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Executives

Riley Timer – VP of Finance

Jeff Yates – CFO

Fred Cooper – President and COO

Analysts

Diederik Basch – Canaccord Adams

Madeline Miller -- D.A. Davidson & Company

Per Osland (ph) – Jefferies & Company

USANA Health Sciences, Inc. (USNA) Q1 2010 Earnings Call April 28, 2010 12:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the USANA Health Sciences first quarter earnings conference on the 28th of April 2010. Throughout today's recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator Instructions).

I will now hand the conference over to your host, Mr. Riley Timer, Vice President of Finance, please go ahead sir.

Riley Timer

Thank you, Danny. Good morning, everyone. We appreciate you joining us this morning to review our strong 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 am joined this morning by Dr. Fred Cooper, our President and Chief Operating Officer; Jeff Yates, our Chief Financial Officer; and Mark Wilson, our Executive Vice President of Sales.

We will hear first from Jeff, who will discuss the details of the financial results and speak specifically to our updated guidance. And then we will hear from Fred, who will provide regional results and discuss upcoming announcements that will impact our business in the future.

I will now turn the call over to Jeff.

Jeff Yates

Thank you, Riley, and good morning, everyone. I am delighted to be here with Fred and Mark to talk about our strong first quarter results and provide additional details about our plans and strategy for the balance of 2010. I will begin by reviewing the details of the income statement, then the balance sheet, followed by our guidance for 2010. Once again, it feels great to record that net sales for the quarter reached a new record at $119.1 million, which represents a 22.4% increase when compared with the $97.3 million we reported for the first quarter of 2009.

Please note that the first quarter will likely be our most favorable comparable when looking at year-over-year results in 2010 as the first quarter of 2009 experienced the most dramatic impact from negative changes in currency exchange rates.

Changes in FX rates during this quarter had a positive impact on our net sales by $8.6 million when comparing our results to the same period last year. That said when looking at net sales on our constant currency basis, we increased $13.2 million or 13.6% compared with Q1 last year. Our sales growth this quarter was primarily due to an overall increase in the number of active associates. This number increased by 10.9% when compared to the first quarter of 2009, which is the result of continued growth in our Asia-Pacific region.

Also contributing to our sales growth this quarter was the benefit we experienced from price increases that were implemented in certain markets during 2009. We also saw an uptick in the average amount purchased per associate during Q1 which was particularly evident in North America. We are optimistic about this increase and as we believe it is a sign of improving consumer confidence in this region.

Sales in North America increased by 8.3% or $4.6 million to $60.5 million as compared to the same period in the prior year, despite a decline in the number of active associates. Changes in foreign currency positively impacted sales in this region by $3.5 million. Excluding the impact of currency, sales in North America increased by 2% or $1.1 million.

Typically there was a strong correlation between sales and associate counts. In the first quarter, however, net sales increased while associate counts declined. A portion of this disconnect can be explained by year-over-year changes in FX rates and the remainder is due to an increase in sales per associate which only serves to augment momentum as we return to growth in active associates in this region.

During the first quarter, net sales in our Asia-Pacific region increased by $17.2 million or 41.5% when compared to the first quarter of 2009. Net sales in this region totalled $58.6 million during the quarter, representing just under 50% of our total sales. This sales growth is primarily due to a 26.4% increase in the number of active associates in the region. Our largest market in the region, Hong Kong increased by nearly 85% over last year. Notably South Korea sales more than doubled increasing a 105.4% and active associates increased 66.7% year-over-year. Although it accounts for a lower percentage of our total sales, we are pleased to see such strong momentum in this market.

As you know, our international business model allows our leaders to build and expand their businesses in all of our markets regardless of where their home market is located. As we have commented before, this has accelerated our growth in Asia-Pacific, while hindering our progress in North America. Another factor affecting Asia-Pacific is the anticipation of a new market. We typically open a new market every two to three years and our focus has been on the direct selling opportunity markets available in this region, evidenced by our opening of the Philippines just a year-ago.

Additionally, the growth in our Asian associate base continues to climb. We have leaders from markets elsewhere spending time in Asia to take advantage of our global compensation plan. This has been one of the factors fueling greater growth in Asia.

Now let's discuss the other major components of the income statement. Gross profit margin for the first quarter increased as a percentage of net sales to 80.7% compared with 79.6% for the first quarter of '09. This increase is primarily due to leverage gained on higher sales and lower relative freight costs. In addition, the price increases I just mentioned also benefited our gross margins in Q1.

Associate incentives for the quarter were 45.4% of sales compared with 43.1% for the first quarter of last year. This increase was due to higher utilization of our matching bonus program as well as changes in currency exchange rates. In retrospect, we are very happy with the results from the implementation of this bonus program. Although, this expense increased on a year-over-year basis, it is important to note that it has trended downward over the last two quarters and is 30 basis points lower than Q4.

Additionally, as noted in our press release, during the second quarter, we will begin to implement certain strategic changes to further manage this expense and these changes will include adjustments to reduce our exposure to currency fluctuations, as well as certain policy changes. We believe these changes will not only enable us to improve this expense as a percentage of sales, but will also help us to strategically drive the long-term success of our business.

To reiterate our objective, to improve operating margins, our target for 2010 is to end the year on a run rate for incentives under 44%. We will come back to a more detailed discussion of these changes in a moment.

Now regarding selling, general and administrative expenses, we saw this expense decrease to 23.1% of sales for the quarter. This is down from 26% in the first quarter of last year and is primarily due to leverage gained from our 22.4% increase in net sales. During the second quarter, we anticipate an increase to SG&A expense due to costs associated with our upcoming Asia-Pacific convention. We expect that the cost of this event will add approximately $1.5 million to SG&A. The cost of this convention will not be comparable to last year, since we did not hold a convention in this region during 2009.

Due to significant growth in this region, however, we expect that going forward the Asia-Pacific convention will be an annual event to support our associates and the rapid growth of their businesses in this region.

As a result of higher sales and improved operating margins, net earnings for the quarter were $9.6 million or $0.62 per share compared with $6.6 million or $0.43 per share in the first quarter of the prior year.

Now regarding our balance sheet, indicated in our previous call that we planned to use our free cash to further strengthen our balance sheet and to position ourselves for further investment in growth opportunities.

I am pleased with the progress that we have made in this regard during the quarter. Our cash balance at the end of the first quarter was $21.5 million compared to $13.7 million at the end of 2009. And during the quarter we paid off the remaining $7 million balance of our line of credit.

We used very little cash during the first quarter on capital expenditures which totaled about $0.5 million. And for the full year of 2010, we expect CapEx to be between $4 million and $6 million.

Finally, I would like to comment on our guidance for the year. As noted in our release yesterday, we are modestly increasing our financial guidance for 2010. We now project consolidated net sales to be between $470 million and $480 million and earnings per share to be between $2.50 and $2.60.

As I just discussed, we believe that now is an opportune time to make strategic changes to further manage our associate incentive expense which changes may in the short term slow our growth or reduce our top line results in certain markets.

We are however committed to improving this expense and our other operating expenses as a percentage of net sales and believe these changes will not only enable us to achieve this objective, but it will also help us to strategically drive the long-term success of our business.

With that, I will now turn the call over to Fred.

Fred Cooper

Thanks Jeff, good morning, everybody. Once again I am always excited to be on a call when there is another good quarter for USANA. It’s encouraging to see our sales in the first quarter exceed our expectations. This is especially significance in considering that our ethnic Chinese associates in most of our markets are the fastest growing demographic within USANA. And Chinese New Year occurred during our first quarter.

During the quarter, the slowdown in sales and associate productivity that we typically experience from the Chinese New Year was not as significant as it had been in the past years. We believe that one of the key reasons for this is that during the quarter, we offered several different product and business related promotions to entice our associates to keep working during a period of time when they usually stop working. We believe the results from this strategy allowed us to achieve a record quarter for sales.

We continue to see growth in the number of associate leaders, which is also encouraging. The number of people advancing in both rank and title continues to grow as well as the number of associates who are earning a weekly commission check.

Our operating results clearly show that the Asia-Pacific region continues to drive our overall growth. One of the benefits of our matching bonus program is that it provides yet another way for someone to earn income with USANA. In fact, this is one of the key drivers of our success in the Asia-Pacific region.

So to sustain and drive the momentum in the region, in May, as Jeff told you, we are going to host our Asia-Pacific Convention in Hong Kong. Right now, we expect that this event will be even larger than our international convention that we hold annually in Salt Lake City and should be our largest associate event ever held. These events are very important to our business as they provide the perfect settings for recognition, training and developing our core business leaders.

At this event, we are going to launch several new products. Some of which will be exclusive to this region. We are optimistic that these new products will generate significant excitement and provide yet another talking point of the benefits of USANA for our associates. Those of you who have had a chance to attend our conventions that there is always a lot of excitement and buildup over the unveiling of new products and programs. So for this reason, I am not going to share any more details about these upcoming products and announcements.

Now, I want to take few minutes and address our strategies for North America. As you know, returning to North America back to a growth region is very important to us. On our February conference call, I talked about some of the tactics for return the US and Canada back to growth. While modest, we are encouraged by the growth in the US this quarter. We remain optimistic that our strategies to grow the market will begin to gain traction throughout 2010.

I want to give you an update of where we stand and what we are currently pursuing to boost these results. Last quarter, we announced the appointment of a new Vice President of US Field Development and a new General Manager in Canada. Their primary focus is to drive sales and enrollments in these markets. These individuals work closely with our current leaders, but additionally attract other ethnic and generation X individuals throughout North America. These are demographic populations where USANA currently could find substantial growth.

Also important to our strategy is an interactive management team who actively travel and attend associate sponsored meetings. This is an especially important for our associates who are aggressively growing and advancing up the ranks. When an associate knows that they have the support of senior management to help facilitate a large meeting or conduct business training, it adds to their level of success and belief which in turn leads to our sales growth.

One piece of constant feedback that we are hearing from the field relates to the need for new and exciting training tools and materials. To fulfill this need, last September, we introduced a new online training system that we call eApprentice. This training system is for new associates and was designed to make training and network marketing, both simple to use and easy to understand.

In launching this new tool, we were optimistic that would assist new associates in their business building efforts and make them more efficient, productive and knowledgeable about USANA and how to build the home-based business.

So our last couple of quarters, we have been closely tracking the results generated with this tool to help us understand its effectiveness. Here are some very powerful statistics that we found for the people that are our eApprentice.

Individuals who use the system earns four times more income on average, they earn 49 times more matching bonus, they are enrolling 97% more associates, they are enrolling a 118% more preferred customers, are three times more likely to attain pacesetter status and twice as likely to achieve platinum pacesetter status. You can tell these are very powerful numbers and are great early indicators of how successful a new associate can be if they get the proper training early on with USANA.

Currently utilization rate for eApprentice is fairly low. But given the early indictors for success for this program, we are looking for creative ways to further promote our eApprentice for greater field adoption. Should this adoption improve? USANA intends to translate the program worldwide.

Creating sales aides such as teaching, training, and presentation materials that could be understood and utilized by any individual regardless of skill level is a key driver for USANA’s growth as well. As such, we are developing several other key aides to assist our associates. While the unveiling for these are a reserve for convention, we will discuss new material and preliminary results of their impact during subsequent conference calls.

We are also in the finishing stages of evaluating our associate rewards and recognition programs. We have analyzed statistically what measurable behavior and performance metrics best indicate success in business growth for USANA’s associates where we will be changing incentives, recognition and promotional programs to more closely matched those characteristics that are found to be correlated with business growth. We plan to announce our new incentive program at our international convention at the end of August.

Additionally, we are going to test a couple of new programs including a strategy to allow for more autonomy for our leaders to run their own incentives and promotions, by targeting our rewards and recognition at our key business leaders, we believe we will better align our payout with sales performance.

Now this said, as Jeff mentioned, I want to address our associate incentive expense line on our income statement. During the second quarter, we will begin to implement changes which we believe will solve some of the inefficiencies in our compensation plan that are causing our associate incentive expense line to be higher than anticipated. These changes will include adjustments to reduce our exposure to currency fluctuations and certain international policy changes.

For example, I believe the changes to our international policies will entice many of our top leaders to build their business in their home market which is positive for our business. Additionally, the pending modifications will help us reduce our exposure to FX changes by lowering the premiums on exchange rates used to pay our commissions. This is simply a tightening of the rules to reduce paying such high premiums on FX rates which in our business model was never designed to do.

We have carefully considered the impact of these adjustments and we have provided our updated guidance for 2010 in subsequent quarters relative to the impact associated with these modifications. That’s important to note that these changes will still USANA as one of the industry’s highest paying compensation plans to our associates. This strategic position is very important to us and for us associates who are richly compensated, because we want to make sure that provide a competitive advantage to our associates for our benefit.

With that, I will now ask the operator to facilitate the question-and-answer session

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Thank you. And the first question comes from Diederik Basch. Please go ahead with your question.

Diederik Basch

Couple of questions, first on East Asia. I know that market had been very strong for the past few quarters, but especially this quarter it was 60% growth in distributors. And I am wondering if you could maybe expand on that, what seems to be driving that market particularly in this quarter and I have a follow-up after that.

Fred Cooper

The primary growth in that is Hong Kong and frankly they love our compensation plan. The new matching bonus has been quite an enticement for them and this business is about momentum. So when they start generating success in their business organization, they tell others and they are more enthusiastic to tell other and voila.

Diederik Basch

All right. You have mentioned matching bonus in the past. I mean is there also any products were mentioned there, are you seeing perhaps a particular product selling well versus the U.S. and then the follow-up to that would be if I look at the guidance, it kind of assumes maybe the sequential decline in East Asia. And I am wondering if that has to do with some of the incentive changes?

Fred Cooper

So the answer to that is no, our core products worldwide tend to be our core products consistently. There hasn’t been the introduction of a new product that is accounting for a large explosion in the growth. That's not to say we are not excited about our Asia Pacific conference in which we are going to announce some new products. We hope to add that to the enticement. But it really is being driven by the enthusiasm they are feeling for the success of their business.

And the second question was, the guidance, yes, the guidance is tempered by the fact that we will be introducing some international policy changes that frankly we are not sure how it will be received by the field initially. Whether the new is good news, bad news or neutral, it takes our associates sometime to understand it, see how it impacts them and then from there they continue on with building the growth. We don’t believe it’s going to have a significant impact but on the other hand, that ambiguity has caused us to give a guidance where we set it.

Diederik Basch

Okay, that’s helpful. And last question for Jeff. The gross margin in the quarter, 80.7%. If I look at my model, that's the highest gross margin you have reported in 10 years. I am kind of just wondering if there was any currency benefit there. You mentioned you had a price increase, if you could remind me how much that price increase was and do you think you had an inflection point where you can continue to keep that margin over 80%.

Jeff Yates

To answer the last part of your question first, yes, we believe that – that we are in a strong position to maintain our margins. There is a slight benefit of currency in gross margins but because of our standards that we established and we hold for some period of time that won’t have a significant effect in these results and it’s just not a big component of that per se. The efficiency with which we have been producing and shipping and including the freight benefits, we see those continuing throughout the year. And so, we feel like our margin improvements are a strong play for the rest of the year and are considered in our guidance for earnings.

Diederik Basch

Okay, and how much was the price increase?

Jeff Yates

Oh, I am sorry, I meant to answer that question. It actually varies by market. We had a price change in Mexico, in Japan. It depends on the market but generally speaking, it varies 2%, 4%, sometimes 10% in some places.

Operator

(Operator Instructions) And the next question comes from Madeline Miller from D.A. Davidson & Company. Please go ahead with your question.

Madeline Miller -- D.A. Davidson & Company

Hi, thank you. I just had a question about the compensation plan changes. You have said that this is going to the biggest driver or that it has been the biggest driver of growth in Asia Pacific region. Do you expect that these changes will have any negative effect on the growth in the markets or the retention either short-term or long-term?

Fred Cooper

No.

Madeline Miller -- D.A. Davidson & Company

No?

Fred Cooper

I know that's a simple question. The changes that we are looking at aren’t huge, they are just little fine tuning. So that's why there is not a lot, no.

Madeline Miller -- D.A. Davidson & Company

Okay. And then similar question. You said that the – at the convention you are going to be rolling out some specific products to the region. And although there are a lot of associates who you mentioned they sell from a different into the Asian market, are those associates who are not selling into their own home market going to be able to use those new Asian Pacific specific products?

Fred Cooper

The only way you can – I hope this answers your question. The only way you can purchase a product is that product is available for sale by the associates in that region.

Operator

The next question comes from the Per Osland from Jefferies & Company. Please go ahead with your question.

Per Osland – Jefferies & Company

Kind of following up to (Diederik’s) question before on the outlook, as an order of magnitude, the first quarter beat on the top line was pretty significant versus I think the investment community at large. Was it a similar beat versus your internal expectations or were we just off? I guess the reason I am – the reason I ask is the raise for the year was certainly more modest than the first quarter beat. So I am just trying to get a handle on maybe how much you are raining in that last nine months given the planned tweaks to the comp program.

Jeff Yates

As I interpret your projections out of Q4, our guess is that you were probably a little low even beat in this quarter is still our projections but we were running ahead of where you were. And that said, keep in mind that our forecast for the remainder of the year, given the distance between where we are and where the effect of these enhancements, tweaks and adjustments that Fred just described is still a little bit beyond our horizon. I am going to take a conservative stance on that projection at this point. And so, feeling when we get closer to the end of Q2, we will have a better view on what the impact of that is and so, those are the major factors driving the guidance we have given you today.

Per Osland – Jefferies & Company

Okay, that’s fair. On the incentives, it sounds like it is really more kind of policy, it’s policy and FX exposure. So it’s not – it doesn’t sound like it’s being designed to throttle down a specific market or grew specific markets that might have been underperforming. Is that a fair characterization?

Fred Cooper

Perfectly fair.

Per Osland – Jefferies & Company

Back to the outlook, just real quickly on the top line, Jeff has the FX benefit assumption changed from where you were in February till now?

Jeff Yates

A little bit, we got a nice bump obviously in this quarter but as I mentioned, it will be our most favorable comparative. It difficult to say, (Per) –

Per Osland – Jefferies & Company

I know we are all guessing, right?

Jeff Yates

And I would love to be able to say but we feel like we are going to see a bit of an improvement and anticipate through the (remainder).

Per Osland – Jefferies & Company

One last one, Jeff you referred to Asia Pacific perhaps maybe anticipating the opening of a new market. Has the opening in the Philippines and the strength of that opening done anything to accelerate that timeline and what is that timeline right now?

Jeff Yates

We are pleased with the result in the Philippines, albeit a relatively smaller market, we have evidence that our introduction or launch in that market was as good or better than any direct selling companies who arrived there. We almost reached 7 million this first year which means our expectation and anticipate that that will be a strong market for us, as such going forward. It’s evidenced that that region is important for us as is obviously our growth. We are constantly evaluating our opportunities, particularly the major opportunities and where the environment regulatory and otherwise becomes more favorable for us. We will certainly take advantage of those opportunities and are trying to position ourselves to do so.

Operator

We do not appear to have any further questions. Please continue with any points (inaudible).

Fred Cooper

Everybody thank you for joining the call today and thank you for your questions. If you have any remaining questions, please feel free to contact Patrick Richards in investor relations at 801-954-7961. Thanks.

Operator

Ladies and gentlemen, this concludes today’s USANA Health Sciences first quarter earnings conference. Thank you for your participation and you may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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