USANA Health Sciences Inc (USNA) 2004 Q3 法說會逐字稿

Welcome to the USANA Health Sciences Incorporated third quarter 2004 earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Mr. Riley Timmer. Please go ahead sir.

Good morning everyone, and thank you for joining us this morning. Today's conference call is being broadcast live via webcast and can be accessed directly from our Website at www.usanahealthsciences.com. Following the call, a replay will be available on our Website. The purpose of today's conference call is to discuss financial results for the third quarter 2004. 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 predicted in such forward-looking statements. We caution you that these statements should be considered in conjunction with the disclosures, including specific risks factors and financial data contained in the Company's most recent filings with the SEC. I'll now turn the call over to Gil Fuller, Senior Vice President and CFO of USANA.

Thanks Riley and good morning and thank you for joining us today to review USANA's record third quarter results. Joining me on the call today is Dave Wentz, our President who'll discuss our recent business activities. This morning, I plan to update you on USANA's continued strong progress achieved in the third quarter and update our guidance for the remainder of 2004 as well as provide initial guidance for the full year 2005.

Yesterday, for the ninth consecutive quarter, we reported record sales. Our operating margin reached a record, both in absolute dollars and as a percentage of net sales, and diluted earnings per share were also at record levels. For the third quarter of 2004, net sales were $68.7 million, an increase of 30.8 percent, compared to the $52.5 million reported in the third quarter of 2003. On a constant currency basis, sales were up 27.7 percent year over year. The 30.8 percent sales increase was driven by double-digit growth in all of our markets except for South Korea. This growth was in tandem with the continued increase in our associate Preferred Customer numbers. Our total active associate count increased to 111,000, up 27.6 percent from 87,000 at third quarter of 2003. Our continued increase in active associates has been bolstered by recent openings of new markets in Singapore in November of 2003 and most recently in Mexico in March 2004. At our International Convention in mid-September we relaunched our personal care line. Demand for the launch of our newly reformulated Sense line was higher than anticipated, and due to this some of our products sold out and we were not able to ship all our orders before the end of the third quarter.

Cost of sales in the third quarter increased as a percentage of net sales to 24.4 percent, compared to 21.6 percent in the third quarter of 2003. The resulting reduction in our gross margin was driven by 2 factors -- increased third party sales at our Wasatch's operations, which has significantly lower gross margins than our direct selling business, and an increase in our valuation provision for our inventory obsolescence of our old skin care products. You may recall that we launched a reformulation of the skin care, the Sense skin care product line, with new patent-pending, self-preserving technologies that allows the formulation of our products without adding paraben preservatives. This launch resulted in some obsolescence

of existing Sense inventory. We expect that we'll see modest improvements and consolidated gross margins in the fourth quarter of 2004. Excluding Wasatch sales, associate incentive expense in the third quarter was 39.9 percent, compared to 39.2 percent in the third quarter last year. In any given quarter, our associate incentive expense may be up or down slightly, but we believe that the associate incentive in the fourth quarter as a percent of net sales will be consistent with the third quarter. I commend and express appreciation to our thousands of associates throughout the world for their efforts in successfully growing the USANA business.

Selling, general and administrative spending decreased, relative to net sales, to 19.1 percent during the third quarter of 2004, compared to 22.7 percent in the prior-year quarter. This can be attributed mainly to operating leverage we gained on our increased sales base as well as relatively lower SG&A expenses at Wasatch. We expect SG&A in the fourth quarter to be higher due to Sarbanes-Oxley Compliance, anniversary celebrations being held in our international markets, and expenses related to investing and preparation for the development and opening of our next international market in 2005. As a result of these line items, we reported record operating income for the third quarter of 17.7 percent, compared to 16.2 percent during the third quarter of 2003. We continue to gain operating efficiencies as we leverage our growing sales base as well as the investments (Audio Gap) that we have made over the past several years in our physical and information infrastructure systems.

Now, let us look at the bottom line for a moment. Earnings per share increased in the third quarter to 39 cents compared to 28 cents in the third quarter of 2003. This represents nearly 40 percent growth. Earnings per share was positively impacted by 1 cent in the third quarter due to a one-time tax benefit from the use of research and development tax credits. On the flip side, EPS was negatively impacted by about 2 cents due to our foreign currency hedging instruments used to limit our WAN side exposure.

Now, turning to the balance sheet for a minute. Cash and cash equivalents increased in the third quarter to $21.4 million from $19 million at year-end and $13.8 million at the end of the second quarter of 2004. Inventory in the third quarter increased to $16.2 million compared to $14.1 million at the end of 2003 and $13.6 million at the end of the second quarter of 2004. The increase in the inventory is due to higher net sales and the build up of inventory associated with the relaunch of our newly reformulated Sense products. In regards to share repurchase, we were active buyers of our stock again in the third quarter, purchasing approximately 236,000 shares, an investment of $6.8 million. This works out to be an average price per share of $28.56.

For the first 9 months of 2004, we have repurchased a total of 760,000 shares, at an investment of $21.7 million. For the nine-months period, the average price per share works out to be $28.50. We have 240,000 additional shares that are authorized for repurchase under the current plan. We continue to carry no debt on our books and have minimal receivables as a result of our primary business model. Now, looking ahead to the remainder of 2004 and reiterating the guidance that was updated in yesterday's press release, we still expect net sales for the full year 2004 to approach $270 million. We previously announced that we expected earnings per share for the full year 2004 of $1.42 to $1.44. Now, we expect that earnings per share will be as much as $1.46.

In addition, we are offering our first look at 2005. We believe that we can grow sales in 2005 between 15 percent and 18 percent, which includes revenue from the opening of 1 new market by the end of the third quarter of 2005. We expect earnings per share to expand and grow between 20 percent and 25 percent. These preliminary 2005 estimates exclude any potential sales that were developed from entering into Mainland China. I will now turn the call over to Dave.

Thanks Gil. Good morning everyone. Gil mentioned that the third quarter marked the 9th consecutive record quarter for sales. I think an important factor in that is you saw us achieve double-digit year-over-year growth in each of our markets, except South Korea, our smallest market, which we launched at this time last year. North America continues to see excellent growth, with US up 25 percent and Canada up nearly 17 percent on a year-over-year comparison. In mid September, we held our annual international convention in Salt Lake City. We have record attendance at this year's convention; we also have record product sales of $1.7 million. While this convention was the largest ever, the net cost of this year's event was lower than in the past, this is because of the recent acquisition we made of FMG media productions, which was the key ingredient in putting together the best convention ever.

The convention was highlighted by the announcement of the reformulation of Sense, our innovative and a positive skin and personal care line. Sense is the first major skin and personal care line that we know in the world to implement the science of not adding parabens to preserve its products and still maintain a two-year shelf life. Parabens are showing up more and more in the press with studies suggesting potentially harmful effects. Our competitors have no other choice than to use parabens or even worse for mal to high-producing preservatives. We believe this breakthrough in preserving technology puts us in an excellent position to differentiate ourselves and increase market share. In the next couple of months, the new Sense products will be launched and available in all of our markets. We are very optimistic about the new self-preserving technology and we believe that we will begin to see the benefits of the relaunch of the Sense line by the end of the first quarter of next year. We believe, we now have a differentiating skin and personal care line that will attract a new category of Associates, who are focused on building a home-based business through the use of Sense. We saw the direct selling business model has proven it successful and include the focus on our leaders, targeted promotions, capitalizing on technology, and commitment to core products. Growing and retaining leadership is the key initiative we focused on each and every day. The success of any market is based on how successful our leaders can become. Our job is to create the tool necessary to allow our leaders to become successful.

We work with our Associates to develop DVDs, flip charts, and other audio/visual material that helps them in their daily recruiting and training activities. This is done for every market and in every language where we conduct business. Maintaining operational excellence is also very important, which we saw as business model. When one of our Associates puts his or her reputation on the line and recognize USANA products, we must always commit to doing our product, which means providing the best customer service, by filling orders on time, and insuring product quality, and satisfaction. We are committed to providing great service to our Associates for our most important customer. While our international development team is working on future market expansions, we remain focus and dedicated to growing our presence in the markets we currently serve. We believe there is significant opportunity for growth even without international expansion. It is very encouraging to see growth in areas such as Wisconsin and New York, 2 areas where we historically have had little market penetration. As far as new market openings, we look forward to updating you on our plans for entering new markets. However, as a general rule, we typically do not announce the name of the market until 3 to 4 months prior to opening.

Concerning China, our time frame for opening China remains uncertain because of the regulations that will govern network marketing in the region have not yet been finalized. We hope that the new direct selling regulations will be finalized by the end of the year, but there are no guarantees that this time frame will be met. Once we have had a chance to digest the changes, we will make a decision about that market. We are pleased with the progress we achieved and we will continue to focus our efforts on building and strengthening our Associate base for growth and success in the years ahead. I will now turn now the call over to the operator to facilitate the question and answer session.

(OPERATOR INSTRUCTIONS). Scott Van Winkle, Adams Harkness.

Congratulations on a good quarter. A couple of questions. First, the gross margin was down a little bit sequentially. Could that have been a write down of the old Sense product or could you lead me in the right direction as to why it was a little weaker?

Scott, this is Gil. Yes, that was a factor in it, clearly the -- providing toward some of the lessons that we were going to have there was a factor in that margin.

Okay. And it looks like the sales -- the contract manufacturing sales were down a little bit sequentially. I assume that kind of benefited the gross margin a little bit. Was there anything else in there that was a bit down or was it all the product write down?

It was primarily the product write down. There was another element there, I mean, this was our -- really our first effort in producing our entire Sense line. There was such and as you can imagine, there was a typical kind of early aspects of being on the learning curve there. So, we expect to see some progress as we go forward. Scott, I think as far as the third-party business being down there, we are okay with that because, as you know, we didn't acquire this company to get the contract-manufacturing business. And so, what happened is that, that our business is beginning to dominate there and we do look forward to margins to improve this week, get more efficient at the new process and processing our own skin care line.

Okay. And I know you guys were really rushing to get the product to convention on time. Was there any problem with manufacturing post convention?

Well, we had a few minor things. I think it is rather typical of -- when you launch something new, you end up with maybe a certain container -- certain package element like a certain or something being delayed and are not being in quiet. We had a few minor things like that got in our way. But overall, I think we are making good progress here. We have got these launches in our other markets now scheduled right one after another. And so we went from producing the North American product into the Asian products and that process, it's a very tight schedule, and so there is some efficiencies related to that.

All right. Inventory availability of the new product line will be up markedly, I would assume in Q4 from Q3?

Yes. I think we will be through all of those issues by the end of the quarter, fourth quarter we should be on top of our gain completely and not have the tight deadlines that tend to create some modest inefficiencies.

Okay. And which currency was the primary contributor to the hedging loss?

That was -- the Canadian dollar was the major one. Our hedging strategy is kind of interesting, I think we are glad we have it in place. The way the accounts make a deal with the issue, you have to mark these things in market. We are hedged out to February, which is generally kind of the 6-month time frame that we go out and normally. And yet, to mark-to-market as though they were all realized today, and of course these are all unrealized losses that are shown there. If the currency stays strong, we should correspondingly have higher sales in each of these months as we go out. So, it's a little bit of a mismatch in my mind, but that's currently the way we have to account for.

Okay. And the SG&A was down sequentially. I know you had talked about that having a conventional coordinator in-house helped out a lot. I assume that was a more of a year-over-year impact. Was there a reason for SG&A to be down sequentially?

Yes, a bit. You may recall that in the second quarter, we terminated 3 of our General Managers. One in Taiwan, one in Korea and one in Japan. And so that second quarter had some severance and related costs to that severance, extra travel, so forth for some of us who were involved, and we did not have that in the third quarter. And in addition, I think one of the nice things about this FMG acquisition is that we put the net convention cost in our SG&A line, and we had the lowest net convention cost, at least as I have been around, on convention in the third quarter. And so, we were pleased with that, that also had an impact on the SG&A line. Those two things, I think are the primary.

Okay. I'll come back. Let's see whether -- let someone else ask questions.

David Block, The Seidler Companies.

You went for another very solid quarter. I have a handful of questions. Let me start with some income statement and modeling questions. The tax rate this quarter was down roughly 300 basis points sequentially. What should we expect to see in the fourth quarter as you guys make, I guess your adjustments are being multinational ?

The third quarter has impacted as we mentioned by about a penny per share by one-time R&D tax credits. We had undertaken a study, third quarter, the results came back, we were able to benefit from that. So, that -- the fourth quarter would be back up, and whereas now -- estimated now about 33 percent tax rate in the fourth quarter and then going into next year, there's some law changes that are potentially out there, and we estimate this right now, but next year we would be probably looking at 34 percent.

Okay. With respect to Wasatch, in a response to a question last conference call Gil, you gave a 2 to $2.1 million figure as the appropriate run rate for the division, and this quarter, you guys obviously clinched . Will you still be modeling $2 million run rate for Wasatch or how should we go about looking at this division?

Our guess right now is it might be closer to what we reported in the current quarter. I think one of the things that has happened is these third parties have seen our ultra-clean facility there and their business is, they tend to like what they see there. So, we've got a, I think probably look to see that number being closer to what the current quarter was than what we had thought when we commented in the last conference call.

Okay. And staying on Wasatch for a moment, you mentioned that demand outstripped supply in the quarter for the reformulated Sense line. Can you speak for a moment about production capacity at Wasatch as it relates to the new line, and also I don't know if it could be quantified, but how many dollars of business can be done with the new line when that storey is running in full capacity?

Let me take a step of that, maybe Dave can chime in too. First on capacity issue, I think we are running a couple of shifts over there right now. And, we've got some other equipment on ordered as, that is not in yet, some filling equipment. But at this moment of time, the new Sense line is a bit of unknown for us. It has been enthusiastically received. We've been quite pleased with that. We're very optimistic about it. So, it's tough for us to right now to say just how much this is going to mean to us, going forward, very pleased, very optimistic about it. But, we don't believe we're going to be constrained by capacity. Once we get caught up and have successfully got products in each of our markets, one of the challenge right now is to get markets on -- products on airplanes -- that is for these markets, and you know and the other-- in Asia for example, to coincide with their launches of the product, which by the way those launches should be done by mid-November. And, but we don't anticipate being pinched on capacity.

Okay. And one more quick question is with the reformulated line, is this is a higher margin product than the old Sense line, and did you raise the price point on the new line?

It's a little bit tough to compare because a lot of things change, their size or something change and so forth but the margins are pretty well consistent with the old Sense line, maybe down ever so slightly. We also tipped up the volume points up a bit made that a little more attractive for our field force. Overall, we think our absolute margins are to benefit from the changes that we've made.

Doug Lane, Avondale Partners.

Question on the backlog. Can you quantify what the backlog on Sense was at the end of the quarter and have you shipped all that by now?

Doug, it was in the order of about -- on Sense was about, I'll say 300,000 or so. But in some cases it kind of actually a little hard to quantify exactly, because in some cases we have the orders that we had in addition to Sense on them, had our regular traditional products and we hope to some of those orders as well. So, its probably overall as in, deferred revenue, I figure that is the question you are getting at, but probably bit higher than it.

Yes, that's exactly what I was looking for. And can you quantify how much of your Sense is made in-house now? And will it be all by 2005 full year?

Yes, it will all be made in-house. Before to get it all done and shipped over to Asia and getting a supply chain full in. We'll be in house along with our third-party manufacturing.

And Gil, you mentioned the 34 percent tax rate, which is consistent with the tax rate earlier this year. Will you get a benefit if this new legislation passes, is that 34 percent not assuming the new tax legislations?

Yes, we're analyzing that right now as we're starting our budgeting process for after 2005 and it is just too early for us to comment Doug. So, right now, we're thinking that we'll probably start out with 34 percent then as it becomes clear, as to how it is going to impact us, is a manufacturing credit possible, it is, the number of things going on at work. We are not sure what the full impact will be on us, yet.

So, the bottom line is until it's actually passed and you got a chance to look at it. You just not making any assumptions at this point?

Yes, I think we'll just go with the 34 percent for next year.

Can you give me what capital spending and depreciation or amortization it is looking to be for the full year in '04 and '05?

At the '04 we're likely to be around CapEx of about, Dough, Gil you are going to have to fill for me -I am going to have to maybe look -- at, probably around 7.5 to 8 million, something of that sort. And depreciation is running about 1.2 million a quarter. Next year in the process of putting our plans together, and that is an on-going stuff, there is the normal stuff that would likely be in the 6 to 8 million kind of range. However, if we get into a new market where the requirements are such that we had the manufacturing and overseas location, something that could change that. That's way speculation at this point. We have no idea about that yet.

Right, well clearly China likes to have bricks and mortar on the ground. Have you done any on what you think a factory would cost there to handle your anticipated volume or just way premature?

It's way premature, don't you think Dave? There are a number different ways to go into China. We're looking at a whole bunch of scenarios until we pick one.

We have no idea what that cost will be.

And lastly, I've been noticing that the productivity of your associates, the active associates, the number was very strong, your growth is very strong on the associate front but the revenue for associates seems to be softening here. It's not just the new markets but even the older markets like the US. Can you give us some color on why that number seems to be going down, I'm talking specifically about the revenue for active associates?

I think in large part it is due to -- actually I think there is some seasonality here. We tend to see in the third quarter, which is kind of the summer quarter if you will, some modest variations in that. But we are not -- we don't look at it in quiet those terms very much. To be honest with you, we tend to focus on the active number of associates that is the leading indicator. We do notice that we see some ups and downs, fluctuations over the longer term. If you go back 8 or 10 quarters we've made some modest progress, and I guess -- in my case I am certainly not concerned about that math that you've done to get out but I did see your email run out this morning.

Okay. Yes, now just from a modeling perspective I just noticed that because I use that obviously to figure out revenue line. It just struck me that that number was coming down, it is not I think -- it's my math that was basically flat but it had been up a little bit. I didn't know that was just a function of rapid growth in associates, which you are seeing, or if there is a product mix shift going on here that we should know about?

No. I think it is normal kind of little fluctuations that we -- we didn't track that number but we are not changing anything on our own forecasting model because of what we saw in the third quarter.

Scott Van Winkle, Adams, Harkness.

With the exception of China with market of its own, what are the -- can you just run through again what the economics of the new market are both in SG&A up to and including the first quarter of launch and what type of spending levels -- I know there are big markets and small markets but may be if you could just give us the average?

Well, let's talk about Mexico. Maybe that's the most recent one that we opened. That typically -- we always look in for ways to leverage our basic SG&A that in Mexico we may be spent in terms of facilities that is leasing the facility, the cubicles, and computers, and phone switches and that kind of things, it is typically -- I don't know -- may be a million dollars in terms of just basic underlying staffing, you've got working capital for inventory on that which is typically may be -- you can try that. Have a little extra there and then work down once we see how things are going but you are probably in there for a couple of million of dollars kind of thing. In the case of Mexico, we were able to leverage on our call center here in -- across 2 call centers here in Salt Lake City agents by design, and so we take a lot of those calls here and they dial a local number there in Mexico and it rings here, we are able to have those orders printed out there on Mexico facility. So, we are always looking for things like -- that we can do to leverage that. In the case of Mexico, we opened as you recall in mid-March, and so we obviously work positive in that first quarter of -- the partial '04 I should say that we had there in the first quarter this year. By the second and third quarters, we were doing just fine and we had positive impact. Other markets take long -- as you know Japan has taken us where we are making progress there and Korea has been a problem for other reasons but most of the time by the second and third quarter we are doing pretty well in those markets. That is where we are positive cash flow and positive on operations.

There are no further questions at this time, and now I'd like to turn the presentation back over to Gil Fuller.

Well, thank you for your questions. And thanks for joining us on our conference call this morning. If you do have remaining questions, please feel free to contact us at investor.relations@us.usana.com or call Riley Timmer, our Manager of Investor Relations at 801-954-7100. Thanks again.

Ladies and gentlemen, thank you for your presentation. This concludes your conference call. You may now disconnect.