USANA Health Sciences Inc (USNA) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the USANA Health Services fourth quarter and year-end 2005 earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host, Mr. Riley Timmer, please proceed, sir.

Thank you. Good morning, everyone, we appreciate you joining us this morning to discuss our fourth quarter and our full-year results. As a reminder, today's conference call is being broadcast live via webcast and can be accessed directly from our website at www.USANAhealthsciences.com. Shortly following the call, a replay will be available on our website.

Before we begin, as a reminder, during the course this conference call, management will make forward-looking statements regarding future events or the future financial performance of our company. Those statements involve risks and uncertainties that could cause actual results to differ. Perhaps materially from the results projected in such forward-looking statements. We caution you that these statements should be considered in conjunction with the disclosures including specific risk factors and financial data contained in our most recent filings with the SEC. Also during the course of this call, management will discuss non-GAAP information. An example of a non-GAAP measure we provide is our customer count data. We provide this and other non-GAAP measures to assist investors in understanding our operating performance. I'll now turn the call over to Gil Fuller, Executive Vice President and CFO.

Thanks, Riley. And good morning, everyone. Thank you for joining us to review USANA's record fourth quarter and full-year results. Members of the management team joining me this morning are Dave Wentz, our President, who you will hear from shortly; Fred Cooper, Executive Vice President of Operations; Mark Wilson, Executive Vice President of Customer Relations; and Doug Hekking, our Vice President of Finance.

This morning I plan to update you on our conditioned strong financial progress achieved in the fourth quarter and the past year, and also talk about our guidance for the first quarter and full-year 2006. In terms of fourth-quarter results, net sales for the quarter came in about as expected. We were pleased with the top-line results in the fourth quarter which we achieved without the anticipated opening of a new market. We reported net sales of $86.9 million, an increase of 15.7%, compared with $75.1 million reported in the fourth quarter of 2004. Net sales growth in the fourth quarter was driven by a 16.7% increase in the number of active associates, and an 11.1% increase in the number of preferred customers compared with the fourth quarter of last year.

Additionally, the RESET program rolled out at our September, 2005, convention has been well received by our associates. Driven by the launch of this program, our functional foods sales increased to 11.6% of total product sales in the fourth quarter compared with 8.8% of total product sales in the prior year fourth quarter. The monthly auto ship order rate continued its consistent pace, representing 54% of our total product sales during the fourth quarter.

Earnings per share for the fourth quarter increased to $0.54 compared with $0.46 per share in the fourth quarter of 2004. This represents EPS growth of 17.4%. During the fourth quarter, the estimated tax rate was adjusted to 33% for the year. Which is lower than the 34% tax rate we had previously estimated for the full year. Earnings per share in the quarter included an increase of approximately $0.01 due to a lower than expected effective tax rate.

Let's now turn to the P&L operating lines. Our gross margin in the fourth quarter of 2005 improved as a percentage of net sales to 76.1%, compared with 74.9% in the fourth quarter of 2004. The year-over-year improvement in our gross margin was due in great part to the contract manufacturing segment being a smaller portion of our overall business and to a lesser extent, lower costs of certain raw materials.

Looking forward, we expect progress with consolidated gross margins from what was reported for the fourth quarter. We are also seeing a relief on prices of certain raw materials which were in short supply in 2005. Thus we further anticipate modest improvements to margin in each quarter as we continue to leverage our growing business in 2006. Associate incentive expense in the fourth quarter was 41% of our direct selling revenue, compared with 40.2% of direct selling revenues in the fourth quarter of last year. We expect associate incentive expense to be modestly higher in the first quarter as we focus on maintaining our competitive compensation plan. We believe our best in class compensation structure that rewards our associates through contests and promotions for increased activity and sales results will continue to allow us to drive top-line growth.

Selling, general, and administrative spending decreased relative to net sales to 17.9% during the fourth quarter of 2005 compared with 19.5% in the prior year fourth 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 first quarter of 2006 as a percent of net sales to be higher than the fourth quarter of 2005 due to additional planned spending and more resources deployed for certain markets. And of course, don't forget that equity compensation expense will now be included in our SG&A line beginning in the first quarter of 2006. For fiscal 2005, the full year, the Company reported record net sales of $327.7 million, an increase of 20.1% compared with $272.8 million reported for 2004. Gross margins for the full year 2005 were 76.2%, a 70 basis point improvement compared with 75.5% in 2004.

Associate incentive expense for the full year 2005 was 40.3% of our direct selling revenue compared with 39.8% of direct selling revenue for the prior year. Selling, general, and administrative expense for 2005 was 18.4%, an improvement of 160 basis points compared to 20% recorded in the prior year. Earnings per share in the full-year 2005 were $1.98, an increase of 31.1% compared with $1.51 reported in the full year, 2004.

Now regarding our share repurchase program, during the fourth quarter with the use of internally generated cash, we repurchased a total of 808,000 shares for an investment of $34.2 million. For the full year 2005, we repurchased a total of $1.16 million shares for an investment of $49.2 million. As of year end, we had approximately $40.8 million remaining in our current share repurchase program. As we anticipated, inventories declined in the fourth quarter by more than $3 million compared with the level recorded in the third quarter of 2005.

Before I turn the time over to Dave, I'll comment on our future guidance. Beginning with the first quarter of 2006, we are required under FAS 123R to begin expensing equity compensation. We estimate this expense will decrease earnings per share by approximately $0.03 in the first quarter of 2006 and by approximately $0.14 for the full year 2006. Now to reiterate what was stated in the press release, we expect net sales in the first quarter of 2006 to be between 87 and $89 million, which is an increase of up to 16% over the first quarter of 2005. Also we expect earnings per share in the first quarter of 2006 to be between $0.54 and $0.56, which excludes the expensive equity compensation. After adjusting for the expensing of equity compensation and an anticipated higher tax rate, we expect earnings per share for the first quarter of 2006 to be between $0.51 and $0.53.

For the full year 2006, we reiterate the guidance that was provided last quarter and continue to believe that net sales will grow between 15% and 20% compared with 2005. Additionally, we expect earnings per share growth for the full year 2006 to be between 15 and 20%, excluding the expensing of equity compensation. Please also note that this earnings per share estimate assumes a tax rate of 35.5% compared with 33.7% tax rate for 2005, which translates to a reduction of EPS of approximately $0.06 per share during 2006. I'll now turn the time over to Dave to comment on recent operating activities.

Good morning, everyone. It's a pleasure to talk with you this morning about our fourth quarter and 2005 results. We achieved our 14th consecutive quarter of record sales in the fourth quarter. With the exception of South Korea, which was down just slightly, we had year-over-year growth in all of our markets. Sales were particularly strong in North America during the fourth quarter, increasing 18.5% over last year. The US led the growth in this region, growing nearly 23%. We attribute this growth to strong associate leadership in North America. These associate leaders serve as the foundation for growing the region and fostering new enrollments and activity. Sales in our Pacific Rim region in the fourth quarter were up 13.9% over last year, driven by our Australia-New Zealand region which grew by nearly 23%. On a consecutive quarter measure, sales were up in all of our markets except Singapore.

Our priority has been and remains to introduce greater numbers of people to our products and opportunity. We will continue to invest in our associates who choose to grow their business by offering more programs, recognition, and incentives to reward growth activities. We will also commit additional resources to areas where we see an increasing number of associate leaders and growth potential. We believe these initiatives will lead to higher enrollments.

We are real pleased with the initial response and results that we achieved from the changes made to RESET, our weight management program. RESET is a simple way for someone to break their bad eating habits. Our program consists of an intensive five-day cleanse using high fiber, low glycemic foods to break carb addictions and cravings and initiate weight loss if appropriate. After the five day cleanse our program encourages replacing one or two meals per day with our low glycemic bars and shakes. In early January, to coincide with typical New Year's resolutions to lose weight and improve finances, our associates hosted RESET meetings throughout North America. We sent out approximately 1,400 host kits which had an interactive presentation, suggesting RESET as an excellent solution to people's goals to lose weight and improve their financial situation. So far, the feedback has been tremendous.

As many of you are aware, we anticipated opening a new market in the fourth quarter. Unfortunately, the government registration process in that target country has delayed the opening. Bradford Richardson and his staff are devoting a significant amount of attention to this issue, and we hope to initiate operations there in 2006. Please note that we have not included any sales for the new market in our first-quarter guidance numbers. 2005 was the first year since 2000 that we did not open a new market. Yet we were still able to grow our business by 20%. The delayed opening of our new market is frustrating, but our number-one priority remains significant -- significant growth in our 12 existing markets. For example, we think Japan and South Korea have the potential to be significant markets for USANA. In 2006, we will continue to support these markets by committing appropriate resources.

And finally, despite the recent, unfavorable direct signing laws released by the Chinese government, we continue to believe that China could provide a significant direct selling opportunity in the future. We have a development staff in place in the region, and we continue to keep apprised of that market. While we are not in position to give a timetable for that market, we have started the product approval process but have not yet applied for a direct selling license. With that I'll now turn the call over to the operator to facilitate the Q&A session.

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from Tim Ramey with D.A. Davidson.

Good morning and congratulations. Dave, you mentioned you had not yet applied for a license in China. Would you not function in China or -- or do you have no interest in China if it is a single level rather than multilevel?

We're still in a wait-and-see mode on how they are actually going to enforce those laws. How strict they're going to be, what direction they're going to take. As all of the markets -- the companies that are in that market currently are anxious to find out, since most of them are operating in a forum that is not allowed by the new law. So it's going to be interesting to see just how the Chinese government interprets the laws that they've put out. They're a little bit vague in areas. So we're not sure just what they're going to focus on and how they're going to -- what they're going to read into those rules as the important thing. So it may be possible for us to go in as a direct sales single level, but we're just trying to get a better feel for just how close we can get to our current existing model. We'd like to keep as much of our strength as possible as we go into that market.

Got it. Just on the new market opening, I assume that there are parallel efforts in other regions of the world beyond this one new market that's giving you fits. And you probably need new markets to exceed 20% sales growth as you did in '04 and early '05. Am I right in assuming that there are parallel trends or parallel efforts going on elsewhere, and if this one for whatever reason takes longer, then other stuff would be in the pipeline?

International development is always working on different countries. We always have a few being worked on in parallel, you are correct there. We -- the problem is we fully expect any time to be getting this registration. So we haven't really moved toward putting any other markets into play prior to the one we had planned on previously.

Finally any quick update on Sense' and how it did in the quarter?

This is Gil. Sense' was about 13.7% of our sales in the quarter, it's consistent with where it was in the third quarter. We continue to remain enthusiastic about the product. But--.

But our to focus changed to the functional food of the RESET in the last six months. From convention to attention. We always try and come up with new and exciting themes for our volunteer army to focus on and there focus has been on RESET for the last six months.

Thank you.

Your next question is from Scott Van Winkel with Canaccord Adams.

A couple of questions. First, Gil, the operating income was up 26% in the quarter, if I have my numbers right. EPS only up 18. Last year was there a one-time gain or something on the net interest line?

Yes, there was Scott. Last year in the fourth quarter, that's fourth quarter of 2004, we settled with the Canadian revenue service a long, outstanding tax case. And the net effect of that was $0.03 extra per share in the fourth quarter of 2004. $0.01 of those was on the interest line, and the other $0.02 were down in the tax line. So really that's why you had that disparity in relative growth. Otherwise, EPS would have been up, kind of on an apples for apples basis, significantly more.

Okay. One other just number out there. What did you say the auto ship portion of revenue was in the quarter?

54%.

54%. Is that negatively impacted by RESET growing?

No, I don't think so. I think, again, just to kind of -- the way we view this, we think that 54% is a terrific number because not all of the products that we sell are necessarily lend themselves to running out every month. And so in other markets, also tend to not do auto ship like Hong Kong for example. They love to come into the office and network. No, the RESET program, I don't think had any effect. Maybe others have other views on that. Anybody else view it differently? It was steady with what we -- I think it was 54% in the prior quarter also, Scott.

Okay. Sticking with RESET, are the margins similar on that business to where they were before it was relaunched and relative to other products?

When we repackaged the RESET products and reformulated them, approved them, and so forth, we did see some improvement on margin. So that was part of the strategy.

Okay. And the 1,400 host kits, I think it was called, talked about -- was that a January figure, or is that a figure cumulatively since the convention last summer?

That was -- we sent them all out in December for a meeting -- kick off the first week of January. So all 1,400 should have been sent out by the first week of January at least. It was a DVD, and some gifts and prizes, and some checklists and things to help people put on a good meeting. Those were all sent out hopefully by the beginning of January. Maybe a couple of stragglers at the end if people wanted to do theirs the second week of January.

Got you. Is this a revenue source?

Oh, no. Just kits at cost to get them out there and have them do meetings. The kits were just to help them put on a great meeting in January. And we only had a limited supply of 1,400. Sold those all out. And had great meetings throughout North America. Which a number of management team members attended to great response, great crowds.

What would you compare that to a year ago? Did you have anything similar?

A year ago we didn't have as much, but two years ago we had a pretty strong push on weight loss. We didn't push as hard last year. We came back at it harder again this year.

Okay, okay. And I guess anyone can answer this question. If we look at Hong Kong, Taiwan, and Singapore, all looked a little softer on the growth level. Is there any correlation with those markets weakening, and what's going on in China? And coincidentally, looked like the Nu Skin results this morning saw the same type of weakness in those specific markets.

We had some different things depending on the market. We had a few markets I think where a lot of new competitors came onto the scene which provided some pressure as some of yours of course jumped ship hoping for greener pastures. The grass is greener issue. So we had some competition with new companies. We had some real strong pushes early in the year in some of the markets that they couldn't sustain. So maybe quarter to quarter they didn't look as well. But still doing great in most of those markets. We're very pleased.

And anything related there to the upcoming market opening, which I believe is in Asia?

There could be some anticipation of that in there, Scott. We do have a Asia Pacific convention coming up here in March. And there's always some anticipation of those kinds of things, as well. That will be held in Singapore.

And did you do that last year?

No, this is our first ever Asia Pacific convention. Which we're hoping to continue to kind of split the difference between our international convention, which is in September. Every March we're looking to hit another major city in Asia Pacific and have a large convention that will rival eventually hopefully the one here in Salt Lake.

Okay. When you gave guidance and reiterated it today for next year, for '06, that is, you talked about incremental spending in China. Can you give us an update as to where you are as far as infrastructure in that market.

Let me take a crack at it. As you know, we have a small manufacturing facility in Tianjin. With I think there's -- Fred, maybe what, about 20 people that -- that work there at Tianjin? Something like--?

I don't think it's that many.

Something, 20 or less people there. And we have a regional Vice President based in Hong Kong who has the responsibility for greater China. And then we have a small staff in Shanghai of three people. It's a -- it's basically where we were in the fourth quarter. I mean, nothing new thus far this year. We mentioned in our comments, the product registration process is underway. As Dave said, we're taking a little bit of a wait-and-see attitude on the license application, waiting to see what comes back from those who have filed for life and made application.

Okay. Oh, and the contract manufacturing picked up a little bit sequentially. Is there a new customer in there? Or just stronger sales to that one customer?

Fred, maybe you want that one.

We don't have just one customer, but it's stronger sales to the existing customers on the third party OEM.

Okay. Thank you very much.

Your next question is from Doug Lane with Avondale Partners.

Gil, can you talk in a little bit more detail -- well, first of all, do you have a dollar figure of incremental spend in China this year, and the incremental costs of the Singapore convention. And then just more broadly, can you talk to a couple of key factors that are driving the lack of leverage if you will to the EPS line from the sales line?

Yes, Doug. I think first with regards to China, we're -- rough cut is going to be something like $0.04 a share next year. Say, $0.01 a quarter kind of a cut. So something on the order of 1 million, $1.2 million.

Okay.

That's built in there. And that will be a factor on the nonleverage issue that you asked about. Secondly, the convention in Singapore we have also built in there. And that will be a net cost something on the order of 300,000, before tax, something of that sort.

Okay.

Then the other factors that are in the apparent nonleverage will be the equity compensation requirements. And then also the tax rate. The -- the Act of Territorial Incentive Exclusion is going away, and the new manufacturing credit just isn't quite as beneficial for us. So we're seeing an increased tax rate next year, best of our judgment, that will impact us.

One of the other things that will impact -- our tax rate actually may be a little bit more volatile in '06, because of the way the accountants now have you accounting for the equity compensation. You do get a tax deduction for the exercise of options. But you can't anticipate the exercise of options. And so you can't use your historical norms to do that. So it's a little more difficult to predict that tax rate. But those are the factors that are impacting leverage. In terms of gross margins, as we noted we expect some modest gains there. And SG&A is going to be -- shows a lack of leverage because of what we're going to do in China and because of the equity compensation. And then the issue, tax rate issue.

Will associate incentives be up as a percent of sales?

It will be up modestly.

Okay. So finally if I -- if I back out the options expense increment, do you look for operating margins then to be up in '06 versus '05 on an apples-to-apples basis?

I'd say it would be more like steady as she goes.

Okay. Thank you.

Your next question is from Mimi Sokolowski with Sidoti and Company.

Hi. It's Mimi Sokolowski. I just had a question about Canada. The growth slowed dramatically from the pace of growth in September. Dave, to what would you attribute that? And likewise I think your associate growth there was only about 5% in the quarter.

No real idea why Canada slowed down. For North America we pretty much don't look at the borders too much. We treat North America as one region. Servicewise, productwise, in every shape of the word, we treat Canada, Mexico, and the US all equally. And the leaders co-mingle and move across borders with no thought to borders whatsoever. A lot of Canadians still focusing on Mexicos and the US, and we're hoping that things will pick up in Canada, but basically just the whole region, we want to continue to see the great growth there. No particular idea why Canada as a subsection was lower than the others.

Have you ever seen that sort of a phenomenon before?

Leaders tend to focus -- leaders go through spurts where they are really pushing hard and times when they get comfortable and we need the new blood to move in and try and dethrone them and climb the ranks. And it just happens in different -- not in seasonalities, but just different time periods where we'll go through a spurt in the US where we have a bunch of new leaders up and coming. And Canada will happen when it happens. In Mexico it will happen when it happens. And we'll have new leaders get hungry and try and move up past the other leaders who have gotten comfortable over time. It's a normal succession.

Okay. And I guess the next question is a little more vague. But you talked about continuing to support your existing markets, to generate meaningful growth there. Can you be more specific with the type of support that you offer, either in dollar terms or activities?

We just continue to improve and increase our incentives for associates who are growing to give more rewards, and incentives. Rather than putting money into other places such as number -- numerous markets or international expansions. We're putting that money into the associates in our existing markets. We could be opening a couple countries a year. Like some companies do. But we're putting that money that we have put into those resources into fueling and funding associate incentives that will cause them to grow locally, which enables us to leverage our resources better.

And when you say improve the incentives, exclusive of increases, what sort of changes might that imply?

We're constantly learning which things -- which activities motivate them. Which ones include the most people. We're using online technology more and more to make our contests more effective. Online has brought a great deal of benefits so that we can do things that we never could have done before if we were depending on voice-mail or even just e-mail to communicate with people. There now are obviously graphs and charts and plan and work with teams. So we're seeing a lot of improvement as we learn. We've learned which ones don't work. We've gotten rid of those. And we're doing better with the ones that do work, giving bigger prizes, or focusing the prizes in the right area. Or improving prizes to be what the customer or the distributor wants. So we're just getting better and better at it every quarter.

Okay. That's helpful. Thank you very much.

Your next question comes from David Cohen with Midwood Capital.

My question's actually been answered. Thanks.

[OPERATOR INSTRUCTIONS] Your next question comes from Willy Toma with Long Trails Investments.

Hi, guys, just a couple of questions. First of all, what was the currency impact for the quarter?

The currency impact for the quarter was basically neutral. It was less -- like $200,000. And it was positive. Largely because of the strengthening of the Canadian dollar relative to the US. So very nominal. Almost nothing.

Based on current trends, any expectations going forward for this quarter for currency?

No. Predicting currencies is something that -- really tough to do. We don't anticipate any great things. As general rule as you know, a stronger dollar for a multinational company, generally is -- hurts the top line. A weaker dollar generally helps it.

Yes. Okay. And just going back to the new country that you guys are working on. Any thoughts on time frame? I mean is it a first-half event? Second-half event?

It was a mid last year event. Our time frame is six months ago. We're struggling with bureaucracy. And paperwork and we -- we've given up guessing and predicting. We're hoping, we're working as hard as we can. We're trying to influence and encourage the paperwork to move quicker. But we have very little control over the actual signing and stamping.

Right. Right.

The day we get our stamp on the license, why, we'll go out with an announcement.

Okay. And so on the guidance that you're giving, is there any implied -- anything implied with regard to the country being in it? Or is that just not in there at all?

There's no guidance in the -- there's no inclusion in the first quarter. There's some for the annual guidance.

For the annual. So what would be implied for the annual numbers? Would you have to -- for that to make sense, would it be like a mid year or just--?

Yes, something like a mid year would be a reasonable assumption. But--?

Okay.

We hope it's sooner, of course.

Right. You said Sense' was 13.7% of revenues?

Yes.

Can you go over the other product lines?

Sure. The nutritional -- in total that is including essentials, optimize and macros, it was 83.4%. The Sense' was 13.7%. I'm sorry. I've included functional foods and nutrition. Let me do it this way. Essentials including all the ways that we package essentials, that is the health pack and the adolescent product and the children's product, all of that in total was 37.8%. The optimizer portion of our nutritional line, things like Proflavanol, and so forth were 34%. The functional foods, we call them macro optimizers were 11.6%. Sense' 13.7%. And then just other things, miscellaneous stuff was 2.9%.

Approximately 71% for nutritionals, 11.6 for the foods, and 13.7 for the skin and personal care.

Got it. Thank you, guys.

As there are no further questions in the queue, I'd like to hand the presentation back to Mr. Gil Fuller for closing remarks.

Well, 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, Manager Investor Relations at 801-954-7922. We appreciate your interest in USANA. And thank you for joining us on our call this morning.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes your presentation. And you may now disconnect. Have a great day.