USANA Health Sciences, Inc. (USNA) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the USANA Health Sciences Second Quarter Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this call is being recorded today, July 25, 2012, at 11:00 a.m. Eastern Time. I would now like to turn the conference over to Patrique Richards, Manager of Investor Relations. Please go ahead.

Good morning, everyone. We appreciate you joining us this morning to review our second quarter results. Today's conference call is being broadcast live via webcast and can be accessed directly from our website at www.usanahealthsciences.com. Shortly following the call, 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 our company. Those statements involve risks and uncertainties that could cause actual results to differ, perhaps materially, from the results projected in such forward-looking statements. Examples of these statements include our 2012 strategies for our North America region, Greater China region and other markets, as well as our updated outlook for 2012. We caution you that these statements should be considered in conjunction with the disclosures, including specific risk factors and financial data contained in our most recent filings with the SEC. I'm joined this morning by Dave Wentz, our Chief Executive Officer; and Doug Hekking, our Chief Financial Officer. We'll hear first from Dave, who will discuss our business activities during the quarter, as well as our strategies moving forward. We will then hear from Doug, who will discuss our financial results and 2012 updated financial outlook. I'll now turn the call over to Dave.

Thanks, Pat, and good morning, everyone. I'm pleased to report that USANA delivered another quarter of record results both on the sales and EPS lines. While there were many positive developments during the quarter, the highlight was certainly the launch of our new Lifetime Matching Bonus. For several years, USANA has offered a matching bonus to our Associates around the world. However, many Associates viewed it as a short-term incentive and did not result in the long-term benefits we hoped for. Additionally, the old matching bonus was successful only in certain regions and underutilized in other regions, especially North America. We have attempted to change it's dynamic with the introduction of the new Lifetime Matching Bonus. As the name suggests, the Lifetime Matching Bonus is a long-term incentive. It rewards Associates for helping those they sponsor become successful over the life of their business. This new bonus is intended to incent our Associates develop long-term, enduring sales organizations by developing and continuing to mentor new Associates they bring into the business. We launched the Lifetime Matching Bonus at the end of April in front of thousands of Associates worldwide. It has been received by our sales force with overwhelming support and enthusiasm, and we are confident that the Associates in all of our regions will utilize the bonus to grow their organizations. We also launched the Lifetime Matching Bonus with an 8-week promotion that we have offered with success in the past. The objective of this promotion was to immediately increase the number of Associates who will receive the Lifetime Matching Bonus. This 8-week promotion proved to be successful again and helped fuel our record results for the quarter. Operationally, we expect that the Lifetime Matching Bonus will relieve pressure on Associate incentives by reducing monies being paid out for the wrong behaviors and provide us with flexibility to implement market-specific incentives to drive sales and customer growth in each of our regions. We intend to continue providing a rewarding compensation plan for our Associates that is sustainable long term. I'd now like to discuss our regional results and then update you on our strategies and expectations for the remainder of 2012. We continue to see strong momentum in our Asia Pacific region where sales increased by 11% and the number of active Associates increased by 10%. This growth was driven by solid results in Southeast Asia/Pacific and Greater China. The Philippines, which increased 124.4% in sales, was a significant contributor to our growth in the region. We continue to see impressive growth in this market where our Filipino Associate leaders include highly educated professionals who have capitalized on the unique earning potential under the USANA compensation plan, which is often more rewarding than their current profession. In addition to the Philippines, we saw growth in almost every other Asia Pacific market in this quarter. Factors that led to this growth include increased Associate counts in many markets, price increases in certain markets and increased Associate productivity from the introduction of the Lifetime Matching Bonus and the related short-term promotion we offered during the quarter. Also included in our results for Southeast Asia/Pacific this quarter were sales for Thailand. Our initial results in this market were softer than expected primarily because our customer base currently consists of more consumer-minded customers as opposed to the entrepreneurial Associate leaders. Fortunately, we have a well-experienced Thailand management team that is focusing their efforts on developing Associate leaders and organizations in this market. In May, these efforts focused on our grand opening event, which was very well attended by our Thailand Associates and prospects. Although growth in Thailand will come in a slower pace than originally anticipated, we believe that this market will be a meaningful addition to the region. In Greater China, we continue to invest time and effort in educating our Associates on building successful direct selling organizations in China. We are emphasizing our newly introduced adult nutritional products, as well as our compensation plan in China. During the quarter, we held several product nutrition-related events throughout China, which were well attended by leaders and prospects. We expect to launch 2 more skin care products by the end of Q4 2012 and are currently working on the registration of additional USANA nutritional products. We believe that the strategies we are executing are positioning the company for long-term growth in Greater China. Turning now to North America. We are pleased to report the sales in this region increased 3.6% year-over-year and 5.7% sequentially. While our Associate accounts in North America were down monthly year-over-year, they were up 6.5% on a sequential quarter basis. We believe that the sales growth in North America is primarily due to the excitement from the introduction of the Lifetime Matching Bonus and the related short-term promotion we offered during the quarter. We also believe that much of the success in North America is attributed to our continued efforts to strengthen the relationship between USANA management and Associates. This is being accomplished through increased meetings, calls and general interaction with our sales force. Our management and Associates work together to solve problems, exchange effective sales techniques and grow the business. While we are pleased with our results in North America this quarter, we recognize that we still have work to do in this region. Our strategy focuses on strengthening our partnership with the sales force, developing new Associate leaders, introducing North America-specific incentive offerings and implementing our long-term branding and marketing strategy. During the first half of year, we made progress on each component of the strategy, and we must continue to execute going forward to return North America to consistent growth. The component that I mentioned last, our long-term branding and market strategy, is centered on personalization, innovation and strengthening our brand worldwide. While this is a global strategy, it will be introduced at our International Convention, which is less than a month away, here in Salt Lake City. This is our 20th anniversary celebration, and it will be larger than any convention we have held in the past. It will feature recognized keynote speakers such Dr. Mehmet Oz, John Maxwell and Larry King, as well as several professional and Olympic athletes. We will be announcing a new innovative approach to personalizing nutrition, as well as several surprises that promise to make it an event that our Associates will never forget. In closing, I'm pleased with USANA's performance during the first half of 2012, and I believe the second half of the year will be even better. I'm confident the momentum will continue to build in each of our regions as we continue to execute our long-term growth strategy. With that, I'll ask Doug to review our financials and discuss our updated guidance.

Thanks, Dave, and good morning, everyone. I'm going to begin by reviewing our second quarter financial performance and commenting on the better-than-anticipated results for quarter. I'll then discuss our updated financial guidance before turning the call over for questions. Sales for the quarter increased 8% and came in higher than our projections due largely to the introduction of the Lifetime Matching Bonus and related promotion that we offered. We estimate that these events added around $5 million to the top line for the quarter. We had modeled for sales to trend up in light of these events, but our projections were a bit soft mainly because of the consideration we gave to the tough year-over-year comparison for the quarter. As you might remember, we experienced about a $4 million increase in sales during the second quarter of 2011 relating to the certain policy changes that were announced in our Hong Kong market but ultimately were not implemented. Additionally, changes in currency negatively impacted sales by about $2.7 million on a year-over-year basis for the quarter, which was less than we projected. Gross margins improved 20 basis points year-over-year largely as a result of the price increases that we implemented during the first quarter, and to a lesser extent, improved freight cost and leverage gain on fixed cost from higher sales on the line. As we anticipated, we continued to see increased cost on certain raw materials and pressure from changes in currency during the quarter, but at a lower level than previously anticipated. Overall though, gross margins were better than we expected. Associate incentive expense for the quarter decreased 140 basis points to 44.1% of net sales compared to the second quarter of the prior year. This increase was due to the lower relative payout of base commissions and matching bonus. Base commissions were lower due to price increases, and matching bonus was lower as a result of our continued efforts to manage this component of our Associate compensation plan. Associate incentives were in line with our projections for the quarter. SG&A expense in the second quarter was better than we anticipated and came in at 22.8% of net sales due primarily to the leverage gain on the higher-than-anticipated net sales. The absolute increase in SG&A expense was due primarily to an increase in equity compensation mostly attributed to the low comparable in the prior year resulting from a cancellation adjustment. Additionally, cost associated with the opening of our new markets added to the absolute increase in SG&A expense. The leverage we gained on SG&A from higher sales was meaningful in driving our bottom line results higher than projections for the quarter. Our effective tax rate for the second quarter was also better than expected at 32.8% of pre-tax profit. This 170-basis-point improvement is a result of a onetime restructuring benefit we recognized in certain of our Asia Pacific markets during the second quarter. The result of this, all of this, was record net earnings for the second quarter of $16.7 million. Earnings per share for the second quarter increased 26.1% to $1.11 per diluted share and can be attributed to higher net earnings and a lower number of shares outstanding due to our share repurchases over the last 12 months. During the quarter the company invested $26.6 million to repurchase just under 700,000 shares. Turning to the balance sheet. We continued to generate strong cash flow from operations and end the quarter with nearly $66 million in cash. Cash generated from operations totaled $21 million for the quarter and $44 million for the first 6 months of the year. I would now like to provide some details in our updated guidance for the remainder of 2012. We now expect net sales for the year to be in the range of $630 million to $640 million. We are taking sales up as a result of our strong second quarter results and the general minimum in the business. We believe this momentum will continue as a result of the excitement surrounding the Lifetime Matching Bonus, as well as the initiatives we have planned for the second half of 2012. We are also increasing our EPS guidance for the year to be in the range of $4.10 to $4.20. This increase in our guidance for earnings per share can be attributed to better-than-expected results for the second quarter, leverage benefit expected on higher sales and improved gross margin outlook, a lower effective tax rate due to benefits associated with the manufacturing tax study that is nearing completion. For the year, we now expect the tax rate to be right around 32%. Finally, a lower number of diluted shares from share buybacks in the second quarter expected to have about a $0.06 benefit for the second half of the year. Note that our EPS estimates reflected diluted share count of about 14.8 million shares for the remainder of 2012, and we've not modeled for any significant share buybacks in the second half of 2012. Please note that SG&A expenses in the third quarter will be noticeably higher due to the comps associated with our 20th anniversary celebration at our annual International Convention held here in Salt Lake City. We expect our cash balances to continue to build by year end, and we explored various alternatives to invest our cash to grow the business long term. With that, I will now ask the operator to facilitate the question and answer.

[Operator Instructions] First question today comes from John San Marco with Janney Capital Markets.

Can you tell me what it takes to qualify for the Lifetime Matching Bonus? And then also, is that now a permanent fixture in the comp line going forward?

Yes. The qualifications are the same as they were prior for the other matching bonus. It's just the payout plan is different for this matching bonus. It's over the lifetime of the business, the smaller percentage rather than a very large percentage for a short period of time.

Okay. And then I guess the related temporary promotion that you ran, at least I think you called that related. What was that? And how did it relate?

Every time we've made modifications to the matching bonus and a few other times we've allow them to requalify, those people who hadn't qualified for matching bonus in the past. And so we see a lot of activity as people who don't have that status trying to upgrade their status so that they can receive a higher percentage of Lifetime Matching Bonus going forward.

Great. And then sticking with the comp plan. As you keep -- I guess as new markets contribute more to the overall business, what impact on -- from mix, what impact should we expect on Associate incentive comp? Or does it come out of the cage right at that 44% level?

You should see us roughly falling in line with what you've been seeing in the last couple of quarters. You've got to remember, excluding China, with worldwide global thing with comp plans, so you'll see the payout kind of approximately at 44%. And that's what we're modeling.

And then my last question was just on cash. It seems like you've got more than you normally keep on hand, and the business is still throwing off a lot of cash. So if you can just state for the record what our cash priorities are and maybe what's keeping you from using that more aggressively.

We'd like to build a little higher and get a good bank account there, sitting there in case an opportunity comes along. Some opportunities came up during the past where we've spent our cash down. But we'd like to get it back up a little higher than it is now before we look to start spending the excess.

And when you say opportunity, you mean acquisitions or big capital projects or...

Yes, yes.

[Operator Instructions] Your next question comes from Rommel Dionisio with Wedbush Securities.

Could you just walk us through the 8-week promotion, a little more granular detail in terms of how exactly did that increase in size to pull people that were sort of qualified for the matching bonus? Could you just talk us through that?

Yes, just real high level. What the promotion is, we're giving a certain status. They have to go out and bring certain number of people into the business that meet certain criteria during a certain period of time so. So it was an 8-week promotion where they're encouraged to go back and attract new people to generated sales volume for those first 8 weeks. And so that -- it was kind of a short-term promotion to drive immediate behavior and give them an opportunity to go back and participate in this lifetime match at a higher level.

Okay. And did I hear that correctly, that was up 5 million for the quarter?

Yes, that was added -- contributed for the quarter.

Your next question comes from Frank Camma with Sidoti. Frank A. Camma - Sidoti & Company, LLC: Yes. Just a couple of questions. Can you speak a little more detail about the effective tax rate going forward? Is that what we should follow? The 30 -- I believe you said 32% in your guidance, is that correct?

Yes. Frank, you kind of broke up a little bit there, but I think I understand the question. So we've given you what we expect for the remainder of this year. I think moving forward in 2013 would be on at least what we currently have in the works. We're expecting that 34% tax rate roughly for 2013 and beyond. We're always working on opportunities to go back and try to leverage that line item and get a little bit more of the lower tax rate. But that's what we're currently modeling, about 34% ongoing. Frank A. Camma - Sidoti & Company, LLC: So 34% for 2013. But how about for the rest of 2012?

Well, I could say that for the year, we expect 32%. So you'll see the second half of the year dip a little bit lower than that 32%. This manufacturing tax study, they're getting close to wrapping up, should go back and allow us to go back and run that through the second half of the year as soon as we go back and see debt nearing completion. Frank A. Camma - Sidoti & Company, LLC: Okay, great. And what was the CapEx for the quarter?

Our CapEx for the quarter was about $1.2 million. Frank A. Camma - Sidoti & Company, LLC: Great. And final question, what was the stock option expense for the quarter?

The option expense for the quarter was about -- I think it's about $2.7 million -- $2.7 million, $2.8 million. Frank A. Camma - Sidoti & Company, LLC: And are you able to give us a little more color on just the revenue that was achieved from new markets, approximately?

Yes, I mean, between France and Thailand, we're about $1.2 million between the 2 of them. So it's definitely lower than what we're expecting on the run rate. We're still optimistic, but we see a high, high level of folks who are just interested in the product consumption and not a real business-minded group at this point. But I think we'll see some of that evolve over time and better metrics in the market over there. But it was definitely below where we thought it would be for the quarter. Frank A. Camma - Sidoti & Company, LLC: Okay. But that means that the North America was definitely up on a year-over-year basis to strip that out of the total since you combined Europe with North America, right?

Yes, absolutely. We added roughly 0.5 million from Europe in there. So yes.

Your next question comes from Tim Ramey with D.A. Davidson. Timothy S. Ramey - D.A. Davidson & Co., Research Division: I'm just trying to better understand the impact of the matching bonus. And first observation is it sounds like an exciting thing, but you're actually telling us Associate incentive expense will be slightly lower as a percent of sales going forward. So was there an offset somewhere else that some other program that was -- I mean, I know the predecessor program was discontinued, but overall, it looks like you're spending like a little bit lower.

Yes. The primary contributor there was really that price decrease or price increase that you saw we did in Asia Pacific and a few other markets. That was a primary catalyst to the lower payout. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay. And just in terms of how the matching bonus, Lifetime Matching Bonus thing works, I assume that it's just keyed off of future sales. And so if sales occur, there's bonus accruals that happen, is that correct?

Yes. Real simply, what they do is if I personally sponsor someone and bring them in the business and they earn a check, I get a match on that as long as they meet certain criteria and I meet certain criteria. So it's the way to go back and leverage their investment in time in the business. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay. But it is ultimately performance based?

Absolutely. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay, terrific. And then just any further color on the Philippines. It's not a brand-new market but a pretty impressive number there. Maybe you gave it and I missed it.

It's pretty exciting to see some markets get off to an extremely fast start. And from the day we opened our doors, they're flooded. Then others take a little while to going, but then when you pick up momentum, the momentum is a beautiful thing in the Philippines. It has picked up momentum in the last year or so, and it continued to fly high and grow at a great pace. And the events over there are amazing. If you go on a weekday, you only get 4,000 people. If you go on a weekend, you get 7,000 or 8,000 people on a meeting. So it's just a fantastic market, full of energy. And we're excited about the future.

We have no further questions at this time. I'll hand the call back over to you, Mr. Richards, for closing comments.

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.

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