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USANA Health Sciences (NYSE:USNA)

Q1 2014 Earnings Call

April 30, 2014 11:00 am ET

Executives

Patrique Richards

David A. Wentz - Chief Executive Officer

Paul A. Jones - Chief Financial Officer and Principal Accounting Officer

Analysts

Scott Van Winkle - Canaccord Genuity, Research Division

Rommel T. Dionisio - Wedbush Securities Inc., Research Division

Frank A. Camma - Sidoti & Company, LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to USANA Health Sciences' First Quarter 2014 Earnings Conference Call on the 30th of April 2014. [Operator Instructions] I will now hand the conference over to Patrique Richards. Please go ahead, sir.

Patrique Richards

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 results projected in such forward-looking statements. Examples of these statements include those regarding our strategies and outlook for 2014. We caution you that these statements should be considered in conjunction with disclosures, including specific risk factors and financial data contained in our most recent filings with the SEC.

I'm joined this morning by Dave Wentz, our Chief Executive Officers; and Paul Jones, our Chief Financial Officer. Dave will begin with a review of our operational progress during the first quarter and our strategies for 2014. Paul will then follow with a more detailed look at our first quarter financial results and outlook for 2014.

I'll now turn the call over to Dave.

David A. Wentz

Thanks, Pat, and good morning, everyone. First quarter was another solid quarter for USANA and we've made progress in several key areas. As we indicated in our release yesterday, net sales for the quarter increased 7.9% year-over-year to $182.4 million. This increase was driven by overall customer growth of more than 16%.

During the quarter, we saw Associate and Preferred Customer growth in every region and nearly every market. This type of growth has always been a key focus for USANA, and it has been encouraging to see this metric accelerate as a result of the improvements we've made to our business in 2013. These improvements have not only had a positive impact on our customer accounts but also on other key areas of our business that we have discussed with you over the last few quarters. These areas include worldwide unit volume, Auto Order sales, the number of check earners and rank advancements.

During the first quarter, worldwide unit volume increased 15% year-over-year. Our Auto Order increased to 45% of unit sales compared to 30% a year ago. The number of Associates who received a commission check from USANA in the first quarter increased 51% year-over-year and includes many who received their first check with USANA. Finally, we continue to see an increase in the Associate rank advancements. These metrics show how are our business has accelerated operationally as a result of the changes we've made in 2013.

As we anticipated, however, our financial results are trailing our operational results right now as a result of these enhancements to our business. In particular, our first quarter sales were impacted by the price discounts that we introduced at our August convention last year. An unfavorable shift in currency exchange rates year-over-year also reduced sales by $5 million. Finally, in addition to the seasonal pressure we experienced as a result of Chinese New Year, the challenging media and regulatory environment that emerged in China during the quarter impacted our sales and customer growth there, which I will discuss in a moment.

But first, turning to bottom line. Net earnings for the quarter decreased 7% on year-over-year basis. This decrease is attributable to pressure on our operating margin from lower gross margins and higher Associate incentives expense due to the price discounts and compensation plan enhancements we made last year. We anticipated this pressure and realized that it will impact our year-over-year comparisons for much of the year.

As previously noted, our top and bottom line results this quarter were impacted by the media and regulatory focus on companies in our industry in China. This impact was evident in several ways. First, because of the media and regulatory environment in our industry, we saw our Associates in the market begin to adopt a wait-and-see mentality for a portion of the quarter. Consequently, the number of sales meetings held in China during the quarter was greatly reduced. Beginning in April, our number of sales meetings began to return to normal levels.

Next, we experienced a softer direct selling market in China during the first quarter. The biggest impact followed Chinese New Year as our sales did not rebound to their normal run rate. We believe that much of this market softness is due to the increased media and regulatory focus in China on direct sales organizations. Additionally, due to the success of our China national sales conference last November, which had record attendance, many of our China Associates unexpectedly chose not to attend our 2014 Asia Pacific Convention in Hong Kong. This led to a reduction in the seasonal boost that is typically linked to our Asia Pacific Convention.

We believe that the challenging environment in China will continually impact our results for the few quarters. As a best practice, we continue to require that all sales meetings be registered with the local government and continue to provide extensive training to our field management staff and sales leaders regarding our policies and procedures in China. We remain confident in our long-term growth opportunity in China, and we'll continue to invest considerable time and resources in that country.

In this regard, we will continue to improve our systems and infrastructure in China to make it easier and more enjoyable for customers to do business with us there. This includes renovating our branch locations in China to make it more modern and customer-friendly. It also includes moving forward with construction of our new $40 million state-of-the-art manufacturing and production facility in Beijing. We are on target for this facility to become operational during the latter half of 2015 after breaking ground this quarter.

Our growth strategy for 2014 remains the same. We will continue to capitalize on the initiatives implemented last summer in order to continue increasing and improving our customer base. Again these initiatives were designed for the long-term growth and sustainability of our business and it will take several years for us to realize the full return on this investment. We will also continue to execute our personalization initiatives by enhancing our information technology systems, website, shopping cart, sales tools and other customer resources, all in an effort to enhance our customers' experience with us.

Before turning the call over to Paul, I would like to emphasize our team's confidence and the strength of our underlying business in all of our regions. We are well positioned for continued growth in 2014. With that, I will turn the call over to Paul to review our regional and financial results.

Paul A. Jones

Thanks, Dave, and good morning, everyone. I'll start by taking you through our regional results, and we'll then turn to the income statement.

As Dave mentioned, net sales of the fourth quarter increased 7.9% to $182.4 million. This growth was led by our Asia Pacific region, where net sales increased by 13% to $118.6 million for the quarter. Sales growth in all 3 areas contributed to the growth in Asia Pacific. As expected, sales in Hong Kong were down significantly compared to previous year as we continue to focus on growth in Mainland China. Greater China as a whole generated nearly 12.5% sales growth on a year-over-year basis and Associate counts increased 26.4%. On a sequential basis, however, top line results decreased modestly as a result of the Chinese New Year and the challenging environment in China.

The 14.6% sales increase in our Southeast Asia Pacific region was driven by sales and customer growth in Singapore and the Philippines. Notably, sales in this region were negatively impacted by changes in currency, which reduced net sales by $3.6 million. We are particularly pleased with our results from the Philippines, where the operating environment had been challenging over the past year. We are also encouraged by our results in Australia and New Zealand, where we have achieved double-digit local currency sales growth, notwithstanding 2 price decreases. We believe that both the pricing initiatives we announced in early 2013 and the initiatives launched at our International Convention have contributed to customer growth in the Southeast Asia region, where Active Associates increased 14.3%. In our North Asia region, South Korea led the way having another solid quarter with 14.3% sales growth and a 16.7% increase in active customers.

Turning now to the Americas and Europe. Sales for the first quarter were essentially flat due to lower sales in the U.S. and the negative impact from changes in currency of $1.9 million. Net sales in the United States decreased $2.6 million or 6.5%, primarily due to pressure from price discounts, particularly as this market has one of the highest usage rates of our Auto Order program. The U.S. was one of the few markets where we did not experience an increase in unit volume to overcome the impact of price discounts. This decline in the United States, however, was mostly offset by net sales growth in other markets within the region.

Sales in Canada and Mexico continued to improve, increasing 5.4% and 14.5%, respectively. Like Australia, New Zealand, local currency sales in Canada were particularly strong and increased over 15% year-over-year, notwithstanding 2 price decreases. Active Associates also increased by 13.6% in Canada and 16.7% in Mexico. Although on a much smaller scale, Europe showed a nice improvement of 14.5% in net sales.

Let's now turn to the income statement. Gross margins declined 60 basis points year-over-year due mostly to the negative impact of changes in foreign currency exchange rates and the strategic price decreases we introduced at our 2013 International Convention. This decline was particularly offset by production efficiencies and favorable changes in product and sales market mix. Associate incentive expense for the quarter increased 190 basis points year-over-year to 43.2% of net sales compared to 41.3% in the prior year quarter. This increase can be attributed to the compensation plan and price changes introduced at our annual convention in 2013.

SG&A in the first quarter was 24.4% of net sales, a decrease of 70 basis points from the first quarter of 2013. This relative decrease is due to leverage gains from higher net sales. On an absolute basis, SG&A increased as a result of the cost associated with supporting a higher sales base and spending associated with our newest market of Colombia. Our effective tax rate for the fourth quarter of 34.5% was 150 basis points higher than the first quarter of 2013 due in great part to a lower U.S. manufacturing deduction benefit due to an increase in China sales, where products are manufactured locally.

Earnings per share for the quarter decreased 10.2% to $1.15 per diluted share. This decrease can be attributed to lower net earnings and a higher weighted average diluted share count. There were no share repurchase during the quarter. As noted in our earlier -- in our release yesterday, the Board of Directors has authorized up to of $200 million in funding for share repurchases by the company of its outstanding common stock. This authorization is inclusive of the approximate $13.6 million that was remaining under the prior authorization as of the end of the first quarter of 2014.

Turning to the balance sheet. We ended the quarter with $142.7 million in cash and $146.4 million in net working capital. Before addressing our guidance, I'd like to remind you that we are still expecting our total CapEx, which includes our new facility and branch upgrades in China, to be a little north of $40 million for the full year of 2014.

Now let's discuss our updated guidance. As Dave mentioned, we anticipate that the challenging environment in China will impact our results for the next couple of quarters. Consequently, we now expect that net sales will be in the range of $770 million to $790 million for the year compared to our previous guidance of $790 million to $810 million. Diluted earnings per share for the year is expected to be in the range of $5.50 and $5.65 compared to our previous guidance of $5.80 and $5.95. For the full year of 2014, we estimate earnings from operations in the range of 14.5% to 15% of net sales.

We continue to expect our growth to accelerate as the year progresses. I am confident in the financial strength of USANA's business and believe that we are well positioned to deliver another year of just solid results. With that, I will now ask the operator to facilitate the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Scott Van Winkle from Canaccord Genuity.

Scott Van Winkle - Canaccord Genuity, Research Division

So a few questions. I think at the beginning, Dave, did you give a unit growth number? I'm wondering if you have a unit volume growth number to kind of compare to the revenue in dollars, so we can see the impact of pricing, like company-wide.

David A. Wentz

We're looking at about 15%.

Scott Van Winkle - Canaccord Genuity, Research Division

Okay. So you're up 15% in units going out the door, only impacted by the sales, the dollar impact on the pricing. Okay. And then Paul, the guidance, does that include any buyback? I don't know if you said that at the end.

Paul A. Jones

That does not include any buyback. That's modeled without buyback.

Scott Van Winkle - Canaccord Genuity, Research Division

Okay, great. And then on China, a few questions. I think Paul said Hong Kong was down significantly again. Obviously, you posted growth in the broader Greater China. So Mainland had to be up triple-digits again. Is that right? Or can you give a number?

Paul A. Jones

Yes. We were up -- let me get that real quick. But Mainland was up in the triple-digits year-over-year, significant and we anticipate that again it will be another strong year, even with the headwinds we're experiencing.

Scott Van Winkle - Canaccord Genuity, Research Division

Was the growth consistent? I think, last quarter, you were -- I think it was over 200% you were talking last quarter. Is it kind of in the same range?

Paul A. Jones

Same range, yes.

Scott Van Winkle - Canaccord Genuity, Research Division

Okay. And then the publicity. Herbalife reported a couple of days ago, had very strong growth in Mainland China. It didn't really call out any impact from the publicity. Was there anything specific to BabyCare or USANA? Or was this all because of that paper's exposé on Nu Skin?

David A. Wentz

No. There was nothing specific to USANA. I think we're all just being conservative to -- we wanted to see what happens to Nu Skin, and we're very relieved to see the way things went there and made us more optimistic and excited about the future there.

Scott Van Winkle - Canaccord Genuity, Research Division

Yes. I mean, you're talking about your meetings kind of returning to normal in April. That kind of flips with Nu Skin kind of restarting its meetings at the end of April. Did you just pull back a little bit on the meetings? Or was it more distributor-led, saying that they'll pull back on meetings?

David A. Wentz

It was a combination of both, where we all just kind of eased off and we wanted to -- and we, of course, invested even more time and effort in training and making sure that everyone understood all the policies. So it was a great time. It was a great opportunity for us to go back to all those leaders and train them a second or a third or a fourth time because of the attention made them even more attentive and even great attendance at training meetings. And it was a fantastic opportunity to make sure that everyone understands the policies and they're doing things correctly. And so I think that, that took some time and effort, of course, spending all that time making sure we did extra training and that can take away from sales meeting time. So I think it was a good opportunity. It was a good chance for us to remind and emphasize. And I think it was normal for most companies across the board that there were a few less sales meetings and a few more training meetings to make sure that we are doing things correctly.

Scott Van Winkle - Canaccord Genuity, Research Division

Got you. And then why -- can you expand on the comment about distributors not going to the Asia Pac Convention in Hong Kong? Was there any particular reason behind that?

David A. Wentz

I mean, we just had in Nanjing, I believe that's where I was last, can't keep track, close to 8,000 people. Fantastic event that when I was there, it felt like a convention, it didn't feel like a national meeting. And I'm sure the meetings in China are going to be larger and larger. And so they are basically conventions. And why travel to a convention outside of your country when you can go to a convention in your country?

Scott Van Winkle - Canaccord Genuity, Research Division

Got you. And then last one on China, one of the call-outs in that article about Nu Skin that started all this was the sale of products that haven't been improved in Mainland China. Have you made any changes in that regard? I know you put that policy in last year. You can't buy a product from another market if it's available in your existing market, I believe, is how it's put out. But have you made any number [ph] of changes about buying products outside of the market for personal consumption?

David A. Wentz

As you mention, yes, we put those policies in and had a great impact. And we continue to monitor and police it as long as we can so that we hopefully don't have to make more changes. But we'll continue to make changes as necessary until that we're positive that there are no concerns there.

Scott Van Winkle - Canaccord Genuity, Research Division

Got you. And then Paul, the -- if -- the China compensation plan, so when you pay commission on a sale, that's going into your commission line, your volume incentive line. And when you pay a salary, is that going into SG&A? Is that why the SG&A didn't show the same type of leverage this quarter that it did in Q4? Was it the bigger mix of China?

Paul A. Jones

No, really the SG&A -- we have, as we talked about, the AP convention. We didn't cover some of the costs that are associated with that because of the last-minute decline in the number of people that came there. That was part of it. And we also had some ongoing initiatives for worldwide business, build into that SG&A that we continue to move forward with, even though the sales were slightly softer than we anticipated. So that's what's creating the deleveraging.

Scott Van Winkle - Canaccord Genuity, Research Division

Got you. And is that what assumed going forward? I mean, is this -- I mean, what should we think about -- obviously, your volume incentives are going to say a little elevated. They actually weren't as high as I thought they were going to be this quarter. Is SG&A going to stay kind of elevated on a year-over-year basis, maybe up as a percentage of sales?

Paul A. Jones

Yes, slightly. And that really is a function of the top line. The Associate incentives, we still anticipate to be around the 43 -- 43.3 percentile right in there. And then the SG&A will be a little bit higher as a function, really, more of the top line being a little bit lower.

Scott Van Winkle - Canaccord Genuity, Research Division

Okay. And then last question, I apologize if I you answer this in your prepared remarks. I didn't catch it. When you talked about the U.S. market being the market where you didn't see growth in units and volume to offset pricing, anything specific behind why the U.S. didn't kind of follow track with the rest of the markets?

Paul A. Jones

Well, there are a couple of issues. And one of them is that the U.S. really started this initiative, had the highest percentage of Auto Orders already in place. And so the impact of the movement on that wasn't as great here. And so there's some work there. And then the other issue would really be in the issue of just getting some excitement built in again into the U.S. And I think we have, as we've talked about, some of the initiatives that are built into our SG&A will help us to create and generate some excitement and some user-friendliness of USANA. So we believe that we have some good things coming there.

Operator

The next question comes from Rommel Dionisio from Wedbush Securities.

Rommel T. Dionisio - Wedbush Securities Inc., Research Division

On the upcoming manufacturing center in Beijing, I wonder if you could just give us a little more granularity or detail on that. Will it still have the functionality that the U.S. production has with regards to MyHealthPak and its ability to sort and package those products?

David A. Wentz

The facility in Beijing will be similar to, if not better than, Salt Lake. But the MyHealthPak is not a product that we will have in China. The MyHealthPak would be too challenging with regulatory. With all the multiple combinations of ingredients, you'd have to register every single pill combination with their current rules and regulation. So of course, with the 3- to 5-year wait time for every product, that would be impossible and economically not make sense. So everything but the MyHealthPak, it would be new equipment, newer equipment than we have in Salt Lake, the same protocols and procedures we follow, but MyHealthPak, as you specifically mentioned, will not be a part of it.

Operator

The next question comes from Frank Camma from Sidoti.

Frank A. Camma - Sidoti & Company, LLC

Just a couple of quick questions. Not to beat up on China, but the growth was still obviously pretty strong in China despite the difficulties you called out. And you're basically back online in April. So can you just -- why are you kind of focused on that as a negative? I mean, it seems like you're essentially back in the market.

Paul A. Jones

Yes. We hope to see that continuing and we believe that we'll see that uptrend. But there's still -- anytime you have that kind of noise in the industry, it does create some headwind for the Associates and the sales team, and so we would anticipate that a little bit. I believe we'll overcome it quickly and be able to get back on target. Our growth rate has slowed down a little bit as a run rate. But, again, we anticipate that will pick back up. The other point on that is that's a fairly large -- as you see from the results, that's 38% of our sales, that Greater China area, and so making sure we're conservative and yet as realistic as possible, we wanted to make sure we're representing that.

Frank A. Camma - Sidoti & Company, LLC

Okay. And can you just go on to a little more detail on the -- I think you called out a couple of things, but I may have missed some. The decrease in the gross margins, is that -- should we kind of think of that as something that's going to affect the next a couple of quarters as well? I mean, you haven't seen -- you historically have been doing a little bit better than that over the last several quarters, 1.5 years or so. Just can you give us a little more detail on that?

David A. Wentz

Yes. That should continue on through the year. We do our price increases every January for all our products around the world. And that's when we'll see larger movements in gross margins. Of course, if we find some efficiencies, we'll be applying those. When we get the manufacturing facility in Beijing up and running, we believe that our efficiency and productivity will go up meaningfully. The facility that we're in currently in 4 or 5 floors and the amount of movement of products and things really reduced our efficiency that we'll be able to have in this large region, as we talk about, much more efficiency as we're manufacturing our products. So looking forward to that, but that's, of course, latter 2015.

Paul A. Jones

Yes. There's also, in addition to that, the currency impact year-over-year affected those numbers and also the price discounts that were put into place have an impact and will continue to have an impact going forward to probably about the same amount that we're looking at.

Frank A. Camma - Sidoti & Company, LLC

Okay. So it wasn't that like the input cost had increased, it was really other factors in that, that...

Paul A. Jones

Lowering the prices compressed it.

David A. Wentz

Correct.

Operator

There appear to be no further questions. Please continue.

Patrique Richards

Well, thank you for your questions and for your participation on today's conference call. If you have any remaining questions, please feel free to contact Investor Relations at (801) 954-7961.

Operator

Thank you. This concludes USANA Health Sciences' First Quarter 2014 Earnings Conference Call. Thank you for participating. You may now disconnect.

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