USANA Health Sciences Inc (USNA) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the USANA Health Sciences first-quarter earnings conference call. At this time all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. [OPERATOR INSTRUCTIONS]. As a reminder this conference is being recorded today, Wednesday, April 19, 2006. I would now like to turn the conference over to Mr. Riley Timmer. Please go ahead, sir.

Good morning, everyone. We appreciate you joining us this morning to discuss our first-quarter results. As a reminder, today's conference call is being broadcast live via webcast and can be accessed directly from our web site at www.usanahealthsciences.com. Shortly following the call, a replay will be available on our web site.

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 account 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 Chief Financial Officer.

Hey, thanks, Riley, and good morning, everyone. Thank you for joining us to review USANA's record first quarter results.

I'm pleased this morning to have joined with me Dave Wentz, our President, who you'll hear from shortly; Mark Wilson, our Executive Vice President of Customer Services; and Doug Hekking, our Vice President of Finance. This morning I plan to update you on our continued strong financial progress achieved in the first quarter and also to talk about our guidance for the second quarter and for the full year, 2006.

In terms of first-quarter results, net sales for the quarter came in slightly higher than we expected. We reported net sales of $89.7 million, an increase of 17.1%, compared with $76.6 million reported in the first quarter of 2005. Net sales growths in the first quarter was driven by a 14.3% increase in the number of active associates, and a 10.6% increase in the number of preferred customers compared with the first quarter of last year. Additionally, the RESET program we rolled out at the September, 2005, international convention helped bolster sales of our macro optimizers or functional foods product line to 13.1% of sales from 9.1% in the first quarter of last year. Our monthly auto ship order rate continued its consistently strong pace and represented 53% of our total product sales during the first quarter.

Now, beginning with the first quarter, we began the required implementation of FAS 123R requiring the expensing of equity-based compensation. Keep in mind as we go through the statement of earnings equity-based compensation expense had the following impact on our line items. Cost of goods sold, about $127,000; SG&A expense, $707,000; and R&D expense, $113,000. Earnings per share for this first quarter, including equity-based compensation expense, increased to $0.50 compared with $0.45 per share in the first quarter of 2005 which, of course, excluded equity compensation expense. Equity compensation expense decreased earnings per share by about $0.03 in the first quarter. Excluding this expense, earnings per share would have been $0.53, an increase of about 18% compared with the first quarter of 2005.

Now let's go through the major line items on this statement of earnings. Our gross margins in the first quarter of 2006 declined slightly as a percentage of net sales to 76.2% compared with 76.5% in the first quarter of 2005. This year-over-year reduction in our gross margin was due to the contract manufacturing segment which has low gross margins and which represented a larger portion of our overall business during the current quarter. If you look at our direct selling segment alone, gross profit margin improved to 78.8% in the first quarter compared with 78.3% in the first quarter of last year. This improvement can primarily be attributed to lower pricing on certain raw materials which were in short supply in 2005. On a consecutive quarter basis, consolidated gross margins improved by 10 basis points. Now, looking ahead, we expect to achieve additional modest progress in our consolidated gross margins throughout the year.

Associate incentive expense in the first quarter was 40.8% of our direct selling revenue, compared with 39.6% of our direct selling revenue in the first quarter of last year. As planned, and as we have previously noted, the level of payout increased because of an additional emphasis on contests and promotions. These incentive programs are designed to fuel excitement and enthusiasm for driving top-line growth and have historically been successful. We expect associate incentive expense going forward to be consistent with the first quarter on a relative basis. Now as expected, selling, general administrative spending increased relative to net sales to 19.7% during the first quarter of 2006, compared with 19.4% in the prior year first quarter. SG&A expense was up in the first quarter due to the following reasons. $707,000 increase due to the required expensing of equity-based compensation. $460,000 increase related to our first-ever Asia Pacific convention. Additional spending for preparing for our planned eventual entry into China and ongoing expenses related to entry into one other planned new market of approximately $300,000 with no offsetting revenue. And lastly, our strategic decision to add new employees to support our Asia Pacific regional structure and add to local bench strength in preparation for continued growth. As you will recall, during our February conference call, we mentioned that we would see an increase in SG&A expense in the first quarter due to our planned spending and investment for the future. As you know, SG&A expense can sometimes progress in a step function rather than linear. However, we believe the investments we are making now will give us the base necessary to drive sales in the future. Notwithstanding this expense investing, we believe SG&A costs in the second quarter of 2006 as a percent of net sales will be slightly lower than the first quarter of 2006.

Now turning to the balance sheet for a moment, our cash balance increased about $15 million from year end to $25.5 million at the end of the first quarter of 2006. We did not buy back shares during the first quarter, though we do have $40.8 million remaining in our current share buy-back authorization. Cash flows continue to be strong, and we anticipate directing this cash flow toward our repurchase program, our larger capital expenditure initiatives, and new market expansion.

Now, before I turn the time over to Dave, I'll comment on our future guidance. To reiterate what was stated in the press release, we expect net sales in the second quarter of 2006 to be between $92 and $94 million compared with $82 million in the second quarter of 2005, an increase of up to about 15%. Also, we expect earnings per share in the second quarter of 2006 to be between $0.51 and $0.53, which includes the expenses of equity-based compensation. We expect the impact of equity-based compensation to reduce earnings per share by about $0.04 in the second quarter. Please note that our sales guidance for the second quarter does not include any revenue from the anticipated new market. 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 expense of equity-based compensation. The upper end of both our sales and EPS estimates anticipates that we will open a new market during the second half of 2006. I'm pleased to 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 in earnings per share of approximately $0.06 per share for the full year.

Now I'll now turn the time over to Dave to comment on our recent operating activities.

Thanks, Gil. Good morning, everyone.

The first quarter marks the 15th consecutive quarter of record sales for USANA. Sales were up year-over-year in each of our markets except Japan and Taiwan, which were down just slightly in the quarter. Mexico led the sales growth in North America, improving 28.3% over last year. The U.S. was also very strong, growing $7.8 million or 25.2% compared with last year. Canada was a solid performer during the first quarter as well, and was up 14.2% over last year. Overall sales were very strong in North America, growing 22.1% compared with the first quarter of last year. As I mentioned in February's conference call, in early January, to coincide with typical new year's resolutions to lose weight and improve finances, our associates hosted RESET kickoff meetings throughout North America. These kickoff meetings provided an excellent jumpstart to the new year for a large number of our associates. We also continue to train and teach our associates about the advantages of using sales tools and sampling to grow their businesses. We continue to develop our sales tool culture, which we believe will help our associates achieve even greater success.

Sales in our Pacific rim region in the first quarter were up 4.8% over last year, driven by sales in Singapore. During late March and for the first time ever, we held an Asia Pacific convention in Singapore. This large, three-day event was attended by about 1,500 of our associates, primarily leaders from our Asian markets. We felt that this convention was very successful, given the high level of enthusiasm and engagement from our Asian leaders. The event was held the last three days of the first quarter. Accordingly, we believe that the anticipation of this event, coupled with Chinese new year, resulted in somewhat softer sales in the Asia Pacific region in the first quarter. Of course, we will judge the success of this event in the months ahead.

As many of are you aware, we continue to work toward opening a new market sometime during 2006. Bradford Richardson and his staff are devoting a significant amount of attention to gaining the proper approvals necessary to open this target market. To reiterate what Gil stated in his remarks, we have not included any revenue for the new market in our second-quarter expectations. Again, as we said last quarter, our number-one priority remains significant growth in our 12 existing markets. Regarding China, we are pursuing a market entry strategy that is consistent with the direct selling legislation. And we now believe that we will be ready to apply for direct selling license sometime during the second half of 2006.

With that, I'll now turn the call over to the operator to facilitate the Q&A session.

[OPERATOR INSTRUCTIONS]. Scott Van Winkle, Canaccord Adams.

Hi, gentlemen. A few questions. First, since you mentioned China at the end there, and new markets. What do you think the issue is with the new market you're trying to enter, not China, the other one?

Scott, I'll take a crack at it first. This is -- we're not really certain. We're dealing with a government that's nontransparent. So it -- it's just very hard to see what the issues are there. We remain optimistic that we can get this thing done before too terribly much longer. But it's just been -- it's been very frustrating. It's the nontransparency that I think is the most frustrating aspect if it to us.

When you talk to your peers in this industry, is this a market that generally is kind of tough to get into?

Yes, extremely. We've talked to a number of people on the DSA, and it's a tough one to crack. And we -- I don't know that we're actually slow compared to other companies. Maybe we just -- were too optimistic early on.

But I think it's a market with a pretty vibrant direct selling industry anyway. So you know it's there once you get in.

That's -- that's our belief. That's our belief. It's one of the top dozen markets or so. And it should -- should be a good market for us once we've -- get the regulatory issues behind us.

Okay. And, Dave, I think you talked about trying to create a tool culture at the Company. Can you talk about other new initiatives other than the extra point you're throwing into incentives. You started last year. And what kind of tools you're throwing out to distributors. I've seen your improved media. But what other things are you trying to implement?

Well, it's mainly a focus on the tools. Because what we talk about is what people tend to do. We're not looking to really change our tools that much, just to give people handing out 10 of them instead of 1 of them. The mentality has been to hand out 1 and get it back, then hand it out to the next person rather than to have 50 out there seeding the market. So we're just trying to change the mentality. That's why we lowered the cost our -- our price of our sales tools. To try and get bulk. Get them buying. We're focused a lot on getting them to put 50 or 100 tools on their auto ship just like they put their products on their auto ship every month. We're hoping this will just increase the number of seeds that are out there. We've learned from experience that as people get tools out there, they may not get the response within a week. They may get it six months later when the person just happens to have the right timing and the tool is sitting on their shelf. So we're trying to change that mentality from having a couple tools out there to having hundreds of tools out there. And that just takes the process -- the time and process to have it filter down from the leaders down through the many levels to get people implementing that kind of business strategy. But we think with tools we can tell the story better, more consistent and safe manner as we get to be a larger and larger company. It's hard to pass the story down from level to level without those consistent tools. So we think that's the key to taking it to the next level.

Is it all video and audio, of is there something else in there?

Our number-one tool is the newspaper, actually.

Okay.

A very inexpensive, leave-behind newspaper that tells the entire story. And people can pick and choose selections from that newspaper based on their interest and need. So it's been a very popular tool, and we're just -- we want to double the sales of those tools this year and then work to double them next year, as well.

Okay. Gil, you -- thank you very much for giving us the gross margin excluding contract manufacturing. Could you do the same without samples? I mean, I have to assume your sampling efforts are twice what they were a year ago, and I believe that's zero gross margin business.

Yes, I don't have that number off the top of my head, Scott. But I don't think it's that material. We did show progress in our direct selling gross margins. And as we noted in our prepared comments, that we -- we expect to see some continued modest improvement there.

Do you think -- do you think that -- if you look across your peer group, do you think that gross margin ought to be higher than 78%?

No, I really don't think so. I think if you look at the total value that you're delivering to your ultimate consumer of your products, it -- we look at it as a combination of -- one way to look at least is a combination of cost of goods sold. That is, the value that's going into your products. And -- then the commission that you're paying out. That combination we think we're delivering greater value, if you look at it that way, than virtually all of our peers. So if -- it's not going to go -- when you build the kind of quality products we're building, it's not going to go to 10% or 15% of cost of goods sold.

Okay. And just last question, a small market, but South Korea was positive again. Anything different happen there? Or has the market gotten a little bit better?

We're starting to see some energy and enthusiasm. It's a small group, and so it's going to take a while for them to get the momentum and the masses. But they were very vibrant, excited group at the Singapore convention. And we're hoping they're taking a lot of that energy back to their market to get it growing faster. They were definitely enthused at the event.

Great. Thank you.

Tim Ramey, D.A. Davidson.

Good morning. Dave, I was interested in your comments on China, the application going in in the second half. What -- I understand there are several hurdles there in terms of capital that you have to have on deposit and storefronts open and manufacturing. What are some of the things that you'll have to deal with between now and then to get that application in place? Or can you kind of do them concurrently with the application?

Well, our main concern is that the compensation strategy, we're wondering how other companies that are already there and forced to do it are adapting do the December rule that goes into place. And we're wondering how successful they're going to be with those rules in place as we've already seen some of them are struggling with that level -- with that new design of single level. So we wanted to watch and make sure that when we license, we have the best possible compensation plan to take advantage of that market, according to what the laws will allow. And so that is our biggest focus is getting that done properly. And we're going to be studying the other applications and how other businesses are working to see which way of handling those new laws with your compensation plan is the best to get us the most success there.

Okay. And just a quick question on RESET. It was a nice percentage of sales. Can we assume that -- it sort of gave up some -- Sensé gave up something and RESET replaced it, or how did the Sensé line perform?

Overall, it -- all of our product categories made progress. But in terms of relative percentage, Sensé was down a bit. And so were our optimizers down just a bit.

But Sensé did grow?

Yes, we did see modest growth in Sensé. Overall, the sales were up nicely. And so we saw all of the product lines grow.

Okay. And, Gil, would RESET tend to depress the auto shipment percentages? How did that come in in the quarter?

Auto ship was pretty consistent. I don't think RESET would have any -- any basis for depressing the auto ship percentage.

Those foods are also on a monthly serving size. So they tend to work the same way the essentials or any of our optimizers will work, even better than Sensé in that you need to buy your foods each month because you go through them each month.

And just -- I had modeled some share repurchase in the 1Q which you didn't do. I'm just wondering about kind of having a very heavy share repurchase effort in the fourth quarter, and then none at all in the first quarter. And the share price was about the same.

One of the things that we looked at is that -- well, first of all, we're -- the Company's also blacked out. In that first quarter, you have year end kind of things going on. So there's a longer quiet period, if you will, where we couldn't be in the market. But having said that, we're also -- wanted to build just a bit of cash up. We've got some expansion going on here at -- in our Salt Lake facility. And anticipate, and as Dave mentioned in his comments, investing in China and this other new market. So I think we're at a level now where we -- we're likely to be more active as we go forward.

Thank you very much.

Mimi Sokolowski, Sidoti & Co.

Okay. Thanks. I just have one quick question. Gil, can you give me an idea of how much capacity you have in USANA's current infrastructure? I guess in terms of where annual revenue could go before meaningful step up had to occur.

In our K we reported our capacity at both of our facilities at just under 70%. And in -- so we've got room to -- to grow without adding capacity. However, it's been our -- kind of strategic philosophically to anticipate the growth. And we're certainly optimistic about what we see out there. So we have a -- expansion plan underway right now for our manufacturing facility and some administrative room here in Salt Lake facility that should see us through -- I suppose doubling the size of the Company once that's done without too much -- too much of a hassle. And the anticipation of this is something on the border of -- this year of -- of maybe $13 million. Something of that order.

That's the investment, 13 million?

That would be the capital expenditures.

Okay. All right. That's helpful. Thank you.

Doug Lane, Avondale Partners.

Hi, good morning, everybody.

Good morning.

Gil, with the sales slightly beating your range and EPS coming in a penny or two under it, can you give us the one or two key reasons for that disconnect in the cost structure that -- that took you from a slight beat on the sales line to a slight miss on the EPS line?

Yes, I think if you look at the following areas, our Asia Pacific convention, while it was in our guidance when we gave our guidance back in February, ended up costing us a bit more. Probably a penny more in rough terms than we had anticipated. We think it was a wise investment, but that was an element there -- [inaudible] Also I think the combined expenses we get cranking in China and can prepare to eventually enter that market. And continuing to get ready for the -- the other new market we've been working on. Those expenses are starting to grow a bit on us. And that was slightly more than we anticipated. So we have those element added. And don't forget, if you -- if you take out the option expense out of that first quarter, we would have had 18% growth year-over-year, which -- which we were pleased to see.

Okay. Staying on China, I'm trying to -- you mentioned applying for the direct selling license in the second half. And there'll be some lead lags there. Can you also put some color on how it's going to play out from a capacity standpoint, when you'll be up and running on capacity? I assume you have to be 100% vertically integrated there. And then also, on the product regulatory front as well as the recruiting front, when do you think the four elements -- all four elements will come together and really enable you to start in earnest in China?

I'll take a crack and then, Dave, you can jump in and correct me or whatever, add to it. But we certainly aren't looking for any revenues before 2007. That's -- that's a given. We do have a small manufacturing facility there near -- in Tianjin, which is currently capable of managing personal care products. We don't believe that the -- the new rules are going to require 100% vertical integration in China. At least that's my understanding. And in terms of product registrations, that process is underway. We're uncertain as to how long that will take. Now some products won't take much at all. But our core products, essentials, which are fairly sophisticated, and fairly potent supplements as you know, that may take a little while. And we don't know whether that's going to be six months or 12 months. We just don't know the process on that. But we are working on a parallel basis on all these elements. And in some ways, our strategy's been to see if we couldn't assess where the success and problems and challenges that others were having which is why we have delayed even making application for license. We'd like to see how those play out. So don't look for revenues before 2007. That's a given. And it may be late in 2007. We just don't know yet. We'll provide guidance each time we have these conversations, of course, and provide updates. But it's -- it's out there on the horizon a ways.

All right. That's helpful. Thank you. And just if you could address the recruiting. Once you get the other three elements in place, what's the lead lags on recruiting? Can you start that now? Are you -- do you have leadership in the market yet, or is it premature to even talk about that yet?

It's really premature to talk about recruiting. Since -- since the apparent methodology of doing business there will be a single level basis, the recruiting element's probably going to be a little different than we've been used to. We know that we have existing field leaders in our other markets who are certainly anxious to have us do business there. So when the time comes, we anticipate that we'll have people working pretty hard at recruiting. But it -- its way early to -- to kind of anticipate what kind of form that may take and how quickly it would ramp up.

Okay. Thank you. Just a couple of quick follow ups. Did you -- did you say CapEx this year will be 13 million? Have you given that figure before, Gil?

In the K, what did we put in the K, Doug, do you remember? 10 or so? And this last year we spent under $6 million in '05 in total CapEx. And -- and I -- I think we have talked about 10 regarding the facility here. But we'll also have some other things scattered in some of our other markets, which is why I put out the number this morning of talking about could be -- could be as much as 13. Some it will be -- depend on timing whether it falls this year or next. But that's kind of the order of magnitude that we're looking at.

Okay. And then lastly on the contract manufacturing, almost $3 million this year. Is that a new run rate? Should we be more looking like -- looking more for 12 million this year than something in -- the 8 or 9 million, or was that just a timing of orders kind of thing?

Yes, good question, Doug. A lot of that was catch up. Because we had in the fourth quarter, we were doing a lot with Sensé. And -- so some of what you saw in the first quarter was catch up. So rather than look at that 3 million run rate, I'd drop back and looked more at what we were in the fourth quarter, somewhere around the 2 million run rate a quarter, something like that.

Okay. Thank you.

Andy Speller, A.G. Edwards.

Hi, guys. Good morning. I was hoping to get some -- get some answers around capital deployment and you've got the 40 million out there in terms of share repurchase. Don't pay a dividend. What are your thoughts there once that 40 million's used up? Do you expect to use it up this year? As I look at cash flow, looks like operating cash flow could more than offset -- you could produce more than -- more than enough to take care that from a share repurchase standpoint. If I could just get your thoughts there.

Yes. Good question, Andy. Our EBITDA continues to run very strong for us. So cash flow is just one of the great things about this model. It wouldn't surprise me to see us use that 40 million authorization on share buy back this year. That'll depend on a number of things. Dave and I have certainly -- in touch with the Board on a regular basis about these matters, and they've indicated that if that weren't enough, they'd consider additional authorization. So I don't think we would necessarily be limited by that amount if we were able to -- if we ran through that amount before the year was out. But we do have some commitments out there. I mentioned the CapEx that we have planned. We know at some point we're going to have to invest some money in the Chinese market as we get closer and closer to entering that market. We're not sure of the timing of that yet. So there are a number of issues out there that -- that could swing one way or the other, either this year or next year, as to when we actually make those expenditures.

Your -- do you view ROE as a -- as a strong tool in terms of evaluating your capital deployment or do to use some other metric?

I'm sorry, Andy, I --

Do you use return on equity or some other return metric to determine your capital deployment effectiveness?

Well, that's certainly one measure we do. On -- on capital expenditure, of course, we do the standard IRR and ROI kind of computations on those kinds of things and with established thresholds and so forth. But we're looking for ways to increase shareholder value. And so like last year, we spent nearly $50 million returning that money back to shareholders through our share buy-back program. And so we're certainly interested in -- in continuing to have what we think is probably the premiere, unleveraged return on equity calculation -- or outcome in -- in the industry.

Okay. Thanks. Appreciate it.

[OPERATOR INSTRUCTIONS]. Steven Martin, Slater Capital Management.

Hi, guys.

Hi.

Just a quick -- couple of quick points. Most of my questions have been answered. When you talk about 15% to 20% EPS growth, what base are you operating off of?

We're operating off that $1.98 from last year.

Okay. And when you -- given the higher tax rate, when you look at operating earnings embedded in that 15% to 20%, what is the -- and whatever your thoughts are on share count -- what is the operating earnings increase?

We have not put that out there, Steve. I guess the best way I would answer it. The -- we're -- that tax rate's going to cost us about $0.06 a share. But we have not -- we have not gone through the math. And Doug, is there anything else that we could say about that without --

I think it's fairly straight-forward math to go back -- it would be something north of 20% -- just north of 20% on the high end. Just north of 15% growth on the bottom end. $0.06 on $1.98 and not a -- about a 3% impact, so you'd have to go back and factor that in accordingly.

Okay. I guess I can work backwards on that.

Just work backwards on it, Steve.

All right. At one point you had talked about in the event you can't get this other new market open that there was a possibility of a second new market. Can you comment on that?

Steve, we are always looking at other areas and other markets. There are always efforts going on to evaluate markets and their attractiveness. We -- we would probably -- our emphasis, and Dave mentioned in his comments, our emphasis is really going to be to push the existing markets we're in. The potential in them, we believe, remains very high.

We're not -- we're not going to push a market just to force a market. We're very excited about the 22.1% growth in North America as a much more efficient way for us to get profitable sales. So there are only a few markets that we would consider very viable. And productive markets for us. So we're going to not force the market, just based on adding a market. If we don't get the ones we want, we'll continue to focus on the existing markets.

All right.

Long term, though, Steve, there's some attractive markets out there that we'll be addressing long term.

Okay. And one last one. Now that -- looking into the second quarter, is there any -- call it extraordinary expense, but is there any expense other than options and some of the things we've talked about like new markets that is going to occur in the second or third quarter that didn't occur last year like the Asia Pacific conference?

I think in our comments -- our prepared comments we said that we thought SG&A would moderate in the second quarter some. And so there may be some smaller items, maybe a bit of advertising, this kind of thing. But nothing extraordinary, Steve, that's out there.

All right. Thank you very much.

At this time, there are no further questions. I'd like to turn the call back over to management for any closing comments.

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, our manager of investor relations at 801-954-7922. We appreciate your interest in USANA, and thank you for joining us on our conference call this morning.