USANA Health Sciences Inc (USNA) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter one 2005 USANA Health Sciences earnings conference call. My name is Anika and I will be your coordinator for today.

At this time all participates are in a listen-only mode. We will be facilitating a question and answer session towards the end of today's conference. If at any time during the call you require assistance, please, press star followed by a 0 and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to the host of today's conference, Mr. Riley Timmer. Please proceed, sir.

Thank you. Good morning, everyone. Thank you for joining us to discuss our first quarter results.

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 web site.

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 our company. Those statements involve risks and uncertainties that can 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.

Also during the course of this call, management will discuss non-GAAP information. An example of a non-GAAP measure we provide is customer count data. We provide this and other non-GAAP measures to assist investors in understanding our operating performance.

I will now turn the call over to Gil, our CFO of USANA.

Thanks, Riley, and good morning, everyone. Thank you for joining us to discuss USANA's record first quarter operating results.

I am here this morning with Dave Wentz, our President, who will address you shortly. This morning, I plan to update you on our record financial results, which stem from the operational progress we achieved in the first quarter, and also talk about our guidance for the second quarter and full-year 2005.

In terms of first quarter results, net sales for the quarter came in as expected. We reported record net sales of $76.6 million, an increase of 24% compared with the $61.8 million reported in the first quarter of 2004.

Our sales growth in the quarter was driven by a couple of different factors. First, the number of active associates increased 24%, in line with percentage increase in sales. And the number of active preferred customers increased by 20% during the quarter.

Second, the reformulated Sense product line continued to be a key sales driver in the quarter, improving from 13% of total net sales in the first quarter of last year, to 16% of net sales in the first quarter of 2005.

Additionally, sales were positively impacted by foreign currency, which added about $1.9 million in comp and currency to our first quarter revenues.

Our recurring revenue stream for monthly auto ship orders continues to be strong, representing 55% our total product sales during the quarter. This number has remained very consistent over the last two years at 55% of product sales, which is significant given the rapid expansion we've enjoyed over this time period.

Earnings per share for the first quarter increased to $0.45 compared with $0.30 per share in the first quarter of 2004. We were pleased with the operating leverage we achieved during the quarter which allowed us to reach EPS growth of 50%. The first quarter earnings per share were calculated based on a tax rate of 35%, an increase from the 34% tax rate that was communicated during our February conference call. In addition, for comparison purposes, it is important to note that during the first quarter of 2004, we had higher than expected costs relating to the opening of our operations in Mexico.

Our gross margin in the first quarter of 2005 increased as a percentage of net sales to 76.5%, an increase of 90 basis points compared with 75.6% in the first quarter of 2004. Sequentially, gross margin was up 160 basis points from 74.9% in the fourth quarter of 2004. The year-over-year improvement in our gross margin was primarily due to a change in sales mix to products with higher gross margins, improved margins at Wasatch, and modest gains from operating leverage on a growing sales base. Also, if you recall, the first quarter of 2004, we were dealing with integrating Wasatch, which had a negative impact on gross margins in that quarter. The sequential improvement in gross margins can be primarily be attributed to the following -- fewer sales from the contract manufacturing third-party business which has lowered gross margins; no liquidation cost in the first quarter associated with all Sense inventory; and other general cost improvements. Looking forward, we expect gross margin in the second-quarter 2005 as a percentage of net sales to be approximately the same as the first quarter, as many of the anticipated efficiencies have been achieved in the first quarter.

Associate incentive expense in the first quarter excluding our contract manufacturing segment sales was 39.6% compared with 39.2% in the first quarter of last year. We believe that associate incentive expense on a direct sales segment will be approximately 40% of net sales in 2005, but could fluctuate a few basis points based on the timing of different specials and promotions that we offered our associates throughout the year. Selling, general, and administrative spending decreased relative to net sales to 19.4% during the first quarter of 2005 compared with 21.5% in the prior year quarter. The year-over-year quarterly improvement can be attributed to the operating leverage gained from our growing sales base. We expect SG&A in the second quarter as a percentage of net sales to be approximately the same as the first quarter. As a result of our marketing efforts to increase Sense sales and drive demand, we anticipate that any operating leverage we might otherwise have achieved in the second quarter will be largely offset by the associated marketing expenses. Additionally, continued preparation for our new market opening will add to our SG&A expenses in the second quarter.

First quarter operating income was 17.7% on net sales. This is an increase of 270 basis points over the first quarter of 2004 and an increase of 140 basis points compared with the fourth quarter of 2004. We were extremely pleased with our operating results in the first quarter.

Taking a look at the balance sheet for a minute, our inventories in the first quarter increased by approximately $5 million, which in large part was the result of the build-up of our Sense products.

Now before I turn the time over to Dave, I will comment on our future guidance. To reiterate the guidance that was provided in the press release, We expect net sales in the second quarter 2005 to be between $78 million and $80 million, which is an increase of up to 19% over the second quarter of 2004. Note, that during the second quarter of 2004, we experienced initial benefits of a successful opening of the Mexico market, which now effects the year-over-year comparison. We expect earnings per share in the second quarter of 2005 to be $0.46 to $0.47, an estimated increase of 31%. We remain very optimistic about the full year 2005 and reiterate the net sales guidance we provided in February of 2005 of growth between 17% and 20% compared with 2004. With this growth rate, our net sales for 2005 will likely be between $319 million and $327 million. Given our improving margin trend, we are raising our expectations for earnings per share for 2005 to be between $1.85 and $1.90, up from $1.81 to $1.88. With the recent ruling from the SEC, we will now begin expensing stock options in the first quarter of 2006. We believe that earnings per share impact in 2006 will be approximately $0.02 per quarter.

I will now turn the time over to our President, Dave Wentz.

Thanks, Gil. Good morning, everyone.

The first quarter of 2005 marked the 11th consecutive quarter of record sales for USANA. We were particularly strong in Taiwan, with sales up nearly 36% year-over-year and up over 13% sequentially. Our Singapore market also had excellent growth in the first quarter, growing more than 54% compared to last year's first quarter. In addition, North America, which includes Mexico and our most mature markets, U.S. and Canada, sales were up 22% compared with the first quarter of last year. We are encouraged to see more and more associate leaders in these markets drive our growth.

We continue to be very optimistic about the new sampling concept that we introduced to our associates at our convention in mid-September. The Sense Prelude, which contains a five-day sample of each of our skin care products and the Sense Flash Sensation, which contains a five-day supply of our hair and bath products continue to be key in driving the enthusiasm for our reformulated Sense products. We remain excited about the new sampling concept as demand for these sample packs continues to grow.

Demand for our Sense products continues to be very strong. Sense product sales increased from 13% of total product sales in the first quarter of 2004 to 16% of total product sales in the first quarter of this year.

Regarding our supply efforts for Sense, at this point we are nearly at full supply in all of our markets, and as you can see from looking at our balance sheet, we have brought in significant inventory to reduce the risk of out of stock situations in the future. Now that we have believe the supply issues are behind us we will begin our marketing push and start promoting and building awareness of our new self-preserving technology.

As you know, our marketing efforts are a bit different than your traditional retail consumer products company. Our efforts will start with our associates.

First, we are training our associates on the new product and have introduced a new spa party concept and believe that this will facilitate more awareness for Sense. We also will begin holding contests to reward and motivate those associates who are building their business with Sense.

Secondly, we are making a push for building awareness for Sense and the technology behind it. We received significant interest from editorial staff at major health and women's publications and believe that news of the positive benefits of our formulation will be published in one or more of these major media outlets.

Finally, we will continue our focus on selling samples of the Prelude and Sensation trial size products.

We also continue to look at different options for marketing Sense, and if the need arises we may increase marketing spending in an effort to profitably grow the top line.

Although we are currently focusing a significant amount of effort on promoting Sense, our core business remains in nutritional supplements. Our associates are well-versed and interested in nutrition. With the current focus on Sense, we will be teaching the importance of outer nutrition through Sense and our nontoxic technology, as well as inner nutrition through proper diet and supplementation. Our company was founded on the basis of providing only the highest-quality products that are proven to be both safe and effective. Sense offers the same high-quality as our nutritional supplements. We believe that the demand for and positive feedback on our Sense products illustrates our success.

Before I touch upon our strategy for China, I would like to give you a few thoughts about our new market growth strategy in general. As was announced in our press release, we plan to open one new market before the end of the third quarter. We will make an announcement as we get closer to opening that market for business. Although international expansion continues to play an important role in our overall growth strategy, we will continue to focus the majority of our efforts on further penetration of our existing markets.

Moving on to China, China remains a market of significant interest for USANA. Currently we have a staff of three in Shanghai who are focused on issues related to legislation, local manufacturing, product regulatory approval and distribution strategy. This team is supported by our general manager east Asia as well as regional finance, marketing and operation managers, all based in our Hong Kong office. Our International Development team led by our Vice President of International continues to prepare for the potential expansion into this key market.

The major barrier to market entry in China at this stage is the legislative environment. USANA awaits the eventual implementation of the new direct selling laws. The current pilot program approved for one of our competitors to begin direct selling is of limited value to USANA, as well as other players in our industry, as it limits a company to single level direct sales carried out by direct employees of the Company. This model is inconsistent with the mode of direct selling, which has made USANA's direct selling model successful on a global basis.

We continue to lobby as part of the Direct Selling Association to have a direct selling law passed which adheres to the tenets of the World Trade Organization. USANA believes that China is a significant opportunity despite these challenges. We are committed to fully exploring the means by which we can enter this market. The Company is prepared to make the investments necessary to establish manufacturing capacity and distribution outlets consistent with the new proposed legislation. However, we would like to make these commitments in an environment which allows us to implement a direct selling model which is as consistent with our global model as possible.

That being said, USANA is prepared to make required modifications to its model which will allow us to gain a foothold in China, begin establishing our brand, and move up the learning curve in this complex market. It is our belief that [mopcom] is getting closer to making a final decision on the direct selling regulations; however, we are still unsure of the timing of these laws. We believe that soon after these final regulations are published we will have a formalized go to market strategy ready to be implemented.

I will now turn the call over to the Operator to facilitate the question and answer session.

[OPERATOR INSTRUCTIONS]

Gentlemen, stand by for your first question.

Our first question comes from the line of Scott Van Winkle of Adams, Harkness. Please proceed.

Congratulations on another great quarter. A couple of questions. First, an easy one here. On the contract manufacturing, what are you expecting now, going forward? Should we use this $1.9 million run rate as kind of a base case for the modeling?

Yes, Scott, that is -- I think that's probably a way to look at it. Obviously, we want Sense to take priority there, but there are some decent opportunities out there that we will take advantage of as they present themselves.

Okay. And so you don't expect that business to ultimately go to zero. You are just going to do it when it is available?

I -- I don't expect to build it to zero. I think -- Obviously, if the demand for Sense were to explode, and we were capacity constrained for a while, that would take -- that would be our priority. But it is nice to have a business that can fill the valleys when we have them. And so we -- we would expect to service those customers that we've got and as capacity and time allows, improve the margins on that business and even perhaps seek some new business if the capacity is there.

Okay. And on the Sense sampling program, how broad have you used that? I mean the last quarter you talked about the Australian convention. How broad has that sampling been implemented in Q1?

We have got it in a number of our markets. This is Dave Wentz. We have got a majority of our markets now using it. Some don't have it yet, but are very close. So it hasn't fully implemented in all of our markets yet at this time, but we are very close.

Okay.

We have our full-sized products in all markets, it is just the sampling products did not have priority over those. So they took -- they have been coming in a little later.

Okay. And what's the plan on South Korea?

Let me try that, Dave, if that's all right. I -- I think what we've been doing in South Korea -- or know what we have been doing in South Korea -- we have been resizing that operation to have -- to let us -- the cost structure to fit the revenue structure. And at this point, I think starting here in the second quarter, we will have that on a basis where it won't be a drag on end count. We have to very that it is a market that has some significant potential if ever the market there in general can get legs under it. I think we are starting to see some -- some steadiness show up there, and it will be interesting to see how that plays out. But it shouldn't be a drag on us going forward.

Okay. And a couple of other International markets -- there was a nice acceleration in Taiwan and Hong Kong was pretty strong as well. Is it possible that your distributors there are kind of anticipating mainland China down the road and starting to get a little more excited?

That's a possibility, but in general, our Chinese group has just been strong overall, even before talks of China arose. They -- they are going -- a growing amount of leaders coming out of the China group that we have. So they are just great entrepreneurs and great networkers.

Okay. And the last one, Gil, did you imply that the tax rate should be 35% going forward or just for this quarter?

No, it looks like it will be 35%. You may recall in our February conference call, we had estimated our -- our '05 tax rate to be 34%. Now looks like it will be 35% this -- let's see, ETI, the -- the Extra-Territorial Income rules have changed, and now there is a manufacturing exemption that is being developed. And it looks like that will be a bit of a negative for us. But we will be looking very hard at ways to minimize the impact, of course. But we are using a 35% tax rate.

Thank you.

Our next question comes from the line of David Block of The Seidler Companies.

Hi. Good morning, guys. Congrats on another strong quarter. First question, I just want to clarify one thing. Gil, you mentioned that associated incentives would run at 40% of sales this year. Was that -- that's ex-Wasatch, I am assuming?

I think what I tried to say was that would relate to our direct selling.

That's what I thought. I just wanted to make sure. Okay. Of the Q1 inventory, was all of that Sense or were there some other -- some nutritionals built in there? Was the majority Sense build-up?

Yeah, about half of it was Sense, but there were also some nutritional elements built in there. There's been some -- a few supply issues. When we get an opportunity to get supply in a couple of these raw ingredients, we have taken the opportunity to do that.

Okay. And then -- I am still trying to get out the dollar capacity of Sense that you can produce. Let's assume running full shifts in the current facility. Do you have any idea of the number of dollars that can be produced in Sense?

Well, we've got Fred Cooper here, our VP of Operations. Fred, do you have a feel for that question that David asked?

Yeah, if we keep our current OEM business that we have, we can still double capacity of Sense and -- and maintain our third-party business without going to a third shift, 24 by 7.

Okay. Great. And this final quick question. Is -- on the raw material market, various checks that I ran throughout the quarter indicated that there were a couple of raw material costs that were up pretty big, CoQuinone up 300% year-over-year in Q1 and Glucosamine drove prices up 100% over the same period. I know that CoQuinone is a popular seller for you guys and that several of your products has CoQ10 baked into them. Are you anticipating raising prices on your CoQuinone products? Or any other product that has CoQ10 baked in? And if not are you making any money on those sales and to that matter, Procosa sales?

Dave, this is Gil. I will try that and then have Fred come in on the supply issues and so forth. We are certainly looking at the pricing side of a couple of these products and we don't like to do the yo-yo thing with our field force, and we try live with it while we can. But having said that, we are not afraid to go out there and deal with the pricing issue. But we are -- we've talked to our field leaders on the pricing issue on a couple of these products. If it looks like these price also be long term, you know, structure -- underlying cost structure change, permanent change, we will address -- we will go ahead and make a price change on it.

Okay. What is your feel for CoQ10? It is kind of outrageously up over the last three to six months. Do you see that as a longer term issue with what's going on in Japan? What is your feel for that?

This is Fred Cooper. From the supply side of CoQ10, actually, we believe it is a temporary restrain in terms of capacity for the providers; however, I don't believe that the price of CoQ10, albeit it is much higher than it used to be, will ever fall to the prices they used to be at. Having said that, we can always get it. It's just a matter of paying the price.

Dave, this is Gil again. You asked if we are making money. Yeah, we still have a gross margin -- not what we would like it to be, quite honest, but we are still doing okay, as you can tell from the over all results.

Absolutely. Maybe one more pricing question. You indicated that the third-party contract manufacturing sales at Wasatch, you would be committed to unless demand kind of made it necessary to just go full throttle on the reformulated line. But looking at it maybe from a different perspective, given that you spent a decent amount of money upgrading Wasatch to a pharmaceutical grade facility, which presumably adds a lot of value to your contract manufacturing customers, is there an opportunity to raise prices on those customers to capture some margin from those value-added services that you provide?

This is Fred Cooper again. In conjunction with our strategy with OEM business, it is our intent to maintain first, the supply of USANA products out of Wasatch. Excess capacity then will be limited by price. We will continue to raise the price on our OEM business as we go forward to make sure we operate at an optimal production capacity while getting advantage of the best margins possible.

Okay. Great. So that $2 million in third-party contract manufacturing sales, albeit it is a small piece of sales, we should see some improved margin there. Great, thank you very much.

Our next question comes from the line of Doug Lane of Avondale Partners. Please, proceed.

Hi. Good morning, everybody.

Good morning, Doug.

Just to follow up on that line of questioning. Gil, can you give me just in general -- you mentioned the high-gross margins, but as a percentage of your cost of goods, what are the nutritional raw materials as a percentage of the cost of goods sold?

Doug, can you -- our controller -- our VP of Finance here -- Doug, you're a little closer to that number.

So raw materials is a percent versus conversion cost?

Yeah. I mean -- And nutritional raw materials, not Sense.

Are you talking relative to the inventory value or what percentage of cost is makes up?

What percentage of the cost of it is sold.

At a -- as a general rule -- Gil, correct me if I misstate her. We're about 80% of the cost of our products is in raw materials and then you go back and apply that proportion to what the nutritional is to make up on the sales line.

Okay. Thank you. Second question on China, Dave -- as I understand it, the model that Avon is testing is a model that the government has preliminarily approved for the direct selling laws in China and you indicated that it wasn't very favorable in terms of your current global model. Does that mean that if these current direct selling laws are enacted that you will not be interested in entering China under those regulations?

It will be very difficult for us to do our business under these current laws, but one good thing that has come about from Avon getting to this point is because of it, people are making a lot more noise and lobbying a lot harder. So actually having them come out with this first has given a lot of voice to the opposition, and we are hoping that it may actually help us get more of what we wanted than we were going to get without Avon getting this little bit of a jump due to the connections with the government. So we think this might actually benefit us in getting closer to our model.

I think specifically three things that would be key would be using independent agents, selling away from fixed locations, and then having a multilevel compensation scheme. As I understand it, the multilayer compensation scheme is the one the government is resisting the most. If that is not part of the direct selling, is that a show stopper?

If we can't find a way to set it up to reward our distributors in a method similar to what we have, yeah, it is going to be a big barrier. We aren't experts at single level. And it would be a whole new business for us that we will have to approach very carefully to make sure that we didn't think we -- just because we had done well in other markets with our existing model we could become a different company in China and still be successful. So it would be a very cautious approach if we had to change that much. There is so much opposition now to what Avon is doing. None of the other companies -- I can't say none, but most of the other companies are in our boat, so they have gotten very loud because multilevel is crucial.

And I think, Doug, another aspect, I think, is important to think about is you have got these other companies who use a multilevel system in there already. They would have to make additional changes. I think one the advantages that we have in kind of keeping our powder dry here at this point is that we can see what this evolves to very quickly. As Dave mentioned in his comments, we are prepared to respond fairly quickly once we see how this plays out. But won't be in the position of having to revamp and revise something that we have established on the hopes that the rules would come a certain way. I think in many ways, we have an advantage by having taken a position that we have taken.

Yeah, I guess -- this particular line of questioning I am just trying to get to a sensitivity, if there is a certain set of laws that is just to the point where -- you know, you are very uncomfortable tweaking your model. I mean, whatever they have passed, you are going to have to tweak it to some extent because it won't be a one for one with your global model, but I was just wondering if the multilevel part is not approved, is that enough to make you think twice of entering China.

It will definitely make us think twice, but we really haven't got in our own minds, I think, how far we are willing to tweak, and I guess we haven't -- we don't want to spend too much time stressing about it when we don't know where the target is going to end up and we could be shooting for a number of different targets and wasting our time. We've got some general ideas, but we are just waiting for the laws now. And then we will do a gut check with -- when they come out and decide. It is hard for me to say at this point, because I don't know where that breaking point is on -- on a different company.

Right. That's right. And you have to see what you actually come up with from a final -- at the final conclusion of all of this. So let me flip around the other way and let's say if you are interested in going to China. I really would love to get some clarity on the lead lags here. I mean, it is more than likely going to require fixed infrastructure from a capacity standpoint. Fixed infrastructure from a retail location standpoint. At what point -- I mean -- what do you see from a lead lag as far as investments into China before you really actually begin to benefit from revenues?

Let me take a crack at that, Dave. I think --

Depends on how the laws come out.

It depends so much on the laws. As we have said in our comments, our prepared comments, we've got people there looking at various aspects that we understand will likely be in the law, like a manufacturing requirement, like a store requirement. Those kind of things. I think we do know about manufacturing, and we actually know a fair amount about stores. We have walk-in stores at virtually every one of our locations around the world. They are single stores. So having multiple stores in a province, say ten or so, whatever the requirement might be would be a different model for us, that's for sure. But there would be a bit of additional -- it wouldn't be as quick as some of our other markets, that's for sure, between the expense investing -- which we are already doing some of -- and seeing revenue come from it. Product approval, I think, is also a bit more lengthy, and that could be an issue. And I don't know, maybe -- Tim Wood, our VP of R&D is here. You may want to comment -- I don't know, Tim, how long -- we do know it is probably a little bit longer -- I guess we don't know for sure.

There are some significant advance times in get products developed and approved. And we are moving forward on that. So get that much of the work out of the way.

So we are doing some expense investing as we speak, Doug. And being as cautious as -- what we think is appropriate. So that when we get a clear direction here, we can respond and hopefully the right way without too many false starts.

Do you anticipate any -- on a quarter-by-quarter basis, any P&L impact from these costs or all going to be basically capital costs that don't get to be depreciated until you actually have sales and earnings?

Right now there are ongoing costs that are right in the P&L now. As we mentioned we have staff in China and we have product approval applications in process, and these things all have cost and those are all being expensed as we go. We included those in the guidance to the best of our judgment.

Okay.

If there is a spike for something unusual that comes up for some requirement or something, why, we'll come out with something and make a comment.

But the basic capital requirements aren't capital expenditures, the plant, the stores. Most of that is not something that gets immediately run throughout P&L, is it, Gil?

That is the expense and we start amortizing that to match it against the revenues, the basic accounting principles.

Okay. One last question. What do you anticipate today based on what you know about demand for Sense, do you think that Sense will be a percent of sales for the full year in 2005?

Yeah, we -- we haven't commented on it, because this is -- know -- this is kind of new for us too. We are very enthused about it. It is a major differentiating element for us with the self-preserving technology, and we think it will -- I personally think it is going to be a big deal. Now what we have found so far is that people that sign up because of Sense, they also start taking nutritionals. So if -- you know, it is a very hard thing to say. What we hope it will do is drag the top line and the Sense customers will pull along the nutritional customers and vice versa.

Is that what you are starting to see?

Yeah, we -- with our people, they are very nutritional focused and Sense just provides a lot of them a talking point to get in the door. But with Sense products, they tend to be two to three month products so you fill in with the other two months buying nutritionals or something else to keep your volume -- the Sense products last longer than the 28 day supply like the essentials, so it is a little bit different model.

Right, that makes sense. Just one last question. Based on what you've seen so far, what percentage of your associates and preferred customers are nutrition only at this point do you think?

Anybody got some insight on that one? Any?

I guess we can't respond to that one, Doug. I think clearly we are a nutrition company first. That -- that's clear. 80% of our business is related to that. But I think there is -- there is certainly a lot of enthusiasm with the new Sense line. I would be surprised if most of our customers aren't experimenting with -- with one or more of the Sense Products. It is my opinion.

Okay. Thank you.

Again, ladies and gentlemen, to ask a question, please press star followed by 1.

Our next question comes from the line of Mimi Sokolowski of Sidoti and Company. Please proceed.

Thank you. Hi, everybody.

Hi, Mimi.

Gil, if I can start with you, can you please repeat the guidance for the margins? I think you talked about gross margin and the SG&A expense for the quarter and the full year, second quarter.

We believed that the margin we achieved in the first quarter will be about the same in the second quarter.

Okay.

Because we got -- we were pleased with the fact we made a little quicker progress and seen the margins come back. We thought it might be, you know, a couple of quarters, maybe even three quarters to get back to the margins that we were hoping to see, and it happened a little faster than we think. So -- we are thinking now that those margins in the first quarter ought to be maintained in the second quarter. And, you know, we never throw in the towel on looking for ways to improve margins, but -- but improvements from here will be modest.

Okay. And that is the gross margin, correct?

Right, the gross margin.

All right. On the SG&A line, did you say -- ?

SG&A, what we are thinking also is that that will probably be fairly consistent going forward, because we are going to start making some -- sales are going to continue to grow hopefully. That's what we believe, and as that happens, we have been able to achieve just some excellent operating leverage in the SG&A line. What we are saying now is because we really want to start marketing Sense strongly is that we are going to sacrifice that leverage that we might otherwise benefit from by expense investing, if you will, to grow the top line on Sense. So my suggestion and what we believe is that the SG&A line relationship will stay pretty steady going forward.

Okay. Okay. Thank you. And now, Dave, if I could turn to you for a couple of questions. How long have you been selling the -- or distributing those Sense sample packets?

The Prelude has been a few years. We modified our model for selling them and our pricing structure completely on them.

Okay.

In -- last September, which pretty much changed the complete feeling on them. They have been used ones or two for people travelling because they are a little bit expensive to hand out as samples. We revamped our pricing structure to change the mind set completely on those. The Splash Sensation, which is the hair and body, was new at convention in September.

Okay. With the Prelude package, I imagine things will change -- or might change now, but do you have any sort of a conversion ratio for that? What percentage of the people who take these packages turn into long-term or auto-ship customers?

Numbers that I have been made aware of are about 1 out of 4 buy who received the Prelude samples. One of our most powerful persuasion tools that we have.

Okay. And do you think -- well -- no, skip that and move on to the next. The last question is the regulatory environment in dietary supplements. Are are hearing or seeing anything domestically that is changing or internationally that might -- that might hurt revenues?

No, there's been the usual continual banter about different possible regulatory bodies taking over, but it has been going on for as long as I have been around.

So, nothing -- ?

Nothing new other than talk.

Okay. All right. Thank you very much.

Our next question comes from the line of Tim Raimi of DA Davidson. Please proceed.

Good morning.

Good morning.

Good morning.

Just trying to understand. You called out specifically the increase in inventories related to the Sense products, yet it pretty much paralleled their increase in sales. Is there a sense that you would be able to leverage the sort of inventory-to-sales ratio over time, and it -- it might not have gone up as much even on that increase in sales, except for this Sense products?

Yes.

Good. Single word answers are nice.

That was Fred Cooper.

Okay. And just a couple of other things on cash flow for the quarter. Did you -- did you give us a number on -- on depreciation amortization. If you did, I apologize.

Depreciation for the quarter is running about $1.4 million a quarter.

Okay.

EBITDA, interestingly enough, was nearly 20% for the quarter, 19 and change as I recall, 19.5%. Very -- very positive aspect of our business model.

Terrific. And one other clarification, and I know an earlier questioner asked something about Korea, but I -- I saw that the sales associates were down substantially. Did you -- did you detail what that was about?

We've done some restructuring to get the size of the operations in line with our sales force there. We've also made a few changes, some of our promotions and issues with the discussion I've had with one of the main leaders in Korea. And we started to see some new enthusiasm there. It's -- it's not where we want it to be, but it takes time to develop leaders to get home-grown leaders, so we are just planning to wait it out. It seems that different markets take off as the leaderships develops, and Korea has a lot of potential. We just need to wait for those leaders to develop.

Longer term, it is still viewed as a high potential market?

Yes. There is plenty of potential in the market and now that we've resized it to not be a drain, we feel very comfortable waiting for those leaders to develop.

Terrific, Thank you.

Your next question comes from the line of Louis Toma of John A. Levin & Company. Please proceed.

Hi, guys. Just a couple of questions. Australia and Taiwan were very strong in the quarter which is reacceleration from the last couple of quarters. Can you just give us some color, what you are seeing there and kind of what expectations you see for growth in those markets?

We've got a great wave of leadership in those countries. Leadership tends to come and go as leaders move up to different points in their careers and new leaders are developed, and we've seen over the last 13 years the ebb and flow of different markets as leaders go through maturation and excitement levels. They have been reenergized in Australia and New Zealand. Taiwan, of course, fairly new market, and they have just been doing a great job at developing leaders over there.

With the international seamless plan that we have, I really don't really look at our business by market. No reason for us to look at Utah compared to California. In my opinion, no real reason to look at Australia versus the U.S. as a whole. Our leaders move around, and they are compensated equally, no matter whether they are going from Utah to Idaho or Utah to Australia. And we have leaders travel back and forth and folks on different areas even move to different countries for a while.

So the volume moves around, but overall, company growth is what I focus on, and if the leaders are excited in that area for a while, great, they move to a different area later. As long as the overall company grows, that's all that we really focus on.

Right. What kind of revenue level do you see in those countries before you get to a normalized sense of growth number. Any idea?

That's a real tough question. And -- and it -- I don't know if we can really answer that other than if you take an example. If you measure it in some way, kind of macro way, like our revenue per population, for example. I think one of our largest markets is in Canada. If we have the same revenue per population in all of our markets that we have in Canada, we would be at least double the size of a company that we are. So it is really tough to -- tough to answer it -- that question. What we do believe is we have just excellent opportunity in all of our markets. We don't see any of our markets that are that are tapped out, if you will, or we think there's no opportunity for growth. We just think we are just really scratching the surface in all of these markets.

Great, okay. Good, good. You mentioned the inventory a couple of times, and I might have missed it, but can you just -- how much of the -- of the absolute balance was Sense?

This is Fred Cooper.

The increase?

Yeah.

Of the $5 million increase, about half of it, right, Fred?

Yep.

Half of the increase?

Yeah.

And how much of the total?

He wants the total. Doug, do you know the total of Sense? Would it be roughly the same percent of sales, roughly 20%?

A little heavier.

If you want a swag at this, we can give you -- it is probably be in the order of 20% or something like that.

20%. Okay. And what do you expect going forward? My sense is that this is an inventory build because you are developing the process, the manufacturing and you don't want to run short like you have. So as we go forward, what is the reasonable number to expect?

In the short run I don't anticipate much of a change because I have ordered an increase in safety stock for each of the finished good products. Because we still don't know on this demand curve if we are riding the wave in terms of being stalked out or if it will debate to some degree. We have decreased safety stocks in the short run. So I would anticipate at least the next quarter or two you won't see much of a change in that heavily-weighted Sense inventory. Thereafter you will as we get a better estimate in our forecast for predicting the sales of the Sense as a result of the sampling we do with it.

And if you are asking, you know, do we pay attention to inventory turns and efficiencies in inventory, we absolutely do. But out of an abundance of caution, we will be in a position of trying to avoid any stock out. That's important in this channel.

Right, right, and that makes a lot of sense. That makes a lot of sense. I am just trying to understand it. The other thing I was wondering is that given -- you have great numbers today, but when you look at what your guidance is for next quarter, it looks like they are not carrying forward. I was just wondering, are you being conservative? Is that a sign that things are slowing? I am just trying to figure out how to interpret that.

One thing to -- we mention in our comments. But one of the things that make our second-quarter comparison a little bit tough is that a year ago, we opened up Mexico. We technically opened it up in late March. So we had a full new market opening in the second quarter of '04. And generally speaking, when you open a new market, you have this kind of initial burst.

Pent-up demand, the anticipation being realized. It makes that kind of tough. When you take that into account, no, we are very happy with the growth that we see and what we have put out there.

Okay.

As we mentioned we are working toward opening the market -- another new market by the end -- by the end of the third quarter.

Right. Okay. And are the 35% tax rate is in the new numbers?

That is in the new numbers.

Right, okay.

In a way our guidance -- on the surface the guidance looks like it is up just $.02, but in a way it is up more because we are dealing with a 1% heavier tax burden.

All right. That makes Sense. Thank you very much.

Our final question comes from the line of Scott Van Winkle of Adams Harkness. Please proceed.

Hi, I don't know if you can answer this. Maybe you can. Do you know if any or what percentage of your preferred customers are Sense customers?

We don't --

I don't have those numbers here. We are looking to focus more on that now that we have the inventory with more sampling and getting those products out to preferred customers corporately, but we don't know where we are currently.

Yeah, we are going to do a lot more of that data mining as we push the marketing side here. The focus has been on getting stuff in -- made. And getting in boxes and getting shipped.

And -- and, Gil, what percentage of the preferred customers are on automatic fulfillment. Is it higher than your distributor number?

It is about the same, Scott. It is about this 55%.

Okay. Thank you.

Gentlemen, there are no further questions at this time.

Well, thank you for your questions this morning. If you have any remaining questions, please feel free to contact us at investor.relations@US.USANA.com or call Riley Timmer, Manager of Investor Relations at 801-954-7922. We really do appreciate your interest in USANA. Thank you for joining us on our conference call this morning.

Once again, we thank you for your participation in today's conference, this concludes the presentation. You may now disconnect. Have a great day.