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Executives

Dave Wentz – President

Gil Fuller – Executive Vice President and CFO

Riley Timmer - Investor Relations

Analysts

Simeon Gutman - Goldman Sachs

Bill Leach - Neuberger Berman

Tim Ramey - D.A. Davidson

Rommel Dionisio - Wedbush Morgan

Mimi Noel - Sidoti & Company

Steven Martin - Slater Capital Management

David Block - Block Capital

Amy Vinson - Avondale Partners

Craig Leighton - Lord Abbett

USANA Health Sciences, Inc. (USNA) Q3 2007 Earnings Call October 17, 2007 11:00 AM ET

Operator

Welcome to the USANA Health Sciences third quarter earnings conference call.  I would now like to turn the conference over to Riley Timmer. Please go ahead, sir.

Riley Timmer

Thank you, Mary.  Good morning everyone.  We appreciate you joining us this morning to review our third quarter results.  As a reminder, today's conference call is being broadcast live via webcast and can be accessed directly from our website, at www.usanahealthsciences.com.  Shortly following this call, a replay will be available on our website.

Before we begin and 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.  Also, during the course of this call, management will discuss non-GAAP information.  We provide non-GAAP measures to assist investors in understanding our operating performance.

I will now turn the call over to Gil Fuller, Executive Vice President and CFO.

Gil Fuller

Thanks, Riley, and good morning everyone.  I am pleased this morning to be joined by Dave Wentz, our President, who you will hear from shortly.  This morning, I plan to update you on the financial results we achieved in the third quarter, talk about our guidance for the fourth quarter of 2007, and give you our initial forecast for 2008.

Before I go into my prepared remarks on our financial results, I will touch briefly on the recent engagement of our new independent auditor, PricewaterhouseCoopers; and the filing of our amended Form 10-Q for the second quarter.  As most of you are aware, on September 5, we engaged PWC, one of the Big Four accounting firms as our independent auditors.  Immediately following the engagement, PWC began their review of our second quarter financial statements.

We were then pleased to file, on October 10, our amended Form 10-Q, which included the necessary auditor review and reflected no changes to our previously reported net sales, net income, earnings per share, or any balance sheet line item for the second quarter.  We now look forward to moving ahead and focusing the majority of our efforts on growing and expanding our business.

Another item that I would like to clarify is the sale of our third-party contract manufacturing business in August.  I believe it is important to point out that we classified the sale of that business as a discontinued operation as reported in our Form 10-Q for the second quarter; and we have adjusted our historical financial periods accordingly.  As a reminder, our third-party contract manufacturing business generated about $8 million to $10 million in annual revenue, which is no longer included in our historical net sales, but is included as part of discontinued operations.  We do, however, continue to manufacture and produce our Sensé skin and personal care products at our facility in Draper, Utah.

Another recent development was the favorable ruling received just yesterday afternoon from NASDAQ regarding the previously announced deficiency notice we received, when our 10-Q for the second quarter was filed without the required independent review.  The company requested a hearing regarding this deficiency, and the hearing was held on September 20.  The company was advised by letter yesterday that the panel had determined that the company had regained compliance with the continued listing requirements of the NASDAQ stock market.  According to the letter received from the Office of Chief Counsel for NASDAQ in support of this decision, the panel noted that the company's audit committee had undertaken and completed an investigation of the allegations made by distractors and found no merit to those allegations.

In addition, the company's new auditor had undertaken a thorough acceptance process before taking on the company as a new client and was able to complete its review process for the June 30 Form 10-Q more quickly than expected.

Finally, the panel concluded that nothing revealed at the hearing raised additional doubts for the panel about the integrity of management, the company's business or its regulatory compliance process.  Obviously, we are very pleased with this result and that our listing on NASDAQ will continue.

Also by way of note, we have no new specific information concerning the SEC informal inquiry.  However, we are in regular communication with the SEC and we will continue to cooperate fully, if further information is requested.

And now to the results.  Net sales in the third quarter were $106.2 million, an increase of 15.5% compared with $92 million reported in the third quarter of 2006.  Net sales in the third quarter were in line with our guidance of $105 million to $107 million.  The strengthening of foreign currencies added $3 million in the third quarter on a year-over-year comparison.  Excluding this impact from currency fluctuations, sales would have increased by 12.1%.

Net sales growth this quarter was primarily driven by a 24.1% increase in the number of active Associates and a 4% increase in the number of preferred customers, compared with the third quarter of last year.  Our monthly Autoship rate in the third quarter represented 52% of our total product sales.  This number is up 200 basis points from last quarter.

Earnings per share from containing operations were $0.70 in the third quarter and exceeded the high end of our guidance range of $0.65 to $0.67.  This is an increase of 25% compared with $0.56 per share from the continuing operations reported in the third quarter of 2006.

Our effective tax rate in the third quarter was 31.4%, which is significantly lower than the 37% tax rate we were expecting.  This reduced tax rate increased earnings per share by approximately $0.05 in the third quarter.

Let us now go through a number of other items on the earnings statement that had a material impact on our earnings per share during the quarter.  First, there was just over $700,000 of legal, PR and other professional services or direct expenses related to USANA's defending against false allegations that many of you are aware have been made against our company.  The impact of these expenses on earnings per share is at least $0.03.

Next, and as I mentioned above, the lower than anticipated effective tax rate increased earnings per share by $0.05 in the quarter.

And finally, due to capital expenditures related to our facilities expansion on several of our markets and the aggressive share buybacks, we have accumulated some debt.  Accordingly, we reported $270,000 in other expense, primarily due to interest expense, compared with $65,000 in other income reported in the third quarter of 2006.  This $335,000 unfavorable swing reduced EPS by about $0.02.

Let us now go through the major line items on the third quarter statement of earnings.  Our gross margins in the third quarter of 2007 improved as a percentage of net sales to 79.3%, compared with 78% in the third quarter of 2006.  This 130-basis-point improvement can be attributed to the sale of our third-party contract manufacturing business, a reduced impact from success from home magazine sales from one year ago, and improved production and procurement efficiencies, including lower freight costs.

Looking ahead to the fourth quarter, we believe that our consolidated gross profit margin will be approximately the same relative percent of sales as the third quarter of this year.  Associate incentive expense in the third quarter of 2007 was 40.5% of sales compared with 40.2% in the third quarter of last year.  We expect that Associate incentive expense will approximate 40% of sales in the fourth quarter of 2007.

Selling, general and administrative expenses increased relative to net sales to 21.7% during the third quarter of 2007, compared with 19.4% in the third quarter of the prior year.  The year-over-year increase in SG&A was due primarily to the following factors: an increase in spending to support growing sales and an increased customer base, which included the expansion of several of our international offices; wage related increases including a strategic initiative to add bench strength in certain areas of our staffing; increased expenses relating to our athletic sponsorships particularly our agreement with the Women's Tennis Association; and higher relative expenses relating to FAS 123(R).

In addition, and as I mentioned earlier, it is important that I point out to you this morning that during the third quarter, we incurred about $700,000 of legal and other professional services expenses related to false allegations.

We believe that we are making good progress on these matters and are encouraged by what we currently see and how we understand it.  We believe SG&A expense in the fourth quarter of 2007 as a percent of our net sales will be flat compared to the third quarter of 2007.

Now in regards to the balance sheet, cash at the end of the third quarter was $11.7 million, compared with $27 million at year-end 2006.  Inventories at the end of the third quarter were $21 million, compared with $22.5 million at year-end 2006.  Additionally, we ended the third quarter of 2007 with a balance of $34.6 million on our line of credit.

Okay, now to update you on our share buyback program.  During the third quarter, we purchased an additional 180,000 shares in the open market for an investment of $6.6 million.  Year to date, we have purchased approximately 1.9 million shares for a total investment of about $80 million.  Currently, we have about $50.3 million available under our share repurchase authorization.

Now before I turn the time over to Dave, I will comment on our future guidance.  Yesterday in our press release, we provided fourth quarter guidance and our initial look at full year 2008.  Based on our current business trends, we believe that net sales for the fourth quarter of 2007 will be between $108 million and $110 million, a growth rate of 10% to 12% compared with the prior year fourth quarter.

Earnings per share are expected to range between $0.66 and $0.68 for the fourth quarter of 2007.  Accordingly for the full year 2007, excluding revenues now from discontinued third-party contract manufacturing businesses, our sales are expected to be between $422 million and $424 million, with earnings per share between $2.66 and $2.68.

Additionally with our first look at full year 2008, we believe that both net sales and earnings per share will grow by about 10% to 13% compared with the full year 2007. These earnings per share estimates assume an effective tax rate of approximately 36% for the fourth quarter of 2007 and for the full year 2008.

We are confident that our business model remains very strong and the most effective and transparent in the industry.  We stand committed to offering the finest nutritional products and home-based business opportunities in the industry. We will continue to do all that we can to keep our Associates active and engaged in their USANA business.

With that, I will now turn the time over to Dave to comment on our operating activities.

Dave Wentz

Thank you, Gil.  Well, we achieved another strong quarter for both sales and earnings per share.  The third quarter was highlighted by a successful international convention, which was held here in Salt Lake City.  We had record attendance once again at this year's convention and our new product and sales tool launches included the following: our reformulation of our BiOmega fish oil supplement, which now eliminates the fishy aftertaste with a lemon taste; the addition of Creme Masque to our Sensé Skin Care line;.we updated our number one selling sales tool, the Health & Freedom newspaper; and we launched MyHealthPak.  It is an exciting new product concept, which I will talk about in more detail later.

Now let us look at our results on a regional level.  Net sales in North America, our most mature region, increased by 10.1% compared with the third quarter of 2006.  Each of our markets in this region increased on a year-over-year basis.  Mexico led the way and was up again this quarter, increasing 19.3% over last year; and the US sales were up 7.7% over the third quarter of last year; while sales in Canada were up 13.4% in the quarter.  The number of active Associates in North America increased by 16.7% to 105,000 compared with 90,000 in the third quarter of 2006.

While there is not much seasonality in our business, the third quarter of each year is historically our softest quarter for sales.  This is due to many of our Associate leaders taking vacations during the summer months in the northern hemisphere, which takes their focus off building the business.  We also typically see a slowdown leading up to our annual international convention, which is due to the anticipation of new product launches that are introduced there.

On a consecutive quarter basis, sales were softer in the US than we had anticipated.  We believe this softness is related to our international convention sales coming in lower than what we expected.  At this year's convention, our major product launch was something I have been looking forward to rolling out for a number of years.  This is a fully customizable supplement pack, which we call MyHealthPak.  Our customers in the US and Canada now have the ability to create their own personalized selection of USANA's line of nutritional supplements in daily AM and PM packs, making it convenient to get the nutrition they need every day.

The reaction to MyHealthPak was very positive.  However, we found that many of our associates did not purchase this product at the convention but appear to be waiting for their monthly supplies of supplements to be consumed before they make their initial order.  Now that we are down the learning curve away with this new product concept, we will begin our marketing push on this product, which we believe will increase the sales of MyHealthPak.

Big picture-wise, we do not want to lose sight of the fact that MyHealthPak has tremendous long-term potential.  We are optimistic this product will help increase consistent consumption and will be a strong recruiting tool for our associates.  MyHealthPak is a great way to introduce a new prospect to USANA.  Remember, this product is uniquely customized to your specific needs.

Turning now to our Asia Pacific region, net sales in this region for the third quarter increased by 25.7% over the third quarter of last year.  Excluding Malaysia, our mature Asia Pacific markets were up 10.1%.  The year-over-year increase in this region can be attributed to strong growth in Hong Kong, Australia, New Zealand, and the addition of the Malaysia market.  The number of active Associates in the Asia Pacific region increased 36.4% to 75,000 compared with 55,000 in the third quarter of last year.

As was mentioned in the press release, the number of Associates in the Malaysia market reached a total of 12,000 in the third quarter.  We have been pleased with our first three quarters of operations in Malaysia, which opened in early January of this year.  We have had significant interest from a number of our large international Associate leaders.

Our global seamless compensation plan allows leaders from other markets to build organizations in a new market such as Malaysia.  This market is geographically close to a large number of existing markets and the ability to work in both English and Chinese has opened this market up to many of our leaders.

On a side note, we are very excited about our relationship with the WTA.  We currently have seven of the top ten players taking our supplements, which is quite an accomplishment when you think about the fact that the majority of these players were afraid to take supplements prior.  So the fact that we are up to seven of the top ten is quite an amazing feat and we are excited about the future of that relationship.

Before I conclude my comments, I want to give you some context around the 2008 guidance that was announced in our press release yesterday.  Our focus for 2008 will be on our existing 13 markets.  We believe these markets hold significant growth opportunities for our business, so we are not planning to open a new market during 2008.

USANA was founded on science based, health products and we will continue to look for innovative ways to deliver and consume our products while holding to our core values.

With that, I will now turn the call over to the operator to facilitate the Q&A.

Questions and Answers

Operator

Our first question comes from Simeon Gutman with Goldman Sachs.  Please go ahead.

Simeon Gutman - Goldman Sachs

Hi guys.  First for Gil, with respect to the additional expenses that you guys were incurring with regard to the bench strength enhancements.  How proactive are those investments?  Or is it partially a response to some of the variability of sales that you saw in some regions?

Gil Fuller

Well, I think it is primarily a function of we have been operating so lean that we have felt like that to continue the growth track that we have been on, that we clearly needed to bring in some additional help.  So it was a function of recognizing that we needed to bring on people to help us continue to push.  We are very pleased with where we are in that process. We are not completely done with that yet but very pleased with the progress thus far.

Simeon Gutman - Goldman Sachs

So incrementally, there could be some more investments on top of sort of the new base that you have implemented, I guess, beginning in the third quarter?

Gil Fuller

Yes, I think that is an accurate statement.  That is one reason in our guidance going forward that we have felt that it was wise of us to say that our SG&A expense would be steady as opposed to showing leverage going forward.  Because we think we still have some additional things that we need to accomplish there.  Otherwise you would probably see some leverage in there. So once we get that new base established, then we hopefully can get back to some leverage in the future.

Simeon Gutman - Goldman Sachs

Got it.  And then just to follow up on the HealthPak.  I was going to ask how it has resonated with associates and customers, and I guess you have partially answered it.  But is it just they are not taking it up that quickly or they had a current supply and therefore they are waiting till their current supply of their existing HealthPak was finished until they bought the new one?  Or is there a lot of education involved and have you not gotten to even the first learning yet there?

Dave Wentz

I think it is a combination of both.  Definitely, there were not any new products introduced.  It is just a new packing system for existing products.  So if they had bottles of the old products at home, to buy more on top of that above and beyond what they buy each month was to kind of put the other bottles on the shelf for a while; and that did not make a lot of sense, I think, for them.

And plus it is a learning curve. This is a whole new way of looking at supplementation in such a customizable way.  Many people are getting comfortable with our, the website is beautiful and allows them to drag and drop pills into their own customized pack.  They are starting to learn how that all works and how to make that work in their business.

The excitement was huge at the convention.  But they realized there was no urgency to buy.  It is just something that becomes a monthly purchase.  I think we will have them consuming more products because they will not have to go through the time to open different bottles and sort pills.  It is all right there for them and it is wonderful for travel.  I have been using it for a few months now and the convenience with travel just is amazing.

Simeon Gutman - Goldman Sachs

What is the learning curve?  Is it a month?  Is it at two months?  Or are you guys looking out maybe by six months, and at that point you will have your Associate base shifted over?

Dave Wentz

Well, those who will shift, I mean this is a customizable product.  So it is priced higher than the bulk type products that come in packs.  So we will have those who feel the customization is worth the money shift over and those who want to go for the bulk or the economy, so to speak, will stay with the bottles.  So we should get a natural selection over time.  But being one of the few companies that can customize like this, we think it will be a unique selling feature as they go out prospecting.

Gil Fuller

(Voice Overlap) Sorry.  Simeon, let me just throw in one other account. Remember that right now the product is primarily offered in the United States.

Simeon Gutman - Goldman Sachs

Right.

Gil Fuller

The Canadians can buy it on a not for resale basis.  But really at this point, it is primarily U.S. opportunity for us.

Simeon Gutman - Goldman Sachs

I do not know if you shared it, but what is the assumption for the conversion rate, at least among U.S. distributors?  I mean, 50% or is it something higher than that?

Dave Wentz

I do not think anywhere near 50%.

Simeon Gutman - Goldman Sachs

Okay.

Gil Fuller

We have not officially commented on that, Simeon.  I think, the way I have looked at it, it is going to be a transition as opposed to a stampede to this kind of thing.  I think that we are going to see a steady progress as we continue to, as they, (Voice Overlap)

Dave Wentz

Similar to what we saw when we announced the HealthPak as we moved from bottles to packs in the first place.  This is taking packs to the next level.  We had a slow transition from bottles to packs as they realized the convenience factor.

Simeon Gutman - Goldman Sachs

Got it.  Just one more, if I could, Gil or Dave.  How did the top line progress throughout the quarter?  Was it a steady build or was it actually just steady growth throughout the quarter?

Gil Fuller

It was pretty steady.  We always see some softness as Dave mentioned in his comments about summer time in the northern hemisphere.  We always see that every year.  And also just prior to convention, people back off a bit just to see what is coming at convention.

But basically it was steady throughout the quarter with a little pick up after convention and a nice strong finish.  But I would characterize it basically as just a steady quarter and a very typical third quarter for us.

Simeon Gutman - Goldman Sachs

Okay. Thanks a lot.

Operator

Thank you. Our next question comes from Bill Leach with Neuberger Berman.  Please go ahead.

Bill Leach - Neuberger Berman

Gil, I have a few questions.  Can you tell me what the option charge was in the quarter and how that compares to last year?  And what your estimate is for the full year?

Gil Fuller

Yes.  Let us see.  The option charge for the quarter was $1.55 million.

Bill Leach - Neuberger Berman

That is pre-tax?

Gil Fuller

That is pre-tax.  And it was $1.3 million the quarter before, a year ago quarter, I should say.

Bill Leach - Neuberger Berman

And what is your estimate for the full year?

Gil Fuller

Let us see if I have got that here.  It is about $5.1 million or so.  I am sorry, $6, about $6 million.

Bill Leach - Neuberger Berman

$6 million?

Gil Fuller

Uh-huh.

Bill Leach - Neuberger Berman

And would you see that holding steady in 2008?

Gil Fuller

Yes, I would.  It may creep up.  It depends on a number of things, how many options of course that the Board grants and what happens to the share price.  Some of this calculation is a bit esoteric, as you know anyway.  Remember, it is a non-cash expense item.

Bill Leach - Neuberger Berman

Yes. That is why I wanted to add it back.

Gil Fuller

Yes, I think if you add that back, then you get the truer picture of cash, of cash flow.

Bill Leach - Neuberger Berman

And then the legal fees you mentioned works out to about $0.03 a share after tax.  Should we view that as a non-recurring item more or less?  Or are you just operating at a new level of legal fees going forward?

Gil Fuller

Well, what we have included in our forecast, since we do not know when there is going to be an end to this thing --there will be, we just do not know when—that we have basically said it will be steady going forward for now.  We do not have any better insight than that at this juncture.

Bill Leach - Neuberger Berman

So it is going to continue to cost you $0.03 per quarter?

Gil Fuller

It is going to be something in that order would be my guess.  I do not know what we could say beyond that at this point, Bill, that is our guess.  Hopefully, at some point this will come to conclusion.  If we could get the class-action suit dismissed or something, that would certainly be helpful.  But at this point, I think that is a matter of prudence says that is how we should think about it.

Bill Leach - Neuberger Berman

Okay.  My last question, what is your counter using for your guidance? Or you assuming a continued reduction in shares or just steady state with where you are now?

Gil Fuller

We in our numbers that generate our guidance, we are showing very modest share buyback.  That is perhaps a bit conservative.  We certainly have, as I mentioned in my prepared remarks, we have just over 50 million of authorization there.  We certainly have strong cash flow.  So that maybe a conservative element in what we have said by way of guidance depending on how many shares.

Bill Leach - Neuberger Berman

When you look at the midpoint of your fourth-quarter guidance, it is about I guess a 10% gain.  It looks like you are going to have at least 10% of your shares outstanding. So are you being conservative?

Gil Fuller

Well you know, we will, may be conservative.  But you try to do the best you can in looking at these numbers without overstating things.  But it could be conservative. I certainly hope it is conservative even as it plays out.

Bill Leach - Neuberger Berman

Okay.  Thanks a lot.

Operator

Your next question comes from Theresa MacPherson with D.A. Davidson.  Please go ahead.

Tim Ramey - D.A. Davidson

Hey, it is actually Tim Ramey sitting at her desk.  My question relates to the share repurchase as well.  Gil, is there any kind of negative covenant or pledge on the shareholder's equity account?  Do you have to maintain positive shareholder's equity or some minimum level of shareholder's equity?

Gil Fuller

No, there is nothing on our loan document that says that.

Tim Ramey - D.A. Davidson

Okay. Would the Board be willing to let the shareholder's equity account go negative to buy share repurchase or has that ever been discussed?

Gil Fuller

Well, I am thinking that that probably would be viewed very cautiously to go negative.  Remember we generate in the order of, when you add back 123(R), roughly $20 million of cash flow a quarter.  So I do not think there is any reason; if we got an opportunity, if there is a spike down on the stock, I think anything is possible.  But as a general practical matter, we probably would not look to do that.  But the cash flow is such that we will certainly be opportunistic, I would guess.

Tim Ramey - D.A. Davidson

Great.  And the other question is on the WTA Association.  I thought that was interesting for Dave to say seven of the top ten players were using the products.  How are you going to be able to get that word out or leverage that?

Dave Wentz

Well, we are focusing a lot of our time and effort with our field talking about the credibility that this brings; because these athletes were scared to take supplements.  It was not until USANA came along that they decided to trust the supplement world.  And so that lends a lot of credibility as our Associates are out talking about the message as they are approaching other athletes.  As we get these athletes that people look up to, it makes them confident in taking the product themselves.  So we are just using the WTA to show the credibility of the product and give more confidence to our field as they talk to people.

Gil Fuller

Tim, one other side interesting aspect, to me anyway, is that the WTA sought us out, which is I think is a compliment backing up what Dave says about the quality of our products and reputation of our products.

Dave Wentz

They realize that putting players on the court is how they make money.  When they are injured or unhealthy, they are losing money.  And so they have really made an investment in the health of their players, realizing that that investment will lead to the success of their association, which I think is very forward-looking and very smart thing to do.

Tim Ramey - D.A. Davidson

Great.  And one more quick one on the Autoship number going up.  I guess I had in my head that it would probably never go up that as you became more international, those numbers would, the mix would change and you probably would not.  Why would it go up, what happened to make it go up?

Gil Fuller

Tim, one of the things that we try to do sometimes more successful than others is create incentives for people to be on Autoship.  Just looking at it by country here, it looks like we had the U.S. go up a couple hundred basis points in the quarter versus on a consecutive basis for the second quarter.  That was what drove, since it is the biggest market that we have, that was the thing that seemed to drive our overall number up nicely.  So we are always looking for ways to give folks a reason to have their products on Autoship.  It helps compliance.  It is a great, that is healthy, likely to keep taking their products.  Also of course, it is a great cash flow thing for us and also gives us some visibility as to what is coming.

Tim Ramey - D.A. Davidson

Terrific, thanks.

Operator

Your next question comes from Rommel Dionisio with Wedbush Morgan.  Please go ahead.

Rommel Dionisio - Wedbush Morgan

Good morning, I have two questions.  First just one of your smaller markets, but just with regards to Singapore, there is a 20% decline in the average active Associates.  I know you guys have talked about how some of those folks have shifted their attention to Malaysia.  Does that continue to be the case there?  Is there some other factor going on in Singapore?

Dave Wentz

Yes, they definitely chase the excitement.  Malaysia is the exciting thing and they realize it is a larger market.  And so Singapore, a lot of Singaporeans have focused almost all of their attention on Malaysia, which is part of the reason that Malaysia is doing so incredibly in its first nine months.  So yes, as Malaysia develops its own leaders, the leaders will be able to go back to their markets and spend more time.  But they need to make sure they have the leadership developed in the country before they leave.  Otherwise they will have to go back and rebuild that leadership.  So I think they are being smart by making sure they get Malaysia to a certain level before they move back or focus back on their existing market.

Rommel Dionisio - Wedbush Morgan

Okay.  Well, they are certainly doing a good job in Malaysia so far.  Just my second question on a bigger picture.  Your guidance for next year, you are looking for 10% to 13% sales and earnings growth.  I mean, this year you had legal expenses, plus you are going to deploy cash to either buy back shares or pay down debt next year.  I mean when I read that, I see flat margins.  Is there something I am missing in terms of additional expenses that you expect to incur next year?  Or are we just being a little conservative here with regards to margin assumptions for next year?

Dave Wentz

I think we have definitely reached a point where we need to do step-up investments.  We have been running very lean.  We were very restricted in our existing building.  Now that we have the ability to bring out some more resources that we have needed but have held off on bringing aboard, I think we will be able to prepare for the long-term future a lot better.  And so we have some investments that we need to make.  We believe the future.  A lot of that depends on technology and so we want to make some more investments in technology to make sure that we set the example and are one of the premier companies with technology to help our Associates be as efficient as possible now and in the future.

Rommel Dionisio - Wedbush Morgan

Fair enough. Thanks very much, Dave.

Operator

Your next question comes from Mimi Noel with Sidoti & Company.  Please go ahead.

Mimi Noel - Sidoti & Company

Hi, thank you.  Gil, can you tell me the year-to-date legal and PR expenses pre-tax?

Gil Fuller

Well, related to, I presume, Mimi, that you are asking—(Voice Overlap)

Mimi Noel - Sidoti & Company

Oh yes.

Gil Fuller

Those related to all the distraction?

Mimi Noel - Sidoti & Company

Correct.

Gil Fuller

About $2 million year-to-date.  We have been running about $1 million a quarter.  It was a little more than $1 million in the first quarter where this happened, our second quarter, but the first quarter this really happened.  And then just a little under that in the most recent quarter, the one we just completed.

Mimi Noel - Sidoti & Company

Okay, okay.  And then also, maybe this is a better question for Dave. But I understand the seasonality of the business and the impact of convention.  But this is the first time I have seen, looks like seven out of your ten major regions generated sequential sales declines.  Can you provide a little commentary on that?

Dave Wentz

Well, we have always, Q2 to Q3 is always a tough one.  In the past, we have just barely had Q3 beat Q2.  We did amazing in Q2.  Q2 was huge.  We did too well in Q2, if you want to look at it that way.

Mimi Noel - Sidoti & Company

All right.

Dave Wentz

I mean we could have put fewer promotions in Q2 and more of them in Q3 and made it shift. So, (Voice Overlap)

Mimi Noel - Sidoti & Company

In a sense there might have been a borrowing effect, second quarter from September?

Dave Wentz

Borrowing effect as in our Associates--

Mimi Noel - Sidoti & Company

Sales activity.

Dave Wentz

Sales activity, yes.  We did a lot in the second quarter, had an amazing second quarter, jumped big time.  Because of that, they have to take a break and summer is the time they like to take a break.  So kids are out of school and it is a good time to vacation when you have that freedom of lifestyle.  So Q3 is always a tough one.

Gil Fuller

Mimi, let me just throw in two thoughts.  Remember this was our second best quarter ever that we just had in sales.  Secondly, just looking at 2006, going from 2Q to Q3 in 2006 in North America, we were down slightly.  So it is a very common thing, as Dave says, that third quarter is always tough.

Mimi Noel - Sidoti & Company

Okay.  Can you give me a couple of points why I might expect productivity from your distributors to improve on a go forward?  I have also never seen such a disconnect between sales growth and consolidated associate growth.

Dave Wentz

I feel we always have a difference in timing or a delay between the two.  I think the Associate growth is an indicator of what the future is.  And so we are definitely going to invest to make our Associates more efficient going forward. We need to keep focusing them on bringing new customers to the company.  I am very excited about what our Associate growth has been in the last little bit and we are going to continue to push that.

Gil Fuller

Mimi, again as just a sideline on that thought.  If you look at our newest market, Malaysia, just to illustrate the point that Dave made.  And you take the active number of distributors and divide it into quarterly sales, you get a certain number, like $400 or something per quarter per active distributor.  Whereas the overall company is closer to 600.  So it takes a while for these new markets to mature and it takes a while for new distributors to get up to speed where they are really embracing the whole product line.

Mimi Noel - Sidoti & Company

So it might be a short run drag on productivity as it matures more efficiency and the productivity goes back up?

Gil Fuller

That is what we want to see happen.

Mimi Noel - Sidoti & Company

Great. That is very helpful. Thanks, Gil. Thanks, Dave.

Operator

Your next question comes from Steven Martin with Slater Capital Management.  Please go ahead.

Steven Martin - Slater Capital Management

Hi guys.  I got on a couple minutes late.  You were already talking about the legal stuff.  Have you learned anything and what is the status of your lawsuit against Minkow and the Discovery?  Anything about his backing or his position or I do not know what else?

Second question is can you comment on the status of your bank loan and some of the language in that amended second quarter Q about the possibility, potential possibility of it being in breach?

Dave Wentz

Well, legal-wise, I do not know exactly without Jim Bramble here to guide me.  I am not aware of what I am allowed to say about it.  But from a personal standpoint, I am very excited about the progress we have made so far with the Minkow lawsuit.  We are starting to get some information and we are excited about where it could take us.  But I do not know what detail I can go into.

Gil Fuller

Steve, I would just chime in here.  We are finding some interesting things.  But it is probably wise that we do not say too much at this point.  A lot of what is going on right now is procedural.  Where our deposition is going to take place, arguing whether it will be Utah, California, all this kind of thing is going on. But we are making progress and we feel good about the progress we are making.

With regards to the bank line, let me comment on that.  Out of an abundance of caution in that second quarter, we did file our financial statement with the bank loan shown as short-term debt, even though the term of the agreement was the loan was not payable until 2011.  Because the Q that we filed, we knew was not a complete Q, because we did not have a review by an accounting firm based on the timing of the resignation of our old firm, and so we went ahead that way.

As a matter-of-fact, just yesterday, we got a note back.  By the way, we had kept Bank of America informed all along about what was going on.  The day our prior accountant resigned, we called them and just kept them informed all along.  They never mentioned the word default to us, never.  But we felt that that was the wise way to go.  But just to be clear, we recently asked them about just giving us a statement regarding that particular issue, that the fact that that one Q originally was filed without a review and now has been filed, whether or not that constituted any kind of default; and reading this one sentence from the letter that I got yesterday from Bank of America that the bank does not consider that reporting failure to have resulted in a default.  So that one is behind us and over and done.

Steven Martin - Slater Capital Management

So that means you will take that language out in this current Q?

Gil Fuller

That is correct. And if you notice in the current Q, the debt is now classified as long-term.

Steven Martin - Slater Capital Management

Good, thanks a lot.

Gil Fuller

I am sorry, I said, (Voice Overlap)

Steven Martin - Slater Capital Management

Oh, one other—

Gil Fuller

(Voice Overlap)  The press release, Steve, I am sorry.

Steven Martin - Slater Capital Management

Right, I do not have the Q yet.  Dave, you and your family have been buyers of the stock of late.  Can you comment on to the extent you are willing to, your intention?

Dave Wentz

We saw it as a great investment and so we looked at the opportunity of a good time to buy.

Steven Martin - Slater Capital Management

All right, thank you very much.

Operator

Next question comes from David Block with Block Capital.  Please go ahead.

David Block - Block Capital

I was wondering if all the negative media that has come out in the last several quarters will at all impact your ability to get a direct selling license in any of the markets that you guys might be prospecting?  And then I guess separately, are there more hoops that you have to jump through in light of all the allegations?  Thanks.

Dave Wentz

No, this has not caused any issue.  We are not pursuing any licenses in any other countries at the moment.  But the countries that we are researching, this would not cause any issue whatsoever in getting those licenses.  So that is not hindering us.  It is purely a strategy to make sure that we continue to focus on our existing markets and make sure Malaysia develops and matures before we move onto any other possibilities.

Gil Fuller

As far as other hoops go, Dave, we got one of the top four, perhaps the top accounting firm in the world now engaged with us.  We have overcome that little glitch with NASDAQ.  We are hopeful that the SEC informal inquiry will go away soon.  The lawsuits may take a little time to work through.  Those are hard to judge.  But I think one by one we are getting these things behind us in a very successful way thus far.  So we are quite optimistic about it, Dave.

David Block - Block Capital

Okay. Thank you.

Operator

Your next question comes from Amy Vinson with Avondale Partners. Please go ahead.

Amy Vinson - Avondale Partners

Hi guys.  Just a couple of quick questions.  Could you give us an update on what you are expecting capex to look like for fiscal '08?

Gil Fuller

Let us first talk a little bit about fiscal '07.  Through nine months, we spent about $19 million and we are thinking that that will be on the order of, I do not know, 22 to 24; depending on when we complete a couple of projects that are underway.  So that is what we are thinking of for '07.  In '08, we will be finishing up the tail end of our project here in Salt Lake.  We will also be completing one fairly large one in Australia.  I am guessing that next year it will be in the order of $15 million.

Just to put that in context, our typical capex is somewhere around $6 million to $8 million a year, something of that sort.

Amy Vinson - Avondale Partners

Okay.  And quickly, if you are not opening any markets in '08, can you just give us an idea how we should think of China over the next couple of years?

Dave Wentz

For us, China is a wait and see, with the laws the way they are and currently they are throwing more laws and getting stricter.  We see that as a very difficult environment to be successful.  We are waiting to see if some of the other companies crack the code and come up with a way to be successful there.  We have not seen a lot of success from our competitors.  We do not want to jump into that situation that has not been successful for others.  So we are going to have things going slowly in the sidelines, keeping an eye on it and watch it till we believe it is a potentially successful market for us and then we will pursue with great speed.

Amy Vinson - Avondale Partners

Okay. Thanks guys.

Operator

Thank you.  Our next question comes from Craig Leighton with Lord Abbett. Please go ahead.

Craig Leighton - Lord Abbett

Just a few questions.  I know a lot have already been asked.  But on the new market situation, I guess, if we do not have anything in 2008, would you expect a new market in 2009 whether it would be China or another?

Dave Wentz

That will depend on the environment.  We do not know at this time.  We need to make sure we are growing our existing markets before we look to open any new.  And so we need to make sure we are strong.  As that time comes around, we will have any that we are prepared to sitting in the wings; and if we want to, we will launch.  If we feel we need to focus more on existing markets, then we will hold off.

Craig Leighton - Lord Abbett

Just out of curiosity, how many markets are being researched right now?

Dave Wentz

We have a few being researched.

Craig Leighton - Lord Abbett

Okay, a handful. And then just switching gears here, on the MyHealthPak, I am wondering if you plan to give an update on a quarterly basis or whatever about the number of Associates on MyHealthPak?  Sort of like Autoship.  Would you provide an ongoing continuous progression there?

Dave Wentz

No, I do not think that we would ever focus on the products.  I mean that is just a compilation of all of our optimizers and nutritionals.  So if we see a shift toward nutritionals as a segment then I believe MyHealthPak will probably be a big part of that.  But I do not see us breaking down as we introduce each new product.

Craig Leighton - Lord Abbett

Okay, I just thought because there is, I guess, a price differential, it may be helpful.  But nonetheless that is fine.  And then just in terms of Associate incentive costs for 2008, I am just wondering what you might forecast?  Or if you have any particular promotions that you are starting to think about to keep the momentum going?

Dave Wentz

We look to see Associate incentive stay flat with where it is. We are going to. we feel we are at the right ratio, very competitive in the industry and the right ratio for our Associates.  So we do not see that moving in either direction.  But we will continue to invest in other things that help our Associates become more efficient.

Craig Leighton - Lord Abbett

When you say flat, you mean as a proportion of (Voice Overlap)

Gil Fuller

Relative to sales.

Dave Wentz

Yes, a flat percentage.

Craig Leighton - Lord Abbett

Okay, fair enough.  Are there any particular promotions that you found successful in 2007 that you may reproduce?  It seemed like through the year-to-date period, your sales certainly have been very sensitive to the promotional activity.

Dave Wentz

Yes, we have become somewhat sensitive to promotions.  We are going to work to smooth out that curve and that is going to be the focus for 2008 is to make things less promotion focused and just create that steady sustainable growth.

Craig Leighton - Lord Abbett

Great.  Just lastly, when does the window open for share repurchase?

Gil Fuller

This Friday.

Craig Leighton - Lord Abbett

Great. Thanks guys.

Operator

Thank you.  Your next question is a follow-up from Mimi Noel, Sidoti & Company.  Please go ahead.

Mimi Noel - Sidoti & Company

Yes.  Building on Craig's last question, if you are in a position to comment; you were very active in the second quarter, and then relatively speaking threw the brakes on in the third quarter.  Can you talk a little bit about the rationale?

Gil Fuller

In the third quarter, remember we had a Form 10-Q that was filed without a review and so we were deficient in that way, and we felt uncomfortable, and we did not have an accountant.

Mimi Noel - Sidoti & Company

Sure.

Gil Fuller

So there were a number of issues there that were going on.  We felt like it was better to be quieter.

Mimi Noel - Sidoti & Company

So you were not pushing the envelope on any debt covenants or any restrictions along those lines?

Gil Fuller

That is true.  It is also a function of our judgment on timing, cash flows.  We had big capital projects that are going on and so forth.  Just a judgment call.

Mimi Noel - Sidoti & Company

Okay. That is all I have. Thank you.

Operator

We do have another follow-up coming from the line of Craig Leighton with Lord Abbett.  Please go ahead.

Craig Leighton - Lord Abbett

Sorry, just a real quick question.  If you have the cash from operations and I guess you gave us capex, but just the cash from ops for the quarter, I did not quite get that.

Gil Fuller

Yes.  For the quarter, the cash from ops for the quarter came in at about $12 million.

Craig Leighton - Lord Abbett

Okay.

Gil Fuller

Capex for the quarter was about $4.8 million.  And for the year, after nine months, about $19 million.

Craig Leighton - Lord Abbett

Okay, terrific.  I appreciate the time.  Thank you.

Operator

Thank you.  And management, there are no further questions.  I will turn it back to you for closing comments.

Gil Fuller

Thank you for your questions.  We continue to remain confident in the future outlook for USANA and the investment opportunity we provide. If you do have any remaining questions, please feel free to contact us at investor.relations@us.usana.com, or call Riley Timmer, Executive Director of Finance at 801-954-7922.  We appreciate your interest in USANA and thank you for joining us on the call this morning.

Operator

Thank you.  Ladies and gentlemen, that will conclude today's teleconference. We do thank you again for your participation and at this time you may disconnect.

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Source: USANA Health Sciences Q3 2007 Earnings Call Transcript
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