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Executives

Rachel Levine - The Global Consulting Group

Simin Zhang - Chairman of the Board

Jiannong Qian - Chief Executive Officer

Andrew W. Chen - Chief Financial Officer, Vice President

Lucia Qian - Director, Marketing and Investor Relations

Analysts

Caroline Lee - Goldman Sachs

Ben Lee - Merrill Lynch

Hal Hong - Susquehanna

Barbara Miller - Federated Investors

Michael Cass - Barron Capital

China Nepstar Chain Drugstore Ltd. (NPD) Q3 2007 Earnings Call December 11, 2007 8:00 AM ET

Operator

Greetings and welcome to the China Nepstar third quarter earnings conference. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Rachel Levine with Global Consulting Group. Thank you. You may begin.

Rachel Levine

Thank you. If you have not received a copy of Nepstar’s third quarter 2007 earnings press release, it is currently available on the company’s website at www.nepstar.cn. A presentation to accompany today’s call and live webcast is also available on the website under the investor relations section.

Before we begin, I would like to remind you that certain statements that are not historical facts made during the course of this conference call about future events and financial results constitute forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. You should note that the company’s actual results may differ materially from those projected in these statements due to a variety of factors affecting the business.

Forward-looking statements are subject to risks and uncertainties. Discussions of the factors that may affect future results are contained in the company’s filings with the Securities and Exchange Commission. Nepstar undertakes no obligation to correct or update any forward-looking statements provided as a result of new information, future events, or even changes in expectations.

Joining us on today’s call are Dr. Simin Zhang, Chairman of the Board; Mr. Jiannong Qian, Chief Executive Officer; Mr. Andrew Chen, Chief Financial Officer; and Ms.

Lucia Qian, Marketing and IR Director, who will also be our translator during the question-and-answer session. We will be translating questions and answers and ask your patience at that time.

Mr. Qian, the CEO, will now deliver his opening remarks. Please go ahead, sir.

Jiannong Qian

Thank you, Rachel. Good morning and good evening. I would like to welcome you all to China Nepstar Chain Drugstore’s third quarter 2007 financial results conference call, our first conference call as a public company.

For those of you who are new to our company, we are China’s largest drug store chain by the number of directly operated stores. As of September 30, 2007, we have 1,791 stores in 62 cities in Mainland China. In addition, we also have 11 regional distribution centers and one headquarter distribution center.

And 2007 has been an exciting year for us and it’s also a tremendous milestone. On November 9, 2007, we successfully completed our initial public offering of 20.6 million American depository shares, representing 41.3 ordinary shares on the New York Stock Exchange. That deal has provided us with the financial wherewithal to continue to pursue our business strategy, which is to increase revenues through same-store sales and new store openings, drive margin growth through private label offerings and centralized procurement, and enhance operating efficiency and [keep] cost control.

Now let me turn the call over to Andrew, our CFO, who will discuss the financial results of the third quarter. After Andrew finishes his prepared remarks, he will join me, Dr. Zhang, and Lucia to take your questions. Andrew, please.

Andrew W. Chen

Thank you, Mr. Qian. Ladies and gentlemen, I’m glad to report a strong third quarter 2007, as indicated by tremendous growth in our net income and our gross margin. One of our growth drivers for the quarter was the optimization of our product portfolio, specifically the increased share of our private label products and the centralization of our procurement process.

Let me now walk you through our numbers. Our revenue grew 6.6% RMB484.3 million, or $64.6 million, over third quarter 2006. Our growth was affected by strategic initiatives implemented in August 2007 to optimize our product portfolio. Specifically, we added more high margin merchandise to our product mix and pulled low margin ones off our shelves, which affected revenues for much of the quarter.

We saw sales begin to increase again at our projected pace in September, as we completed the product portfolio overhaul.

Let me give you a breakdown of our segments during the third quarter. Sales of prescription drugs accounted for 23.3% of our revenue, compared to 23.7% in the third quarter 2006. Over-the-counter drugs represented 34.4% of the revenue compared to 35.9% in third quarter 2006. Nutritional supplements represented 19.3% compared to 17.1% in third quarter 2006. Herbal products represented 2.7% compared with 1.9% in third quarter 2006, and other merchandise accounted for 20.3% compared to 21.4% in third quarter 2006.

We opened 179 new stores during the third quarter. Same-store sales for those that opened before December 31, 2005 declined 1.9% compared with the prior year’s period, due to the strategic decision to discontinue certain low margin products and shift the revenue mix to higher margin private label products, which were mentioned above. Again, we have already seen a recovery in the revenue trend from the shift.

In third quarter 2007, we also increased the number of our private label products to 1,177. Private label products contributed 18.3% of the company’s revenue and 28.6% of the gross profit for the third quarter, and approximately 17.8% of the revenue and 30.2% of the gross profit for the nine-month period. Developing private label products has been one of our core business strategies.

Private label branding gives us more freedom and flexibility in pricing and more control over product attributes and quality. Our long-term goal is to raise the revenue contributions from private label merchandise to 40%.

Our gross profit grew 40% for third quarter 2007 to RMB228.2 million, or $30.5 million over third quarter 2006. Our gross margin increased to 47.1% compared to 35.9% in the third quarter 2006. Again, this was driven primarily by the changes in our product portfolio to increase the representation of high margin products, as well as our enhanced efforts to consolidate procurement of merchandise from fewer suppliers. By centralizing our purchases, we have been able to gain margin power with our suppliers and win more favorable terms from them. Increased economies of scale realized by our large network of retail outlets have also contributed to significant improvements in our gross margin.

Our sales, marketing, and other operating expenses for third quarter 2007 increased 14.2% to RMB154 million, or $20.6 million over third quarter 2006, primarily due to the costs of new store openings and additional hiring to support this expansion.

General and administrative expenses decreased 1.3% to RMB15.9 million, or $2.1 million, compared to RMB16.1 million for the third quarter of 2006, thanks to our cost control initiatives.

Our operating income jumped 381.9% to RMB58.4 million, or $7.8 million over third quarter 2006.

Lastly, our net income surged 512.6% to RMB46.3 million, or $6.2 million over third quarter 2006. This translates into RMB0.28 or $0.04 in diluted earnings per share, compared with RMB0.03 in the third quarter 2006.

Now let me briefly tell you about our financial results for the first nine months. Nine-month revenue rose 14.1% to RMB1.4 billion, or $190.9 million, compared to the first nine months of 2006. Nine-month revenue contribution from prescription drugs was 24%; OTC drugs represented 35.1%; nutritional supplements represented 18.9%; traditional Chinese herbal products represented 2.5%; and other products represented 19.6%.

We opened 376 new stores during the nine months of 2007. Same-store sales increased 4.6% compared to the same period last year.

Gross profit rose 42.7% to RMB608.6 million, or $81.2 million for the nine-month period over the same period in 2006. Gross margin was 42.5% compared with 34% for the same period of 2006.

Nine-month operating income was RMB119.4 million, or $15.9 million, compared with RMB3.1 million for the same period of 2006.

Sales, marketing, and other operating expenses rose 15.6% to RMB437.1 million, or $58.3 million, over the same period in 2006, primarily due to increased salaries and bonus payments in connection with an increased headcount as a result of the continuous expansion of our store network. The increase in sales, marketing and other operating expenses was also due largely to higher rental and utility expenses for our drug store outlets and distribution centers, and increased depreciation for store and distribution center leasehold improvements and store equipment, as we open additional drug store outlets and additional distribution centers to accommodate our growth.

Nine-month net income was RMB89.7 million, or $12 million, compared with a net loss of RMB4.1 million for the nine months of 2006. Diluted earnings per share was RMB0.54 or $0.07, compared with diluted net loss per share of RMB0.14 for the same period of 2006.

Our cash position is strong. As of September 30, 2007, our total cash and cash equivalents was RMB136.1 million, or $18.2 million, compared with RMB83 million as of December 31, 2006. Total shareholders equity increased to RMB74.2 million, or $9.9 million, from a total shareholders deficit of RMB2.4 million as of December 31, 2006.

Let me switch gears now and talk to you about the outlook of our business. Our IPO on NYSE on November the 9th raised gross proceeds of $384.2 million, including over allotment options with net proceeds of approximately $350 million. We intend to use the proceeds to open more stores and distribution centers in China, extending our market presence and customer reach. As we grow, our ability to leverage centralized purchasing will increase as will our private label capabilities. We are also focused on enhancing operating efficiency and cost controls through upgrades to our IT and inventory management systems. Finally, we will be evaluating synergistic acquisition opportunities where we can utilize capital for maximized returns and accelerate our growth.

At this point, I would like to spend a few minutes discussing [guidance] for fiscal 2007 and give you some perspective on our business operations.

For the fiscal year 2007, we expect to generate between approximately RMB1.95 billion to RMB1.96 billion in revenue. Our net income is expected to be between approximately RMB147 million to RMB150 million.

I would like to emphasize that this outlook is based on our organic store performance and approximately 210 brand new store openings in the fourth quarter. These target updates on our current views on the operating and market conditions, which are subject to change, of course.

As we move forward, we will issue annual guidance to the best of our ability now that we are a public company. Of course, this guidance will also be based mostly on organic growth and certain projected new store openings. We anticipate issuing guidance for fiscal 2008 in conjunction with or shortly after our release of fiscal 2007 results.

Finally, before we conclude, we would like to share some thoughts on the outlook for Nepstar and our industry in the future. Nepstar’s blend of superior customer service, broad geographic reach, and extensive product offerings at competitive prices has made us the market leader and we believe that we are well-positioned to capitalize on the demographic trends and regulatory changes in China’s pharmaceutical retail industry to enhance shareholder value.

China’s fast-growing economy has led to increases in disposable income, improvements in standards of living, and accelerated urbanization, which have made pharmaceutical products more affordable and spending on pharmaceutical products more common. Moreover, China’s aging population is a key contributor to the increased expenditures on pharmaceutical products we have seen in recent years. The portion of the Chinese population age 60 and above has increased in both absolute numbers and as a percentage of the total population and we believe this trend is likely to continue in the next decade.

Several initiatives implemented by the Chinese Government in an effort to improve consumer experiences and outcomes and reduce corruption have also been spurring the growth of the retail pharmaceutical industry. Anti-corruption measures targeting procurement and drug dispensing in government-owned hospitals have created more growth opportunities for non-hospital drug stores. Pharmaceutical product labeling and prescription management policies have weakened hospitals’ monopoly on prescriptions and prescription drugs. Regulating the advertising of pharmaceutical products is expected to increase manufacturers’ reliance on retail pharmacies to build brands amongst the general public.

The increased availability of funding under the National Medical Insurance program and inclusion of more pharmaceutical products in China’s National Medical Insurance scheme is also expected to significantly increase prescription purchases. [Additional participants] in the National Medical Insurance program mainly consisting of urban residents are entitled to buy medicines when presenting their medical insurance cards in an authorized pharmacy, as long as their medicines have been included in the insurance program catalog published at the national or provincial level. Nepstar currently has 480 medical insurance designated pharmacies.

We have also recently learned that the Chinese Government is in the process of developing new regulations to separate drug prescribing and drug dispensing in China. We are closely following these developments and are analyzing how we may capitalize on opportunities coming out of any new government policies.

With that, let me join Dr. Zhang, Mr. Qian and Lucia to take your questions. Operator, please begin the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Caroline Lee with Goldman Sachs. Please state your question.

Caroline Lee - Goldman Sachs

Thank you. Well, first of all, congratulations on the very successful IPO and a high growth quarter that just ended. I do have three questions for the management. First, could you provide some more information regarding potential acquisitions, especially around the timing and possible size of those acquisitions?

The second question is about store openings. I wonder if management could provide some guidance on store opening plan in 2008 and ’09, and the third question is regarding gross margins. Mr. Chen just mentioned on the private label penetration is targeted to contribute 40% of revenue. I was wondering what kind of timing are we talking about and what is your view on sustainable long-term gross margins? Thank you.

Lucia Qian

Please allow one minute for me to do the translation.

Just then, the speaker was Mr. Jiannong Qian, our CEO. Mr. Qian said that at the moment, we have been contacting many of the potential acquisition targets and we have been carrying out various negotiations and we are, at the management level, very much confident that the 2008, we will have successful cases in terms of acquisitions, although at the moment, we do not have anything to disclose.

For the fourth quarter of 2007, we will definitely complete our target of opening 210 drug stores in China and for the year 2008, our store opening plan will be 1,050 new drug stores in China.

Caroline Lee - Goldman Sachs

-- beyond ’08?

Lucia Qian

’08.

Caroline Lee - Goldman Sachs

-- the guidance for 2009?

Lucia Qian

We do not provide guidance for 2009 at the moment but we do believe that we will open as many as, if not more than, year 2008.

To your third question of the timeframe for us to reach that 40% contribution by private label products, we would aim to reach that 40% of contribution by year-end 2008 and we’ll see that in the year 2007 Q3, our gross margin rate has already made quite a substantial improvement over that of quarter two. Quarter three we had a gross margin rate of 47.1% and the number in quarter two is 42.6%, and we will forecast a further improvement in terms of gross margin rate in quarter four this year and of course, for next year, we will see a further improvement of gross margin right along with that improvement of the private label products contribution.

I hope that we have answered those three questions that you raised, Caroline.

Caroline Lee - Goldman Sachs

Yes, just a follow-up on the gross margin; what is management’s view on the sustainable long-term gross margin? Do you think -- at what level do you think you’ve reached the ceiling of the gross margin and once you reach there, do you think you are going to see it slightly decline or are you going to stay at that level?

Lucia Qian

Before we really drop an answer to what is the ceiling of the gross margin rate, we would like to share our views as to the potential space for us to further improve our gross margin on top of our already pretty high 47% of the gross margin rate in Q3.

At the moment, you will see that 40% of our total procurement is still down at the regional level and those regionally procured products actually have an average gross margin rate of less than 20%. Next year, we will enhance the proportion of centralized procurement and to minimize the contribution of those products procured at the regional level.

With improvement of the contribution by centralized procurement, we will see that our gross margin rate will have a significant growth and at the same time, as we have just mentioned, that we will try to introduce more of our private label products and the contribution, the growing contribution made by our private label products will also contribute to a higher gross margin rate. Therefore, although we cannot give you a specific date, or specific data as to where the ceiling lies but we do see that at least for the next few years, there is great room for Nepstar to further improve its gross margin rate.

And we would like to share with you our view of the improvement that we are going to make in quarter four in terms of gross margin rate. We will improve our gross margin rate to a range of 48.5% to 50% in quarter four in terms of gross margin rate, and that already is an improvement over that of quarter three.

Caroline, are you happy with that answer?

Caroline Lee - Goldman Sachs

Yes, great. Thank you very much.

Operator

Thank you. Our next question comes from Ben Lee with Merrill Lynch. Please state your question.

Ben Lee - Merrill Lynch

Thank you. Congratulations first for the IPO. I want to ask a few questions on the quarter first. First, you’ve improved gross margin substantially during the quarter. One might say this comes at the expense of soft or weak top line growth. I just want to hear your comments on that, because your top line growth for the third quarter is right around 7%, which is lower than the first half, which is right around the high teens year-over-year growth. Would you provide some color on that?

Lucia Qian

We’ll see that in quarter three, we successfully have brought up the gross margin rate and we agree that the top line growth was rather weak in quarter three compared to the growth of the first two quarters of this year, and we have to say that this is quite within the management’s expectations.

This is partly because that in August, we started a campaign of streamlining our product portfolio and within that one-month campaign, we have discontinued quite a lot of products that are of very low margin, and those discontinuations of those low margin products did bring some disruption to our store operations. Therefore, we’ll see in August that sales were impacted by this campaign, although as a result we have substantially improved our gross margin rate.

But we are happy to see that in September, the revenue has demonstrated quite a strong comeback from a dip in August and we’ll share with you some of the data of the same gross sales.

We took the 1,084 stores that were opened by year-end 2005 and we see that for those stores, in the first quarter of 2007, per store per day output was RMB4,035, store revenue. And for the second quarter, per store per day output was RMB3,962. And for quarter three, because of the reasons that we have just mentioned, the campaign, that the same-store sales did show a decline to RMB3,857. However, because we have seen the trend has come back, we will be quite confident to say that for the fourth quarter, we will see the same-store sales per store per day to be improved to RMB3,948 and that is almost back to the level of the first two quarters.

And for this fourth quarter, we will try to grow our revenue as well as our gross margin rate at the same time.

Ben Lee - Merrill Lynch

Great. Thanks for sharing the same-store sales number. Just a follow-up question on that; it is interesting -- you know, you comment on same-store sales for your company but regarding whether you know any data, similar data for the industry. What is the trend for the same-store sales for the industry?

Lucia Qian

Well, for the industry wide, national wide, we’re sorry but we don’t have any accurate statistics released by the government, so we can’t provide you with that. However, we do observe our peers in Shenzhen, where we have some of the chains that are saying that they are reporting a quite disappointing Q4 and some are having very flat growth. And we will see that this is possibly due to our very strong Q4 performance and that has posed a competition pressure to our peers in the Shenzhen area.

And just then, it was our Chairman, Mr. Zhang Simin. He would want to add that as far as to his understanding, for a lot of our peers nationwide, those chains did not actually adopt as aggressive store opening strategies as Nepstar does and most of them did not grow their scale for quite a long time.

And we know that there is actually no one within this industry except Nepstar that has the profitability level and the successful profitable model and we actually think that even for same-store sales, we are actually among the best.

And as to -- just refer to what Mr. Zhang just said, that in Q4 and in the long run, the company is determined to grow same-store sales or revenue alongside with the growth of gross margin rate and we are now having an even clearer view as to how we should implement all our strategies and how we should try to in the long run to reach our strategic aim of bringing up those very important key indicators in our business. And for that improvement, the company and the management is full of confidence.

Ben Lee - Merrill Lynch

Great. If I could, just one more question on the guidance; if I take the midpoint of your revenue guidance, it implies that you are projecting 4Q sales to be at roughly RMB524 million, which implies about a 10% year-over-year growth burst. Is my math correct?

And second, also if I apply the same math, I think you are suggesting your 4Q net income will be something like RMB60 million and this implies actually 11% net margin, which is substantially higher than your 3Q net margin. So my question is whether the net margin improvement from my calculation is mostly coming from the gross margin improvement or you are also getting some leverage on the operating costs?

Andrew W. Chen

Let me take this question. I think you are absolutely correct on your calculation and the numbers, both the revenue and net income that you quoted in your question were consistent with what we had projected when we were doing the road show before the IPO in NYSE.

I would say that the improvement in our net income, the bottom line, is contributed to several factors. First of all, the top line has been growing. I think the revenue is coming in at a significantly higher levels than in comparison with third quarter results and at the same time, our gross margin is approaching 50%, estimated to be between 48.5% to 50%. And also we have been keeping a very close eye on our expenses, so expenses are also expected to be under control and actually for the first two months that already closed, that we have seen all these factors, all these pieces come in pretty nicely, so we are standing behind with what we have promised the market when we did the road show.

Ben Lee - Merrill Lynch

Thanks. I’ll go back to the queue.

Operator

Thank you. Our next question comes from Hal Hong with SIG. Please state your question.

Hal Hong - Susquehanna

Good morning, guys. My questions are very similar to the earlier questions that have been raised by the other analysts. I just wanted to follow-up on the same-store sales. Just now you disclosed the same-store sales for the four quarters this year. I’m just wondering whether you have the same numbers for last year.

Lucia Qian

Mr. Hong, would you please clarify your question? Should I understand that you are asking for the same-store sales number for year 2006 for the four quarters, right?

Hal Hong - Susquehanna

That’s right.

Andrew W. Chen

The same-store sales for the 1,084 stores during 2006 on an annual basis was RMB4,000.

Hal Hong - Susquehanna

For the entire year 2006?

Andrew W. Chen

For the entire year, yes, 2006.

Hal Hong - Susquehanna

Also, I understand that for this quarter, your top line growth was impacted by your change in the product mix. I’m just wondering for the long run, what do you see as a sustainable same-store sales growth for your store network?

Lucia Qian

We’re happy to say that we are actually in the finishing phase of our streamlining of existing product portfolios, therefore we don’t expect to see severe campaigns in the next years to come.

And at the moment, we are trying to optimize our product offerings. We are, starting from this quarter, are going to put more emphasis in building stronger categories in terms of traditional Chinese herbs, nutritional supplements and personal care products. And we believe those front-end product offerings will improve the vast size of our traffic and at the same time, increase the traffic into our stores. And that will contribute to a better same-store sales growth.

At the same time, because we are standing on a rather good profit margin and we will be even stronger and even aggressive in terms of having our marketing campaigns and that will help us to gain a better marketing advantage over our competition and that will actually help us to grow stronger same-store sales.

With all those measures that we are actively taking, we think that the year 2008 will turn out to be a much stronger same-store sales performance compared to what we had in the year 2007 and we again are quite confident that we are going to grow our revenue alongside with the growth of our gross margin rate.

Hal Hong - Susquehanna

Okay. Also, another question on the gross margin; you mentioned that by -- probably by the end of 2008, you will have 40% private label in your store. I’m just wondering then for the branded medicines and also for -- there’s another type of medicine. I think it’s called non-central procured, or central procured medicine. So what would be the percentage for that mix for those products?

Lucia Qian

Okay. Our aim is that by the year end of 2008, private label products is going to contribute 40% of the total sales and for our centrally procured, non-private label products, the contribution shall reach 40% and we will bring down the contribution by those locally procured products to 20%.

We are actually changing our contributions or improving our contributions by different categories as we just described and at the same time, we think because we have been literally growing our store networks in each region that we are present in, for those regionally procured products we are actually having good chances to further improve their margin contributions. And at the moment, the gross margin for those products are less than 20%. We have good chances to improve that to above 20%.

Hal Hong - Susquehanna

Thank you.

Operator

(Operator Instructions) Our next question comes from Barbara Miller with Federated Investors. Please state your question.

Barbara Miller - Federated Investors

Thank you. Just a clarification; you have talked about controlling your corporate expense but you are growing rapidly. What exactly are you doing now and how sustainable is that as you go into next year, just on the corporate expense line? Thank you.

Andrew W. Chen

The controls on corporate -- when you talk about corporate expenses, are you referring to general administrative expenses or overall expenses?

Barbara Miller - Federated Investors

Yes, I understand.

Andrew W. Chen

Are you referring to overall expenses or are you only interested in administrative expenses?

Barbara Miller - Federated Investors

I was interested in the administrative, the central administrative expenses.

Andrew W. Chen

We have been taking actions, including we have relocated our headquarters from a more expensive location to the current location and saved significantly on our rental expenses. And at the same time, we keep a very close eye on the headcount that we hire into the headquarters to support our business across the country. And at the same time, I think for the logistics expenses, which are part of this administrative expenses, the distribution center related expenses, we are also tracking them very closely and we believe that -- I can quote you some numbers.

For Q3, the expense ratio for general administrative expenses was 3.3%, which is a -- there was a 0.3 -- in comparison with the Q2 of 2007, there was a 0.8% decrease and then that’s because if you -- in Q2 of 2007, there was a RMB5 million of auditing fees that were charged in Q2. If you take the fees out, I think the two quarters, the expense ratio for administrative expenses ratio have remained very stable.

And then into Q1, we are estimating that the expense ratio for the administrative expenses is going to further go down to 3.1%.

Barbara Miller - Federated Investors

Okay, so you don’t foresee any significant expenses related to the growth as you go into next year?

Andrew W. Chen

No, I don’t think so. Because our growth is actually on a store level, right? And then as you increase the store network, it doesn’t necessarily would have to increase -- you have to increase the headcount or you have to lease for bigger offices, those kinds of things. I don’t expect this to happen.

Barbara Miller - Federated Investors

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Ben Lee with Merrill Lynch. Please state your question.

Ben Lee - Merrill Lynch

Thanks for taking my follow-up questions. I have a couple of questions regarding the government policy. We noticed recently, actually just late last week, the government said that they are considering some new mechanisms to control the drug prices in China and we noticed that there were two proposals specifically related to the drug store industry.

First, the government is saying that they want drug makers to print or to display the manufacturing price on the drug package. That’s the first thing. Also, the government wants to equalize the drug price in hospitals and the retail drug stores, making the price to be the same.

I was wondering whether you have a view on these proposals and what do you think the potential impact is to your company or to the industry.

Lucia Qian

Mr. Qian would like to tell everyone that last week, he attended a committee meeting of CACDS, which is China Association of Chain Drug Stores and over that quarterly meeting, several drug stores and the association had various discussions over those said proposals to the government. And it is discussed that first of all, there have been so to speak rumors that there will be such a proposal taken by the government but it is still within very heated discussion and we don’t foresee that it will be launched in the very near future.

Even if it is one day adopted by the administration, we still don’t think it’s going to be a negative impact to Nepstar because while Nepstar actually is the biggest chain drug store in China and with the biggest procurement volume, and we do have our private label products and as you know, for any manufacturer, if you want them to specifically calculate the X-manufacturer prices, you have to take into account not only the raw material, labor costs, but lots of other factors like goodwill, et cetera. And we don’t think that the manufacturers will be strictly controlled, or will be strictly manipulated by any forces to demonstrate very similar factory prices and Nepstar, as you know, has always been quite price competitive compared to those small chains.

We don’t actually think, first of all, this is something very practical for the government to adopt because we have 6,000 manufacturers in China and it’s just impossible to really gauge who is going to or who is telling the factual price on their boxes. And at the same time, as you do know, Nepstar is very price competitive and we don’t think that we are going to leave any bad impression to our customers because our products are very price competitive compared to our peers.

And at the same time, the company is going to carefully monitor what possible actions that the government is going to take on that topic. Mr. Zhang Simin just said that we’ll have to see it from the other angle, which is the intention of the government to launch various actions to curb the price, curb the selling price of certain pharmaceuticals. And we believe that the intention of the government is trying to lessen the burden on the patient because there is actually quite serious over prescription in the hospitals to those patients. And if there is no incentive for the doctors to over prescribe as the result of any government measures and those hospitals will not withhold all those prescriptions within their hospital pharmacies and the patients will have more freedom to take their prescriptions out to be filled at the chain drug stores.

Ben Lee - Merrill Lynch

Thank you.

Operator

Ladies and gentlemen, we are out of time for questions. This will be our final question. Anyone who was not able to ask their questions, please feel free to follow-up with investor relations after the call. Our final question comes from Michael [Cass] with Barron Capital. Please state your question.

Michael Cass - Barron Capital

Thank you. Could you give a little more detail on how you trade off during the inventory streamlining? How do you trade off revenues for gross profit? Because obviously there was some impact on your revenue growth during the streamlining, so I guess I’m trying to understand -- was that just an inventory issue or could you be specific about when you switch over to private label, how much lower the products revenues are but then how many gross profit dollars come back versus what that product was replacing? Thanks.

Lucia Qian

Actually, to elaborate on what we did over that campaign, we discontinued quite a lot of known products that have a very low margin contribution and those mostly are those locally procured products. We replaced those products with very low margin contribution with our private label products or with the products that we procured centrally.

And you know, if we do such replacing of the product portfolio, we will actually incur those re-planogramming of our stores and we will actually move things from this shelf to the other shelf and that will actually disrupt our store operations. And because of such disruptions, we do see that for the transaction traffic in Q3, we are losing certain of our traffic.

For example, in quarter two, our per day per store transaction volume is 145 times for those same stores opened by year-end 2005 and in Q3, we see that the transaction times was down to 136. That means that we are losing around 9 transactions per store per day and the loss of transactions, or I’ll say the loss of traffic is the trigger to a lower same-store sales performance in year 2003.

But as our store sales are gradually used to the new planograms and our customers are gradually used to the new store display and actually try and come back for those new products, we see that we are getting back those transactions gradually and especially in Q4. Every month we are seeing a pick-up in terms of transactions for those same-stores. We think that disruption to our traffic and to our same-store sales is quite temporary and in 4Q, we are actually going to have a stronger same-store sales.

And in this quarter, quarter four, we are still gradually growing our gross margin rate but we are also seeing that the revenue and same-store sales is recovering and that recovery is actually ascending on a higher platform of our gross margin rate, therefore we see that we have met our growth when we started that campaign in August.

Michael Cass - Barron Capital

Thank you.

Operator

There are no further questions at this time. I will turn the conference back to management for closing comments.

Jiannong Qian

Thank you for joining us on this conference call and we look forward to updating you on our first quarter results. Thank you, everyone.

Operator

Thank you. To access a replay of this conference, please dial 877-660-6853, and for international dialers, please dial 201-612-7415. The replay account number is 286 and the conference ID number is 264885. Once again, to access a replay, please dial 877-660-6853; international dialers dial 201-612-7415. The replay account number is 286 and the replay conference ID number is 264885. This replay is available until December 18, 2007.

Thank you. Have a great day.

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