USANA Health Sciences Inc (USNA) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the USANA Health Sciences third-quarter earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, October 15, 2008. I would now like to turn the conference over to Riley Timmer, Vice President of Finance. Please go ahead, sir.

Thanks, Michaela. Good morning, everyone. We appreciate you joining us to review our third-quarter 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. A replay will be available on our website shortly after this call.

Now before I turn the call over to Fred, I remind you that during the course of this conference call management will make forward-looking statements regarding future events for the future financial performance of our company. Those statements involve risks and uncertainties that could cause our actual results to differ perhaps materially from the results projected in those forward-looking statements. We caution you that these statements should be considered in conjunction with the disclosures, including the specific risk factors and financial data contained in our most recent filings with the SEC.

Also during this call management will discuss non-GAAP information. We provide non-GAAP measures to assist investors in understanding our operating performance. I will now turn the call over to Dr. Fred Cooper, our President and Chief Operating Officer.

Thanks, Riley. Good morning, everybody. Welcome to the call. Here I am pleased to be joined with Mark Wilson. He is our Executive Vice President in North America. I have Jeff Yates here to my left, our newly promoted Chief Financial Officer, and you will hear from him when I am finished.

I want to begin reviewing a few important announcements that we've made over the last few months here at USANA. First, on July 24 we announced the dismissal with prejudice of our shareholder class-action lawsuit, which we were very pleased to have happen. Next, on July 28 we also announced to you that we had settled our outstanding lawsuit with Barry Minkow, and this settlement required Mr. Minkow to remove all the information he had related to USANA from his website and other places on the Internet. It also precludes him from making any further disparaging public statements about USANA, which should be a very, very beneficial help to our associates in the field.

Finally, on October 2 we announced that our distributor class-action lawsuit had also been dismissed. I want to point this out because I think it is very rare for a public company such as ours to find favorable dismissals in one significant lawsuit over a year's time, let alone the three that we've had. The favorable outcome in each of these suits is a direct result of the strength of USANA's position in each of its lawsuits and ultimately I believe it is the character and integrity of our company. We are confident that the dismissal of these suits will make it easier for our associates to enroll new customers once they want to efficiently grow their home base business.

Turning to our third-quarter operating activities, the third-quarter was highlighted by another successful international convention which we held here in Salt Lake City. This event is our most significant corporate sponsored event that we hold annually, and we spent four days training, motivated, celebrating and recognizing all of our associates here. Over 7000 associates were in attendance, and we made several exciting announcements. The most significant announcements we made were related to our new associate compensation plan enhancements. The first enhancement is directly aimed at our top 25 earning and growing associates. We call this new enhancement the elite bonus. This bonus is designed to deliver an additional 1% of sales volume points, which translates to about 8/10 of a percent of net sales to our top associate leaders.

We think that this bonus is going to motivate our top 75 business leaders to grow their business through urgency since it is paid quarterly and good old-fashioned competition between them. The second enhancement rewards all business minded associates, and we call this new enhancement our matching bonus. The goal under this new program is to create other business builders or, as we call them, Platinum PaceSetters. As an associate, if you enroll someone who becomes Platinum PaceSetter you qualify to earn a matching bonus on any commission that they earn in their first 32 weeks after they've been enrolled with USANA.

Depending on your personal status these new enrolling associates can earn anywhere from between 25% to a 100% match on any new Platinum PaceSetter that they create. To maximize the effects of this new enhancement for both new and existing associates we held a requalification period which allowed existing associates a second and final opportunity to achieve Platinum PaceSetter status. This chance to requalify as a Platinum PaceSetter generated a lot of excitement with our associates. In fact, sales and enrollments in the last couple of weeks of the quarter were near record highs for us. We believe that by increasing these incentives for our business model minded associates we will be more competitive in our market in relation to other direct selling companies and instill a sense of urgency with those new to USANA.

Further, at convention we announced our operations in the Philippines beginning in the first quarter of 2009. This is going to be the company's 14th market, and we find Philippines to be very promising for us. Many of our associates have strong ties in the market. And additionally according to the Direct Selling Association of Philippines annual direct sell revenues total about $500 million, making it one of the 25 largest markets globally for direct sales.

In addition to these announcements, we also launched new products. We introduced two new energy drinks, our Rev3 energy and Rev3 energy surge pack. Rev3 energy comes in a ready to drink 12-ounce can, and the surge pack comes in an individual stick pack which are conveniently mixed with water. These products were developed to be a healthy alternative to energy drinks that are loaded with sugars and artificial flavors.

USANA has a growing number of Gen X and Gen Y associates who are actively growing their businesses and who feel that -- these have been the individuals that have been asking for this type of product. We feel that there is a significant opportunity in this growing demographic to gain market share. Overall we are very pleased with the results of this year's international convention and we are optimistic that these improvements and additions will foster for us additional sales and future growth.

I would now like to talk about our regional sales results. In North America sales were down 3% year-over-year. This decrease was mainly due to lower sales in the United States where the number of active associates declined by 3.2% year-over-year. However, the good news is active associates has increased by 7% in the US compared with the second quarter. As our most mature market, we are encouraged to see the number of active associates increasing in the United States.

Let's now discuss Asia-Pacific. Year-over-year sales in these regions grew by 7.6%. The growth was led again by Hong Kong which improved by 39.1% over the third quarter of last year, and Malaysia which increased by 25.2%. Active associates in the Asia-Pacific regions increased by 8% compared to the same quarter last year. Now this compares to -- I'm sorry -- second-quarter active associates, which increased by 11% with a 26.7% increase in Hong Kong, a 15.4% increase in Malaysia and a 10.5% increase in Australia, New Zealand.

By making significant investments in our associates through two compensation plan enhancements we believe that we will appropriately position our sales growth and to continue to increase our profitability. With that note I would like to turn the time over to Jeff Yates, our CFO.

Thank you, Fred and good morning, everyone. Before I begin, I would like to make a brief comment in tribute to Gil Fuller who just retired from USANA as Chief Financial Officer. The setting we share this morning is important to him. He has served this company's stakeholders for many years with integrity and professionalism. He is a fine man, and it is an honor for me to follow in his footsteps.

Now to our third-quarter results. Net sales for the third quarter were $107.2 million, an increase of 0.9% compared with $106.2 million reported in the third quarter of 2007. The slight increase year-over-year was primarily the result of growth in our East Asia region, driven by associate incentive programs. Comparing sales results to the second quarter of 2008, we reported a decrease of $2 million or 1.9%. It is important to note that the third quarter is seasonally our softest quarter. We know that many associates take advantage of their home based businesses by vacationing with their families during the summer months, and also traditionally associates also hold off purchasing in the weeks just prior to our annual convention in anticipation of new product introductions.

Other factors that suppress sequential quarter sales by approximately $4 million included volatility in certain foreign currencies and deferred revenue. As a US-based multinational company for years our top line has benefited from a weakening US dollar. In contrast to prior quarters when sales benefited from changes in foreign currencies net sales in the third quarter were reduced by $1.9 million on a sequential quarter basis due to a stronger US dollar.

Additionally, as a result of the four week requalification period described by Fred a large number of orders were received at quarter's end. Unfortunately with the large increase in orders we were unable to ship all of these products before the end of the quarter, thus $2.1 million of revenue will flow into the fourth quarter. Our gross margin for the third quarter of 2008 was flat to last year at 79.3% of sales.

Speaking now of earnings, third-quarter earnings per share from continuing operations were $0.50, a decrease of 28.6% compared with $0.70 per share in the same quarter of last year. This is the result of higher overall operating costs, which can be explained by the following. Associate incentive expense was 41.6% of sales compared with 40.5% in the third quarter of last year. This increase of 110 basis points is due to a higher payout rate of base commissions, an increase in the amount paid for contests and promotions, and increases relating to the compensation plan changes described by Fred and announced at our annual convention. With these enhancements, we believe that associate incentives going forward will run about 42.5% of sales.

Selling, general and administrative expenses increased to 25% of sales compared with 21.7% in the third quarter of the prior year and this increase was due primarily to the following. First, an increase in the staffing and higher executive salaries totaling $1.9 million. Second, an increase in depreciation expense of nearly $500,000 relating to the expansion of our facilities. Third, equity grants made in July of this year, which increased equity-based compensation expense by about $500,000. And fourth, we incurred additional expenses in the third quarter relating to the tender offer, adding nearly $900,000 to SG&A, which represents about $0.04 per share. Please note that we do not anticipate any additional expenses relating to the tender offer.

And finally, fifth, our income tax rate increased to 33.6% of earnings from operations compared to 31.4% for the same quarter in 2007. This higher tax rate is attributed to a decrease in tax benefits when compared to last year. For the fourth quarter we expect SG&A to be down both in relative terms and in absolute dollars.

Turning now to the balance sheet; cash at the end of the third-quarter was $13.7 million compared with $12.9 million at the end of 2007. Over the past couple of years we've made significant investments in our facilities and infrastructure to address growth and to prepare for anticipated future growth. Capital expenditures for the quarter were about $3.5 million, which brings our year to date total to just over $15 million. These expenditures were primarily for our new facilities in Salt Lake City and Australia. These facilities are essentially now complete.

We expect capital expenditures to now return to a normal run rate of approximately $2 million per quarter. During the third quarter we purchased 809,000 shares in the open market investing $28 million. Currently we have about $22 million available under our share repurchase authorization. In addition, we ended the quarter with a balance of $30.7 million on our line of credit.

Before we open the call to your questions I would like to comment on our guidance. We now expect net sales for 2008 to be between $432 million and $438 million and earnings per share to be between $2.22 and $2.28. Accordingly, we expect the fourth quarter of 2008 to reflect record sales of between $114 million and $120 million and earnings per share to be between $0.64 and $0.70 per share. This earnings per share estimate is of course based on effective tax rate of 35%.

With that, I will now ask Michaela to facilitate our question and answer session.

(Operator Instructions). Simeon Gutman, Goldman Sachs.

A couple questions. First on the matching promotion, you mentioned in the remarks that some of the sales probably were pushed into the second quarter. Does that reflect just what was happening at the last minute, or was there some additional because I think the window that people can sign up expanded by about a week. Was there even more business that came through in that week that wasn't included in that bucket that you just mentioned earlier?

Yes, indeed. We had a slight lift coming into the last week to week and a half of the third quarter with the rush largely in the last couple of days. We did see a continuing increase in enrollments of significance going into the first quarter -- excuse me the first week of the fourth quarter, so the answer to your question is yes.

And relative to your expectations, for your existing distributor population in terms of re-qualifying with that one time recall window, were you pleased with that response?

I will respond to this. Absolutely. When you think about this was a recall opportunity, those that are the aggressive builders probably already did the qualification when we offered the Platinum PaceSetter lifetime program here a little over a year ago. So we did not anticipate as many people that actually did, so this was a very encouraging trend for us to see the individuals that found this (technical difficulty) important. Especially with the new bonuses that Fred talked about there is a whole new interest in being qualified as a Platinum PaceSetter.

And I imagine the system I think the matching bonus it probably works really well as long as the successive generations of people who come in, I guess continue to strive to get their people in so they can match. How do you ensure that success? I know you had the convention, which probably effectively rallied the existing population, but then how do the people who are just coming into the business stay very motivated at the same level of energy that the existing population probably brought those people in with?

Great question. That is the key. The key is the duplication and the leverage that we hope to gain off of this and that is the whole basis behind the matching bonuses. And I think it will take some time; with any change to get people to understand the new bonus how to leverage this, how to use it in their business and building. We changed our presentation so that they are talking about this. We've created a video for people to help them understand this. It is in all the different languages so they have access to kind of better explain the matching bonus and the power of this, as well as it is an ongoing education with this new program. So those new people will give us the opportunity to push to have them become Platinum PaceSetters.

Okay, and then with regard to the environment that we are in now and I know you guys experienced a little bit of a downdraft a year ago partly macro, maybe partly reputational. What are you expecting going forward? I don't know if you saw the article today about Avon in this environment. Should this business really accelerate, or is there a trade-off with some of the discretionary purchases that you see on the other end or does the recruiting just drive it?

This is Fred. I will answer that one in part. Mark can take his turn. First of all, in the economy it is -- there is two aspects to this economy. The first one is on preferred customers. Certainly there is going to be pressure on preferred customers as they concern themselves with the economy on purchasing and buying product. So from that aspect you are going to see downward pressure on preferred customer enrollments because they are going to be a little less likely, a little nervous to have discretionary spending income for our nutritional supplements.

On the associate side there will be upward pressure we anticipate because now alternative means of making income becomes available to them. So with that I think that is why you are getting also a little reflection in the number of our current active associate counts going up.

And Fred, maybe in the past have you looked at during a tougher environment preferred customers who have left, do you see preferred customers eventually coming back? Just thinking about this, let's say 12 months from now where the recruiting drives the bulk of the business today but some of the preferred customers who liked the product just can't pay for it, then come back in the business and then the business is stronger for it. Do you know what the, I guess the come back rate would be from the preferred customer side?

USANA we have classified our associates and our preferred customers into classifications. We have those are actively building the business, which is a fairly small proportion of our total associate base. Then we have some that are new just pursuing where we haven't identified whether they are just total product consumers or business builders. Our third group of associates who are really nothing more than preferred customers and our last classification are for the preferred customers themselves. In each of these groups there are buying habits associated with them. And in those buying habits we find that in both the classification of associates really acting as preferred customers and preferred customers themselves do purchase on an irregular basis.

However, if that length of purchase goes much beyond a year, they are not likely to repurchase unless they are approached again by our associates. And to that end from time to time we offer what we call win back campaigns in which case we try to send out messages to entice our associates to recontact these associates that are preferred customers, as well as the preferred customers and entice them to buy again.

Okay, thanks.

Doug Lane, Jefferies & Co.

Question for you as kind of a follow-up. Clearly you are happy with the requalification, enthusiasm among your distributors. Can you give us any kind of early characterization of the subsequent recruiting effort on plan, above plan, too early to tell?

I will tell you from coming out of convention has been probably one of the most exciting moods of our associates in many years. I've been at the company 12 years. This has probably been the most excited that I have seen our leaders, as well as many of the associates who now have a new hope with the matching bonus to kind of put a little more in their pocket as they are getting started. And it also encourages retention as we are trying to drive good behavior to help people become successful, both people win. So there is -- and the urgency to get off to a big start there early on with the new people, to push them to become Platinum PaceSetters is all very, very encouraging. Certainly the elite bonus at the top end I think as Fred said, the good old-fashioned competition among some of our top leaders will be encouraging.

So there is a great deal of excitement and anticipation out there. We realize that it's going to take a little time to get some traction because with any change it takes time for people to figure out how to use this, how to take advantage of it and how to incorporate it in their business, in their presentations etc.

The economy, it has been an interesting thing because we've had some people ask questions about well, can I really build a business. But we've seen a real increase in interest recently with even some of our, what I would consider quasi-retired or slowed down associates who were not actively -- have not been actively building are now going back and building because there is an interest in finding alternative means of income like Fred is saying. And people's minds are much more open to the business side all of a sudden in these kind of times because they are worried about their financial future.

Okay, looking at your fourth-quarter outlook you have sales higher than last year. Is it looking like the associate counts should be higher than last year, as well?

I would say yes.

Okay, and can you give us a little rundown briefly on your thoughts about currency with the currency markets being so volatile and you saw the swing from the second quarter to the third quarter turn negative. What are your top most important currencies, and how should we think about where kind of a base case is for them in the fourth quarter based on your guidance?

Clearly Australia and Canada are the currencies where we have most of our currency risk. We, of course, hedge against our cash flows from those countries. But that is where the volatility that we watch for most closely and where the impact we felt in this current quarter comes from.

So we should just maybe take a look at what current spot rates are and assume that any deviation from there will be a plus or minus as we move through the quarter?

As will we.

Fair enough. Thank you.

Rommel Dionisio.

Good morning. Earlier in the year I think you guys talked about some supply-chain improvements that you were putting and I think some high-speed filling and packing lines. And I wonder if you could update us on the progress of that? And if I remember correctly that was supposed to be done by the summer time. Are you on track with that, and if so, were there any cost savings in the third quarter that you saw from that?

Let me answer that. Yes, we put in a pic pack system for improving the accuracy of our picks and the reduction in our labor. That was completed and has been installed. We had a few little glitches on initial shipping orders going out on a delay but none of the orders were missed or delayed beyond three or four days. But we noted it to our field since we are really kind of big on perfection. That now has been stabilized running just fine on our line, and we kept them a little bit longer than we had anticipated in the second quarter in our additional labor headcount to assure that we got the packages out in a timely manner. So now you will see a reduction in that department on headcount; the savings that we anticipated when we did the initial ROI will be confirmed.

Is it fair to say you did not see a full quarter impact of those cost savings in the quarter you just reported?

No.

You did not, okay. All right, great. Thanks very much, Fred.

(Operator Instructions). Tim Ramey, DA Davidson & Co.

Fred, as you are looking at the top 25 and the elite bonus, I realize that the top 25 sort of are the company, but is there any way to talk about rates of change among the top 25 or signs that there might be acceleration of activity there?

If I understand your question correctly, our top 25 in some ways are the company in terms of they are someone's downline. If I look at all the Fortune 25's downline it represents the majority of the entire organization, true. But in each one of their own individual spending it is fairly insignificant to the total company involvement. So the best way to look at that Fortune 25 and the elite bonus impact will be how much jockeying of positioning is going on in the Fortune 25 as a result of the elite bonus. That will be the best indicator that the competition for that elite bonus in the top 25 is having a significant impact.

For those associates in the top 25 that are not building their business, they will watch their relative position in the 25 fall, and the elite bonus -- one of the details as you are paid based on your rank in that 25th position and your growth quarter-over-quarter. So those that are kind of relaxing and not building their business with as much vigor as others will eventually replace them. They will move out and our elite 25 will be those individuals that are building the fastest business for USANA.

Are you seeing evidence of that kind of jockeying for a position yet?

There is a lot of talking about the importance and getting into it and already on a -- we track this on a week by week basis. And already on a weekly basis we can see people moving in positions. So in the short run there are very positive indications that it is being effective, but the long run will be the one that ultimately tells how effective it is.

Two questions for Jeff. Were there -- did you say what your legal expense was in the quarter? If you did, I missed that. I'm sorry.

I did not. In total we are a little over $900,000.

So it would be fair to characterize legal expenses $0.08 or $0.09 per share, is that right?

I'm sorry, Tim we were 1.4 relative to tender offer and other lawsuits which will not recur.

Okay, so that is terrific news. And also, on the -- I'm wondering if there is any impact on auto ships from banks pulling in credit lines on credit cards. It might be too early to tell on that, but have you seen any evidence of that?

Not to this point.

Thanks so much, guys.

Amy Greene, Avondale Partners.

I just wanted to see if you could give us some idea of what kind of traction or progress your new products are making relative to the goals that you had set for them.

Regarding the new products -- I want to make sure I understand that question correctly.

Yes, the new products, the Rev3 and then the new versions of the Nutrimeal, etc.

We've seen some very encouraging response to this. The new Rev3 especially with offering a cleaner, healthier, stronger alternative, which the results so far are very, very encouraging that we are onto something with this. It is kind of a fun new exciting product to talk about. We think this is also going to be a way to open doors to people instead of the nutritional focus up front. And so a lot of folks who are already telling us this is kind of an icebreaker for the conversation. We think if we can leverage that right and have some fun with this, this can be a real door opener for us.

As Fred mentioned also we have a young generation, the new Gen Y, Gen Xs that are coming in. In fact I was just in a meeting this last week in Anaheim where we probably had out of 1000 people, 600 of them were 18 to 24-year-olds. They are very, very excited about this product because this is a very high consumable item for that age demographic. And so we think this will also encourage that market to continue to grow and look to USANA as their opportunity.

Have you seen any pushback? I know the cans in particular seem to have a pretty high price point. Has that been accepted okay within the ranks?

It certainly needs to be explained, and that is some of the things we are looking at. And we are hoping as we gain economies of scale and some other things that we can continue to look to deliver the very best value we can in both the cans and the stick packs. But when you understand that it lasts twice as long as any other energy drink there because you don't have the crash in a typical energy drink normally gives you, with ours it maintains it. So people are noticing a big difference and they are seeing the value there. So it hasn't been too much of a problem yet.

Great. Thanks, guys.

Mimi Noel, Sidoti & Co.

Just a few questions for Jeff. Jeff, you are probably aware that Gil had a long-term operating margin objective of about 18% be it officially or unofficially. To what extent did the compensation changes undermine that? To what extent might you back that or back away from the legacy objective?

No, not necessarily. We anticipate an increase in the overall cost on the compensation, and particularly through equity-based compensation leverage that we anticipate from these plan enhancements and other sales efforts should more than compensate for that, and the objective on that operating margin would remain appropriate going forward.

And then two housekeeping questions, somewhat related. What was the stock-based compensation in the third quarter either pretax or after-tax?

Pretax $2 million, $2.1 million.

$2.1 million pretax?

Yes.

And then the last question if you don't mind would you review the repurchase activity that you went over in the third quarter?

Yes, just commenting there on we purchased 809,000 shares for a total of about $28 million. Average share was mid-30s.

I'm sorry, you cut out after average share.

I am sorry. Let me just repeat. 809,000 shares, $28 million purchase, average price was in the mid-30s.

Okay and what is the balance that remains?

On our option to -- excuse me -- repurchase authorization?

Correct.

22 million.

All right. Thank you very much. That's all I have.

At this time I would like to turn the call back over to Jeff Yates for any closing remarks.

Thank you, Michaela. And thank you, everyone, for your questions. We continue to remain confident and very optimistic about the future of USANA, and of course the investment opportunity that we provide. If you've got any remaining questions please feel free to contact us at investor.relations@US.USANA.com or call Patrick Richards in investor relations at 801-954-7961. Appreciate your interest in USANA, and thank you again for joining us this morning.

Ladies and gentlemen, this concludes the USANA Health Sciences third-quarter earnings conference call. You may now disconnect. Have a great rest of your day.