USANA Health Sciences Inc (USNA) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the USANAHealth Sciences second quarter earnings conference call. (Operator Instructions). This conference is being recorded today, Wednesday, July 28, 2010. I would like to turn the conference over to Riley Timmer.

Thank you. Good morning, everyone. We appreciate you joining us this morning to review our second quarter results. 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.

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.

Now I am joined this morning by Fred Cooper, our President and Chief Operating Officer, Jeff Yates our Chief Financial Officer and Mark Wilson, Executive Vice-President of sales. We'll first hear from Jeff who will discuss the details of our financial results this quarter. We will then hear from Fred who will discuss our business activities during the quarter as well as our plans for the remainder of 2010. I'll now turn the call over to Jeff.

Thank you, Riley. Good morning, everyone, and welcome to the conference call. We appreciate your joining us this morning. It's a pleasure to be here with Fred and Mark to talk about yet another record quarter for USANA Health Sciences. I'm pleased to report that for the third consecutive quarter net sales set a new high point, breaking through $126 million, which represents a 12.4% increase when compared with the $112.1 million we reported for the second quarter of 2009.

Our growth in sales this quarter was primarily due to an overall increase in the number of Active Associates, which for the second consecutive quarter also resulted in a new high at 210,000. The number of Active Associates increased by 5% when compared to the second quarter of 2009, which is largely the result of continued growth in our Asia Pacific markets.

Additionally, favorable changes in FX rates this quarter added 5.2 million to our top line when comparing our results to the same period last year. Regionally, sales in North America decreased slightly by 1% to $62.1 million compared to the prior year, while we were disappointed with our year-over-year results, we are encouraged to see that on a second consecutive basis net sales increased 2.6% while Active Associates increased 1.1%.

It was also encouraging to see sales in the US increase for a second consecutive quarter. We believe that we now have the right mix of executive and associate leadership in this market and are optimistic that sales and Active Associates will continue to increase. Looking now at results in our Asia Pacific region, net sales increased by $14.5 million or 29.5% when compared to the second quarter of 2009. Net sales for the region totaled 63.9 million for the quarter, which represents more than 50% of our total sales.

Sales growth in this region was primarily due to a 22.3% increase in the number of Active Associates. In Hong Kong, our largest market in the region, net sales increased by 100%, and Active Associates increased by nearly 86% over the prior year. In late May, we held our Asia Pacific convention in Hong Kong.

We were pleased with the success of this event which added $2.8 million in sales. Because of the significant growth in this region and the excitement generated by this event, it will now be held annually. During the event we made several exciting announcements, including our intention to open business in China.

We believe these announcements have added to the already significant momentum we are experiencing in this region. Fred will discuss more about these announcements in his remarks. Now to discuss the other major components of the income statement. First, gross margin for the -- excuse me, gross profit margin for the second quarter increased as a percentage of net sales to 82%, compared with 78.8% for the second quarter of 2009.

This increase was primarily due to lower direct costs and the leverage gained on higher sales. Associate incentives for the quarter were 45.3% of sales compared with 44.9% for the second quarter of the prior year. This increase was due to higher utilization of our matching bonus program and the negative effect of changes in currency exchange rates.

Although, this expense increased on a year-over-year basis, it is important to note that it has trended modestly downward over the last three-quarters and is 10 basis points lower than Q-1. Additionally, as we discussed last quarter, we made certain strategic international policy changes to manage this expense. Many of these changes were made to better align payments under our Associate Compensation Plan with actual sales growth.

We will also implement additional changes this quarter to further manage this expense and place greater emphasis on associate productivity. While these changes may negatively impact sales in certain markets in the short-term, we believe they are necessary to drive the long-term success of our business. Because the major Compensation Plan changes were implemented at the very end of our second quarter, we expect the impact of our changes to begin in the third quarter.

Accordingly, our expectation is that associate incentives expense will continue to decline relative to sales in both the third and fourth quarters. We also have enhancements planned for our international convention that we believe will further benefit our shareholders. SG&A this quarter increased to 23.1% of sales, compared to 22.1% last year.

Of note, during this second quarter we incurred $1.6 million in expenses associated with our Asia Pacific convention which is not comparable to the prior year. Excluding these convention expenses, SG&A decreased as a percentage of sales to 21.8%. As a result of higher sales and improved operating margins, net earnings for the quarter were $10.8 million or a record $0.69 per share compared with 8.8 million or $0.57 per share in the second quarter of the prior year.

We continue to make progress in strengthening our balance sheet to better position ourselves for growth opportunities, specifically our planned entry into China. Our cash balance at the end of the second quarter was $28.4 million compared to $13.7 million at the end of 2009, while we continue to carry no debt. We are pleased with the quarter and our optimistic that we will have a strong finish for the year.

Accordingly, we are raising our guidance and are now -- excuse me, and now project net sales to be between $488 million and $495 million and estimate that Earnings Per Share will be between $2.73 and $2.80. With that I'll now turn the call over to Fred.

Thanks, Jeff. Good morning, everyone. I've been looking forward to discussing our second quarter results with you. And once again we've exceeded expectations. I'm particularly encouraged by our third consecutive record-setting quarter. What is great about our business model is that when sales grow, coupled with managed spending comes leverage.

Now leverage was evident in our financial statement this quarter where we experienced over 28% improvement to our operating margin by significantly reducing our relative spend on cost to goods sold. This quarter we benefited from improved production efficiencies due to higher sales, lower standard costs on law materials, lower freight costs, foreign currency changes, and price increases implemented during 2009.

We'll continue to closely manage COGS but we expect this line item as a percent of sales to be just slightly higher than quarter two in the second half of 2010. Last quarter we talked to you about certain international policy changes and adjustments to our compensation plan. We did these because they were designed to enhance rewards for greater associate productivity and also to reduce our exposure to currency fluctuations.

Well, these changes were implemented in the last three weeks of the second quarter, so the third quarter will be the first quarter we see the full impact. During this quarters we also introduced new enhancements -- we will be introducing new enhancements to our Compensation Plan at our international convention.

Similarly the full impact of these enhancements on the incentive line will not be reflected fully until the fourth quarter. Now I want to spend a few minutes talking about our regional results. First in North America, looking at our sales results this quarter compared with the second quarter of last year we're obviously not happy that it had the slight decline of 1%.

What does make us optimistic about North America is the sequential quarter improvement, albeit slight at 1% that we experienced. In local currency, each of the US, Canada and Mexican markets increased from the first quarter. And for the US, this is now the second quarter in a row that sales have improved from the previous quarter.

I point out the statistics not because I'm overly pleased but because we believe that North America is progressing. We're optimistic that as we continue to deploy our strategies over the next few quarters we'll continue to see growth in our North American market. Now, in August we'll hold our 18th international convention here in Salt Lake City. And as always we plan to make several new and exciting enhancements at the event.

Which -- At this event our primary goal is to recognize, train and develop our core business leaders. Also at this convention, we plan to announce new products, training material and exciting enhancements to our Compensation Plan that we hope will incent our leaders to grow sales. As we discussed last quarter, we finished the evaluation of Associate rewards and our recognition program. Hence, that our convention will be improving some of our recognition and promotional programs to further drive growth.

Now as Jeff already mentioned, our Asia Pacific region continues to drive our overall growth. The number of people advancing in both rank in title in this region continues to grow as well as the number of Associates who are earning a weekly commission check. Not surprisingly, this region is now our largest region in both sales and associate count. The primary driver of our growth in this region is Hong Kong. The market continues to deliver record quarters for sales and associates for us. In May we held our annual Asia Pacific convention in Hong Kong, and the event was met with record attendance. In fact, it was our largest ever gathering of USANA Associates on any one event.

At that convention we launched three new products designed specifically for the region; Two skin brightening products to enhance our skin care line and a calming tea product. The launch of these products was added to the record sales achieved at the convention. The highlight of this convention was the announcement of our intention to enter China. This is a market that we have been monitoring and considering for several years.

Essentially since the rules were changed to allow direct selling to take place in the market, we have had our eye to enter there. I believe this is by far the number one opportunity market right now for USANA. Indeed, our expectations are really high for China. We believe that now is the opportune time to aggressively invest and prepare for this market.

If you look across geographies, it is the Chinese communities in markets like Canada, Australia and even the US that are aggressively growing for USANA. Remember for us, international expansion is largely driven by where our Associates believe opportunity lies. We see China as the next big opportunity. As you're probably aware, the compensation structure for China will be different from all other markets.

Historically, there has been uncertainty in regards to how best to compensate a sales force in China. Many companies have made significant investments to find out what works best. We wanted to wait for the environment to stabilize in China in terms of what type of compensation plan is acceptable and is proving to be the most successful. For us this is a critical sticking point for not entering the market sooner as we wanted to be able to be educated as possible in order to minimize risk and be able to enter with minimal investment.

It was critical that we learn the best strategies and practices from what the 25 companies operating with a direct selling license in China have done that is enticing to their associates, acceptable to the government and profitable to the organization. Now, however, most companies are migrating to a model that works well for this market, and one that we believe will work well for USANA.

At this point in time with only 25 companies operating under a direct selling license, we believe China to be the largest opportunity for USANA. Considering the significant momentum in this region and the success of AP convention, which by the way we've already sold to capacity for 2011, we are expecting our Asia Pacific region to continue this pace of growth. With that I'll now ask the operator to facilitate the question and answer session.

Thank you, sir. (Operator Instructions). Our first question is from the line of Perron Olsen with Jefferies & Company. Please go ahead. Perron Olsen: Thanks. Good morning, everybody. Congratulations. Quick question on China, just kind of I guess housekeeping. But do you have --what sort of a time line do you have? I mean, it sounds like it's certainly the next frontier for USANA. But do you have kind of a date in mind in terms of when that launch would occur?

Unfortunately, no. It's a matter of getting acquainted with the regulatory agencies there in China. It's difficult to go through all the rigorous processes of obtaining the license. So no, we can't be more specific on the time other than we are aggressively pursuing it.

Fair enough. I feel like I asked this probably last quarter, too, and I think it merits maybe asking again, given the strong results here. The raise in the outlook was pretty strong on both the top line and the bottom-line, and certainly and beyond the beat versus all of us on the call. So I'm wondering, kind of A, I guess, how much did the results beat your own internal expectations since you don't look at it quarter to quarter with us on your releases? And sort of where did you see the biggest up side surprises in your view?

Good question, Perron. Appreciate your being on the call with us today. There are a number of factors that we consider when evaluating our forecast and so forth. And you know our MO. We're careful and we're anxious about the dynamics of the market place. Obviously, not that far out of a really chilled market in so many of our markets that we operated in. We've been concerned about that. We wanted to get a better feel for how the progress was going to continue in our Asia Pacific region, anxious about what might continue to be the case for FX. Considering all those factors, have been cautious but optimistic obviously. We did anticipate the growth that we projected with our last release on guidance. We were pleased to see that Hong Kong grew at an even greater pace. We were pleased to see the progressive growth in the US. We've been anxious about the impact of our comp plan changes that we've been describing to you, the strategic impact of those. Haven't modeled all of those now and now having some experience with them in the last several weeks we're pleased to see what the impact of those is having on our fields and wanting to be cautious as well with all of that. All in the mix of where do we think we're going to go, want to make sure that we're meeting or beating expectations overall. But we felt like we met what we had anticipated, and we were pleased to see that we did a little bit better than we thought.

Yeah, you certainly did. On the comp plan changes, I know you said that you put them in the last three weeks of the quarter and now we've had four to five weeks additional transpire since then. When you talked about them on the first quarter call, there was sort of the tone of caution that you weren't quite sure exactly how they may or may not impact the top line in the short-term. Are you incrementally more optimistic that it's not going to be a drag at this point, given the strong performance that you saw in the second quarter and obviously now that we're a month into the third?

Yeah. Predicting human behavior is difficult. I would say yes, we're feeling much more comfortable that the field understood why the changes were necessary. And most important is the relationship we have with the field. They understood the requirement of changing the Compensations Plans' payout for international exchange to be fair. When they feel that it was a fair change and understandable why it was done, they seem to accept it a lot better.

That makes sense. One last one then I'll get out of the queue. Just in terms of kind of raw numbers can you give us an idea of how many people were at the Asia Pacific convention, how many people were at the -- remind us how many people were at the global convention in Salt Lake last summer, and does the obvious strength of the Asia Pacific market sort of affect the attendance for the Salt Lake convention now given that that's going to be an annual event there?

So to answer the questions, first, of all it was probably up 500 from 7,000, up from 6500 to 7,000, about 500. And the second, is certainly individuals who go to the AP convention are probably a little less likely to now feel the need to come to the international convention in North America. But additionally, the fact that it is in Asia means more individuals are able to attend one or the other. So we definitely get more people by holding two than one. But the North American one would be down a little because people didn't attend.

Makes perfect sense. Thank you. Congratulations again.

Thank you.

Thanks, Per.

The next question is from the line of John San Marco with Janney. Please go ahead.

Thank you. Congratulations on a nice quarter.

Thanks, John, and welcome.

Thank you. Can you break out what drove that huge year-over-year spike in gross margin? And then specifically and in addition to that, whether there are any positive margin mix implications from the disparate growth rates we're seeing between Asia and North America?

I'll have you repeat the second half of the question, but let me answer the first half. We've had a positive impact from lower direct costs, materials, direct labor and so forth. And obviously, when we're producing higher volume we get the benefit of leverage on the sales line. Our costs don't increase exactly in concert with the sales line at our cost of goods level. Now, repeat your other question.

Sure. The second part was whether Asia was any part of that. Obviously, it drove all of the leverage benefit you're speaking to, but whether the price points are different there or is there something else for us to consider that the rapid growth you're having in Asia is margin specific in some way?

No, about the question whether Asia pacific had a significant impact to that theme. But generally speaking because margins are about the same everywhere we operate. And we do have an impact of FX that rolls through some of our cost of goods. It's not a significant factor per se, but overall it was just better operations, better packaging, better shipment, and improved direct costs, materials and so forth.

Thank you. That's helpful.

(Inaudible) (Overlapping Speakers)

And just to clarify a comment you made earlier, I think you said that back half gross margins will be up year-over-year but not as strongly as we just saw this second quarter, is that right?

Yes.

Okay. And all the same drivers there?

Exactly.

Also to clarify one other comment, pricing, I know you took some pricing increases in 2009. What was the timing of those? And when -- how significant were they to your top line and when should we expect those to anniversary?

Repeat the --

The pricing you reference in 2009 that contributed a little bit to the top line this quarter? How significant was that? And when does that benefit go away?

Yes. We didn't do a global price increase worldwide at one specific time. So as I hear you asking the question, there won't be per se an anniversary date. Some were done in some countries early in '09, of which the anniversary has come and gone. And some are coming in the fourth quarter that would be their anniversary date. But it's kind of throughout the entire year. And then given that it was in different markets, the weighted average of that increase, it would be very difficult to say there's an anniversary date.

Got it. That's helpful color. And then just lastly on your balance sheet, what do you guys think the optimum cash balance is for the business? That level moves around a lot. And right now you're sort of at peak cash levels without any debt. And I'm wondering how much of that you feel like you can put to use without having to tap your credit line at all.

Well, we try to optimize around $1 billion.

There's better uses than just sitting it there, though, right?

Totally. It should noted that as Fred has described it's hard to know how much and when the types of investments and the extent of which will be required of us as we enter this new market, coupled with other growth opportunities that we're investing in the US and in other markets that we feel are coming out of a really difficult economic environment. And so we see ourselves in a position that's very opportune. We've got freedom. We're liberated by the balances that we have and anticipate getting return on that cash in ways that will strengthen us over the long-term. So needless to say, and while we have been building our cash and haven't been able to say much about it in the AP convention, we're excited to follow that cash into those growth opportunities going forward.

And we expect China is going to cost us some money.

And will that show up in the form of a little bit higher CapEx rates in the years ahead of us?

Obviously likely with respect to those -- with those investments in that new market.

Great. Well, I look forward to seeing $1 billion on the balance sheet.

We do, too.

Thank you for taking my questions.

And by the way, thanks for joining us, John. All right.

The next question is from the line of Tim Ramey with D.A. Davidson. Please go ahead.

Good morning and let me add my congratulations on a pretty amazing quarter.

Thanks, Tim.

And I guess without beating on the same question, my question was similar in that you talk about investments in China. But usually those are P&L investments rather than capital investments. I understand there probably is some need to create some source of manufacturing in China. But that's likely to be quantifiable and relatively modest, I would think.. So can we revisit that one more time? The investments you're likely to make would be margin rather than capital?

Yeah, I'm struggling with that because it's anew market for us. So the reason I struggle in the answer is, we just know what others have gone before and the amount that they have spent to get in there in terms of manufacturing. We have a Tingin facility that we're going to be looking at, what options to do with that one, which may or may not necessitate a buildout on the CapEx side and then all the expenditures going in to enter into that market.

Furthermore, Tim, there are minimum investment requirements made by Chinese regulatory agencies, particularly in our industry. And it is significant. We know that some of the hurdles are no less than $20 million. And while we have created a footprint in there with our Tingin facility, that's unrelated to our core operations at this time, we have a whole variety of other requirements that are made of us that are minimum investment amounts, obviously prepared for those coupled with Fred's comment that there are a number of unknowns for us at this point. And so we want to be prepared to deal with them. Coupled with the fact that there are a variety of ways to enter into this market, some of which are more expensive, some are less. And so for us and our strategy for that market, we're considering every alternative and feel like we're well-prepared to take advantage of any of them.

And it's also -- adding to that, it's also not uncommon to have branches done in China. And all of those necessitate that kind of capital expenditure.

So Fred, should we sort of as we model the Company looking forward should we assume that share repurchase is a pretty low priority right now? Or an unlikely alternative?

A relative statement. I would state we believe there are better uses for our cash right now probably than share repurchase. But again, that's a board call, not for me to decide on how much they're going to spend on it. But yes, I would say the other sources of cashes I wouldn't necessitate saying share repurchase.

Gotcha. Okay, thank you.

(Operator Instructions). The next question is from the line of Rommel Dionisio with Wedbush Morgan. Please go ahead.

Good morning, everyone. My question is on China again, not to dwell on that. But really the whole Asian business. I mean, given how quickly you've grown in Asia does it make sense to ramp up Asia manufacturing anyway even regardless of your timing and extent of entry into China?

I think that makes a lot of sense, Rommel. For years and years we were operating in the low-cost country, in the US. Obviously, with the strength of the US dollar that has caused us to evaluate what other options that we have. It's something that we consider. We do have options there. And as an item that is of importance to us strategically. And it's part of what we consider as our growth opportunities. And so your point is well taken and has been considered for a very long time.

I would add to that also, aside from just the pure ROI decision on whether or not it makes financial sense to move over there. There is also value perceived in that region for an American-made product. So it also tempers you a little bit. It's not completely a ROI. The ROI has to kind of get to a point of overwhelming to switch it and then do maybe work in process manufacturing partial here and then final there. Certainly China is going to have some legal requirement that have to be manufactured there, so that will necessitate as well some manufacturing over there. To some extent.

Okay. Thanks very much. And my congratulations on the quarter as well.

Thank you.

The next question is from the line of Scott Van Winkle with Canaccord. Please go ahead.

Hi. Good morning, everyone. A couple questions, first the preferred customer numbers in North America were flat sequentially. I know you round those numbers. But with distributor growth in that region starting to return, even though it's still relatively modest, are you seeing the same kind of trend in the preferred customer counts in North America?

Scott, this is Mark Wilson. We're certainly seeing a new resurgence as people come out of this recession I think we're seeing more activity of our leaders, they're getting back to work, there's things starting to happen. We have some good signs. It's not where we want it to be. We have some other things in place that will continue to rollout over the next several quarters. You'll see some good, I believe, trends heading in the right direction. And so yes, I think you can plan on preferred customer growing as associates. Usually it follows a fairly tight trend of what we've built over the years.

And you've made some changes in your Compensation Plan. Have there been any changes on the Preferred Customer, the discount you get on getting on a continuity plan? Have you thought about any enhancements there to drive that number as well? Because that's obviously a nice predictable number.

We haven't put anything in place based on what you're talking about. Our Preferred Customer program is very generous, and in fact sometimes our associates are a little disconcerted in the fact that our Preferred Customers get the exact same price that they do with no qualification requirements, with no annual fees or anything like this. But certainly some things we could look at. And we constantly look for ways to -- and we market -- our marketing team markets both to our Associate base and our Preferred Customer base very separately. So we have separate communications to them, we have specials that are geared directly to them, so that we make sure we're communicating to those audiences differently. And the PCs tend to be also a grounds where Associates sometimes try to evolve someone into becoming a business bidder. So it's kind of a prep area for our people that start out trying our products, find that they love them and wanting to share them.

Okay. And moving over to margin, the commentary in the gross margin, I heard that. Was that any detail given on why the back half gross margin might not quite be to that 82% level?

No. Just wanting to be cautious and in anticipation of the remainder of the year.

Okay. But no radical changes in things like your productivity or your standard costing and ingredients and things like that? You talked about being the driver. Just you don't want to project that high of a number?

Yeah. One of it is we got some significant improvement in cost to good on ROZ in the first half. We don't expect to see that good. So you're not going to see a negative impact significantly. We just got some great gains on cost of goods first half.

Okay. And the new skin care product launched at convention, do the margins, are they a little different there than the margins in the rest of the business?

Fairly consistent with what we have elsewhere.

Okay. And last question. When Jeff said that $1 billion in the balance sheet, I want to know if he had hit pinky to his mouth like in --

With a subtle grin.

All right. Thank you guys. Congratulations.

Thanks, Scott.

Management, there are no further questions. Please continue.

Thanks, everybody, for your time and your questions. If you have any other remaining issues or questions to ask, please feel free to contact Patrick Richards in investor relations. His number is 801-954-7961. Thanks.

Ladies and gentlemen, this concludes our conference for today. If you would like to listen to a replay of today's conference please dial 1-800-406-7235 or -- and entering in the access code of 4329110 ACT would like to thank you for your participation. You may now disconnect.