USANA Health Sciences Inc (USNA) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the USANA Health Sciences second-quarter earnings conference call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). I would like to remind everyone that this conference call is being recorded today, Wednesday, July 24, 2013 at 9 AM Mountain Time. I will now turn the conference over to Mr. Patrique Richards. Please go ahead.

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 website at www.USANAHealthSciences.com. Shortly following the call to 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.

Examples of these statements include this regarding our personalization initiative, our strategies for each of our regions of our outlook for 2013. 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.

In addition as we disclosed in Form 8-K filed yesterday, the Securities and Exchange Commission is conducting an investigation which appears to involve possible issues regarding trading in the Company's stock during late 2012 by certain of the Company's directors including the Chairman. The Company and members of its Board of Directors are fully cooperating with the SEC in connection with this matter. Because this is a pending matter we are not able to provide any further comment at this time, nor respond to questions about this matter. We are confident, however, that the outcome of this matter will not have a material adverse effect on the Company's financial condition or results going forward.

I'm joined this morning by Dave Wentz, our Chief Executive Officer, and Paul Jones, our Chief Financial Officer. Dave will begin with a review of our operational progress and highlights during the quarter. Paul will follow with a more detailed look at our second-quarter financial results and Dave will then conclude by providing a preview of our expectations for the second half of 2013. I will now turn the call over to Dave.

Thanks, Pat. Good morning, everyone. The results we reported after market yesterday afternoon reflect a stellar performance by our team during the second quarter. Sales increased 17.5% and earnings per share increased nearly 55%. The number of worldwide active associates increased 8.1% and preferred customers increased 6.1%. We believe this growth reflects the continued successful execution of our strategic initiatives. After generating another record quarter we are on track to report our 11th straight year of record results in 2013.

Net sales for the second quarter were $189.1 million, our sixth consecutive quarter of record sales. The key factors contributing to this growth include strong sales and customer growth in Asia-Pacific, especially in greater China, and continued growth in North America, primarily from increased associate productivity.

Another factor that influenced sales for the second quarter was our introduction of a worldwide policy focused on customers purchasing products offered outside their home market. With the global nature of our business and the Internet making it easier for consumers to research and purchase products online we have experienced some cross border purchasing by our customers in several of our markets in an effort to get desired formulations, products or pricing which are not available in their home market.

The price reductions we implemented earlier this year were also intended to minimize cross-border purchasing and to help make our products and business opportunity more equitable across all of our markets.

This latest policy change is hopefully our final change to minimize cross-border purchasing. We believe that we realized approximately $7 million in additional sales during the quarter due to increased purchases ahead of the implementation of this policy. These positive factors were partially offset by an estimated $1.1 million negative impact from the pricing initiative in Canada, Australia and New Zealand that we implemented during the first quarter of this year to increase parity between markets. I will now turn it over to Paul to talk about our regional performance.

Thanks, Dave. Sales growth this quarter was led by our Asia-Pacific region where many of our markets continue to generate solid sales growth. Sales increased 36.3% in greater China and 9.3% in Southeast Asia Pacific. We were also pleased to see 19% sales growth in South Korea in our North Asia region which was driven by strong increases in customers as well as price adjustments implemented earlier this year.

The greater China growth was driven by strong results in each of the markets in this region, but was led by mainland China. The number of active associates in greater China increased 18.4% which was again led by significant associate growth in mainland China.

We are pleased with our continued success in this region; particularly in mainland China where sales were approximately $3.5 million stronger than expected. We believe that these better-than-expected results are due to continued excitement and momentum from our sold-out Asia-Pacific convention that was held in this region during the first quarter and the emergence of new associate leaders and customers in China as we are beginning to see a number of associates in that market advance up through our leadership ranks.

We also believe that the three additional direct selling licenses that were granted during the first quarter, as well as are significant offering of licensed USANA products, are contributing to our success in mainland China. While we are encouraged by our results in greater China for the quarter, we are conscious about the events that accelerated our performance in the region, both the carryover momentum from our Asia-Pacific convention and the sales ahead of our worldwide policy changes meaningfully contributed to our results in this region for the quarter.

Additionally, we continue to anticipate that our results in Hong Kong will taper and that we will continue to grow in mainland China as we focus our efforts and resources on this market.

Now just to clarify some details about our business in China, we maintain a direct selling license in the province of Beijing and we were also granted direct selling licenses in three additional provinces during the first quarter of this year. In China we sell eight USANA branded products, six Sense branded products and 10 BabyCare branded products, all of which have been registered within and approved by the Chinese government.

Our associates around the world are required to comply with local laws and regulations as well as our internal policies and procedures. We continually update our policies and procedures to ensure that they are in accordance with best practices.

The policy I mentioned a moment ago is simply one example of a policy that we have implemented or modified during the last year to strengthen our business. We are aggressive in ensuring that our associates comply with our policies and procedures and will continue to be aggressive going forward.

Turning now to Southeast Asia Pacific, sales growth in this region was again driven by double-digit sales and customer growth in the Philippines. We continue to see solid growth in the Philippines albeit at the reduced rate we anticipated.

We were also pleased with our results in Australia and New Zealand during the quarter where the number of active associates increased over 5% and the number of preferred customers increased 15%. We believe that the success and momentum that we are beginning to see in these markets is directly related to the pricing initiative we announced earlier this year.

As a reminder, we implemented price reductions that were designed to help expand our customer base in several of our mature markets. They better align our product pricing with the economic and competitive environment while incenting associates to purchase within their home market.

We also saw solid sales growth in Singapore this quarter which can primarily be attributed to the sales of our MyHealthPak product which have improved noticeably throughout Asia. Remember that our entire Asia-Pacific region is serviced by Singapore for our MyHealthPak product.

Turning now to North America, sales for this region continue to improve and increased 6.9% which was largely the result of strong sales growth in Mexico as well as sales growth in the US and Canada. Our sales growth in Mexico was driven by double-digit increases in both associates and preferred customers, as well as price increases that were implemented during the first quarter. Sales growth in the US was driven by increased associate productivity and price increases on certain of our products that were implemented during the first quarter.

In addition, you may recall Dave discussing on previous calls the iPad promotion and True Health Assessment initiative. Both of these programs generated a lot of excitement with our associates during the first quarter. The enthusiasm continued to build during the second quarter and we are continuing to utilize and promote the True Health Assessment.

In Canada we are beginning to see improvements in both customer counts and productivity, which we believe is the early result of the price reductions made in the first quarter. Although this pricing initiative is still in the early stages, we are pleased with the results so far and expect it to generate both customer and sales growth over the long term in Canada and the other mature markets that were targeted.

Let's turn now to the income statement. Gross margins improved 50 basis points year-over-year largely due to a decrease in cost of goods sold, which can mostly be attributed to production efficiencies. These efficiencies were partially offset by an unfavorable change in sales mix by market.

Associate incentives expense for the quarter decreased to 41.1% of net sales compared to 44.1% in the prior year quarter. This decrease can primarily be attributed to the change to the lifetime matching bonus program launched in the second quarter of 2012. In a moment Dave will walk you through our plans for associate incentive expenses for the remainder of this year and going forward.

SG&A in the second quarter was 22.7% of net sales, a relative decrease of 10 basis points from the second quarter of 2012. This relative decrease is largely due to leverage gained from higher net sales. On an absolute basis SG&A increased as a result of the cost associated with supporting a higher sales base which largely can be attributed to higher wages and benefits.

Our effective tax rate for the quarter was 33.4% of pretax income compared to 32.8% in the prior year. We expect our effective tax rate for the year to range between 33% and 33.5%.

Net earnings for the first quarter increased to $24.2 million, an improvement of 44.6% compared with the prior year period. This increase was due to higher net sales, higher relative gross margins and lower relative operating expenses for the quarter.

Earnings per share for the quarter increased nearly 55% to a record $1.72 per diluted share. This increase can be attributed to higher net earnings and a lower number of shares outstanding from share repurchases over the last 12 months. We did not repurchase any shares during the quarter and there is approximately $13.6 million remaining under our Board authorized repurchase program. Our diluted share count as of the end of the quarter was 14.1 million shares.

Turning to the balance sheet, we continue to generate strong cash from operations and ended the quarter with $96 million in cash. Cash generated from operations in the second quarter totaled nearly $27 million.

Before turning the call back to over to Dave I would like to reiterate how pleased we are with this quarter's results and more specifically with the underlying strength of our business and the financial strength of the Company. With that I will turn the call to Dave to review some new initiatives and our guidance.

Thanks, Paul. As a management team we focus on many different areas and goals, but our most important commitment is for the long-term growth of the Company. As we discussed on previous calls, we believe that growing our customer base by sharing our products and opportunity with as many consumers as possible is the best way to drive long-term sustainable growth for the Company. Initiatives during the first six month of the year have helped move us in that direction.

In August we will hold our annual international convention here in Salt Lake City. As you know, we often reserve our most exciting and significant announcements for this event. Our announcements this year are very exciting and designed to create lifetime customers and successful entrepreneurs.

Because our convention is only a few weeks away I'm going to keep the details to a minimum at this time. What I can tell you at this point is that these announcements will include significant investments by USANA in initiatives that are designed to reward both new and existing customers who loyally use our products; simplify the USANA opportunity for all associates, helping them to become successful faster; and increased rewards for our associates who are creating more lifetime customers.

We expect these announcements to be well received and generate a great deal of excitement amongst our associates. While we believe that this investment will accelerate our growth rate of associate and customer counts by increasing customer longevity and helping our associates become successful faster, we also expect short-term pressure on our top-line performance during the second half of the year and corresponding pressure on our operating margin.

This past quarter our associate incentives expense was 41.1% of net sales and well below our target range for incentives. Over the past year we have communicated our intent to reinvest the savings in our associates to create long-term customer growth. We believe the initiatives we will launch at convention will accomplish this. That said, our target operating margin remains around 15% for the full year 2013 and beyond.

As a result of our performance during the first half of 2013 combined with planned investments in the second half of the year, we are reiterating our top-line guidance and increasing our EPS guidance as follows. Net sales will be in the range of $700 million to $720 million for the year; diluted EPS for the year is now expected to be in the range of $5.30 to $5.45.

As our guidance and first-half results suggest, we expect these initiatives and investments to reduce our operating margins during the second half of 2013. This reduction can be attributed to, in order of significance -- increased associate incentives that we believe will temporarily increase to around 45% for the second half of 2013; pressure on our top-line results for the second half of 2013; and an estimated 100 basis point decrease in gross margin. We anticipate that associate incentives for 2014 and beyond will settle in between 43% to 44% of net sales.

Let me reiterate my confidence in the long-term benefits of these investments and initiatives. I strongly believe that these investments are coming at the right time and will provide the opportunity for more rapid growth for the Company over the long-term.

Before closing I would also like to point out that we recently opened Colombia. This is our 19th market. Our Mexico leaders who are doing a phenomenal job growing in their own market have strong ties to Colombia as well. As a result we have high expectations for this market.

In closing I want to be clear that our guidance does not signal a slowdown in our business but rather an investment in the future. I'm very pleased with the performance of our business and excited about the direction of the Company. Our business has never been stronger and our expectation is that we will report our 11th consecutive year of record sales and another year of record earnings per share for the full year 2013.

While it is premature to offer specifics about 2014, we are quite confident that we will expand our record to 12 years. It is my expectation that the implementation of our upcoming initiatives will support our growth in the years to come. I fully expect our business to continue to produce excellent results as we continue to focus on rewarding our associates who are increasing the growth of lifetime customers which must be the foundation for long-term growth for the Company. With that I will now ask the operator to facilitate the Q&A session.

(Operator Instructions). Scott Van Winkle, Canaccord Genuity.

Hi, good morning, it is Mark Sigal in for Scott. I was wondering if you guys can provide a little more detail on the rule change you implemented during the quarter. Is it a strict prohibition on purchases outside the Associate's home market or are there other aspects of the rule as well? And then perhaps as a corollary to that, the $7 million one-time benefit you saw, could you give us a geographic breakdown of what comprised that?

Yes. The main gist of the rule was to stop people from buying products where they had a similar product in their own market. If they have a similar product in their own market they are not allowed to buy it from another country.

There are still other products that they don't have available that they are interested in and we want to take care of their long-term health, so for personal use they might buy some other products, but not the ones that they have in their own markets. And for -- primarily we saw the greatest impact in Asia as we saw a stock up before the change of the policy.

Okay, and can you give us any more breakdown in Asia, Hong Kong versus mainland?

Greater China was definitely a large aspect of that with the difference in products between markets.

Okay. And then respect the earlier commentary regarding the SEC investigation. I was just trying to get a sense of the timeframe that is being called into question, does it strictly just relate to late 2012 or are there any other time frames that go along with that?

Because it is pending we can't comment on that.

Okay. You spoke a little bit about Colombia coming online in the back half of the year. Can you give us a sense of what your expectations are at this time? Are the expectations more robust than some of your more recent market openings such as France or Belgian or can you just sort of give us a sense of how you are thinking about it?

Yes, we are only one week into it but -- well, a week and a half now as of today. But very optimistic, much better response and experience than in France and Thailand. We are off to a much faster start and better run rate and great prospects based on what we saw with the meetings going on throughout the country with thousands of people. It is going to be a great market for us. Very smooth opening without any glitches that I know of. It is one of the best openings we have ever had so we are very excited.

Okay, thanks a lot.

Tim Ramey, DA Davidson.

Congratulations on a great quarter. The sales shift, I am assuming -- the way I read that was it pushed sales out of the 3Q into the 2Q and didn't place as much impact in my analysis on the 4Q. But how would you react to that? Does that sound about right? I know you are not going to give us quarterly guidance, but it seems to me the brunt of that would be in the 3Q.

Yes, that would be correct and it will have some impact on the third quarter, but I think we will anticipate that we would see -- continue the great run rate that we were seeing in the first quarter. The second quarter is a bit of an anomaly because of this, but we will continue to see going forward the run rates that we have seen from the first quarter and prior.

And the associate incentive expense being as low as it was on a percentage of sales in the 2Q, did that reflect anything about mix and structural differences in terms of how mainland China sales roll up into the P&L, or is that just kind of the --?

No, it really didn't. We have been managing that line for and working on it for a number of years all to put us in a position to make these investments that we are looking to make at conventions. So that number hasn't moved on accident, we have managed it to a point where we want to get it so that we can put this investment back into our leaders to grow the Company faster. And so, it has been a process in place for a year or more to get to this position and we are very excited about where -- what this allows us to do at the coming convention.

And, Dave, the statement -- I think you made it this morning and maybe you made it in the P&L as well -- or in the press release as well that mainland China really was the growth driver, which is somewhat counterintuitive if we were thinking that some of this rule change was about minimizing gray market importation through Hong Kong.

That is just how amazing mainland China is doing right now. It is growing very fast and doing very well. So we are excited that we have been able to accomplish this switch and focus for our leaders and they are taking off with it in, as we know, the biggest market. So we see a great run rate there in mainland China.

And if we think back, I think it was 2011 you attempted a similar thing and then reversed it in the 2Q of 2011 I believe it was. But I mean, it makes sense that you didn't have the approvals, you didn't have the product listings, you didn't have a lot of it and for structure that you do on the ground now. Is that kind of why this makes sense for today but it didn't stick in 2011?

Yes, there have been a number of steps over the years to get to this point. And now I feel like we've pretty much taken the final step and are seeing the great growth now in China that we were trying to get to over the last years. And so, yes, things had to be put in place, they had to take time, it couldn't happen overnight. And we feel like, as we said, kind of the final step and now we are just ready to roll and grow in mainland China.

Sounds good. Thanks so much.

John San Marco, Janney Montgomery Scott.

I may have missed part of your answer earlier in Q&A, but will the policy that you have already put in place aimed at getting customers to buy product in their own market, should that have an impact outside of Hong Kong or will that just be a Hong Kong issue?

No, that has had effect in many different markets. We've tried to create parity between markets and we will continue to take more steps to do that. But there are still differences in formulas, differences in prices due to exchange rates, etc., between markets and we've become such an Internet well researched everyone knows what the prices are in different places, they now think about exchange rates.

So it has created challenges where we needed to put this policy in place going forward so that it didn't increase our cross-border purchases and will in effect send them in the other direction. That is just the nature of the world that we're living in now and took a corrective step to make sure that we keep people buying the products in their country even for personal use.

Okay, thanks. And then on that same topic and I guess more broadly the policies it you will put in place at convention. Can you just talk about your compliance and oversight programs? What do you do to ensure that distributors who say they reside in one country truly reside there and how do you ensure that product -- I guess the other big issue you hit on earlier was that product purchases for self consumption are indeed self consumed when they need to be rather than being resold from the gray market? Can you just talk about your compliance efforts there, how you will step that up, etc.?

Yes, well we have I mean in order to be doing business in a country we are looking at ID -- federal ID numbers, we are looking at addresses, bank accounts, number of different things to find -- for them to pick a market. People do move, change countries, there are snowbirds that come down from Canada to the US, etc. We take that into account. If they can prove residency for a few months then we can allow them to switch their purchasing to their market they are living in for a few months, etc.

All of these things we are able to monitor because we have so much information on our customers and associates to know who they are, where they are and to be able to find out if things have changed or if that is not the case. And so, it is part of the information, it's part of the technology and information systems we have to know more about them and where they are and that allows us to help keep an eye on things.

And I guess when it comes to your compliance and you said your monitoring, do you think that is already where it needs to be or do you think there is incremental investment you've got to make there?

I think we might just see purchasing more from one market then another, it is not an issue for us. We are in a good spot right now, policies and place have been accepted and moving forward. We have seen the changes in habits already and people are -- have accepted the policy and are moving forward.

And if I could just add, this is Paul, we already have in place a very strong and robust compliance team with individuals located throughout the world and a large team here in Salt Lake that are constantly and continually looking at behaviors through customer reports. So we are very confident and very strong in the compliance area. I think that we really look at best practices continually in that area. So the policies that we put in place are just augmentations of a very robust compliance plan already.

Okay, thank you for that view. And then just last question, more of a clarification. It sounds -- what I have heard in the script and in the press release is you're going to make these incremental investments at the convention, I think you are referring to them as investments. But it's going to have a dampening second-half impact on revenue. So I'm just trying to -- did I miss hear that? Is it not an investment to these new restrictions or just what type of announcement is it that we should be waiting for at the convention?

As I alluded to, we are going to invest more in our business builders to grow the business faster and give incentives to our lifetime customers. As a result we want to see our customer count and associate count grow faster, accelerate that growth, which will lead to acceleration growth of sales and earnings. But that one step initial investment is what will cause the comparables to be different for a quarter or two.

Okay, thank you very much, guys.

Frank Camma, Sidoti & Company.

I was wondering if you could be a little more granular on the growth, specifically mainland China. I mean, you gave us some of it, some delta -- some numbers. Can you just tell us what the associate count has grown to now and what the sales now is?

Yes. If we take a look at -- and as you know, we try to keep it at regional results, but I think this is an important point here. From year-over-year growth in China we are over 200%. If you look at sales year over -- I'm trying to get my numbers here so I make sure I give you the accurate numbers. But year over year sales were well over 250%.

So the first number, the 200% is the associate count?

Yes, correct. So what is so exciting about this, Frank, is that we are really poised and in a position -- what I would say very quickly into our experience in China to be able to really start to see that market grow and expand with the things we put in place. If you look at some of our competitors in that market it has taken them several years, so, we are pretty excited about our position there.

Yes, starting to take off. Just a clarification. I know you are not going to get into what your -- exactly what the initiatives are here at the convention. But wouldn't it be fair to say, I mean if you are going to crank up associate incentive pretty significantly to build the sales leaders, I mean wouldn't you expect a positive revenue impact from that like almost pretty much immediately? I'm just trying to grasp the -- because you've said in the past that margins would top out at around 15%. That obviously wasn't the case this quarter and hasn't been the case for some time. I am just trying to grapple with that a little bit.

Well not to give too many details and give away the big announcement, as I said, we are making investment in our business builders and in our customers.

Oh, okay.

So it is not just on the incentive side.

Okay.

And if I can take just a second and clarify one point that I made earlier, I want to make sure we are clear on it. When we're talking about the associate growth in China, we are looking at year over year, we are not looking at run rate. So that is important to look at. (multiple speakers) year over year.

From quarter -- Q2 of last year is what you are talking about, right?

Yes, correct.

Okay, okay, that is all I have for now.

Tim Ramey, D.A. Davidson.

Yes, just a confirmation and maybe you haven't thought about this yet, but according to my model 2014 will be a 53-week year for you. Is that right, the 4Q will be a 14-week quarter?

Yes, 2014 will be a 53-week year for us.

Great. I just wanted to make sure I got that right in the model, thanks.

There are no further questions at this time, I will turn it over to Mr. Richards for closing remarks.

Thank you for your questions and for your participation on today's conference call. If you have any remaining questions please fill free to contact Investor Relations at 801-954-7961.

Ladies and gentlemen, that does conclude our conference call for today. Thank you for participating. You may now disconnect your lines.