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Executives

Riley Timer - VP of Finance

Jeff Yates - CFO

Fred Cooper - President and COO

Analysts

Tim Ramey - D.A. Davidson

Mimi Noel - Sidoti & Company

Doug Lane - Jefferies & Company

Rommel Dionisio - Wedbush

Scott Van Winkle - Canaccord

USANA Health Sciences, Inc. (USNA) Q3 2010 Earnings Call October 27, 2010 11:00 AM ET

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the USANA Health Sciences third quarter earnings conference call. At this time, all participants are in a listen-only mode. And following the presentation instructions will be given for the question-and-answer session. (Operator Instructions).

As a reminder this conference is being recorded October 27th, 2010. I would now like to turn the conference over to Riley Timer. Please go ahead.

Riley Timer

Thank you Craig, good morning everyone, we appreciate your joining us this morning to review our third quarter results. Today's conference call is being broadcast live via webcast and can be accessed directly from our website, www.usanahealthsciences.com. Shortly following the call a replay will be available on our website.

Now, as a reminder during the course of this conference call management will make forward-looking statements regarding future events or the future financial performance of our company. Those statements involve risks and uncertainties that could cause actual results to differ perhaps materially from the results projected in such forward-looking statements. We caution you that these statements should be considered in conjunction with the disclosures including specific risk factors and financial data contained in our most recent filings with the SEC.

Now, I'm joined this morning by Dr. Fred Cooper, our President and Chief Operating Officer, and Jeff Yates our Chief Financial Officer. We'll hear first from Jeff, who will discuss the details of the financial results this quarter. We'll then hear from Fred, who will discuss our business activities as well as our plans for the remainder of 2011 and a bit of a snippet in 2011.

I'll now turn the call over to Jeff.

Jeff Yates

Thank you, Riley. Good morning everyone and welcome to the conference call. We appreciate your joining us this morning. It's a pleasure for us to talk about our fourth quarter, fourth consecutive quarter of record results for USANA. I'm pleased to report that net sales for the third quarter were $135 million, which represents a 21.9% increase when compared with the $110.7 million, we reported for the third quarter of 2009.

Our growth in sales of this quarter was primarily due to an overall increase in the number of active associates, which for the third consecutive quarter resulted in a new high of 234,000. This represents an increase of 17.6% when compared to the third quarter of 2009 and is largely the result of our continued growth in Hong Kong. Also our acquisition of BabyCare in China added 10,000 associates.

Favorable changes in FX rates this quarter added $3.5 million to our top line when comparing our results to the same period last year. Looking at our results regionally, sales in North America were about the same as last year, coming in at $60 million for the third quarter.

Notably, sales in the U.S. increased modestly year-over-year and on a consecutive quarter basis. We were, however, disappointed to see associate counts decline in the third quarter. We believe that these decreases are due primarily to the following factors. An increasing number of our associate leaders based in North America building their businesses in Asia, a continued tough economic environment, particularly for the consumer segment, and typical summertime seasonality in North America when the associates take time off to vacation with their families.

Looking now at results in our Asia-Pacific region, net sales for the quarter increased by $24.6 million, or 48.7% compared to the third quarter of 2009. Net sales for this region totaled $75 million for the quarter, which represents 56% of our total sales.

Sales growth in this region was primarily due to the 47.4% increase in the number of active associates. The majority of this growth is due to our continued success in Hong Kong, where sales increased 134% over last year and were up 20% compared with Q2.

Notably active associates in Hong Kong increased 40,000, or 143%, over the last year. In addition to Hong Kong, we also experienced double-digit growth in the Philippines, Japan and South Korea, while small relative to our total we continue to gain market share in these countries and are building a strong base of leaders to influence further growth in sales.

BabyCare added $3.4 million in sales for the quarter, and both Fred and I will discuss this further in our remarks later. We are pleased this quarter to announce again, to once again see strong improvements to our operating margins. The great thing about our business is the earnings leverage we gain at the top line growth.

In the third quarter, our operating margins improved nearly 56% over last year, and nearly 9% compared with Q2. I'll now take a few minutes to walk you through each of the major expense items on our P&L.

First, gross profit margin for the third quarter increased as a percentage of net sales to 81.4% compared with 79.6% for the third quarter of 2009. This 180 basis point increase was primarily due to lower overall costs on our raw materials, benefits from changes in currency exchange rates, reduced freight costs, production and shipping efficiency due to capital investments, and leverage gained on higher sales.

On a consecutive quarter basis, gross margins decline 60 basis points, which can be primarily attributed to our international convention. Now at this event, we offer product specials, sales tools and USANA logo wear at a discount. We also see a decrease in our production efficiencies due to this event. All of these factors had a reducing effect on our gross margin during the third quarter. It is important to note that we do expect to see additional improvements in gross margin in the fourth quarter.

Associate incentives expense for the quarter was down a full point to 44.9% of sales compared to the third quarter of the prior year. This decrease was primarily due to the strategic changes we made to incentive programs just several months ago. Remember that these changes were implemented to place greater emphasis on associate productivity and to better align payments under our associate compensation plan with actual sales growth.

Notably, this expense has trended downward over the last several quarters, as anticipated. We expect that associate incentives will continue to decline relative to sales in the fourth quarter. That said, it is very important to us that we remain among the highest paid compensation plans in the industry.

SG&A this quarter decreased slightly to 22.1% of sales compared to 22.2% last year, and decreased 20 basis points compared with Q2. As a result of higher sales and improved operating margins, net earnings for the quarter were a record $12.8 million, or $0.79 per share compared with $7.9 million or $0.51 per share in the third quarter of the prior year. I'm very pleased with the leverage we have gained on our higher than forecasted sales.

Now, I'd like to discuss changes in our balance sheet. Our cash balance at the end of the third quarter was $22.9 million compared to $13.7 million at the end of 2009. Notably, our inventories increased 6.8 million in absolute terms compared to this time last year. This is due to a buildup of inventory to accommodate our higher sales, inventories to accommodate our Asia-Pacific and international conventions, and the inventory we acquired and is held with BabyCare.

The significant increase and other assets is due to a $41 million in intangible assets acquired with BabyCare. Also in connection with the acquisition we drew on our line of credit, which had a balance of $19 million at the end of the quarter. It's important to note that our borrowing rate is very low, at 1.1%, and in addition, in the third quarter we generated nearly $21 million in EBITDA, which allows us to pay down this acquisition debt in a matter of months.

This positions us obviously with a very strong balance sheet in anticipation of future growth and other opportunities. During the quarter we repurchased approximately 200,000 shares for an investment of $8.6 million.

Now, I would like to spend a few minutes to discuss the financial impact of BabyCare on our operating results in the third quarter. First, acquisition related costs. You will recall that we acquired BabyCare in mid August, and as a result, incurred some acquisition costs that are included in our SG&A line in Q3. This expense totaled $1.2 million, which equates to a $0.05 reduction in EPS in Q3. Of course, these are non-recurring expenses. Acquisition costs have totaled $1.9 million to date.

Also, in conjunction with the acquisition, we issued certain equity awards to BabyCare management, as an incentive to grow China and quickly moved to profitability. This additional expense reduced SG&A by $0.02 in the third quarter. Please note that this added equity expense should be modeled to add about $900,000 to SG&A, which is approximately $0.04 per share each quarter in 2011.

Now, let me give you some visibility into BabyCare's operating expenses, which are similar to USANA'S in some respects, and different in others. Like USANA, BabyCare has very strong gross margins, but they have lower associate incentives. They do, however, have higher relative SG&A, primarily due to their infrastructure and current level of sales.

Going forward, we expect BabyCare sales to continue to grow and as a result of this growth they will experience incremental leverage against their SG&A line. Excluding all transactional related costs, the resulting impact of BabyCare's operations in Q3 was a benefit to earnings of $0.01 per share.

Just to make it clear, let me quickly recap the impact of BabyCare on Q3. It was a $0.05 dilution due to non-recurring transaction costs, a $0.02 dilution from equity compensation, $0.01 dilution from the issued shares, and finally a $0.01 benefit from BabyCare being profitable in the quarter. So, the net impact of BabyCare on our Q3 results was a $0.07 dilution.

That said, I'm pleased with the early indicators we're seeing with BabyCare's sales and operations. Accordingly, we currently anticipate that BabyCare will be accretive to earnings in the back half of 2011. This estimate includes all expenses, including the additional equity compensation, increased amortization and higher shares to pay for the acquisition.

Now, with respect to our guidance for 2010. In light of our strong sales growth and improved operating margins, coupled with the acquisition of BabyCare, we are raising our guidance and now project net sales to be between $512 million and $515 million. And estimate that earnings per share will be between $2.90 and $2.93.

With that I'll now turn the call over to Fred.

Fred Cooper

Thanks Jeff. Well everybody, I have to say and deviate a little bit from script before we start. It always makes my peers nervous when I do that, but I have had the opportunity to be able to report quarter-after-quarter record sales. In fact, now for USANA it's been eight years, and given our new guidance it will be nine consecutive years of growth.

I happen to be the individual, who gets the opportunity to report the good news, but I would be remiss if I didn't take a minute to thank all of the employees at USANA for their tireless effort, for helping us perform so well.

In addition, it's also the Associates. Those individuals out in the field have had to put up with changes to our compensation plan, have put up with changes to the international seamless situation, the uncertainties of China, and the impact that it would have to them, and as I've had the opportunity to go out into the field, I have felt nothing but enthusiasm, encouragement and appreciation for USANA, and it is manifested in their efforts. So, on behalf of all of USANA, we want to thank them. I just happen to get to be the benefactor of delivering the good news.

So, obviously in this quarter, we are very pleased with our sales in our Asia-Pacific, and also very excited about the acquisition of BabyCare in China. However, of course, we are a little bit disappointed that our results in North America came in a bit lower than we hoped. So, we ought to begin by discussing North America.

In North America, I believe the tough economy continues to play a key factor in software than anticipated sales. Remember, we offer a premium quality, premium priced product, and for some people at this time, our prices are a significant portion of their discretionary income. This factor has played a role in the loss of some of our associates, particularly those who are merely consumers of our product.

To combat these losses, we've implemented and we're working on a number of different solutions to attract both customers and potential business owners to USANA. Here is a few of those projects. First, we've wants to eApprentice and it's a training system mainly for new associates designed to make training and network marketing both simple to use and easy to understand.

Unfortunately our adoption has been slower than we'd like, so we're going to be doing many more promotions to increase its use. We're pushing it strongly because the metrics we have been looking at suggest that the success of those business building associates who use the program is better than those who do not. So, as more associates continue to utilize the training program, USANA will introduce this program worldwide.

Second, at convention, we introduced the new interactive presentation tool. We call this our health and freedom solution. The tool was developed by our international multimedia department, who worked very closely with our top associates in North America, and this presentation was created and designed to help our associates explain and share the USANA opportunity, but important here is that it requires little public speaking by any new associate, while educating them about USANA, its products and our compensation plan.

Third, we are making a push to enhance our global brand. This includes providing products to amateurs, professional athletes, as well as advertising and partnering with credible organizations such as the Sony Ericsson, WTA Tour. These endorsements provide talking points, confidents, credibly and brand awareness to our USANA prospects.

Fourth, we are looking to enhance our associate rewards and recognition program. We have statistically analyzed what measurable behavior and performance metrics best indicate success in business growth for our associates. And as a result, we announced a few new changes in late August in our international convention. We believe these changes will more closely match the characteristics that are found to be correlated with business growth.

We will continue to look for creative ways to incent and recognize our top performing associates. So now, as change gears and spend a moment talking about another factor that make a kind of difficult for you to understand USANA's growth when we look at it on a market-by-market basis. The culture in USANA Incorporates the two founding principles that made us successful over the past 18 years, which are a proven science based product and a rewarding compensation plan for interested home based business owners.

In regards to the home based business principle, one of the dynamics that makes USANA unique in the industry is what we call our global seamless binary compensation plan. By global seamless, we mean that we pay our associates for the sales volumes they generate in all markets in which USANA has business operations. It's a real competitive advantage that our USANA associates help and take advantage of financially.

Now, given the fact that our compensation plan is global seamless, it's not long before someone in their organization builds a business that crosses international borders. And as a result their earning commissions on sales generated in a market other than their home market.

This is the natural result of our global seamless compensation plan. So, if you look at the surface of our regional sales results, you see that North America is down as well as Southeast Asia Pacific. A reason for this, in addition to the tough economic environment, is that we offer a global seamless compensation plan with unlimited borders. What we are seeing in many of our key associate leaders is that they are based in these two regions rather than building and generating sales in their home market, they are spending time working and growing in our East Asia region. Hence, this is where the majority of our sales and our associate growth is taking place.

For management it is critical that we provide a continuous opportunity for our leaders to expand and grow their business internationally. For USANA, BabyCare will provide the opportunity in China. The second largest direct selling market in the world.

For now, BabyCare will continue to operate independent from USANA. In particular BabyCare offers and will continue to offer a compensation plan in China that is different from the compensation plan we offer in all of our other markets. These differences are the result of the legal and regulatory landscape in China. Although, BabyCare's compensation plan is different from other markets, we believe that it is among the most rewarding in China. We also believe that it will be enticing to current and prospective associates, acceptable to the government and profitable to our organization.

Although, BabyCare will operate independently from USANA, we're working hard to get USANA products registered and approved to sell in China. These approvals, however, take time. Our BabyCare staff fortunately is among the most experienced and qualified in China, including with regard to government and regulatory matters.

With our in-house expertise, we believe we will be able to navigate more clearly through this process and offer USANA labeled products through BabyCare in the next 6 to 12 months.

Although, we are excited to offer USANA products through BabyCare, we will not cut corners or otherwise sacrifice quality for expediency. One of the reasons we are initially impressed to BabyCare was due to a shared philosophy for selling only high-quality products and using pristine manufacturing practices. 15 of BabyCare's products are registered with the SFDA, which is China's highest level of product regulatory approval. And BabyCare was the first direct selling company to be GMP certified in China.

For us it was very important to find a partner, who shares our core product philosophies of quality, safety and efficacy. As a result of the time requirements to gain product registration, enrollment and BabyCare are not expected to dramatically increase beyond the current growth rate until we have USANA products available for associates to recommend in China. Hence, we anticipate a significant increase in the growth of BabyCare midway through 2011.

With that I'll now ask the operator to facilitate questions and answers.

Question-and-Answer Session

Operator

Operator Instructions]

And our first question is coming from the line of Tim Ramey with D.A. Davidson. Please go ahead.

Tim Ramey - D.A. Davidson

Good morning guys, congratulations on a wonderful quarter. Fred, I'm a little confused, I'm sorry, but let's say I'm a U.S. associate and I decide to work in Hong Kong. So, I still show up as a U.S. associate, I don't affect the number of associates there, but I maybe increase the number of sales in Hong Kong, which is not the pattern that we are seeing. I mean, as I think about your comments, I guess it's a lot of Hong Kong associates were working in the U.S., we can see down associate numbers, but stable sales numbers. How am I misunderstanding this?

Fred Cooper

Alright. If I am an associate who lives in the United States, and I go and build a broad the credit for the enrollment and the sale that is generated from that enrollment happens in the country where I am doing business, not necessarily and in this case not my home market. So, while you see an exorbitant growth in the Asian market, it is not to say that our American leaders are not working, it is simply saying another market is getting credit for the efforts in terms enrollment and sales.

Tim Ramey - D.A. Davidson

So, I understand what you're saying. They are down line shows up in Hong Kong. But they still show up in the U.S., is that correct?

Fred Cooper

Yes, if I understand the question correctly that is true. But when we report our numbers in sales and enrollments, my down line doesn't, if I'm an American I don't get credit for a Hong Kong enrollment in terms of counting that as a U.S. sale.

Tim Ramey - D.A. Davidson

I see what you're saying. Okay. Fair enough. I guess the question that I have and I had it when you did the acquisition, is the hesitancy to make the BabyCare integration move quicker, is that all regulatory, or is there other reasons why you intend to keep the organization somewhat separate for a period of time?

Fred Cooper

Regulatory is the fundamental principle behind that. They're our business operations that have already begun underway. So, I don't mean to construe by the statement that there is no integration or oversight or management in that arena simply that from an associate perspective, they do not share the same products currently, which the associates would like to see. But from an operations, from inventory management, from a compliance issue, all of those reporting structures will begin to change over the next 6 to 8 months.

But it's also a learning curve for us in that arena, we want to make sure we understand that market, we want to make sure we understand how they operate to take the best practices of both organizations. We have found that many times American companies in particular go over and try to impose the American way in the Chinese direct selling community and they are not effective.

Tim Ramey - D.A. Davidson

Fred, if you'll allow me one more. So the sales performance in the U.S., as an example, or North America, wasn't bad. It was flattish, but associates down close to 10%. Now, I have been explaining that something along the lines of your platinum pacesetter program that you're getting more productivity out of associates. I don't know that's really true. What's the right answer here?

Fred Cooper

Actually that is an accurate statement, but it's a piece of it. The other items that are attributing to that are the fact that we've made changes to our compensation plan on what it takes to activate and generate sales from a business center, and that qualifying volume has moved from 15400 to 200, 400. So, we get better productivity out of each new associate that enrolls as well. And we get greater sales from each new associate that enrolls. Coupled that with price changes and we get a little more from each associate.

Tim Ramey - D.A. Davidson

Great, thanks so much guys.

Operator

And our next question is come from the line of Mimi Noel with Sidoti & Company. Please go ahead.

Mimi Noel - Sidoti & Company

Thank you. As a follow on to Jim's question, the decline in associates in North America, does, just be perfectly clear, that does or does not have anything to do with domestically based associates conducting more business overseas?

Jeff Yates

It does. They are spending more time, an inordinate amount of time developing, understanding, starting their organizations in that growing market. So, it has been a distraction to them.

Mimi Noel - Sidoti & Company

But not, it's not the case that instead of getting recognized in North America, they are getting recognized as associates overseas. It's more a function of their not as active domestically or internationally as they would otherwise be.

Jeff Yates

Yes. That would be true as well. We have a number of associates, particularly in the U.S., who take time off during the summer. So, the third quarter is soft in that regard--

Mimi Noel - Sidoti & Company

So, you have that dynamic year in year out, so it really shouldn't affect decline year-over-year, right?

Jeff Yates

Right, that coupled with--

Fred Cooper

I want to make sure we are clear on something. I'm a U.S. associate and I'm building in Hong Kong. Just because I'm building in Hong Kong, I don't show in my financial reports any of my enrollments in the United States. They all show up in Hong Kong. That doesn't mean I'm not working, it just means Hong Kong is getting the credit for it.

Mimi Noel - Sidoti & Company

I understand, okay, that's helpful. Thanks for that follow, Fred.

Fred Cooper

The other point of that I would make is so if some of my American down line are leaving for whatever particular reason they are leaving for in his economic time, it shows that we are kind of losing some and I'm replacing them over with a business in Hong Kong.

Mimi Noel - Sidoti & Company

That helps, thank you. And then just one added question regarding guidance for Jeff. He typically, as he touched on the seasonality, you typically have the December quarter that stronger than the September quarter. But the step up as implied by annual guidance in terms of EPS from September to December, it is not that meaningful. Are there any expenses in play that are unusually inflated in December relative to September?

Jeff Yates

No, we had a particularly strong third quarter. And so, I wanted to make sure that we were being careful about our projections in the fourth quarter, we are obviously still learning from the acquisition, and plus we have more equity comp as a result of not only the acquisition of the issued shares and that isn't increased cost for us in the fourth quarter.

Mimi Noel - Sidoti & Company

In the equity comp, jumps from $0.02 a share to about $0.04?

Jeff Yates

That's correct.

Mimi Noel - Sidoti & Company

Okay. That's helpful. That's all I have for now, nice quarter. Thank you.

Operator

Our next question is come from the line of Doug Lane with Jefferies & Company. Please go ahead.

Doug Lane - Jefferies & Company

Good morning everybody. Can you talk a little bit more about the strength that you are seeing in Hong Kong, and what's driving that? And the sustainability of those kind of growth rates?

Fred Cooper

Our field is excited that USANA is making a concerted effort towards the development of Asia. That's the bottom line. When there is momentum and people are fired up, they will build and momentum is a very precarious thing. Where it shows up you never know. But when it does, are people flock to it and they gravitate towards it to build. China is an exciting opportunity because many of our existing associates or Asia. Our Asian and those Asians have connections in China, and they want to bring the products and opportunities to individuals in China.

And USANA has now given them a venue under which they can do that. That's why they are growing and that's why they are excited. And that's also why we are very excited about China because we are not just going in there naively with no distributor base, USANA does very well when it goes into a new country, when we have an existing force that is taking us to the country. And in this case, it is a dominating force for USANA

Doug Lane - Jefferies & Company

It sounds like just the announcement of the acquisition and the buzz surrounding China is manifesting itself initially in the growth in Hong Kong. But that's sort of an indicator of potential pent-up demand for USANA in mainland China. Is that a good way to read at?

Jeff Yates

Absolutely perfect. And I would emphasize very pent-up.

Doug Lane - Jefferies & Company

Alright, thank you.

Operator

Our next question is come from the line of Rommel Dionisio with Wedbush. Please go ahead.

Rommel Dionisio - Wedbush

Good morning everyone. For BabyCare I think you guys last updated around 22 service centers and provinces, and two questions. First, I note that you're applying for some licenses for additional regions. Could you maybe update us on that process? And second, given the growth you expect in China are you going to be ramping up CapEx to build up more service centers there next year?

Jeff Yates

Yes. Thanks for your question Rommel, appreciate you joining us on the call. The additional applications for provincial licenses is a formal process. The application can be made every six months for five additional provinces at a time. The provincial application for the next five is already underway, of course, we have the first licensed in Beijing, which is considered a provincial license, it's the most important of the licenses in the nation. And that application has begun in connection with the applications for our product introductions as well.

Now, with respect to the CapEx question, the service centers that are opened as we increase our footprint throughout the country are mainly driven by associates. The cost of those is primarily borne by those associate leaders. The branches that might be invested in by BabyCare operation are more significant. They're a bit like a retail store, so to speak in the various major metropolitan cities. We will likely open a few of those as we expand into larger cities, but the expense to do so is fairly minimal.

So, while we will have a bit of CapEx, it's not much to speak of. Mostly the service centers are fairly small, and we will anticipate that they are mostly driven by an associate. In addition to that, keep in mind that BabyCare facility, their production facility is operating at about 10% of capacity. So, our growth with respect to production and warehousing facilities is quickly scalable and requires not much investment. In addition to that, we have owned for the last five years a production facility in Shenzhen, which we have married with their production, its focus is on skincare products. They are operating at very minimal capacity right now. They have significant excess capacity available to them. So, we can grow and scale in a significant way in China. We're prepared for that as we speak.

Rommel Dionisio - Wedbush

Great, thanks very much and congrats on the quarter.

Operator

(Operator Instructions). Our next question does come from the line of Scott Van Winkle with Canaccord. Please go ahead.

Scott Van Winkle - Canaccord

Good morning guys. Jumping back on to the U.S. market, first, the comments about higher productivity because of Platinum PaceSetter and the compensation plan changed or for volumes, how long does that continue to cycle as well as pricing. And my question is if we continue to see the natural attrition without recruiting, and you run through those volume and when do we come to the point where you'll see revenues start to rely themselves with the growth or decline of distributor turns?

Fred Cooper

That's a good question. It's a good question because I don't have a great answer for you. Let me break it up in to pieces. First, Platinum PaceSetter program changed in August. They have a re-qualification period on an annual basis. So that impact will not be stable i.e. we will get a benefit from it at least until the fall of next year. That's one. Number two, the compensation plan changes for enrollment, the full impact on the price per consumer, or the wallet share that we received, won't be fully realized for another six or seven months. So from that aspect it won't.

And then finally, this is terrible too, but they don't, while they are correlated, they don't always precisely move together. There is a strong relationship, but in my 12 years, I've seen times when enrollment has exceeded and didn't quite, they were faster than sales, which would suggest the little bit heavier turnover, and I have seen it in the reverse. So, lately the last couple of years the trend has been slightly the opposite direction. But certainly, enrollments mirror and are an important aspect to the growing of our business, both on a customer account and associate count.

Scott Van Winkle - Canaccord

And following up on that, your comments earlier about building the business into market hence recruiting is occurring, is it fair to say that attrition rates have stayed the same, they have gone up or they have gone down, and the recruiting is something completely separate?

Fred Cooper

Yes. My answer to that one is in the economy, we have seen, it's flat to slightly down as a result of the economic conditions for some base associates that are really acting as preferred customers or consumers of our product. That is being offset by our matching bonus, which is generating improvements in enrollment counts. So, if we're going to make a prediction, I believe the enrollment count will increase to more closely match the increased percentage in sales. But they are not 100% tied. That's a fact.

Scott Van Winkle - Canaccord

Okay. And Jeff, your comments about higher SG&A rates for BabyCare and the lower incentive rate, can you give us a magnitude, or if you did I miss that, I apologize.

Jeff Yates

I didn't give you much of the magnitude, and there's two reasons for that. One, we are just beginning to influence that structure as we speak and that transition period, it will take us several months, and we will bring what you sonic and bring to the operating model in a significant way. The other point that I would make on that is, keep in mind that they are transitioning from a model that is different today than it was just even prior to the acquisition. And their infrastructure was set in such a way to accommodate more over retail distribution with employee based distribution and sales force, obviously with the license converting to a commission based program, without benefits, employee type benefits, and they are able to now recruit away from fixed service centers, i.e. the direct selling model.

And so, with that we anticipate two things. One, the decreased SG&A cost that will shift a bit to the associate incentive line, but their payout overall is about where ours is but a little less. And we anticipate leverage from sales. So, relative to sales we anticipate their SG&A line to come down, and the associate incentive line will stay approximately with where ours is by design.

Scott Van Winkle - Canaccord

Okay. Last question, backup to Asia. You've talked about you've always had the most success when you are going to new market explode into by your distributors, you're having great momentum in that market. Is there a new market or to where you're getting pulled because you're getting pretty high revenue per capita and distributor counts per capita in markets like Hong Kong. Is there an anchoring from the distributors for the next market, and is that something we might see accelerated just because of the success in Asia?

Fred Cooper

My answer to that would be every associate pulls us to every market where they have a family member that resides. There are certain markets that are high on our list, but right now we are focusing on China. It is the second largest direct selling market, and it is a big one for us to tackle. We anticipate great growth there, so for the next long bit, it will be China.

Scott Van Winkle - Canaccord

Great, thank you.

Operator

At this time, there are no further questions. I'd like to turn the call back over to Riley Timer for any closing comments.

Riley Timer

Alright, thank you. We appreciate your questions today and for your participation. If you have any remaining questions, feel free to call any of us, including Patrick Richards in Investor Relations at 801-954-7961. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude the USANA Health Sciences third quarter earnings conference call. If you'd like to listen to a replay of this conference you may do so by dialing 303-590-3030, or 1-800-406-7325. You'll need to enter the access code of 437-8050. Those telephone numbers once again are 303-590-3030, or 1-800-406-7325 with access code of 437-8050. Again, we do thank you for your participation on today's call, you may now disconnect your lines at this time.

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Source: USANA Management Discusses Q3 2010 Results – Earnings Call Transcript
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