USANA Health Sciences Inc (USNA) 2003 Q2 法說會逐字稿

Good morning and welcome ladies and gentlemen to the USANA Health Sciences Inc. second-quarter 2003 earnings release conference call. (CALLER INSTRUCTIONS). I would now like to turn the conference over to Mr. Riley Timmer, Investor Relations Analyst.

Thank you, Rob. Good morning and thank you for joining us this morning. Today's conference call is also available live via webcast and can be accessed directly from our Website at www.usanahealthsciences.com. Shortly after the call, a replay will be available for approximately 90 days.

The purpose of today's conference call is to discuss financial results for the second-quarter of 2003. Before we begin, 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 the 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 the Company's most recent filings with the SEC including its most recent annual report on form 10-K.

I will now turn the call over to Gilbert Fuller, Chief Financial Officer of USANA.

Good morning. Thanks, Riley. Good morning everyone and thank you for joining us to review USANA's second-quarter results.

As a sidenote, Dave Wenz, our President, will not be with us on the call this morning. He is currently in South Korea participating in that market's opening events.

On July 10th, we announced the acquisition of a manufacturer of skin and personal care products. By bringing the manufacturing of our skin care products in house, we should be able to reduce production cost and gain greater control over the quality of products we sell. As you know, we take great pride in our pharmaceutical grade manufacturing and the science based products we provide. We believe that this vertical integration is a key step in our business strategy.

On July 14th, we officially opened the doors for business in South Korea. The level of the excitement and drive we are seeing from the associates there is greater than any new market opening we have experienced. We believe this market has the potential to be very successful for USANA. South Korea represents the third largest selling market in the world with annual sales of about $4.6 billion.

This quarter was very rewarding in that we saw double-digit year-over-year growth in each of our markets. Our Australia and New Zealand markets saw the most significant growth increasing by 62 percent compared to last year's second-quarter.

It is also gratifying to see North America, our most mature market, grow at double-digit rates. Our associate leaders from around the world have dedicated themselves as (inaudible) of true health and true wealth, driving sales to record levels for the fourth consecutive quarter.

I will now review key financial statement line items with you. Net sales for the second quarter of 2003 were $47.2 million, an increase of 47 percent compared to the $32.1 million reported in the second-quarter of 2002. Sales were also up 15 percent on a consecutive basis for the first quarter of 2003. The growth in net sales is due to the increasing number of active customers, driving increasing sales in each of our markets.

Sales in the second-quarter were also impacted by stronger foreign currencies relative to the U.S. dollar, which positively impacted sales this quarter by approximately $2.3 million when compared to the second quarter of 2002. Excluding the positive impact from the weaker dollar, year-over-year sales growth would have been about 40 percent.

Cost of sales this quarter decreased as a percentage of net sales to 22.1 percent compared to 26.1 percent in the second-quarter of 2002. Our gross margins improved during the quarter primarily due to improved production and procurement efficiencies, the effects of a price increase in certain products implemented in the fourth quarter of 2002, and to improve economies of scale associated with an increasing sales base.

We expect to see modest benefits to cost of sales for the remainder of 2003 due to continued operating leverage from increasing sales. As we announced last week, we recently acquired an in-house manufacturing capacity for our personal care products. We anticipate that realized benefits to cost of sales resulting from the production of our USANA products in-house will begin to take effect at the end of 2003.

Associate and Senate expense for the second quarter was 39.6 percent of net sales. This is an increase of 150 basis points compared to the second-quarter of 2002 but is in line with our guidance provided for the second-quarter. The year-over-year increase in associate incentives can be attributed to a larger portion of sales coming from products with higher sales volumes point ratios, an increase in the amount of commissions paid to associates in Australia and New Zealand, and the elimination of processing fees on associate commission checks. USANA remains committed to our associates by providing what we believe to be the most fair and equitable compensation plan available in the industry.

Even the just completed acquisition will not add to this line items. We expect the associate incentives to increase in the third and fourth quarters relative to sales due to special associate promotions and incentives we will be running to aid further growth on the topline.

Selling, general and administrative spending decreased to 22.4 percent of sales during the second quarter of 2003 compared to 26.7 percent in the prior year quarter. This can be attributed to operating leverage gained on higher than anticipated sales. Although we would typically expect to see leverage in SG&A from a rising sales base, we believe SG&A for the year will run at approximately this relative level due to the added expenses from our recent acquisition and to the opening of the new satellite office in (inaudible), Taiwan.

As a result of these line items, we saw operating income for the second-quarter of 2003 increase to 15.1 percent of sales as compared with 8.4 percent achieved during the second-quarter 2002. Income tax for the second quarter was 37 percent, which is in line with our guidance. We believe that the effective tax rate for 2003 will remain at 37 percent of pretax earnings, although we would note that the effective tax trade might be affected by stock option exercises and changes in foreign markets during the next six months.

Let's now look at the bottom line for a moment. Earnings for the second-quarter were 41 cents per share compared to 16 cents in the second quarter of 2002. This is an increase of about 156 percent on a year-over-year basis.

Now to reiterate the guidance that was updated in the press release, we now expect to see annual sales in 2003 in excess of $190 million and earnings per share for the year approaching $1.65. We believe third quarter sales will approach $52 million with the earnings per share in the range of 43 to 45 cents depending upon the success of our South Korean market.

I would also like to comment on cash and cash flow for just a moment. EBITDA for the second quarter was just over $8 million. Our strong cash balance allowed us to pay for our recent acquisition without adding debt to our balance sheet.

With that, I will turn the time over to Rob, our operator, to facility the question-and-answer session.

(CALLER INSTRUCTIONS). Scott Coleman, Forest (ph) Asset Management.

Congratulations on a great quarter. A couple of questions. The first question is about the new offices which are opening. I noticed a line right in the press release about we expect (inaudible) significant market but realize our upward guidance is dependent in part upon the actual results of the market. I was just wondering how much you are expecting out of Korea that is in the current guidance? When can we expect guidance for next year? What is going on in Japan in the overhaul in Japan? What things are being done differently in Korea as you (inaudible) into the Asian market have not been successful in the past as you would have liked?

Let me talk about Korea for a minute, and then if I miss some of the points you made, let us cycle back to them. We have not specifically set forth publicly the amount of sales we are expecting in South Korea in our guidance. So I probably cannot comment on that other than just to say that we have estimated obviously some numbers for that market and believe we can -- obviously or we would not have said it, of course -- achieve that guidance we've got out there now for the third quarter.

With regards to successes in Asia, we have really done quite well in Taiwan. We have done well in Hong Kong. In Japan, we still had year-over-year double-digit growth in Japan. So while it has not achieved what we had hoped it would achieve, since the Japanese market is a very significant market for this market channel for direct sales, we are seeing some progress there. We remain cautiously optimistic that the new management team there will be able to continue growing those numbers. So, again, I would say we are cautiously optimistic we will see that progress there.

In terms of guidance for 2004, we will start looking at providing guidance for that for next year in our press release and conference call that we will come out with in the third quarter. That will be in October at our conference call, and we just feel like that would be the appropriate time to start looking out that far ahead. We remain very optimistic, and certainly the signs that we see are constructive and good.

Maybe if I could phrase it this way on what is going on in Japan. I know the new management team, you guys are very excited about it. How far along would you say we are in implementing the new management's strategy in getting out their ideas, or are they still settling in out there?

I think they have gone beyond settling in, but it is still is early in the process. Our manager there, Sampei Nakao, really started implementing his changes early in the second-quarter. But he has a plan outlined that involves the entire year, of course, as you would expect. So I would say we are in the early stages of him implementing what he believes to be strategy to get that market moving.

So I think as we get into seeing how that impacts the third quarter and especially the fourth-quarter, that we will be able to assess that better and decide if we have gone far enough in the changes that we have made.

Ralph Miller, UBS.

Great quarter, great guidance. What you say the future growth -- you are growing at about 40 percent. How much of that would you anticipate will come from opening new markets, and how much growth would be from just growing your present business?

That is a real good question, Ralph, and it's also a tough question. Both elements are a part of our strategy, that is opening new markets is clearly an important element of growing this business. The thing that gets tough is that opening new markets tends -- since we have a seamless compensation plan, I think it is important to maybe relate to that for a minute, is that our compensation pays our distributors based on their global business so that they can have a distributor in Australia, for example, can have people in his or her organization in any of the countries where we are doing business.

So when you open a new market, what tends to happen is people in our other markets often have contacts in that new market. So you have this cross-fertilization, if you will, of growth in some of our other markets as well. I think that has been one of the things that has been helping us here.

So, for example, we are opening Korea. Well, we know there are fairly large Korean communities in places like Tokyo and Los Angeles and so forth. We are hoping to see that backwash, if you will, back into our existing markets. We are going to open up, if plans hold, our Mexican market in the first quarter of 2004. We are beginning to see a little better activity in our Hispanic markets here in the U.S. as a result of that. So it's very tough to say, Ralph, how much will come from a specific opening.

Remember we opened Taiwan last year in the fourth-quarter, so the comparisons are obviously getting tougher as we finish that fourth-quarter. But we have got enough things going on that we certainly remain optimistic about our growth plan.

One last question. Australia seems to have grown at about 38 percent. Why would that growth rate be greater than others? Is it working obviously from a lower base, but is there something different, profiles or anything different down there?

Again, sometimes we wonder ourselves what is going on in specific markets. When you get an enthusiastic group of independent distributors working, sometimes they can really get something going. But it's a combination of things I think in Australia.

We had Australia is a very cosmopolitan country with large ethnic Chinese communities in Sydney and Melbourne and so forth and Brisbane. So when we opened Taiwan last year we saw a lot of activity in those ethnic communities there in Australia.

We also have a relatively new manager down there. He has been down there just a couple of years, but he has turned out to be a very effective individual, very highly regarded and trusted by our field force.

And then we mentioned in our script, in the first of the year, we raised the payout rate just a little bit in Australia and New Zealand because the currency had changed so much. The (inaudible) dollar and the Kiwi dollar had both strengthened relative to the U.S. dollar significantly, and so we had made an adjustment there, and that seemed to fire them up a bit as well. So it was a combination of things, Ralph, but all very good I think, that have caused that to grow so well.

Great, Gil. Thank you so much, and it's a very exciting time for USANA.

Ester Cho, (inaudible).

Can you comment on what the growth in your active customers was this past quarter?

Yes. On a quarter over quarter basis, we saw the active customer base go up by 35 percent with regard to our associates. We also have preferred customers, and that increased quarter over quarter by 16 percent. So totally we were up, if you count both our independent distributors as customers which we do and preferred customers as customers, in total we were up about 27 percent on a year-over-year basis.

We were pleased with that because we saw growth in our associate count double-digit growth in each of our markets on a year-over-year basis. So, again, we were very very pleased with that.

Also, how much would cost be lowered by manufacturing your products in-house?

That is a good question, a little bit unknown. We have done some work inside on a pro forma basis and believe that we will see some progress. It will take us a bit to get there. I think as we mentioned in our script that it would probably be fourth quarter before we start to realize some of those benefits. Currently our (inaudible) products are manufactured primarily by third parties, and now we are in the process of transitioning them in-house for just our personal care products.

Our nutritional products are virtually all manufactured in-house already. I believe we have made great progress just in efficiencies gain there with bigger scale and better efficiencies in our systems and so forth. So the benefits from the acquisition of the personal care manufacturer will be more modest because personal care is about 11 or 12 percent of our sales, but we do expect to see some, and that will start to show up we think in the fourth-quarter.

Evan Stein (ph), U.S. Partners.

You mentioned what the increase in the active associates preferred customers and things like that was across all regions. If I go back a year, obviously those numbers were negative in a lot of markets. Could you just describe what has occurred that has caused the rapid increase over the last four or five quarters in those active as well as active customers and associates, and not necessarily in one specific market but appears to be on a global basis?

Is there something, steps that were taken, other than as you mentioned increasing the payout, or it does not seem like you constantly introduce new products, but there is not necessarily a brand-new product line. I am just curious what you would attribute the rapid increase to?

Again, another good question and one that is sometimes difficult to answer. If you are a regular retail scanner like Wal-Mart and you open up a store, you know what sales you are going to have per square foot. In this business where you are dealing with independent distributors, it is much tougher to gauge always their motivations and their actions. But what we do believe is that we have done a number of things that have been positive to the field.

About two years ago, for example, we started an independent distributor counsel we called the IDC. We felt that we were perhaps not communicating as well with our field as we could have. And so we introduced this counsel, and we have an individual here, one of our Vice Presidents, who spends virtually full-time talking to our field leaders about issues of concern that they have. Is our service adequate? What would be helpful? In thinking about this particular product, would that be important to you? Here is what our pricing ranges are thinking about.

Just trying to involve them in the process, and this has been a very helpful thing because they have clearly bought off -- for example, last fall we introduced a reformulated product, our flagship product called the Essentials. And we had been granted a patent about a year ago for a process that generates a very powerful antioxidant from all these byproducts. We knew we had to reprice this product, and we repriced it from about $35, just about $40, a rather significant price increase, but did have a new patented ingredient in it. We discussed this with our independent distributor counsel as to the reasons and logic and the powerful story behind this, and there were very supportive of that, and we just had no push back on that price change.

Also, I think our commission plan is a bit unique. I talked about it briefly. We do pay commissions weekly, and we pay them on a seamless basis, so that we have one commission plan in effect that crosses borders in any country that we are in. It's quite remarkable when you think about it that someone in Auckland, New Zealand who may have friends in Canada or Taiwan or wherever we are doing business, they can get paid each week the Wednesday or Thursday or Friday following the prior week sales. We think that is a powerful story.

Also, our software is such that this is a browser based system so that distributor in wherever Auckland we can say in, has real-time access. If they can get to the Internet, they can track their own organization as to which of their folds in their organization are doing something or maybe more important doing nothing that they can call or email or something and talk to it. I think that has been a big factor.

Also, we have worked very hard on our customer service issues and have just tried very hard to make fewer mistakes. We think that our customer service levels have improved and that we have made fewer mistakes. I could go on with a few other reasons that seem like it has been a factor in it, but it has been a combination of things. We have just been very pleased with that, and we are going to continue to work very hard to continue improving.

Do you feel that you are taking perhaps some sort of momentum here where you are taking distributors away from other companies that compete with you? Sort of one goes and the next one tells their friend and the next one tells their friend, and suddenly as you look at this quarter, you are up 35 percent, which is a phenomenal number.

That is certainly the way this business works. It is a person to person business, it is a word-of-mouth business, and that is clearly how we get customers. We think of our competition in two different ways. We want to provide the very best nutritional products and personal care products that you can buy, so there is that kind of competition.

The other competition in this channel is, as you say, to recruit independent distributors, and clearly we do recruit consciously and unconsciously people from other entities. In a survey we did not too long ago, I don't remember the exact number, so don't quote me on this specifically. But we found that most of our new enrollments were people who really had tried network marketing before. But it is clear that, for example, in Korea which we are just opening, we are certainly seeing people who have been associated with other network marketing companies. So it is a combination, and what we have tried to do is create a story of trust both in terms of products but in commission plan and longevity for those who are interested in pursuing this as a way to supplement their income and perhaps even do it full-time.

Scott Coleman.

One follow-up question. I think I missed what you guys were saying about guidance on the R&D line co-op and on the SG&A line. Could you just go over that one more time?

First, SG&A. What we are trying to communicate there is our SG&A line improved very nicely on a year-over-year basis coming in for the current quarter at -- let me make sure I get the right percentage here -- at 22.4 percent versus 26.7. What we are trying to communicate there is that we think, notwithstanding the growth on the top line, that we will probably run at that relative rate for the rest of the year because we've got this acquisition we have got to assimilate, and we have also opened a new office in Taiwan, a branch office, and of course, we still got some Korean opening expenses that will be in there. So we are looking for running at this 22.4 percent rate as we go forward.

In R&D, our goal there has been to be about at 1 percent. Now sales have been ramping fast enough that we have not been at that level. I would just say that our Vice President of Scientific Operations is also a very conservative individual. He is not one to throw money in things. He is one to think about it very thoughtfully, and unless he can see something that makes sense and has the potential for creating a marketable product or an improvement on an existing product, he is probably not going to spend the money.

But, nevertheless, our goal is to spend sufficient to make sure we have a good pipeline of products and reformulated products and that we are also very much up on the latest developments in the scientific community with regards to nutrition.

So in the past two years, '01 and '02, you have been just north of about $1 million. Do you think it will stay in that range, or is it going to continue to come down?

On R&D?

Yes.

I would think that the real thing to look at is we would think look for it to be close to that 1 percent. But the reality is with sales growing it will probably be more like in the .8 percent or something like that range. The big thing is we want to make sure that what we're doing is effective again and not just throwing money at the wall.

Frank Byrd, (inaudible).

Actually my questions have been asked.

Gary (inaudible).

Can you tell me what percentage of your revenues go to customers who are other than active associates or active preferred customers in the quarter? Can you comment or shed some light on what the trend in that percentage has been over time?

Let me make sure I understand your question. What you are asking is what percent of our revenues are going to people who are not active distributors or active preferred customers, that is what we would think of retail sales by our distributors. Is that your question?

That is correct.

That is a very good question. What we do know is that for the current quarter, for example, about 84 percent of our sales were to our associates as we define them, and about 16 percent was to our preferred customers. Now unlike some of our competitors, we don't track with specificity the sales that our associates make on a retail basis. So that if I am an active associates and I am buying products that I consume myself and I am probably buying a little bit of inventory to sell to others or to use in my processes of selling to others, USANA does not track those sales to people outside of our active associates, so I really don't know. We have some guesses that we use internally, but I would not want to put those out in public because we just don't track it carefully enough to give a meaningful statement.

Okay. Thank you.

Thank you, ladies and gentlemen. As there are no further questions at this time, I would like to turn the conference back over to Mr. Fuller for any closing comments.

Thank you for your questions. We continue to remain confident in the future outlook of USANA and the investment opportunity that we provide. If you do have any remaining questions, please feel free to contact us at investor.relations@US.USANA.com or call Riley Timmer, our Investor Relations Analyst, at 801-954-7100.

We appreciate your interest in USANA, and thank you for joining us on our conference call this morning.

Thank you, sir. Thank you, ladies and gentlemen. This brings your conference call to a close. Please feel free to disconnect your lines at any time.

(CONFERENCE CALL CONCLUDED)