the quarter compared to $700,000 in the same quarter of 2003.

Our third-quarter gross margin improved 70 basis points to 83.2 percent compared to prior-year results. The year-over-year improvement was due primarily to discontinued low-margin products and services; higher gross margins in Mainland China resulting from in-house manufacturing; favorable foreign currency rates; and these benefits slightly offset by scanner amortization and depreciation.

Selling expenses as a percent of revenue were 43 percent. This is an increase of 100 basis points compared to the prior year. The year-over-year increase is attributable to the higher percentage of global sales coming from China, where, as you know, selling expenses are higher than the Company average, as well as a temporary increase to selling expenses in Japan.

General and administrative expenses as a percent of revenue improved 20 basis points over prior-year results to 28.3 percent when the impact of the onetime charge in the prior year is excluded. Third-quarter operating margin was 11.9 percent. Interest expense during the third quarter was $1.5 million. We paid dividends of $5.6 million, and invested $8 million in capital improvements, primarily the scanner. We generated cash flow from operations of $30.9 million, and closed the quarter with $124 million of cash on hand.

We also completed a stock repurchase transaction of 3.1 million shares during the quarter for approximately $71 million, using cash on hand.

As we model our business going forward, we anticipate that the scanner will have a slightly negative impact on gross margins, as our lease payments received are recognized as revenue, and are basically intended to offset depreciation and amortization expense associated with the scanners and the scanner program. We estimate gross margin to be approximately 83 percent for the fourth quarter, and moving to a weighted average gross margin of approximately 82.3 to 82.5 for 2005.

This scanner revenue will benefit, however, selling expenses as a percentage of sales, as no commissions are paid on this lease revenue from the scanners. We, therefore, estimate fourth-quarter selling expenses to be higher at approximately 43.3 to 43.5 percent due to the higher selling expenses temporarily initiated in Japan. However, we expect selling expenses will then decline as a percentage of sales to be approximately 42.5 to 42.7 percent on a weighted average basis for 2005.

We reiterate our previous guidance of fourth-quarter revenue of 285 to $290 million. Therefore, 2004 revenue is anticipated to be approximately $1,115,000,000 to $1,120,000,000, or 13 percent growth over 2003. We've assumed a yen to the dollar rate of approximately 111 for the fourth quarter. However, as you know, over the past week, the yen has made a strong move to the 106, 107 level, which if it continues to hold at this level, could result in a 2 to 3 million upside on our fourth-quarter revenue.

We also reiterate our EPS guidance for the fourth quarter at 27 to 29 cents, and remind you that this includes an approximate $4 million expense associated with the Japan convention, to be held in November of this year, and not held in the same prior-year period.

In 2005, we model revenue growth in the 5 to 7 percent range, with earnings per share growth of 10 to 15 percent. This assumes a yen rate of 112 to the dollar, which I note would be approximately a 2 percent negative currency impact in 2005 over 2004. We also are assuming 130 to $140 million in China revenue. And with that, I'll turn the call back to Truman.

Operator, we're ready to take questions.

(Operator Instructions). Our first question comes from Kathleen Reed.

Good morning. Just a couple of quick questions. One, with your fourth-quarter EPS guidance remaining the same, we're just to imply from that that the full-year number will then flow through your two-cent upside surprise in your third quarter? Is that correct?

Yes, there's actually a rounding issue as well. So it should be around, again, using those numbers, $1.03 to $1.05.

Okay. And secondly, just quickly, your other income number -- this is just a model question -- in your third quarter that you reported, you said interest expense of 1.5 million. What's the offset to that? And can you break out that number?

Sure. We have an offset of interest income which offsets that by a couple -- by about $400,000. We also have a gain in foreign currency translation as well as some other small miscellaneous items. Those all net to a negative $400,000 expense in the other income area.

Okay. Great. And can you just give us comment on the recent -- like mother nature issues that have been impacting Japan? And I guess also, there was an additional typhoon in Taiwan, the earthquake, etc. -- some of those issues were cited for some of your shortfalls in Japan in your third quarter. And just any commentary on what -- the yen appears to be moving in the correct direction. But just if there's any issue to product outages, etc., with those disaster type of issues.

Yes, Kathy, the mother nature issues certainly are not positive for us in Japan or in Taiwan. On a couple of days in particular, we have had to close our offices and send people home because of the severe weather. Now, you know, we have not been noticeably, materially, impacted by any one of these event singularly. And it's very difficult to quantify the cumulative impact of all of these issues in Japan. But clearly, all of those things have a negative impact.

Okay. And then finally, just in your comments, when you were explaining some of the confusion regarding some of the proposed changes to the direct-selling regulations. The first one, when you were talking about the commissions being capped at 25 percent, but that's on a retail price and then they would be actually higher if you used a wholesale price. Are you saying that you could, potentially, use the wholesale price, so therefore you are -- it would be like a 35 percent? I just was unclear about that.

Yes, that's what we're saying is that a 25 to 35 percent cap on retail sales equates to something in excess of a 35 percent cap on wholesale lines, which will not -- which is essentially what we do in South Korea, where we currently face a 35 percent cap on wholesale commissions, as well. So we just don't anticipate that that factor, which has been cited by some as a limiting factor on the success of multilevel compensation plans, is going to be a limiting factor.

Okay. And then finally, Ritch, I know you said that the yen is, right now, you have modeled in at a 2 percent negative, because you're modeling, again at 112 for '05. But is that just on a top line or -- because also, your margins benefit from your lower manufacturing costs then. What is the total like EPS impact that you usually -- for every point difference in the yen is an actual translation of X to the bottom line?

Yes. That's a hard one to calculate, Kathy, depending on several things -- how much we're hedged out and so forth. But certainly it doesn't have a direct impact to the bottom line in the same fashion that it has to the top line when we translate back. That impact is smooth, whether the yen weakens or is strengthened by the fact that we are hedged out yen approximately 60 to 70 percent of our cash flows.

Okay. So I mean more meaningful would be the fourth-quarter effect that we're seeing now, with the yen rates being so low as we see them currently.

Yes, that correct. And it's hard. I mean we really are not into trying to model that yen. We've tried to be conservative in putting out their -- where we anticipate the yen might go. Three weeks ago, as you know, when we gave our initial third-quarter numbers, the yen was trading above 111. So we've elected to be conservative on where we think the yen might go in the fourth quarter. There may be some upside to that number if it stays in this 106, 107 range.

Okay, great. Thanks very much.

Your next question comes from Doug Lane.

Good morning, everybody. Question on the distributor convention. You said Japan is going to cost 3 to 4 million in the fourth quarter? Is that correct?

Yes, that's correct. It will be 4 million, Doug.

4 million. So that's what? 3 or 4 cents? Is that about right?

Correct.

Do have a number for what the Hong Kong convention costs in the third quarter?

It was just over $1 million.

Oh, okay. And is that going to be once every 18 months kind of event like the two conventions? Or where do you stand on that?

You know, this convention was an experiment for us, Doug, because we've never done a regional convention of this nature. But yes, I think it's likely that we will repeat this event on an every 18-month basis.

Okay. Then lastly here, is there -- can you update us on -- I know you mentioned the stock that you repurchased in the transactions in October and July. But you also have open market authorization. Can you update us on where you stand there? And what the probability is for additional authorization?

Sure. We currently have, at the beginning of this quarter, about $8.5 million left on our authorized repurchase from our Board of Directors. We have taken that issue up with that, and it's under consideration today as to whether we look at increasing that amount. We should note that over the last couple of weeks, we have been back in our stock and believe that for us, this was a good price to be buying our stock back. And again, we could increase that amount based on board approval later on in the year.

Okay. But nothing from a timing standpoint? Board of Directors meeting, or is there some particular timing? Or you just think sometime between now and year-end?

Yes, I don't have an exact timing for you, Doug, right now.

Your next question comes from Joe Norton.

Yes, thanks. Good morning. A couple of questions. First of all, I wanted to ask about the rep count, particularly in North Asia. Could you tell us anymore specifically? I saw that the executive distributor count was down 7 percent. Was that -- could you give us country breakouts on that?

Yes, actually, Joe, it was down about 8 percent in Japan, which was right in line with our revenue decline, and up just slightly in Korea. The active count, as you mentioned, held even. I think this is a real indication of what Truman talked about in the script. Basically that we haven't had a strong business driver to grow leadership in the market. And yet, we feel very confident that our customer base and our business is stable there. We continue to see very healthy, active distributor numbers. Our retention rates are improving. And I think this is just indicative of the fact that we haven't had a strong business driver there for the last little while. And people have been on hold a little bit as they've anticipated the launch of the scanner.

So are you saying you think that the scanner is going to drive an increase in the executive count in Japan?

We do.

Joe, we feel that the scanner, as well as the compensation plan enhancements that we're implementing, will drive an increase in our executive count.

Okay. And do you see -- I mean, is it just coincidental that the executive distributor count is down? I mean is there a clear correlation between that number and the sales number, do you think?

Well yes, there really is. I mean as Ritch indicated, and 8 percent down in revenue and an 8 percent down in the executive count in Japan. So there is a correlation between those two numbers typically.

Okay. So then, could we say if we don't see an increase in that number in the next several quarters, we're probably not -- I mean is that kind of what we should think if we don't see an increase in executive reps, then we may not see an increase in overall revenue in Japan?

Yes, it's difficult for us to grow our revenue base materially without, of course, finding an increase in our executive count. So we would expect to see an increase in our executive count and an, actually, a little higher increase in our revenue level.

Okay. And then just following up on that, it seemed, on October 4th, you guys were suggesting maybe you'd have a little bit more color on how the scanner initiative was being received, or if there was any stronger conversions of Pharmanex sales. And I just wondered if you have any update on that for us in Japan?

Yes, I don't mind saying that what we're seeing in Japan is very healthy key indicators. Our product subscriber base is going up at a healthy rate. And we're seeing a healthy level of people qualifying to become executive-level distributors. So, so far, the initiatives seem to be impactful.

Okay. Good. Thanks. And then just a couple more quick follow-ups on the comments that you made about China. Regarding the 25 or 35 percent commission cap -- however you want to look at it -- is that in line with what the reps in China have been told that they ultimately could earn?

Yes. The reps in China recognize that we're operating in a very unique environment there. And they will not be disappointed with that level of commission payout. That still really generates significant levels of income within China. So, in other words, they're very excited about that.

Okay. And then finally, just that last point on China, I think I just -- well, first of all, can you just update us on the new market opening? Is that still scheduled for January first quarter? Or is that sort of more of a -- you know, once the new licenses are granted, or how should we think about those new markets in China at this point?

Well, we currently have plans in place to open several more cities in the next two quarters, depending on how the regulations continue to develop. And we anticipate, today, opening about 30 new cities, actually, in the next six months. And we feel fairly confident that we'll be able to do that. It just depends on how the regulations shape up. And we obviously need permits in each of those cities. But that's basically what we have on the calendar today.

Okay. And you're in --

As far as direct-selling licenses, Joe, as we indicated in the commentary, we anticipate that China will begin to issue direct selling licenses by mid 2005.

Right.

And that's just -- that's frankly just our gut feeling. They haven't said that. It could come earlier. It could potentially be pushed back. But that's just our sense.

And then, did you say that you're anticipating the requirement is going to be 1 or tin stores per city?

No, the -- yes, that's where there is some confusion. And what we're saying is that the regulations will require at least one store in at least 10 cities in each of the 34 provinces.

All right. Thanks. Okay.

So in order to operate in a province, you'll have to have 10 stores, basically. And with 34 provinces, that's a 10-store requirement, that's 340 stores.

Okay. So then that would mean you guys need to add more than 200 stores in 2005?

Yes. We could add 200 stores in 2005 or push that out a little bit. And the regulations, we believe, will be issued -- or the permits will be issued on a province-by-province basis. So we could be operating in many provinces with fewer than 340 stores. We already have 10 stores in many of the provinces.

Right. Right. Okay. Thanks very much.

That's helpful.

Your next question comes from Mimi Sokolowski.

Hi. I want to start with a few questions about the scanner. I want to get an idea of the current momentum in the U.S. Are you still issuing -- pretty active in issuing new leases for the scanners?

We are. We actually have quite a waiting list for scanners in the U.S., and people are very anxious to get their hands on them.

Okay. And when were they introduced again?

In March of 2003, is when we put the first 30 or so scanners in the hands of U.S. reps.

Okay. And are they still being manufactured in the U.S.? Or have you been able to move them offshore -- the ones that are distributed domestically?

We still manufacture in the U.S. However, as of this month, we also have a China plant up and running and producing about -- in the month of October, they'll produce a couple dozen scanners out of the China plant. And we have the ability to ramp that up fairly quickly.

Okay. So you would imagine a transition sometime over the next three, four months or so?

Yes, I think we'll keep manufacturing in both places, keep both factories active.

What's the rationale behind that?

Just so that we have a safety facility in case they have problems at one of them.

Okay.

We've gone to a lot of effort to ramp up manufacturing here in the U.S., and we just don't want to turn it off completely. Although we do get a cost of goods benefit in China.

Right. Okay. And I also wanted to ask a little bit about the stores in China. Over the last six months, hasn't it been your strategy to shut down some of the smaller stores in favor of larger ones?

Yes, that has been part of what we've done in China over the last year. We've really just tried to shut down the stores that are less active and some of the major stores. You know, in Shanghai, for example, we opened with 30 stores. And in any circumstance, we likely don't need that many stores in Shanghai.

Okay. And with what you think are going to be the requirements for the licenses, do you think that's going to change your outlook at all in terms of shutting down the smaller, less productive stores in favor of the larger ones?

Yes, the final state of the regs could impact that, obviously.

So you might slow down moving to a more efficient model?

Yes.

For the sake of hanging onto a license?

Right.

Okay. And the last one is for Ritch. If you wouldn't mind, would you just repeat the cash flow figures again? I missed them.

No problem. Just pull it up real quick here. Okay, for the quarter, we spent $1.5 million on interest expense. We paid $5.6 million in dividends; $8 million in capital improvement; cash flow of $30.9 million for the quarter; cash on hand of $124 million; and a stock repurchase of $71 million during the quarter.

What was the depreciation amortization expense?

$6.8 million.

Okay. Thank you very much.

Your next question comes from Cindy Lottin (ph).

I was just wondering if you could go through how long it takes to open up a store and the CapEx that goes into each one in China.

Sure. I'll just respond quickly. The CapEx costs us somewhere between 3 and $500,000, depending on the size of the store. We have to go through a process to get a couple of different licenses on each store that we open up. That process has become a little bit easier, particularly, in Shanghai, where they qualify your business license based on your success and based on the confidence of the government in your business and so forth. We're currently rated at an A rating, which allows the facility of new licenses to move a little quicker. So typically, it would take us probably between about two and three months to get a license and have a store built out ready to open. We anticipate somewhere around 5 to 6 stores that we'll open in the next couple of months, and then several, as Truman mentioned, scheduled for Q1 of next year.

And how long does it take for them to like mature to comp well? Or do you not have enough time in each store to sort of judge that?

It really differs, depending on the city and depending on the location of where we're opening. If it's a city that's very close to other areas where we have sales reps, certainly is easier. And if we're moving out, obviously, into the western part of China, it gets more complicated. It's going to take a little bit longer to get traction in those areas.

Let me just point out, too, again, that the number of stores that we have is not really going to be a governor of our ability to grow revenue. As I pointed out, you know, the largest drug seller in the marker, the Amway organization, only has 130 or so stores, and they're a $2 billion company. Avon, on the other hand, is one-tenth that size with 5,000 or more stores. So for us, the store build out is going to be more of a regulatory issue than a governor to revenue growth.

Okay. Thanks.

Next question comes from Chris Ferrara.

Good morning. Can you guys talk about the competitive set in Japan? I mean aside from the weather and the delay of the scanner, I was just wondering if you could talk about who you're competing with there, who you view as your primary competitors on the direct selling, and on the retail channel side.

Yes, okay. Well, on the direct selling side, we are one of the leading direct selling companies in Japan today. But there are a couple who are bigger than we are. Amway is the largest direct selling company in Japan currently. At a revenue level, we think, you know, of about 800 million or so, 800 to 900 million. And clearly, they are a dominant influence in Japan, as they are in China now. So they would obviously be one of our major competitors on the direct selling front.

Typically, however, the companies that seem to have more of an impact than the larger ones are the smaller ones, who do gather -- garner -- some attention in the early days of their launch in Japan. And there's just typically some enthusiasm associated with the launch of a U.S. company in the Japanese market.

So far, given our success and stability in that market, you can see that none of those competitive influences have had a tremendous impact on our revenue level or our ability to grow. But from time to time, there are competitors who come into the market, get some attention, and cause a little disruption in the early days.

On the product front, we, in the nutrition category, we're really a major player in Japan. And there aren't really that many dominant retail brands in the Japanese market that would be highly, highly competitive with us.

On the personal care front, it's obviously a much more crowded marketplace. And all international players tend to play in the Japanese market. But the dominant factor there, obviously, is Shusetto (ph), with all that they have to bring to the table in Japan.

I would point out that Avon in Japan is probably about half our size or less. So they haven't really been able to garner that much strength in the Japanese market.

Can you also talk a little bit about sort of compare and contrast Japan versus the U.S. and what the saturation differences are in direct selling, and why you might expect the scanner to have a similar impact for the Japanese results as it has in the U.S.?

And also, for that matter, if you have it -- I mean I don't know if you've quantified, relative to U.S. growth, how much of the incremental growth in U.S. has come from, I guess light (ph) (indiscernible) on ADP specifically. And I know that's a long question, but I'll repeat it if you need me to.

Yes, well, why do we expect the scanner to have a positive impact in Japan? You know, some of it, Doug, just has to do with the fact -- or Chris, excuse me -- has to do with the fact that we see a lot of distributor enthusiasm for the introduction of the scanner. You know, if you had attended our convention here in the U.S. six months ago or attended our -- will attend our Japanese convention in November -- you'll see that our leaders are just very enthusiastic about the potential impact of the scanner, and seeing what it's done here in the U.S.

We've had them for just a couple of months now in our walk-in centers in Japan, and sustained very healthy business dynamics as a result of scanners being there, at least on ADP subscriber base.

So we're also seeing a very positive impact from the scanner in Taiwan, you know, which is now generating healthy growth again in Hong Kong. The scanner has been a factor in Singapore and Malaysia. The scanner has been a factor, and we're just slow getting it into Japan again for regulatory reasons.

Just another comment, Chris, possibly on that is that in Japan we're about 2 percent of the direct selling industry, whereas in the U.S., we're about half a percent. So we've penetrated a little bit further. You compare that to markets like Taiwan, Hong Kong, where we're 6 or 7 percent; Hong Kong, we're about 14 percent. Certainly, we feel like there's a lot of room to run and the saturation is not an issue that we're dealing with today. We have a large customer base already in Japan, and so we'll look to add to that.

In the U.S., of the 25 percent overall growth that we've seen, a majority of fact, obviously, has come from our Pharmanex business. And the driver is going to be -- the scanner obviously creates the enthusiasm. And about half of that growth, I would estimate, has come from LifePak and subscription orders related to Pharmanex products, including LifePak. So certainly, it's been a very strong driver. And we would anticipate -- I don't think any of us anticipate 40 percent Pharmanex growth like we've seen in the U.S. But we would anticipate the scanner to generate enthusiasm and probably grow primarily our Pharmanex business in Japan.

And just one other -- you talked about a lack of driver lately in Japan. And I guess part of that is related to the delay in the scanner. But is it any -- is it more than that? Did the other things that were planned on kind drivers not necessarily work out? I guess why has there been such a lag by your own sort of definition between growth drivers in that market? And is it all just the scanner delay?

Well, we have had product launches, obviously, in the last year. And the reality is that those product launches just haven't been enough to drive a lot of leadership enthusiasm to go out and grow the business. And we've been talking about the scanner for a couple of years now. And growing with the scanner initiative has really been distributor leader's expectation, and they've just been waiting for it.

Are there other factors that contribute to some stagnation there? Yes. I mean, I think mother nature has contributed to that a bit. I think that there are some competitive issues that we're facing there. New market entrants who are attracting some attention a bit. But typically, those storms blow over, and we expect that happen again here. Fortunately, we have a mechanism as potent as the scanner that we think will retain a capture a lot of new distributor attention.

Right. And can you just highlight who those new market entrants have been lately that are sort of being testy?

I don't know if I want to give them credit on this call, though. But yes, I mean, honestly, I prefer not to, Chris.

Okay. Thanks for your help.

I'll talk you about it on your own, though. How about that?

Yes, that's great.

You have a follow-up question from Kathleen Reed.

Thanks. Can you just let us know -- I think it was a real positive to get the scanner into Japan, and I think you had to get it qualified -- you got it qualified there as a non-medical device. What's the status going on in the U.S. with what it's being qualified as? Or if you have an update for that.

Yes, it's really quite amazing to us, frankly, Kathy that we still haven't heard back from the FDA. And what our advisors are telling us now, given the fact that it's been what, over 18 months since we filed our original application, they believe that the FDA is not going to respond to our application, and that they are just going to leave us somewhat in limbo, which is a good thing, actually because we can continue to run our program. And sometimes no answer is better than an answer. They just are, we think, in a little bit of a regulatory quandary, given their state of mind generally towards the dietary supplement industry. So we're okay with that. But we still have not had any response from them.

But if they were to come back and say it does need to be qualified as a medical device, do you have the proper registrations, etc., to keep it?

We are all ready to go!

Oh, okay. Great!

On a totally separate issue, your new market, Israel, which I know you said was going to be really small, but you hope to get some good leaders in that environment -- is that market going to be opened like Latin America, with the kind of a lower-priced product point, more incentives for selling as opposed to recruiting? Or is that your more traditional model?

Israel is going to be our more traditional model. And we're still considering what to do in Eastern Europe. But I think in Eastern Europe, frankly, we're leaning towards a model that is more consistent with what we're doing in Latin American.

Okay. And the Israel results will be included in what segment? What region?

Probably in the other markets right now. We don't anticipate to see a large revenue. We open up on November 10, and would estimate somewhere around $2 million a year out of that market.

Great. Okay. Thanks very much

Your next question comes from Doug Lane.

Yes, a couple quick follow-ups on the cash flow here. Ritch, do you have an estimate of what you think capital -- you know, with the scanner and with building out the stores in China, what kind of capital spending we should see in 2005?

We kind of guided 40 to $45 million today.

Okay. And is that assuming you're going to -- I guess it's not really assuming you're going to 340 stores in China.

Well, obviously, that could change our number a little bit. We'll continue to kind of watch that and keep you updated as we go forward. Based on our plans today, we kind of look at the 40 to $45 million range.

Now, how do you measure the economics of your stores in China? Do you look at it that way? Do you look at payback and sales per selling square feet and all that?

Sales per square foot, we really don't look at. That's just not a metric that seems to make any sense in our business. Obviously, we expect every store to be profitable. And if it's not, then we look to close it, put it in another location, and use that license that we've got to really generate some positive results. So we really look at it more on a store-by-store basis than a square foot or other retail metrics that are typically analyzed.

Okay. And on the scanners, with Japan, you started to roll out, you say 100 to 200 a month beginning in February. Is that -- and you're also going to be rolling out the scanner in China beginning in January. So what's the capacity look like at your Chinese facility? Is that going to be running pretty much full capacity to handle those two pipelines for the next couple of years? Or how is that going to shape the?

Yes, we really are getting close to the point, Doug, where our manufacturing constraints aren't going to really inhibit what we want to do with scanner rollout. In China, we're only going to put scanners in our stores; we're not going to put them in the hands, or at least very many of them, in the hands of individual distributor leaders. So the number of scanners that will be deployed there in 2005 will be a relatively small number.

In Japan, we are going to go with an individual scanner lease program. So our demand there will be a little bit higher. But, you know, frankly, we're finding that some scanner scarcity is not a bad thing in our business, and within our sales force, because people work hard to get one, and that's positive. So, some scanner scarcity is actually turning out to be a good business metric for us -- good business dynamic.

Okay. And just sort of asking the same question another way, why wouldn't you expect Pharmanex business to be up 40 percent in Japan, given the fact that half of it's already LifePak, and LifePak is the key product that the scanner sells?

Well, I think it's just a combination of the fact that our Japan business is much more sizable than our U.S. business was when we launched the scanner here, I mean primarily.

So just, you've already achieved a much higher penetration there?

Yes, it's just a bigger market. It's a bigger base to move. And, you know, we're also, you know, basically fighting a little bit of a declining trend here. So we need to turn that trend to initiate growth. But again, Doug, as I mentioned in my remarks, I'm going to be very disappointed if we don't do better than what we're essentially modeling for 2005.

And just finally, wasn't the U.S. in a bit of a declining trend before the scanner?

It was a little bit. I don't think it was quite as pronounced as 8 percent (multiple speakers) to what we just saw in Japan in Q3.

Okay. Fair enough. Thank you.

Thank you, everyone, for joining us today. And I just would wrap up by recognizing that we have a lot going on in our business. And given the importance of developments in China and Japan, in particular, again, we're going to give a mid-quarter update on November 16th and provide an outlook of how the quarter looks, as well as what we see happening in our key markets. So if any of you are interested in participating, please contact Scott Pond here, our Director of Investor Relations. Thanks again for joining us.

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