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USANA Health Sciences, Inc. (NYSE:USNA)

Q1 2009 Earnings Call

April 29, 2009 11:00 am ET

Executives

Riley Timmer – Vice President of Finance

Jeff Yates – Vice President and Chief Financial Officer

Fred Cooper, PhD – President and Chief Operating Officer

Mark Wilson – Executive Vice President, North America

Analysts

Douglas M. Lane - Jefferies and Company

Rommel Dionisio – Wedbush Morgan

Timothy S. Ramey - D.A. Davidson

Dietrich Bass - Canaccord Adams

Operator

Welcome to the USANA Health Sciences’ First Quarter Earnings Conference Call. (Operator Instructions) This conference is being recorded today, Wednesday, April 29, 2009. I would now like to turn the conference over to Mr. Riley Timmer, Vice President of Finance. Please go ahead, sir.

Riley Timmer

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. Again, 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. I’ll now turn the call over to Jeff Yates, Vice President and Chief Financial Officer.

Jeff Yates

We appreciate you joining us on the call today. With me this morning is Dr. Fred Cooper, our President and Chief Operating Officer, and Mark Wilson, Executive Vice President of North America. Following my remarks, Fred will discuss our regional top-line results and certain key indicators of our business.

Yesterday after the close of market, we issued our results for the first quarter 2009. Net sales in the first quarter were $97.3 million, a decrease of 4.2% compared with $101.6 million reported in the first quarter of 2008. This decrease was due almost entirely to the negative impact of changes in currency exchange rates which reduced net sales by 9.7% or $10.4 million. Excluding the impact of currency, net sales for the first quarter would have been about $108 million representing a growth rate of about 6%.

We expect that currency exchange rates will continue to negatively impact the year over year comparison of our operating results in at least the second and third quarters of this year. In fact for the full year of 2009, we’re expecting that the negative impact from currency exchange rates will reduce net sales by as much as $34 million. I have commented before that it is our practice to hedge expected cash flow from our international operations. We will continue to do this, and additionally we are currently evaluating the potential costs and benefits of hedging the topline and the balance sheet.

Lower than expected sales in the US also contributed to the decrease in net sales. Sales in the US decreased 5.3% or a little over $2 million compared to the first quarter of 2008. We believe that our results in the US did not meet expectations primarily because of difficult economic conditions which contributed to an anticipated reduction in associates. Despite these conditions in the US, active customers increased globally by 12.2% compared with the prior year first quarter. However, active associates decreased in the first quarter when compared to the fourth quarter of last year.

Fred will discuss this reduction in associate counts in detail in his remarks. Notwithstanding the current currency pressure on our topline, earnings per share in the first quarter were $0.43, a decrease of $0.01 when compared with the $0.44 in the first quarter of 2008. As with net sales, earnings per share were negatively impacted primarily by changes in currency exchange rates and lower than expected sales in the US. However, earnings per share benefited in the current quarter by $0.03 due to fewer diluted shares outstanding and also benefited by $0.02 from a lower effective tax rate.

Now, let’s go through the major line items on the income statement. Our gross margin in the first quarter of 2009 improved slightly as a percentage of net sales to 79.6% compared with 78.8% in the first quarter of 2008. This modest improvement is due primarily to a reduction in freight costs and fuel surcharges that we incurred during most of 2008. Additionally, we continue to benefit from improved operating efficiencies resulting from new high-speed bottling and shipping lines.

Associate incentives in the first quarter of 2009 were 43.1% of sales compared with 40.7% in the first quarter of last year. This 240 basis point increase was due to the two compensation plan enhancements introduced in August 2008 which are aimed at driving topline growth. We believe these enhancements are effective when considering sales growth in local currencies.

Selling, general, and administrative expenses relative to net sales decreased to 26% during the first quarter of 2009, compared with 26.6% in the first quarter of the prior year. In absolute dollars, this represents a decrease of about $1.7 million. The year-over-year decrease in SG&A was due mainly to a decrease in legal and other professional services, a decrease in expenses resulting from not holding our Asia-Pacific convention which we plan to hold every other year, a decrease in rent expenses, a decrease in promotional and advertising expenses, and a decrease in travel expenses. These decreases in SG&A were partially offset by an increase in equity compensation and an increase in maintenance and depreciation expense. We also benefited during the quarter from a lower effective tax rate due to favourable tax credits taken in this quarter.

Now, regarding the balance sheet, cash at the end of the first quarter was $9.7 million compared with $13.3 million at the end of 2008. Inventories at the end of the first quarter were up year-over-year to $27.4 million compared with the $23.9 million at the end of 2008. This increase in inventories is due primarily to increased safety stock in some markets. For example, inventories increased $2.2 million in Hong Kong where sales increased 42% in the last year. Additionally, the change in currency exchange has increased the value of inventory in our international locations.

Capital expenditures for the first quarter totalled about $830,000, and we expect CapEx to be less than $6 million in 2009. With regard to our share repurchase program, we did not repurchase any shares during the first quarter due to other one-time cash requirements that we experienced during this quarter. Currently we have about $10.4 million available under our share repurchase authorization.

Before we hear from Fred, I will comment on our guidance. Yesterday in our press release, we updated guidance for the full year of 2009. We currently project that our consolidated net sales will be between $390 and $400 million, a decrease of about 7% to 9% from the full year of 2008. This is the result of the negative effect of currency exchange rates and softer than anticipated first quarter results in the US. Given our assumption that there will be little to no relief to exchange rates during the year, we anticipate that the negative impact on sales will be as much as $34 million in 2009. We do however anticipate that we will achieve local currency sales growth in most of our markets during the year. We estimate that EPS for 2009 will be between $1.80 and $1.85 compared with the $1.85 for the full year of 2008. Importantly, we anticipate that the negative impact on EPS due to currency changes will be as much as $0.35 per share in 2009.

It is important for you to know that we have solid strategies in place to grow sales, and we are committed to changing the sales momentum in the US. We believe that we have the right product offering and a great relationship with our associate leaders. They are committed to building up USANA, our products, and the strong growth-oriented compensation plan offering a rewarding home-based business opportunity. As the CFO, I am committed given the difficult economic environment to continue to closely manage spending to ensure that our overall costs remain in line with both reported sales and our long-term financial goals.

I’ll now turn the call over to Fred.

Fred Cooper

Good morning, everyone. I want to begin by discussing some regional results and our key business drivers. With over 60% of our sales coming from markets outside of the US, we’ve enjoyed the benefit of a globally diverse business. With those benefits, however, comes exposure to the international market conditions such as currency rate fluctuations. Over the last year, our local currency sales growth has been bolstered by positive changes in currency exchange rates, enhancing already solid results in most of our markets. I am pleased again to report local currency growth in most of our markets, despite the global economic conditions that currently exist.

Unfortunately, changes in currency exchange rates have dramatically reduced our reported net sales and have hidden the underlying strength of most of our markets. For example, reported sales in Mexico were down 13.1%, and Canada declined by 19.6%. In local currency, however, sales in Mexico increased by 15.4%, while sales in Canada were basically flat. Reported net sales during the first quarter in North America were down 10.2% or $6.4 million, compared with the first quarter of 2008. Excluding negative currency changes, sales in North America were down only 2.2%.

Now, we’re disappointed that net sales in the US were down 5.3% compared with last year and nearly 14% compared with the fourth quarter. Keep in mind, however, that in the fourth quarter of 2008, it was a 14-week quarter. We believe that our results in the US didn’t meet our expectations because of the difficult economic conditions, which contributed to an unanticipated drop in the number of our active associates. During the first quarter, associate counts in the US decreased by 7.9% from the fourth quarter of 2008. To understand this decline, I want to talk about the significant increase in the number of associates during the third and fourth quarters of 2008.

As we previously reported, we saw a record number of associates joining the business during the third and fourth quarters in 2008. This was largely the result of our compensation plan enhancements introduced at our August 2008 international convention. In conjunction with the introduction of these enhancements, for a 4-week period, we allowed any current associate who is not a platinum pacesetter one final opportunity to qualify for this important status. This requalification period, if you will, caused a much higher than normal number of associates to joint USANA. When the requalification period ended, the number of new associates joining the business returned to expected levels. However, in connection with the unusually high enrolment period, we experienced a higher than anticipated level of attrition among this group of associates. Our analysis of this suggests that associates in qualifying for platinum pacesetter status enrolled individuals who would have normally been preferred customers to try the product and made them associates to qualify for the status. We believe this effect coupled with a difficult economy were the primary reasons that our active associate count decreased on a running quarter basis.

Also we’ve seen in the past new market openings generally result in a temporary change in market focus among some of our leaders. As new market opens, many leaders travel to the markets and look for opportunities to expand their international business. The opening of the Philippines followed this same pattern. As such, we believe that that opening of this market in January also affected sales in our US market during the first quarter. Notwithstanding the quarter over quarter decline in the number of associates, we believe that the number of active associates will increase during 2009. We will continue to promote and enhance our compensation plan and look for ways to incentivize our leaders to lead and grow their business.

I’ll now talk the results of our Asia-Pacific region. During the first quarter of 2009, net sales in Asia-Pacific increased 5.4% to $41.4 million. Excluding the impact of foreign currency, sales in Asia-Pacific increased by 19.4%. This increase was led by year over year growth of 42% in Hong Kong, 16.2% in Malaysia, 29.7% in Japan, and the addition of the Philippines as our newest market. Sales in the Philippines during the first quarter totalled $1.7 million. The number of active associates in Asia-Pacific increased by 26.1% to 87,000 compared with 69,000 in the first quarter of 2008. Once again, Hong Kong and Malaysia were our main contributors to this group with the Philippines contributing 5000 new associates in its first quarter of operation.

We’re continuing to focus on the key drivers of the business, and these objectives in 2009 include continuing to promote USANA’s outstanding home-based business opportunity, which will include of course the benefits of the new elite bonus and matching bonus, in helping associates build their USANA business by enhancing their experience with utilizing their great business building tools online, introducing a broader spectrum of our current products into markets where currently now there is only a limited number of products being offered, and evaluating new market opportunities.

With that, I’d like to now ask the operator to facilitate any questions that we may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Douglas M. Lane - Jefferies and Company.

Douglas M. Lane - Jefferies and Company

Can you give us a feel for the associate incentives line which was up a little bit? Is that kind of a going run rate now, or is there something coming down the pipe that might alter that in future quarters this year?

Fred Cooper

Actually it has increased a little bit due to the elite bonus and the matching bonus, but that line, you wouldn’t expect to see that continued increase as compared to total sales. It’s going to flatten out.

Douglas M. Lane - Jefferies and Company

So it’ll still be up year over year, but probably consistent with the first quarter as a percent of sales?

Fred Cooper

Yes.

Douglas M. Lane - Jefferies and Company

You mentioned the sequential decline, particularly in North America where it seemed to be the impactful. What specifically do you think are you going to put in place to try to reverse that, and do you think that’s something that can happen as soon as this quarter?

Mark Wilson

One of the things we’re learning is as Fred talked about the Philippines opening, we had a number of our top leaders spend all of December, the majority of January, and even into February—some are just now returning home, that certainly played an impact when some of your top income earners worldwide are from the US, and I believe I had about 7 of them US alone that spent a significant amount of time over there in looking at the opportunity. As they return home, I think that obviously is going to give us that impact and leadership back in the US again. We also have been doing a lot of training on these new compensation plan enhancements. As easy as we try to make them, any time you do a change to this many people, it takes time for them to really understand and grasp the power of what we’ve done, so we’ve been spending a lot of time on that, and I think as people are starting to grasping this, you’re going to see that continued enrolment trend as well as the strength of the overall growth in the US start to rebound a little more. We’re seeing some very optimistic things. We just completed a regional in San Antonio, Texas, where we saw a number of guests there. That was positive, and the trend will head in that direction. The other thing is we’re starting to attract other potential leaders, big leaders, that are looking at USANA for the first time with these enhancements, that I think we’re now appealing to them, and we’ve entertained several of these already, and I think that’s going to result in some positive things this year.

Douglas M. Lane - Jefferies and Company

It’s very helpful, and I can see the interest in going to the Philippines and getting a foothold in that large market. From a timing standpoint, are those key leaders back in the US and Canada, and then once they come back, how long do you think before that’s reflected in their sales with their US and Canadian networks?

Mark Wilson

All but two of them are back right now to my knowledge, and I think while they’ll return from time to time, while they’re establishing the market, several will not return as I’ve spoken to them because it hasn’t resulted in the desire or the impact they had hoped to gain, so it’s a matter of what leadership they gained over there, so they’ll be focusing, and you will see an increase going forward here in North America pretty quickly.

Jeff Yates

I just wanted to add one additional comment to Mark’s comments, and that is when we introduce compensation enhancements or changes in the program such as we did, we would always expect a significant initial response followed by some commensurate reduction in those initial responders, but the evidence that we’re seeing in this quarter and going forward and the evidence is strong that the new customers that are coming into the business has increased at a higher level, and so while that initial response had increased our accounts through the fourth quarter with the drop-off that Fred mentioned in the first quarter, we anticipate that this will carry forward as Mark mentioned, in the long term.

Operator

Your next question comes from the line of Rommel Dionisio – Wedbush Morgan.

Rommel Dionisio – Wedbush Morgan

I just wanted to follow up on Doug’s question with regard to the impact of the opening of the Filipino market on the US business. Why would US and Canada be more impacted than markets of much closer geographic proximity than the Philippines, like Southeast Asia or Australia or something? Did you not see a drop-off in those markets as opposed one in the US and Canada?

Mark Wilson

That’s a great question. The reality is when you look at the leaders that have jumped into the Philippines market, the majority were from the US. We had a few from Canada, and a few from some of our other markets, but the majority was of focus from the US associates, especially because of the relationship of the Filipino customers and associates that we currently have in the US, so I think they saw this as an appealing market. It was English-speaking, it was an easy entry, as opposed to trying to go to Taiwan or Hong Kong where I don’t speak the language.

Rommel Dionisio – Wedbush Morgan

But you didn’t see any drop off in Australia or any of that?

Mark Wilson

No, we really didn’t have a large group of leadership from those markets that went to the Philippines to my knowledge. I was over there. I hardly saw anybody other than English leaders. We had a few, one or two, from maybe one of our Asian markets and what not, but the vast majority, in biggest teams were all from US organizations.

Operator

Your next question comes from the line of Timothy S. Ramey - D.A. Davidson.

Timothy S. Ramey - D.A. Davidson

Fred, as we think back over the course of the last two years, we’ve seen a pretty significant erosion in margins, not coming at the gross margin level, but coming at the associate incentive expense and also at the G&A level. I’m concerned about it. I know you’re thinking you’re getting bang for your buck, but just compared to 2007 margins, the 2009 forecast now is almost down 600 basis points in operating margin. When are we going to know if we’re getting bang for our buck on some of these investments?

Fred Cooper

Speaking directly to the reference that you’re making on our margins, actually we have a concerted effort this year to raise our prices on the kits that are initially offered to our associated when they get into the business. Some of these kits, relatively speaking, would represent a significant portion of money for us, so I think you’re going to see some increase due to the raises in those prices. Also in some of our international markets, we’ve gone through and looked at pricing adjustments as well.

Timothy S. Ramey - D.A. Davidson

So we’re going to see it at the gross margin level, but the admin expense and the selling expense line, should we continue to think that those as permanently impaired by maybe 200 to 300 basis points?

Fred Cooper

My answer to that is USANA’s management actually has had several meetings in an executive retreat we had to be a lot more conscientious on our budgets and our expenditures that we’re going to be doing throughout the year, but as long as the dollar exchange rate/currency situation that we do, yes, that’s going to have an impact on that line.

Operator

Your next question comes from the line of Dietrich Bass - Canaccord Adams.

Dietrich Bass - Canaccord Adams

I just want to talk a little more on the distributor levels in the US and the current momentum. I just want to sure I understand that the recruiting that you saw over the last few quarters driven by the change in the comp plan, are you saying that was short term?

Mark Wilson

No, not at all. What we said was because we introduced a very short window of opportunity for those who had not qualified as a platinum pacesetter in the program where they have to go out and find four new people, we saw a bump per se in that initial burst there, but we believe this will gain ground as time goes on. As people start to understand the power of the matching bonus program as well as the elite bonus for the competition at the top end, this will result in and our anticipation is that it will result in continued growth for enrolments, so we see this as a long-term thing.

Dietrich Bass - Canaccord Adams

In Mexico, I realize it’s only been a few days with this swine flu that we’re hearing about, but do you have an estimate of your exposure to Mexico City, and have you factored any of this into your guidance?

Fred Cooper

Let me speak out, and I don’t know if anybody else has any comments on this. Mexico, I don’t see any impact so far. I’ve been in contact with them. We certainly have an office in Mexico City, but to date there’s been no impact there, and no one has had any results or scares or anything to that effect to this point.

Dietrich Bass - Canaccord Adams

Final question for Jeff, you talked about lower freight costs in the quarter. I was just wondering if you can give an update on some of the other commodity costs?

Jeff Yates

Overall, our raw material costs are staying fairly flat. We’re not seeing significant costs in the materials, and so the majority of the savings in the shipping costs have been through just the surcharges and freight costs, otherwise we’re staying pretty flat. Other benefit, as we mentioned before, are from improvements in our operating efficiencies, particularly in our shipping lines.

Fred Cooper

To further on that, we spent a significant amount of money in pick-to-light systems on our shipping lines to make us much more efficient on our labor per package shipped, so our throughput rate on that line is also going to continue to improve because we’ve also built in a lot of capacity to be able to pick faster with the same amount of labor that we have.

Operator

It appears we have no further questions at this time. I will turn it back to management for any closing remarks.

Fred Cooper

Thank you everybody for the questions. If you have any remaining questions, please feel free to contact Patrick Richards in Investor Relations at 801-954-7961. Thank you for your time.

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Source: USANA Health Sciences, Inc. Q1 2009 Earnings Call Transcript
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