USANA Health Sciences Inc (USNA) 2011 Q1 法說會逐字稿

Welcome to the USANA Health Sciences first quarter earnings conference call on the 27th of April, 2011. [During the] presentation, all participants will be in the listen-only mode. After the presentation there will be an opportunity to ask questions. (OPERATOR INSTRUCTIONS)

I will now hand 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 to review our first quarter results. 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.

Now, I'm joined this morning by Fred Cooper, our President and Chief Operating Officer, and Jeff Yates, our Chief Financial Officer. We'll hear first from Jeff, who will discuss the details of the financial results this quarter. We'll then hear from Fred who will discuss our business activities as well as our plans for the rigor of 2011 and a bit of a snippet into 2011.

I'll now turn the call over to Jeff.

Thank you Riley and good morning everyone. Once again I am pleased to report that completed another solid quarter of sales, coming in at $143.6 million. This represents a 20.6% increase when compared with the $119.1 million we reported for the first quarter of 2010.

This quarter's sales included $5.7 million from our Chinese subsidiary, BabyCare. Also favorable changes in FX rates this quarter added nearly $4.2 million to our top line when comparing our results to the same period last year.

We also realized approximately $3 million in incremental sales via Hong Kong associates in anticipation of a price increase in that market. Additionally sales from our Asia-Pacific convention, which was held in March this year, added $3.1 million to sales during the first quarter. Remember that we held this event during the second quarter last year so there is a timing difference on the year-over-year comparison.

Although sales were impressive during the quarter, we were disappointed with our associate counts in many of our markets. Excluding the addition of BabyCare associate, the overall number of active associates decreased 1%. We believe that this is the result of many of our associates being distracted by the acquisition of BabyCare in China as many of our associates are evaluating how to incorporate this new market into their businesses.

Looking at our results regionally, sales in North America were essentially flat coming in at $60 million which is due to softer than anticipated associate counts. Along with many other companies in our industry, we continue to see a soft consumer segment which we believe is a result of a lingering tough economic environment. Furthermore, our business model allows an associate to build a business in any market where we have operations, with the exception of China.

Currently many of our North America leaders are focusing their efforts on growth opportunities throughout Asia. As a result of this, we continue to see disproportionate growth especially in Greater China.

Consequently, our Asia-Pacific region net sales for the quarter increased by $25 million or 42.6% compared to the first quarter of 2010. Net sales for this region totaled $84 million for the quarter which represents 58.2% of our total sales. Sales growth in this region was primarily due to the 18.2% increase in the number of active associates. The majority of this growth is in Hong Kong where sales increased 82.7% over last year and the number of active associates increased 35.6%.

Notably a sequential quarter -- on a sequential quarter basis, the number of active associates decreased, which we believe is the result of unusually high enrollments during the fourth quarter of 2010 and softer than anticipated results in the first quarter most likely from Chinese New Year.

In addition to Hong Kong we also experienced double digit growth in the Philippines and in South Korea, two relatively small but emerging markets.

Now shifting to the other major components of our P&L, gross margin -- gross profit margin for the first quarter improved as a percentage of net sales to 82.1% compared with 80.7% for the first quarter of 2010. This 140 basis point increase was primarily due to benefits from changes in currency exchange rates, reduced freight costs, leverage gained on higher sales and lower overall costs of our raw materials. For the full year of 2011, we expect gross margins to be about 82% of sales.

Associate incentive expense for the quarter improved 30 basis points to 45.1% of sales compared to the first quarter of the prior year. This decease was primarily due to the strategic changes implemented in 2010 to better align compensation with actual sales growth and the impact of a slightly lower payout rate through BabyCare.

SG&A in the first quarter increased to 25% of net sales compared to 23.1% last year and also increased 70 basis points compared with the fourth quarter. The higher SG&A expense was largely a result of costs associated with the integration of BabyCare, higher relative wage and equity compensation expenses, costs associated with our AP Convention and expenses occurred in connection with our Brand Awareness campaigns.

We expect that on a year-over-year basis SG&A expenses will continue to be relatively higher for the next few quarters while we continue branding efforts and work to integrate and grow BabyCare.

Net earnings for the first quarter were $11.4 million or $0.70 per share compared with $9.6 million or $0.62 per share in the first quarter of the prior year. The dilutive impact of BabyCare's operations for the first quarter was $0.08. The increase in net earnings and earnings per share this quarter resulted from improved gross profit margins, lower relative associate incentive expense and a lower effective tax rate.

These improvements were partially offset by higher relative SG&A costs. Additionally, EPS were negatively impacted by a higher average number of shares outstanding.

As noted in our release yesterday, we are reiterating our initial guidance. As we focus our efforts to grow China, we anticipate that sales in Hong Kong will decline beginning in the second quarter. Our estimates suggest that we will see meaningful growth in China by the end of 2011 as we introduce additional USANA products into that market and as our associate leaders become more familiar with BabyCare.

We continue to believe that China remains USANA's most significant growth opportunity. As you consider our guidance, keep in mind that we have not modeled for a currency benefit in the coming quarters, nor will the revenue from our AP Convention recur in the coming quarters.

Accordingly, we continue to project net sales for 2011 to be between $530 million and $550 million and estimate that earnings per share will be between $2.85 and $2.95.

I'll conclude by commenting on our balance sheet. Cash at the end of the first quarter was $32.7 million compared to $24.2 million at the end of 2010 and we continue to be debt free.

Additionally we repurchased 251,000 shares during the quarter for a total investment of $8.5 million, leaving $23 million still available under our current share purchase authorization.

I am pleased with the strength of our balance sheet, which positions us well to make the necessary investments for sustainable and long term growth. And now the call to you, Fred.

Thanks Jeff. Good morning everyone. I'd like to begin by updating you on our efforts in China and then we'll go to North America. In China we continue to make the necessary investments to lay the foundation for what we believe will be a meaningful growth in the market.

Our integration of BabyCare continues to move forward and we're focusing on our efforts with the introduction of USANA products, obtaining additional provincial licenses, building stronger government relations and implementing a strategy specific to that market.

We believe the primary reason most associates get involved with USANA and stay with us are the products. Simply put, our associates know that in order to build a successful business in any of our markets, including China, they need USANA products and a rewarding compensation plan.

During the first quarter we introduced the first of three phases for 2011. This will go towards our product strategy in China. Phase one included the rebranding of four high quality BabyCare products that are now sold under the USANA label. This first step was announced by Dr. Wentz at our Asia-Pacific Convention in March.

In phase two we'll begin the introduction of our core five Sense skin care products. We're currently on schedule and expect these products to be introduced by the end of the second quarter.

The phase three of our product integration strategy will include the approval and introduction of four USANA core nutritional products. We expect that these products will be launched sometime during the fourth quarter of 2011.

It's also important to note that we have events and other marketing activities scheduled around each of these phases to help build excitement and help motivate associates to build their businesses through BabyCare in China.

Another important part of the China strategy involves obtaining additional provincial level direct selling licenses. We are currently in the process of obtaining five additional ones. As you this process is regulated by the Chinese government. We have concerted efforts to build strong government relations going forward. This is an important factor as we will do what we can to obtain these licenses as quickly as possible. Our plan is to obtain licenses first in these provinces where we see the greatest opportunity for growth.

Now let's discuss the growth strategy for China. Over the past few years we've experienced very strong growth in our Hong Kong market in part due to our associates' anticipation of our entry into China. As Jeff discussed a few minute ago, now that we have entered into this market, some associates will transition their business activity to BabyCare. We believe that this transition will impact our Hong Kong business and I'd like to explain why.

First, we anticipate that many of our associate leaders who are qualified to operate in both Hong Kong and China will change their focus from growing their Hong Kong business to growing through BabyCare in China.

Second, we have a large group of Asian associates who are involved with USANA only because of the products and are buying in Hong Kong for consumption only. We expect many of these consumers will begin purchasing USANA products through BabyCare and either remain consumers or become entrepreneurs and build a BabyCare business.

Finally, our estimates suggest that the average initial purchase per associate in BabyCare is about 40% lower than in our other markets. So as a result there will always be a natural sales decrease, at least early on, until our volume in this market increases.

Now turning to North America, tough economic conditions, as Jeff said, continue to impact sales in the direct selling industry in this region and we're no exception. Although we've not seen any growth in North America, we also haven't experienced the dramatic declines that many other companies have experienced.

Nevertheless, we're not satisfied with the level of performance that has now been delivered by this region for some time. We believe that it is impossible for -- that it is possible, rather, for us to regain momentum in North America and we are committed to do so. Our primary management performance objectives and incentives for 2011 are tied to sales and associate growth in North America.

Also in an effort to regain momentum in this region we've magnified our efforts to enhance our global brand. This includes additional sponsorships with high profile athletes as well as advertising and partnering with credible organizations. A great example of this is our extended partnership with the Women's Tennis Association as its official health supplement supplier.

This partnership now includes increased USANA branding and participation at WTA events over the next three years. We believe that strong partnerships with great organizations such as the WTA will help us to enhance our global brand ultimately making USANA a more recognized name.

In conjunction with these branding efforts we are also offering contests and promotions targeted at increasing the number of associates while maximizing our branding efforts.

Along this same line, in an effort to increase brand awareness, Dr. Wentz and Dave Wentz recently co-authored a New York Times best-selling book titled "The Healthy Home." Dr. Wentz and Dave just completed a book tour that covered 17 cities in the US, Canada and Mexico where they shared their vision for better health in the home. Many of our associates have purchased the book to use as a marketing tool.

Although 2011 will be a transitional year for USANA, I am pleased with the underlying strength of our business, particularly in light of the current economy. We're excited about the opportunity for USANA in China and remain committed to improving our results in North America.

With that I'll now ask the operator to facilitate the question and answer session.

Thank you sir. (OPERATOR INSTRUCTIONS)

Tim Ramey from D.A. Davidson.

Good morning. Congratulations on a great quarter.

Thank you Tim.

Thanks Tim.

Just kind of trying to better understand the guidance. I do understand the pull forward in sales relative to the convention and I guess what amounts to maybe $8 million of sales that would have been non-organic in the first quarter. But the kind of the shape of the curve of transitioning people from sort of Hong Kong sources to mainland China sources or BabyCare sources still is somewhat foggy to me.

Can you talk a little bit about how you think that plays out with some kind of quarterly specific concepts? Is that -- do you think of this as a second quarter and third quarter phenomena and then by the time you get into the fourth quarter you're starting to ramp that and see organic growth through the BabyCare organization?

Sure, sure. It's a good question Tim. It's -- needless to say it's a challenge to be able to forecast that customer behavior over the next couple of quarters. We've got a lot of work to communicate and to share the opportunity that is there and to train our associate leaders.

We're counting on all the efforts that we've laid in the path ahead of us to be able to achieve a smooth transition to those who would do so and to attack that market aggressively and give opportunities to as many people as possible via the BabyCare model.

It's difficult to predict, as I said, and to forecast what that will look like we anticipate that during the second quarter we'll start seeing an impact in Hong Kong as people evaluate the opportunity. During the third quarter we'll be able to communicate with more and more people as the message spreads and we'll start to see obviously some response to that as we anticipate into the fourth quarter.

I wish I had a crystal ball that was less foggy than yours but we're trying to be careful with that plan knowing that everybody who has entered into that market has had a challenging first few years. We think we'll accelerate that process given the mechanism that we've created through the acquisition of BabyCare. We think we'll leapfrog a lot of those challenges.

We've got a good management team in place. We've got events that we think will be exciting and attractive for people there both in the peripheral markets as well as within Greater China and we'll give you updates as we go.

Tim, if I could add a little to what Jeff said too, this gets down to just kind of evaluating human behavior and the psyche of change and difference. Our China market is unique to us because the compensation plans are so different. The manufacturing process and the rules are different. So trying to evaluate and predict people's adoption of that plan when they've already been accustomed to one paradigm and having to accommodate a second one is uncertainty.

And uncertainty means that they're busy spending time trying to figure out what is going to happen in China, what they're going to do to build their business in China rather than focusing on building the current business that they have. That's why we expect our guidance to not be as bullish towards the end of the second and in the third quarter as this migration occurs.

Gotcha. And just if I could follow up on the focus on reinvigorating the North American associate growth, you mentioned the WTA partnership but surely there are going to be other initiatives there. Do you envision other tweaks to the plan to kind of breathe new life into that organization or can you give us any more detail on that?

We're having everything put on the table for strategies that we can adopt that will help invigorate and get the field fired up to grow their business again. So I would say nothing is off the table or on the table.

Okay, terrific, thanks.

(Inaudible)

Yes, thanks so much. Thanks for taking my questions. Could you clarify your comment related to the decline in Hong Kong, specifically are you saying that the Greater China reported segment will decline? And do you mean that sequentially on -- sequentially or on a year-over-year basis?

To clarify, we anticipate the specific market of Hong Kong to decline as people re-evaluate where they do business with USANA. As Fred mentioned, there are leaders who are qualified to do business in Greater China, in mainland China who will likely be shifting.

There are associates who are consumers who acquire their products in Hong Kong who will likely be able to then acquire their products for consumption via the BabyCare distribution model and we anticipate that overall the sales that are coming through the BabyCare model initially will be a little bit lower on an initial purchase basis but the volume will overcome that. So Greater China as a region we anticipate would have growth combined --

Got it.

-- does that help you?

Yes, that helps. So at first the BabyCare offset will just be less and then by 3Q and 4Q the BabyCare offset, the shift will, you would expect to be greater than the Hong Kong impact.

And end in the fourth quarter or at the end of the fourth quarter, I'm sorry.

By the end of the fourth quarter.

Yes.

Okay.

So we're getting a shift in the people count from -- and for the business activity that's being done, lowering in Hong Kong and then we expect an increase in China at the end of the fourth quarter.

And do you think that's the factor that explains the -- it was a pretty surprising sequential decline in Greater China people count this quarter which will point to BabyCare?

Well there are two factors really. One is a little bit of a shift but we had significant enrollments in the fourth quarter that we didn't match in the first quarter so that would account for a little bit of the difference. And then as people are considering how to -- excuse me, shift their business, for those who can, they're attention has been focused on that rather than doing a lot of business building in the first quarter. So we're seeing a little bit of softening there for those reasons but anticipate that that will recover through Mainland China, as Fred described, later in the year.

Got it. And I hate to focus just on 1,000 people but can you, given the -- how recently you did the BabyCare deal, I was wondering if you could comment on what appears to be about a 1,000 sales person decline in the BabyCare system. How does that compare to your own expectations and does that -- should we expect more bleeding in the coming quarter or --?

We don't expect more bleeding. We anticipate that it will go up. There's ebbs and flows in that. People are evaluating the compensation plan that they have there and we wouldn't be surprised by this and anticipate that as we communicate the opportunity, people will light up again.

We also had during the first quarter some lighter activity because of Chinese New Year and in our market, particularly in that market, it's significant for us now that Chinese New Year has a pretty significant impact on our business during that time.

Okay. Just one last one, please. I'm just looking at revenue per associate and as well as per total membership and the progress has been substantial the last couple -- the last two years and I know you guys have a pretty long track record of sort of driving that number higher, but the last two years it's really jumped sharply.

I know there's a lot of moving parts. I'm not asking you to break each one out individually but I was hoping you could highlight what you think the biggest changes have been that have driven revenue per total active member about 30% higher the last two years and then maybe if you could just comment on the sustainability of those gains.

I'll take an answer on that one and it's basically two-fold. The first one is compensation plan enhancements that we had made to the field over the last couple of years, so that's one. And the second is price increases.

Okay, great. Well thank you very much for taking my questions.

Appreciate you being on the call. Thanks.

Doug Lane from Jefferies.

Hi Doug.

Thanks, this is actually Per Ostlund in for Doug. Good morning everybody. A couple of modeling questions if I could. Starting with the FX benefit on the top line, Jeff, I just want to make sure I interpreted your comment correctly. Are you, in your $530 million to $550 million sales outlook, is there actually no foreign currency benefit in that number?

Correct.

Okay. Is that just because you don't want to project it out or is that because that's where you actually see currency shaping up?

Don't know where it's going to go. We're using the Q1 numbers and forecasting those forward without knowing what direction it's going to go so just doing with what we know.

Okay, that's fair. I think last quarter you provided an SG&A number sort of X the BabyCare. If you said it in prepared remarks, I missed it. Do you have that number handy?

Say again, I'm sorry.

The SG&A line sort of X BabyCare? I think you provided that on the fourth quarter call. I'm just going to see if you might have that available this time around as well.

I don't have it immediately available to me, Per. Sorry about that.

That's okay. I guess maybe on a different but related note, you mentioned an $0.08 impact from BabyCare. Sort of, what are the pieces to that? How much of that's kind of an operating deficit and how much of that would have been like the share count increase and that sort of thing?

Relative to BabyCare?

Yes. Because you had said I think it was an $0.08 impact on the quarter from BabyCare dilution and I just wanted to see how much of that was operational versus kind of that below the line share count issue, if you had it.

Shares -- the shares had a $0.03 impact. The remainder was operating expenses.

Okay. Makes sense. And maybe one last one, just as we're -- as I'm looking at that SG&A line, you parsed through some of the drivers of the increase in the quarter. Thinking about the Asia-Pacific Convention specifically, since that would be the non-recurring piece of the bunch, do you know how much that expense was for the quarter?

Per, that was -- the convention expenses that hit Q1 were just a little less than $2 million, $1.6 million specifically, which will then not be comparative to the same relative expenses in Q2 last year.

Okay. And then there's the convention in the states in the fourth quarter.

That one remains comparable at the end of August (inaudible).

Okay. Thank you very much.

Thanks Per.

Rommel Dionisio from Wedbush Securities.

Hi, yes, good morning. Thank you.

Hey Rom.

On -- you guys have talked about the potential just near term impact on Hong Kong for opening the China market, the (inaudible) market. Do you expect anything to occur with regards to say the North American business? I remember a couple of years ago when you were opening up the (inaudible) there was some temporary distraction on the US market and would you expect any other markets other than Hong Kong to be impacted near term?

Yes, actually it's affecting most of our markets as people evaluate how they can grow their businesses throughout the Asian markets that we have with the biggest single impact that we have being a distraction towards Greater China. There are limiting factors for some of our associates who are not allowed to operate businesses there but for many of our associates who can, that certainly is a significant distraction for them.

But as people begin to figure out how to work their businesses in that arena, we believe that they'll refocus again in their home markets. It's just a cycle that we go through with new market openings and --

Sure.

-- (inaudible) other markets.

Sure, understandable. And just one followup question, is there anything you guys can share with us with regards to the Asian convention (inaudible) some take-aways you came away with either positive or negative that may have surprised you?

They're excited for the opportunity to do business in China. That is very apparent from the meeting. Number two, the endorsement of Dr. Wentz for BabyCare and the company itself was very valuable. Three, the ongoing announcement of products that we will offer through BabyCare has a strong appeal to our associates as well.

Great. That's very helpful. Thank you guys.

(OPERATOR INSTRUCTIONS)

Scott Van Winkle with Canaccord Genuity.

Good morning everyone.

Hi Scott.

Good morning Scott.

I'm doing well.

Good to have you on the call.

I had a change of plans so I'm glad to be here. So I didn't miss anything you said about volume incentives. They were a little higher than I expected. I thought last year you were talking about them trending lower so can you refresh me?

Yes, we agree on volume incentives it has increased. The changes that we have implemented have definitely had the impact that we had anticipated on it. However, as our proportion of business grows in Asia, specifically on the compensation plan and the way it's built over there, it continues to put upward pressure on that but it's offset by the currency exchange rate on a weak dollar that we received.

As individuals transfer their business activities over to BabyCare and the disparity in the compensation plans in terms of what they're pay method and style is compared to ours, we'll see a lowering of the compensation payout as the adoption increases.

Okay, so in the case of BabyCare, as that business grows and Hong Kong is offset, do we see SG&A trend higher as well as volume incentives trending a little lower because of the compensation plan there?

Well, the compensation plan at BabyCare and the compensation plan at USANA pay relatively the same. And so as a result of that, there are some leveraged advantages that leaders can take advantage of in a binary that are unavailable to an associate who is at BabyCare. And as a result, that's why you're going to see the decrease over time.

And also the exchange rate with the currency in China versus the US dollar is a little more fixed, so we don't have that variability as well.

Okay and then back to the comment about the net impacting pretty much unchanged when you consider the currency and Asia. So should we assume that the contribution dollars on a sale are going to be the same even though the volume incentive might be a little higher because of the currency?

I'm thinking on that question.

So gross profit dollars less the volume incentive in dollars, the percentage contribution to USANA corporate might be a little lower but the dollars are going to be about the same.

My -- to answer your question as I understand it, I would say they are roughly the same.

Okay. Great. And for your comment about the weak economy in the US, and this isn't something I talked about with a lot of direct sellers, because when you look at the supplement industry in the US, you've got growth in the mass market, growth in the specialty channel, growth in the practitioner channel and the only place you're really seeing softness is in the direct selling channel.

And then if you look at direct selling more broadly beyond supplements, everybody's getting killed. Is it a function of a weak consumer or is it a function that the consumer is not quite strong enough to where you're willing to ask your friend to buy something or in the case of the party plan guys, you're willing to bring together 15 wives in the neighborhood and ask them to spend money on a party.

Is it more a little bit of a stigma of asking your friends who maybe lost their job or aren't making as much money to get involved in the business more so than just maybe consumer spending?

I would definitely say there's a stigma associated with being concerned to ask friends for money. I don't think there are any less incentives, in fact probably more so to go out and approach their friends. It's just the end consumer watches their dollars more closely. And acutely associated with USANA is the fact that we're a premium priced nutritional product.

So from that end, no, I don't think they're any less enticed. They're just finding it more difficult to get people to pay the price for the nutritional vitamin.

Okay. And then if we look at the product offerings, so you have a Hong Kong associate consuming product who's going to transition their business to China or they're buying product in Hong Kong, they're probably buying your premium multivitamin supplement of some kind. Is that same exact product, or not same exact, but a similar product available today at BabyCare? Is BabyCare's lead product a multivitamin, multimineral supplement comparable to USANA's in some way or another?

They are close. I can't say they are the same because in China the regulations that they allow for minimums of each ingredient are different just like they are across all different countries. So we have to go to the maximum that's allowed by law in China but we hit those maximums and then we try to get the governments to allow greater levels of particular vitamins that we have found to be more efficacious.

Okay.

So when you say are they the same, they're -- no, they're not the same but they're the least -- the maximum allowed by law and we're going to try to get them higher.

Okay. And then speaking on China, the timeline of the next phases, are the Sense products, are they approved today?

Yes.

Okay. And then you don't have approvals yet for the next wave of USANA supplements to go into China, how confident you can make -- are you that you can make that by the fourth quarter? What I always hear as a benchmark is two years and $2 million to get a product approved for international direct sellers.

You're exactly right on that but we already had an anticipation that we'd be going to China so luckily we got a head start on it. So I -- we believe it will be fourth quarter. That's our best estimate. So far we've hit the timelines on all our product registrations that we had, so it's our best guess. We think we'll hit it.

Great, and then was the BabyCare management, had they already made applications for the incremental five provincial licenses or is that something that occurred post-acquisition?

They began that process, Scott, immediately after acquisition which happened immediately after they received their first license, which was the [basine] license. That was the premium license and began the process of submitting applications for the next five immediately thereafter. So we're in -- we're well into that curve right now.

Excellent. Thank you very much.

Thanks Scott. One thing I'd like to clarify, I think aerate the question on the dilution of BabyCare, we've just been able to put together the numbers to clarify that answer that I gave. It's a $0.03 dilution relative to the share count, a $0.02 dilution relative to equity compensation and $0.03 from operations, the $0.05 that I gave you on the other has those two components, equity and operations. I wanted to make sure that I was clear (inaudible).

Thank you. There appears to be no further questions. I will now hand over to Riley. Please go ahead.

Thank you for your questions and for your participation today on our conference call. If you have any remaining questions, feel free to contact any of us including Patrick Richards in Investor Relations at 801-954-7961. Thanks.

This concludes the USANA Health Sciences first quarter earnings conference call. Thanks for participating. You may now disconnect.