USANA Health Sciences Inc (USNA) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to USANA Health Sciences fourth-quarter and year-end earnings conference call. During today's presentation all parties will be on a listen-only mode. (OPERATOR INSTRUCTIONS). This conference call is being recorded today, Wednesday, February the 7th of 2007. I would now like to turn the conference over to Riley Timmer, Manager of Investor Relations. Please go ahead, sir.

Thank you, Mary. Good morning, everyone. We appreciate you joining us this morning to review our fourth-quarter and year-end 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 the 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 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. We provide non-GAAP measures to assist investors in understanding our operating performance. Let me now turn the call over to Gil Fuller, our Executive Vice President and CFO.

Thanks, Riley, and good morning, everyone. Thank you for joining us to review USANA's record fourth-quarter results.

I am pleased this morning to be joined by David Wentz, our President, who you will hear from shortly. Also in attendance this morning is Fred Cooper, our Executive Vice President of Operations; Mark Wilson, our Executive Vice President of Customer Relations; and Doug Hekking, our Vice President of Finance.

This morning I plan to update you on the strong financial results we generated in the fourth quarter, talk about our guidance for the first quarter of 2007 and update you on our full-year 2007 guidance. As you may recall, on January 10th we issued a preliminary fourth-quarter press release announcing to the public an immaterial reclassification to net sales and associate incentives, which adjustments have been incorporated into our earnings press release and financial statement data issued yesterday and into this conference call.

Net sales in the fourth quarter were very strong and came in above our October projections. In fact, during the fourth quarter we achieved our 18th consecutive quarter of record sales. We were pleased to report net sales of $99.8 million, an increase of 16.5% compared with $85.6 million reported in the fourth quarter of 2005. Net sales growth this quarter was driven by a 15% increase in the number of active associates and an 11.4% increase in the number of preferred customers compared with the fourth quarter of last year.

Also our monthly Autoship order rate continued its consistently strong pace and represented 52% of our total product sales during the fourth quarter.

Earnings per share for the fourth quarter, which includes expenses related to equity-based compensation, increased to $0.61 compared with $0.54 per share in the fourth quarter of 2005. Equity-based compensation expense reduced earnings per share by $0.04 in the fourth quarter. Excluding this expense, earnings per share would have been $0.65, an increase of about 20% compared with the fourth quarter of the prior year. We are pleased that our business model continues to show earnings-per-share leverage after excluding the expense from equity compensation.

Earnings per share in the fourth quarter of 2006 were affected by the following -- equity-based compensation expense of $1.3 million; costs associated with the Success from Home Magazine promotions, which had a modest negative impact on our gross margins; a favorable foreign currency gain of approximately $600,000 relating to the repatriation of excess capital from one of our foreign subsidiaries; and a higher-than-expected effective tax rate of 36.1%.

Let's now go through the major line items on the fourth-quarter statement of earnings. First, for comparative purposes I will give you the impact that equity-based compensation had on the fourth quarter by line item. Cost of goods sold, $143,000; SG&A expense, $1 million; research and development expense, $139,000. The total reduction from equity-based compensation was $1.3 million or about $0.04 per share.

Our consolidated gross margin in the fourth quarter of 2006 improved as a percentage of net sales to 76.2% compared with 75.8% in the fourth quarter of 2005. This improvement was due to a smaller portion of our total revenues coming from our third-party contract manufacturing segment, which has low gross margins. Our focus is to grow our direct selling business and not to add new business in our contract manufacturing segment.

If you look at gross profit margins by segment, our direct selling segment declined 60 basis points to 77.7% in the current quarter compared with 78.3% in the fourth quarter of last year. During our third-quarter conference call in October, we announced that we would be promoting Success from Home Magazine during the fourth quarter. These promotions include selling the magazine at our cost and offering free shipping to those customers who placed a 56 pack of these magazines on their monthly Autoship order. Accordingly and as announced, these promotions reduced our direct selling gross margin in the fourth quarter by approximately 70 basis points.

We believe this promotion helped us achieve record sales in the quarter. We are hopeful that the magazine will continue to have positive effects in the next couple of quarters. In addition, we do not expect to see the same level of gross margin pressure in 2007 from these magazines as we experienced in the fourth quarter of 2006.

Looking ahead, we believe that our consolidated gross profit margin will improve in the first quarter and throughout 2007. Associates incentive expense in the fourth quarter was 40% of our direct selling revenue compared with 40.1% of our direct selling revenue in the fourth quarter of last year.

Selling, general and administrative expenses increased relative to net sales to 19.4% during the fourth quarter of 2006 compared with 18.2% in the fourth quarter of the prior year.

As I mentioned earlier in my comments, equity-based compensation expense increased SG&A by about $1 million this quarter. So if you exclude the expense from equity-based compensation of $1 million, our SG&A relative to net sales was about 18.3% in the fourth quarter of this year.

We believe SG&A expense in the first quarter of 2007 as a percent of our net sales will be modestly higher compared to the fourth quarter of 2006. This projected increase relative to net sales is primarily due to expenses related to the opening of the Malaysian market and higher than expected attendance at our Asia-Pacific convention to be held in Sydney, Australia, in mid-March.

Let's now turn our attention to full-year 2006 results. For the full year ended December 30, 2006, the consolidated net sales were $374.2 million, an increase of 15.8% compared with $323.1 million for the prior year. Earnings from operations for 2006 were $62.3 million, an increase of 6.8% compared with $58.4 million for the prior year. Earnings from operations for 2006 were reduced by $4.8 million due to the required expensing of equity-based compensation. Excluding the equity-based compensation expense, operating earnings increased by 15% in 2006.

We achieved net earnings in 2006 of $41.3 million, an increase of 5.8% compared with net earnings of $39 million in 2005. Again, excluding the expense from equity-based compensation this increase in net earnings would have been 13.7%.

Earnings per share increased 11.1% in 2006 to $2.20 compared with $1.98 in 2005. Excluding the expense of equity-based compensation, this increase in earnings per share would have been 19.7%.

We achieved record levels for both net earnings and earnings per share in 2006. We will continue to make investments that we believe will have positive future returns for both our associates and our shareholders.

In regards to the balance sheet, cash at the end of the quarter and year was $27 million compared with $10.6 million at the prior year-end and about $21 million at the end of the third quarter of 2006.

Inventories at the end of 2006 were $22.5 million, which is about flat with the $22.2 million in inventory at the end of 2005.

To update you on our share buyback program during the fourth quarter, we invested an additional $7.9 million and repurchased approximately 177,000 shares. Currently we have about $40 million available under our current share repurchase authorization.

For the full year 2006 we repurchased approximately 1 million shares for an investment of $41 million.

Before I turn the time over to Dave, I'll comment on our future guidance. We continue to be optimistic about the future and expect net sales in the first quarter to be in the range of $103 million to $105 million. This is compared with $88.2 million in the first quarter of last year for a growth rate of 17% to 19%. Please note that this sales guidance includes revenue from Malaysia, which opened for business on January the 8th.

We expect earnings per share in the first quarter of 2007 to be between $0.61 and $0.63. This is compared with $0.50 in the first quarter of last year, for a growth rate of between 22% and 26%.

Now let's look at full-year guidance for 2007. We continue to believe that net sales in 2007 will grow between 15% and 17% over 2006 results. We are raising our earnings per share guidance for the full year 2007 and now believe that earnings per share will grow between 17% and 20% over 2006. This earnings per share estimate assumes a 2007 tax rate of 36.5%, which is higher than the 35.3% tax rate for 2006. Our initial guidance suggested a tax rate for 2007 of 37%; however, Congress acted on the extension of the credit for increased research expenditures, which we have factored into our current 2007 guidance estimate.

With that I will now turn the time over to Dave to comment on our operating activities.

Good morning, everyone. Well, once again, another very strong quarter at USANA. We have now achieved 18 consecutive quarters of record sales. In the fourth quarter sales were up nicely in all but one of our markets.

Looking at our results regionally, net sales in North America, our most mature region, increased by 16.6% compared with the fourth quarter of 2005. Excluding the impact of currency fluctuations, sales in this region would have increased 15.8%. We believe that this continued growth in our most mature markets is indicative of the success of our business model and illustrates the value that our science-based products brings to our associates and our customers' lives.

Our Mexico market led the strong growth in this region, increasing 48.9% over the fourth quarter of last year. Sales during the fourth quarter were up 9.1% in Canada and up 16.8% in the US over the fourth quarter of last year.

In North America the number of active associates increased by 14.6% to 94,000 compared with 82,000 in the fourth quarter of last year. We were pleased to see that the momentum generated at our international convention held in mid-September carried over into the fourth quarter. During the quarter we heavily promoted our November feature in Success from Home Magazine. We sold a total of about three-quarters of 1 million magazines from the launch date in mid-September through the end of the year. These were sold mainly in packs of 56, which was done to promote our concept of giving away two of these magazines every day. We remain optimistic that these magazines will drive incremental associate enrollments, and we will continue to promote this sales tool during the first half of 2007.

In the Asia-Pacific region, sales were also very strong. In this region sales increased by 19.9% over the fourth quarter of last year. Excluding the impact of currency fluctuations sales in the Asia-Pacific region would have increased 16.9%. The strong year-over-year increase in this region can be attributed to double-digit growth in the following markets -- Taiwan, up 18.1%; Singapore, up 46.7%; South Korea, up 58.4%; and Hong Kong, up 62.3%. The number of active associates in the Asia-Pacific region increased 15.7% to 59,000 compared with 51,000.

A strategy of the management team is to offer contests and promotions that reward those associates who are actively growing their USANA business. At the end of the fourth quarter we completed our single largest contest ever offered, which we call Share the Success. This $1 million global contest paid the top position $125,000. We offer this and other types of contests to increase associates' activity levels.

In regards to Malaysia, we're encouraged by the early results in that market. There are associates leaders from a number of our different markets who are on the ground in Malaysia, developing relationships and building their USANA business. We're optimistic that this market will follow a growth pattern similar, perhaps, to that of our Mexico market.

Let me now comment on our expected use of cash during 2007. This year we expect that our capital expenditures will be about $20 million. We're currently in the middle of an expansion effort at our corporate facilities here in Salt Lake City. This expansion includes the addition of parking and warehouse structures. Also we're adding more administrative space, which will allow us to bring our production studio under one roof. In addition, we recently acquired some land and a new building in Australia to support the rapid growth in that region. We're also increasing the size of our facilities in Taipei, Taiwan and Singapore to accommodate growth in these markets. We're excited about our future and believe these investments will assist us in better supporting our associates now and in the future.

As some of you may recall, at our convention in mid-September we launched a product in the US that we call TenX Antioxidant Blast. This is a powerful and convenient antioxidant fruit bar that contains 10 times the antioxidant levels of the finest fruit juices, red wines or green tea extracts, hence the name, TenX. So far this product has been well-received by our associates, and on average we have sold about 1200 boxes per week. Our R&D group is working on extending the shelf life of this product so we can sell this terrific product in our other markets.

Finally, concerning China, I want to make it clear that our 2007 guidance does not include any revenue from China. However, we continue to monitor the competitive environment there, evaluating the few direct selling companies who have been granted a license. Entry into China is an extensive effort, given the modifications to our business model required by the new laws there. We have not determined a specific time for our direct selling license submission. However, we continue to move forward with this process as we pursue a long-term strategy for this large and potentially lucrative market.

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

(OPERATOR INSTRUCTIONS). Tim Ramey, D.A. Davidson.

Good morning, congratulations. A couple of questions on the use of cash, Dave. You mentioned the new land and building in Australia. Is that, I assume, a production facility? Or would it be overhead and support type facility?

Just an expansion of our current facility. No production addition.

You didn't mention anything about share repurchase. You have been fairly aggressive, buying back over 5% of shares outstanding the last two years. Is that likely to continue? I know you do have a continuing authorization.

Yes; we have a continuing authorization. We're going to keep an eye out, and when we see good opportunities we will definitely get back into the market. We're always picking our spots the best we can to make the best investment of our cash.

Maybe not today? Over 60.

Might wait till tomorrow, yes.

Scott Van Winkle, Canaccord Adams.

Congrats, as well, another great quarter. A couple questions on Malaysia, a new market. Thus far -- and if you said something, I apologize -- I was a little distracted during the call. But has there been anything you can talk about with Malaysia thus far? Second, you mentioned China. But are there other markets out there that might come before you actually apply for a license in China?

Malaysia -- we mentioned that it's looking to be on track with the Mexico launch. We always hope it will do better, but things are off and rolling smoothly. We're very excited about the potential of that market and think it's going to be a good one for us.

As for China, we're watching to see how the others do, and we are not in a rush to open any smaller markets, just to fill in extra markets. So we will keep an eye on China. We will have other things we are looking at but not in a large rush to get anywhere else.

So likely the next market would be China, assuming you decide to go in?

At this point, yes.

Okay. Gil, for you, return on equity, return on invested capital has come down the last couple of years; certainly something to be proud of, the numbers you post up there. How do you keep that from coming in like it has, or what is the reason for it coming in? Obviously, you're putting your cash back to work and buying back shares. What else can you do to keep these very high levels of returns?

Obviously, the share buyback program has been a major factor there, but I think the obvious factor is that we have continued to be able to leverage our income. So I think continuing to generate strong levels of operating earnings and net earnings and earnings per share is going to be a major factor in that.

I think one of our challenges out there three or four years -- -- we have been sort of generating so much cash, will be, what do we do with that cash? At this point, we are evaluating a number of things. Currently, we feel very good about what we have underway. The capital expenditures that Dave went through present some good opportunities to employ our cash to facilitate growth in those markets that he mentioned. And of course, when and if we do get into China that could be a big consumer of cash for a few years as well.

Looking back at Success from Home, you talked about how happy you were with its performance in the fourth quarter. Is that something you look to maybe do on an annual basis or something similar? I think that was the first time you had done a third-party tool like that, I assume. But could we expect to see something like that coming again next year or the year after or something like that?

Certainly we will look for opportunities with third-party tools that will leverage our opportunity for the field, to go out and prospect. Forbes magazine has been a huge one for us. Business Week, in the past several years. This is just another opportunity for them to have a tool that they can go out and talk about USANA.

We focus a lot on third-party credibility tools, and I think that has helped us be very successful. Luckily, we have those third-party endorsements to use. As long as we keep this growth going, we will continue to have new ones coming available, which get the field excited about the latest third party that recognized our progress and our success.

Andrew Speller, A.G. Edwards

Good quarter. Gil, just more of a housekeeping type stuff. Do you have any cash flow data available?

Yes, we do. Cash flow generated from operations for the quarter was $15.5 million. During the quarter we invested about $4.7 million in CapEx in the quarter.

What was D&A?

Depreciation for the quarter was $1.3 million and for the year, $5.9 million.

Also along those lines, in terms of --

I'm sorry; $5.5 million for the year.

Just another numbers question, as we look at '07 in terms of equity comp, is that going to ramp year over year from where you were?

Let's see. The equity-based compensation expense?

Yes.

We were about $0.17 for the full year, and it's probably going to nudge towards $0.22 impact. We built that into our guidance.

Okay. As far as Malaysia, what should we look at in terms of key points as you guys move through the year with that new market?

Maybe I can start out and, Dave, you can chip in here. I think we will be looking, of course, for the -- we are very early on, you know; we are four weeks into this market. So none of us know, of course, how this will play out yet. As Dave mentioned we're encouraged by what we've seen thus far. But we will be looking beyond just a sales number that we generate out of there each week. We will be looking at the number of enrollments that we're getting and looking for feedback from our leaders that are over there in terms of what they are seeing and how they perceive that market and that market potential. We will be looking at that on a current basis.

The other thing that becomes very important with a new market is how quickly people rank, advance and our leadership development. Developing leaders in country is the key to allowing the other leaders who have come into the market to build it to go back and, once again, build their local markets after they have established leaders in the new markets. So we'll keep an eye on leadership development, and that's always the key.

The leaders that have gone in there and started building the base -- where are they, predominantly, coming from?

Singapore, of course, mainly, right next door. But all of our Asian markets and a few of our North American markets. The leaders always get excited about a new country, and so we've got them from everywhere, doing what they can, either whether they are doing it long distance or have gone in country and moved there for six months or a year.

Rommel Dionisio, Wedbush Morgan.

Just a question about the '07 guidance. You kept the sales expectation the same, 15% to 17% growth but EPS going up. Part of that is tax rate. But could you just talk about what has changed in the margin differential, especially given that you're actually -- you have been increasing Success from Home initiatives in the first half of this year. What has sort of changed? Is it gross margin or SG&A that is being lowered? Are you cutting expenses somewhere to get to those numbers?

The two main things in the model that you'll see is there will be a lower mix in the contract manufacturing business in there, which will be a catalyst to the operating margin improvement. Also, we expect to see some sequential and consistent progress in our gross margin in the direct selling segment. Those are the two main contributors to that.

. What is the core driver on the gross margin improvement?

In the direct selling business the vast majority of our cost of sales is coming from the cost of materials, so there's a lot going on with reduction in the purchase price of some of the materials through some different procurement strategies we have put into place.

Just a follow-up, on the analyst presentation back last fall you talked about some Web conferencing features and a redesigned Web site. Could you just update us on the progress you made there and what kind of impact that is having?

To answer that question, we are trying to push out the utilization on our Web to also reduce the costs associated with doing business with our associates and improving the ease to which they can do business. So to that end, as we expend that money we hope to get the leverage back and not getting so many calls and questions and also an improvement on the information that is provided to our associates on the Web so that they are driven to come back and back to the Web on a more frequent basis.

Doug Lane, Avondale Partners.

Just to drill down a little bit further on what Rommel was asking you about that added margin expansion that wasn't there when you originally gave your guidance in October or November, what really changed since then on the cost front, if you could just give us one or two specific examples?

Our purchasing group goes out, and they go out semi-annually to go back and get their bids. The bids were not in at that point in time, so we didn't have visibility to some of the purchase contracts we have in place for '07, coming up.

Another thing related to that is that at the time we gave that release we were not quite sure of the impact of Success from Home, how long it would be out there or the impact on the margins in the current quarter that we were then in. So, as we have seen that more clearly now, I think it has given us a little better insight as to what we can look for in '07.

On the Success from Home initiative, I noticed that in the United States the activist associate number only picked up 1000 in December over September, and back in the first half of even '06 sequentially you were up 3000 in the March quarter, 3000 in the June quarter, and then only 1000 in September and 1000 in December.

So I was kind of surprised that you didn't get a little bit of a boost from the Success from Home initiative in the December quarter, since you had that magazine really for most of the quarter. Didn't you? I think you rolled it out at the September convention.

Yes, we had the magazine for the quarter. I think getting them in their hands and getting them out in the field is one thing. Getting them to distribute it is another thing, and then having them follow up to actually sign somebody up is yet another thing. So I think that's one of the reasons we're so optimistic about the first quarter, is that we think we're going to have some carryover from the efforts that we made in the fourth quarter.

You always have some seasonality in that fourth quarter with regards to active associate. For example, in the United States, going from the third quarter of '05 to the fourth quarter of '05 it was up 1000. So, in spite of the magazine, we did the same thing. A lot of that, I think, is seasonality.

So you think it will have more of an impact in the first half of '07 and that the fourth quarter of '06 might have been just too early to look for the big -- for whatever impact that magazine might have had?

We're certainly optimistic and hoping that it will have legs to impact the first quarter.

Lastly, I'm looking at the quarterly -- you had a good year in '06 and, really, four good quarters to make up that year. So I'm looking at your first-quarter guidance, where sales and EPS growth is kind of above your full-year expectation, which implies, then, some deceleration in growth rates thereafter. Without the quarterly comparisons really being obvious, what just in general do you see that either makes the first quarter better than the full year or the rest of the year slower than the first quarter?

Great question. As we have thought about this guidance, the way we have looked at it is we've got this new market open in Malaysia. Typically, the pattern for a new market is to have it spike up in that first quarter, and then you generally see it settle down. Sometimes it will even decline in the second quarter or so. We hope it doesn't, of course, but sometimes it -- it will always settle down and the growth will certainly settle down after a quarter or so and then get into a more normal growth pattern.

In addition, as you get into the second half of the year, we had very strong quarters on a year-over-year basis. So the comps get tougher. So that's really why we've stuck with the 15% to 17% for the year.

Of course, as we see how Malaysia actually develops -- we don't want to get too enthused about it. But as it actually develops, then we will give some more guidance and insight on that.

(OPERATOR INSTRUCTIONS). And management, there are no further questions. I'll turn the conference back to you for closing comments.

Thank you for your questions. We continue to remain confident in the future outlook of USANA, and the investment opportunity 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 again for joining us this morning.

End of conference.