USANA Health Sciences Inc (USNA) 2008 Q4 法說會逐字稿

Good morning, ladies and gentleman, and thank you for standing by. Welcome to the USANA Health Sciences fourth-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) As a reminder this conference is being recorded today, Tuesday, February 24, 2009.

I would now like to turn the conference over to Riley Timmer, Vice President of Finance. Please go ahead, sir.

Thank you. Good morning, everyone. We appreciate you joining us this morning. 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.

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.

Let me now turn the call over to Jeff Yates, our Chief Financial Officer.

Thank you, Riley, and good morning, everyone. I am pleased to be accompanied by Dr. Fred Cooper, our President and Chief Operating Officer, today. Following my remarks Fred will discuss top-line results, key indicators, and the fundamental drivers of our business.

Yesterday after the close of market we issued final results for the fourth quarter and full year of 2008. We also filed a Form 8-K disclosing that we will restate our financials for 2006 and 2007 due to adjustments arising from an IRS tax audit. In our January preliminary conference call and release we addressed the IRS tax audit and mentioned that it was ongoing. Recently we settled the outstanding issues relating to this audit and we will now restate our historical financials to reflect the results of this settlement.

The impact of this negotiated settlement improved the results we announced in our preliminary release just a few weeks ago. The press release issued yesterday reflects these restated financial results. Our results will also be disclosed in detail in our 2008 Form 10-K which we will file shortly.

It's important to note that these restated numbers are not material to the income statement. We determined to restate because the cumulative impact of the taxes payable was material to our 2007 and 2008 balance sheets. As such the restatement primarily resulted in an increase to current liabilities and corresponding reduction in stockholders' equity.

Now, turning to our final quarterly results, net sales in the 14-week fourth quarter were $111.1 million, an increase of 2.1% compared with the $108.7 million reported in the fourth quarter of 2007. It was noted in both our preliminary and final earnings releases that the significant strengthening of the US dollar resulted in a $10 million reduction to our top line. Excluding this dramatic change in foreign currencies, net sales for the fourth quarter would have been about $121 million, modestly above the top end of our fourth-quarter guidance.

We have not historically hedged the top line or the balance sheet. However, we are currently evaluating the potential costs and benefits of doing this. It has been our practice to hedge expected cash flow from our international operations which we do plan to continue.

Earnings per share from continuing operations were $0.29 in the fourth quarter, a decrease of 56.1% compared with the fourth quarter of 2007. There were two significant factors that negatively impacted earnings per share in the fourth quarter. First, an unanticipated arbitration award against the Company for approximately $7 million which reduced earnings per share by $0.28. And, second, the dramatic and rapid strengthening of the US dollar which lowered our top line.

While the bottom-line impact is a bit more complex to calculate, we estimate the impact of currency fluctuations on EPS to be about $0.10 to $0.12 in that quarter. Over the last several years and as a consequence of our growing global presence we have benefited from a steady decline in the US dollar. In the fourth quarter the US dollar strengthened significantly against currencies that are important to USANA, particularly in Canada, Australia, and Mexico.

This spike in the US dollar from the end of the third quarter through the end of the fourth quarter resulted in a $10 million reduction to our top line. Again, estimate that this had been earnings per share impact of about $0.10 to $0.12.

Now let's go through the major line items on the fourth-quarter income statement. Our gross margin in the fourth quarter of 2008 improved slightly as a percentage of net sales to 79.1% compared with 78.9% in the fourth quarter of '07. This modest improvement is due primarily to improved operating efficiencies resulting from a new high-speed bottling line and the introduction of a new state-of-the-art [pick-to-light] shipping line system.

Associate incentives in the fourth quarter of 2008 were 48.4% of sales compared with 41% in the fourth quarter of last year. This increase was due primarily to the $7 million arbitration award. Excluding this award, associate incentives were 42.1% off net sales. This increase of 110 basis points was expected and can primarily be attributed to the two compensation plan enhancements introduced at our annual international convention in August of 2008.

Selling, general, and administrative expenses relative to net sales increased to 23.8% during the fourth quarter of 2008 compared with 22.4% in the fourth quarter of the prior year. The year-over-year increase in SG&A was due mainly to the following factors -- an increase in equity-based compensation expense due to the long-term grants that were issued in July of 2008 and increases in wage-related expenses, primarily due to adding additional human resources over the past two years and increased executive salaries. These increases in SG&A were partially offset by a decrease in the amount spent on legal and other professional services.

Now regarding the balance sheet. Cash at the end of the fourth quarter was $13.3 million compared with $12.9 million at the end of 2007. Inventories at the end of the fourth quarter were up year-over-year to $23.9 million compared with $19.4 million at year-end '07. The factor in the greater investment inventory relates to our preparations for opening the new market in the Philippines.

Net sales for the full year of 2008 were $429 million, an increase of 1.4% compared with the year end at 2007. Net sales growth during the year was primarily driven by a 12.5% increase in the number of active associates compared with last year. As you know, the number of associates is a key indicator of the strength of our business. I am pleased that this key indicator is showing positive momentum. Fred will address the growth in the number of active associates in his remarks.

For the full-year, earnings per share from continuing operations were $1.85, a decrease of 30.2% compared with $2.65 in 2007. This decrease is due to the one-time arbitration award and higher overall operating costs. The following higher operating costs impacted earnings per share by approximately $0.26 for increased wage-related expenses, $0.09 for the change in net other income and expense, $0.08 for higher depreciation and rent expense, $0.06 for higher equity-based compensation expense, $0.04 for the increases in non-recurring legal costs and other professional services, and $0.03 for increased spending on associate events and support activities.

Capital expenditures for the year totaled about $16 million, which were primarily related to the expansion of facilities in the US and Australia. We anticipate capital expenditures in 2009 to be about $4 million to $6 million.

Now to update you on our share buyback program. During the fourth quarter we repurchased 307,000 shares for a total of $11.8 million. For the full year, we purchased approximately 1.1 million shares for $39.9 million. The retirement of these shares resulted in an earnings per share benefit of $0.04 in 2008. Currently we have about $10.4 million available under our share repurchase authorization.

Now before we hear from Fred, I will comment on our guidance. Yesterday in our press release we provided guidance for the full year of 2009. Excluding changes in currency, we expect sales to grow 8% to 10%. We believe, however, that the effect of the strong US dollar will reduce our consolidated net sales by 6% to 8%. Accordingly, we project a modest increase in consolidated net sales of about 2% in 2009. We also expect earnings per share to be dramatically reduced by changes in currency.

We believe that earnings per share for 2009 will increase about 4% compared with 2008. This estimate is in comparison to our reported GAAP results of $1.85 and is based on an effective tax rate of 36%. Our 2009 guidance also assumes that consolidated gross profit margin will be approximately 79% of sales, associate incentives will be approximately 43% of net sales, and SG&A could approach 25% of net sales which now importantly includes R&D expenses of approximately 1%.

While we are excited about the momentum and enthusiasm we see among our associates, we are expecting challenging year-over-year comparisons for the first nine months of 2009 because of the current strength of the US dollar. To illustrate this we estimate that if exchange rates remain at current levels, sales for the first three quarters of 2009 will be negatively affected by over $30 million or approximately $0.40 per share in comparison with that same period in 2008.

Notwithstanding these currency pressures, we are seeing positive momentum in our fundamental business drivers and expect net sales and earnings per share to increase modestly in 2009. Early signs, such as double-digit growth in the number of active associates and local currency sales growth in the majority of our markets, indicate that the compensation plan enhancements we introduced are working.

It's important to note that we will manage spending closely to ensure that our overall costs remain in line with both reported sales and our long-term financial goals. I will now turn the call over to Fred.

Thanks, Jeff. Good morning, everyone. I want to begin by discussing some regional and operational results and then provide you with some insight regarding our 2009 strategies going forward.

Net sales during the fourth quarter in North America were down 1.3% compared with the fourth quarter of 2007. Now this decline was primarily due to an 8.8% decline in Canadian net sales, which reduced by $4.2 million due to the strengthening US dollar. This decrease was offset by an increase in sales of 1.6% in the US and 4.6% increase in Mexico. Notably, though, active associates in North America have increased to 107,000 and that is a 7% increase compared to the previous year.

I would like to talk about the results next in our Asia Pacific region. During the fourth quarter of 2008 net sales in Asia Pacific increased 7.8% to $44 million. The increase in this region was led primarily year-over-year from growth in our Hong Kong region of 56% and 43.8% in Malaysia.

The number of our active associates in Asia Pacific increased as well, up to 19.7% to 91,000 associates compared with only 76,000 in the fourth quarter of 2007. Once again Hong Kong and Malaysia were our main contributors to this growth.

Additionally, the opening of the Philippines in January has really helped to build our momentum in the region. Remember, we selected this country because it was one of the top 25 direct-selling markets globally and also because we had strong ties with many of our current associate leaders in the Filipino communities worldwide. We expect this market to be a nice addition to the Asia Pacific region going forward.

Although our 2008 results were not as strong as expected, I remain optimistic for USANA in 2009. Our fundamental indicators are signaling that our strategies for long-term growth are working. For example, at the end of the fourth quarter our total number of active associates reached 198,000, up 22,000 associates compared to the year-end 2007. In particular, we saw the second-highest number of associates ever coming into the business during the fourth quarter of 2008. It's encouraging because the number of new associates coming into the business is strongly correlated with sales.

The improvement in associate count is specifically related to two new components of our compensation plan -- the Elite Bones and the Matching Bonus. These changes were introduced at our 2008 international convention last fall. The Elite Bones is an incentive paid to our top 25 income earners each quarter and is designed to create competition in our top 50 to 60 associates. We have found that by motivating just a few of these key individuals it will have a significant impact in bringing in new customers.

Next the Matching Bonus allows all associates at virtually any level to earn additional commissions based on new associates achieving a Platinum PaceSetter status within the first six weeks of joining the business. Platinum status is attained by sponsoring four new associates who become active and are involved in producing sales of products within that same time frame. Before this enhancement only 2.5% of new associates attained the status of Platinum PaceSetter, but in the fourth quarter alone that metric increased 160%. This means more people are building their business earlier resulting in a more rapid increase in customers and sales.

Also, our monthly auto-ship rate in the fourth quarter improved to 49.4% compared to 46.4% in the third quarter. This, again, is a strong indicator of long-term associate commitment and retention.

Ongoing our objectives in 2009 include continuing to promote USANA's outstanding home-based business opportunity, including the benefits of the new Elite Bonus and the Matching Bonus. We are going to continue helping our associates build their USANA business by enhancing their experience with us utilizing great business-building tools. We are going to introduce a broader spectrum of our current products into markets where only a limited number of products are currently being offered, and we are also continuing to evaluate new market opportunities.

We are looking forward to another successful year at USANA in 2009. I am confident that our long-term objectives will be met as we continue to promote and support the fundamental drivers of our business. With that I will now ask the operator to facilitate the question-and-answer session.

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

Good morning, guys. You know it looked like the -- maybe I am reading this wrong, but even if I normalize for the extra week and then normalized for foreign currency it looked to me like the sales performance per associate was -- you were losing effectiveness per associate. Do you think that is true? Is it the leading edge of a curve and so maybe that picks up?

But even your sales forecast of 2% growth, even giving effect for the extra week and giving effect for the currency, I think would have to imply some kind of degradation of sales performance per associate. How do you react to that?

My take, sir, would-be first of all you are early in the curve as you denoted. Our fourth-quarter results are out and it usually takes a bunch of months to find out the proportion of the associates that have just been recruited that will continue on and progress up the rates in the commission plan. So when you have a disproportional number of new incomings relative to our stable base it's going to appear that way initially.

But we had a decent associate recruiting performance also in the third quarter, did we not? At least on a year-over-year basis.

Yes. Not as good as fourth.

Yes. Okay. So I shouldn't assume that this means that there is a reduction in effectiveness per associate?

No. The other item of this is the Platinum PaceSetter is a pretty motivating program to try to get our associates to talk to other customers. And in so doing there is also a desire to get more customers for the same wallet share on the initial purchase. So that also has a little bit of an impact on this.

Okay. And, Jeff, on the subject of share repurchase you did note even though your average purchase price was quite a bit above market that it was accretive to earnings. What is your stance on share repurchase right now? I know you only have $10 million remaining. Would you recommend to the Board that this is an effective use of cash going forward or should we be husbanding resources more tightly in this environment?

I would say the latter at the outset, Tim. It's important to maintain the cash to invest in any opportunity that we have, but obviously the impact of the arbitration award and the payment of the settlement with the IRS has put a demand on the cash. So we will probably hold off for a bit, but obviously that remains an option for us later in the year.

Okay, thanks Jeff and Fred.

(Operator Instructions) Doug Lane, Jefferies & Co.

Yes, hi. Good morning, everybody. Can you give us an update, Fred, on your viewpoint, where you stand on China these days? You haven't mentioned it in a little bit and I wondered where you stand in that market?

Yes, there hasn't been any changes in the laws in China to date that would help us get into China and use a multilevel marketing in our direct sales industry to be able to go into there. So from that standpoint there isn't a change.

However, we are -- looking into two items. One, better utilization of our Tianjin facility that we have in China now. And the second is we do all the time spend time exploring alternatives that might allow us to go into China with the key driver on this being in a way that will allow our associates to benefit from participation in China. When we can accomplish that goal and stay within the guidelines and the laws of China, we would like to get into China sooner rather than later.

I see, and in the meantime, would you -- are you looking to maybe manufacture in China? Because if -- am I right that most of your product manufacturing is done in the United States and then shipped around the world?

Correct.

So the currency being what it is that is sort of a double whammy for you. So I wondered if you were thinking about at least diversifying your manufacturing base and maybe using China that way?

Actually, in the short term it isn't going to be an option but in the long term we are looking at the need, ultimately, to diversify in manufacturing. Not necessarily China, but not excluding it either. But for the reasons that you speak of.

Okay. Thank you.

Scott Van Winkle, Canaccord Adams.

Hi, Jeff, kind of go through some of the currency impact on earnings. What percent of your SG&A, non-volume incentive SG&A, is in US dollars?

Just taking a look here, Scott. It's a very high percentage, probably 60% to 70%.

And all of your markets have international on the ground operations, is that correct?

For the most part, yes. Service centers and network development and finance managers, yes.

And the volume incentives are paid in local currency in every case. Is there any change to the points per product sale depending on currency or it's just a straight math?

The points are similar throughout the country because of the seamless -- or excuse me -- throughout the world because of the seamless nature of our program. But there are subtle differences, obviously, and particularly in relation to price because of different tax or duty or VAT requirements that we have. But the points are pretty consistent.

Okay. And I am just kind of back of the envelope here kind of struggling to get to the guidance even on the revenue guidance, even on the currency assumptions that are currently in place today. I would assume -- I mean the expectations -- you just had a very good quarter of distributor growth. To Tim's question earlier about the productivity on a distributor basis not changing dramatically according to Fred's answer, I would assume that you are looking at the fourth quarter and just tempering expectations from here a little bit on the local currency basis and then applying currency?

Yes, there is no question, Scott. Keep it in mind that what impact that we had benefited from over what six-ish years on a subtle but meaningful decline in the value of that dollar reversed itself in probably six weeks. And predicting forward into that even further degradation of the foreign currency values into January, albeit flattening, it's hard to predict against that. So there is no question that we would want to be conservative in our projections.

That said the impact to the first three quarters considering the value of the currency today is significant. Particularly as you compare that with the average rate that we exchanged at in Q1 of '08, Q2 and Q3 of '08, even through Q3 of '08. And so that assuming we don't have much change in currency, it's going to be tough to do, to get over those comparisons.

Now, obviously, with an increase in that rate because of the currencies that we trade in that opportunity would be significant for us. We should see a nice lift from that, but we are hoping that you would be able to tell us where those currencies are going to go.

Yes, keep waiting.

Indeed. We won't hold our breath though.

Fred, I want to go back to that question about productivity on the distributor basis. I understand where you are coming from on that, but if you see the preferred customer totals declining, wouldn't that lead you to believe that there is going to be a little less productivity on a per distributor basis that is offset, hopefully, in this economic environment by better recruiting?

I wouldn't argue with that.

Good answer. Okay. That is it. Thank you very much.

Tim Ramey, D.A. Davidson.

Welcome back, Tim.

Sorry, I am following up on Scott's question. I guess I really wanted to -- and I am sure he knows and I need to catch up -- the understanding of how currency impacts the associated incentive expense. Because it seemed to me -- and maybe, Jeff, this was your answer -- that this is really paid effectively in US dollars and so the associates are now getting a slight currency benefit. Am I wrong on that? Is that how you answered that? Is there a way to maybe take some of that currency volatility out of the associate expense?

It's an excellent question, Tim. Truth is that the commission rate that we pay to our associates in foreign countries is at a fixed rate. We establish a commission payout rate in a country typically near its opening and have held those firm traditionally in the organization for years.

So they don't experience fluctuations as we do relative to our sales. Those commission rates on their local sales remain fixed. So it works for us in some exchanges and it works against us in others.

So it's really working against you right now?

Indeed. Indeed.

I mean is that the type of thing that is sacrosanct because it's part of the compensation plan or is that the type of thing that the Board or the management can review?

We, obviously, are looking at it all the time. It's an important component to our compensation plan overall and it does afford us the opportunity to adjust prices when necessary. It gives us the opportunity to adjust our model to accommodate those and we are always looking at that. Obviously, at this point still doing so. So we just love the benefit that it provides us and are dealing with the challenges that we currently have.

Thank you.

We have no further audio questions. I would like to turn the conference back over to Riley Timmer for any closing statements.

Thanks, everybody, for your questions. If you have any remaining questions, please feel free to contact Patrique Richards in Investor Relations at area code 801-954-7961. Thank you.

Ladies and gentlemen, this does conclude the USANA Health Sciences fourth-quarter earnings conference call. If you would like to listen to a replay of today's conference, please dial 800-405-2236 or 303-590-3000 with the pass code 11126618. ACT would like to thank you for your participation and you may now disconnect.