USANA Health Sciences, Inc. (USNA) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning, and welcome to the USANA Health Sciences Third Quarter Earnings Conference Call held on the 24th of October, 2012. [Operator Instructions] I would now like to hand the conference over to Patrique Richards. Please go ahead, sir.

Good morning, everyone, we appreciate you joining us this morning to review our third quarter results. Today's conference call is being broadcast live via webcast and can be accessed directly from our website at www.usanahealthsciences.com. Shortly following the call, a replay will be available on our website. As a reminder, during the course of this conference call, management will make forward-looking statements regarding future events or the future financial performance of our company. Those statements involve risks and uncertainties that could cause actual results to differ, perhaps materially, from the results projected in such forward-looking statements. 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 strategies during the quarter, as well as our strategies moving forward. We will then hear from Doug, he will discuss our financial results and 2012 updated financial outlook. I will now like to turn the call over to Dave.

Thanks, Pat, and good morning, everyone. For the third straight quarter, USANA has achieved record results. In the third quarter, we generated 15% top line growth and 41% net earnings growth. These results were driven by momentum in our underlying normal course of business, which continues to build in most of our markets worldwide. I believe that this momentum is an indication that strategies we have put in place are working to grow our business. The highlight of the quarter was certainly our international convention, where we held our 20th anniversary celebration with our associate sales force . At this event, we had record associate attendance, record convention sales and a world class line up of speakers and events. The most significant part of the convention was the unveiling of our personalization strategy, which focuses on our customer and their unique experience with us. To launch the strategy at convention, we announced that our personalized MyHealthPak product will be made available to our markets around world. We've introduced 2 new applications that are designed to help our Associates customize USANA products and business opportunity for their potential customers. And we unveiled a fresh new look and message for our company and its products. You may have heard that we also gave a free iPad to every distributorship at convention. The iPad was in part a gift for our Associates' dedication to USANA, but more importantly, the iPad giveaway was a great way to introduce the technology and apps that support our new personalization strategy to our Associates and I will explain why in a moment. First, I want to discuss the expansion of our MyHealthPak product to our countries -- to other countries because I truly believe our personalization strategy starts with this product. MyHealthPak is our premier supplement pack that allows our customers to create their own personalized combination of USANA supplements in a convenient to-go package. Our customers great these customized pack online by selecting the supplements they want in our easy-to-use interactive application. After they have customized their MyHealthPak, our state-of-the-art production line assembles their personalized product pack in conveniently daily to-go packs with their name printed on the box and each individual a.m. and p.m. sachet. Until now, MyHealthPak has only been available in the U.S. and Canada, where it has become a key part of our business and our message as a company. The availability of this important product in our Asia-Pacific region is significant, not only to our customers there but to us here at USANA as well. Our Asia Pacific region represents about 62% of our total sales, and I'm excited about the potential of MyHealthPak in this region. In addition to expanding MyHealthPak's availability, we've introduced 2 exciting new apps at the convention that promote personalization. These apps, which were launched in beta version are our proprietary True Health Assessment and True Health Companion, and they're designed for use on iPads and other platforms throughout the web. This is one reason we gave away free iPads at our 20th anniversary celebration. The True Health Assessment is a short interactive questionnaire for our Associates to evaluate their health need and the needs of their customers. However, the True Health Assessment is not your typical questionnaire. This questionnaire uses minimal written text and instead provides graphical -- graphic intensive images to gather information. Customers respond to the images through an interactive drag-and-drop point-and-click process. The app is very intuitive and asks you about lifestyle, daily activities, eating habits, health goals and more. After you respond to the apps questions, it gives you a list of your top health risk areas, a customized lifestyle plan and a personalized nutrition program. It's intended to be a roadmap to health and wellness for our customers. This will create the belief in the products from the beginning because we are giving them the right products for them that they value. If the True Health Assessment is the roadmap, the True Health Companion is the GPS that helps get our customers to their destinations. In simple terms, it is a wellness app that helps our customers manage, maintain and monitor their health progress on a daily basis. It will create a meal plan for you, provide you with endless healthy recipes and remind you to take your supplements. You can also plug your fitness and weight loss goals into the app and it will help you achieve them by charting your weekly nutrient intake and providing daily exercise recommendation along with helpful videos. There's also a social media component to the app that allows you to share your success with friends, family or teammates, which is the all-important accountability factor. But the True Health Assessment and the True Health Companion use the latest technology in our free and easy-to-use for Associates and definitely captures the cool factor. These apps along with the iPads are intended to change the way our Associates introduce USANA to customers. Instead of approaching a potential customer with just a conversation about our products and business opportunity, these apps allow our Associates to transform their initial conversation into something that is personalized to the wants and needs of that customer. I'm excited about this new apps and what they will mean to our sales force and the company going forward. Finally at our convention, we unveiled a new look and message for USANA and its products. This message, of course, is centered on personalization. Our look is represented through new branding, a new logo, and new packaging. Each of these has been professionally designed to reflect USANA's strength and focus on personalization. Our new tagline is, "Your health, Your life, Your way." We have been saying for sometime now that we believe personalization is the future of nutritional supplements in direct selling. Our new look and method will help us personalize every aspect of our Associates' experience with USANA. While we believe that the initiatives we launched at convention are strong part of USANA's personalization focus, they are only the beginning. Now, I'd like to take you through our regional results for the first quarter -- for the third quarter, excuse me. Momentum continues to build in our Asia Pacific region, where both sales and the number of active Associates increased by 21.6%. This growth was driven by double-digit sales in Associate growth in Southeast Asia Pacific and Greater China, as well as local currency sales growth in nearly all of our Asia Pacific markets. Factors that led to this growth include increased Associate counts in many markets and price increases that were implemented in certain markets back in the first quarter. The Philippines, which increased 73.8% of sales was again a significant contributor to the growth in this region. We're pleased with our results in Greater China this quarter, and believe that the plan we have put in place for this important region is beginning to take hold and build momentum. As discussed on previous calls, this plan is centered on educating our sales force on our products and opportunity in China, integrating our overall systems and improving our sales and training processes, all to personalize and improve our customers experience with us. The USANA branded products that are available in China continued to be -- to do very well and feedbacks from our Associates are positive. During the fourth quarter, we anticipate continued momentum in this region as we hold our annual convention and launch 2 more skin care products in China. Turning now to North America. We are pleased to report that sales in this region increased 5.9% year-over-year and were up modestly on a sequential quarter basis. Associate counts in North America were down slightly year-over-year, which also is an improvement over the historical trend. Sales growth in North America is being driven mainly by increased Associate productivity in the U.S. and continued customer growth in Mexico. In the U.S., an increasing number of our Associate leaders are increasing their personal activity, as well as developing their sales organization. The plan we in place for North America is to continue strengthening the working relationship between USANA and its Associate leaders, and to identify and develop specific incentive offerings for North America, designed to spur long-term growth in this region. While we are optimistic with the progress that we are seeing in North America, there is still significant work to be done to get North America where we believe it should be. And we are committed to doing that. In closing, I want to reiterate that I am pleased with the momentum we are seeing in our business and I'm confident that this momentum will drive USANA to another record year for 2012 and beyond. With that, I'll ask Doug to review our financials and discuss our updated guidance.

Thanks, Dave, and good morning, everyone. I will begin by reviewing our third quarter financial results and commenting, once again, on the better than anticipated results. I'll then discuss our updated financial guidance before turning the call over for questions. As Dave mentioned, sales were up 15% in the third quarter and came in better than we projected. Our active Associate base increased 13% during the quarter, and was primarily a result of strong growth in the Asia Pacific region as well as Mexico. Other notable items that contributed to net sales growth include the price increase we did in certain Asia Pacific markets at the end of the first quarter, increased productivity from Associates in North America, sales contributed from our new market of about $1.1 million, and sales from our International Convention held here in Salt Lake City, which were about $760,000 better than what we did last year. These benefits were partially offset by changes in currency that negatively impacted sales on a year-on-year basis by about $1 million. Gross margins during the quarter declined 80 basis points, largely as a result of increase in material costs and the negative impact of changes in currency. These increases were offset in part by price increases that we -- that I mentioned previously, and the ones were implemented in the first quarter. Associate incentives, expense for the quarter decreased to 42.6% of net sales compared to 46.1% in the prior-year quarter. This decrease can primarily be attributed to the price increase I've noted above, and also the change to the Lifetime Matching Bonus. Please keep in mind that we expect the payout into the Lifetime Matching Bonus to increase relative to sales over time. These benefits in Associate incentives were partially offset by spending on contests and promotions that we ran during the quarter. SG&A expense in the third quarter from a relative perspective was in line with our expectations and came in at 24.4% of net sales, up 110 basis points from the third quarter of 2011. The year-over-year increase in absolute spending can primarily be attributed to the expense associated with our 20th anniversary event at our International Convention held in August, cost associated with the opening of our new markets, increased staffing to support our growth objectives, increased public relations and marketing activities, and general increase in spending on cost that fluctuate with the variable nature with sales. Our effective tax rate for the third quarter was in line with our expectations at around 28% of pre-tax income and meaningfully better than last year. This decrease was due to a favorable adjustment in our manufacturing deduction for the 2011 and 2012 tax years, which was recognized during the current year quarter following the completion of the formal study. We expect our effective tax rate to be approximately 33.5% in the fourth quarter and just over 32% for the year. Earnings per share for the third quarter increased 45.7% to $1.18 per diluted share. This increase can be attributed to higher net earnings and a lower number of shares outstanding from share repurchases over the last 12 months. For the quarter, the company invested $8.9 million to repurchase 200,000 shares. At the end of the quarter, there was approximately $14.5 million remaining in the Board-authorized repurchase program. As a matter of note, at our quarterly Board meeting held yesterday, the Board approved an increase of $50 million to the existing authorization. Therefore, we now have approximately $64.5 million authorized under the share repurchase program. You should see a press release later today on that. Turning to the balance sheet. We continue to generate strong cash flow from operations and ended the quarter with $77 million in cash. Cash generated from operations totaled just under $20 million for the quarter and $64 million for the first 9 months of the year. I'd now like to provide some details on our updated guidance for the remainder of 2012. We now expect net sales for the year to be approximately $645 million. We're taking sales up as a result of strong Q3 results and continued momentum in the business. We believe this momentum will continue into Q4 as a result of the excitement surrounding the Lifetime Matching Bonus, the iPad giveaway and related apps, as well as initiatives and promotions we have planned for the remainder of 2012. We're also increasing our earnings per share guidance for the year to be between $4.35 and $4.40. This increase in our guidance for earnings per share can be attributed to the strong third quarter results and anticipated reduction of SG&A spending during the fourth quarter relative to what we spent in Q3, and leverage benefits on an increased top line outlook for the year. Our EPS estimate reflects a diluted share count of about 14.9 million shares for the fourth quarter of 2012. And although we don't provide 2013 guidance until -- we come out with our fourth quarter results, I just -- I want to go back and make sure that everybody's plugged in the fact that on an ongoing and long-term basis, we expect our operating margin and we target our operating margin to be within the 14% to 15% area, and we plan to go back and invest in growing our customer count in a more matured markets. We plan to continue to invest in our personalization strategy, and we're still waiting to go back and get all the feedback on the material costs that we expect for the upcoming year. With that, I'd now turn the time over to the operator to facilitate the question-and-answer session.

[Operator Instructions] The first question comes from Tim Ramey from D.A. Davidson. Timothy S. Ramey - D.A. Davidson & Co., Research Division: I may have missed it and I know you had strong results in Greater China, but would you mind giving us a little granularity over what happened with mainland versus Hong Kong? Because that's kind of been a source of interesting shifts in sales in previous periods?

We saw north of 20% growth in each of those markets and also strong growth in Taiwan. So we continue to see growth overall in the Greater China region. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Can you give us a little more specificity than just the north of 20%. I mean, I think you're up, what, 27% overall?

Yes. We see that the mainland China outpacing the rest of the markets. But like I said, we're running essentially as one region now and we kind of look at it as one, but... Timothy S. Ramey - D.A. Davidson & Co., Research Division: Great. Okay. And would you say the same for -- I mean obviously, a big increase in recruitment as well. Does that track kind of the sales pattern?

Yes. The active customer accounts that you see are well-correlated in the Greater China region. Absolutely. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Got you. Okay. You didn't spend a lot of time talking about the performance of the new markets and maybe that's because the existing markets were so interesting. But is there anything else that we should really be talking about from the new market entries of this year?

No. It's going slower than we anticipated, Tim. I think we're moving in the right direction. But it definitely haven't jumped out of the gate as we anticipated. But we are seeing slow and steady progress, but it is progress.

We had some unusual experiences in both of those markets with some -- just some of the situations that were before and during, so -- had some more computer glitches in some places than normal, which was strange. And so we're getting all of the bugs worked out and we believe that we'll get them going. But we didn't have the jump out of the gate that we were hoping for. We did just have a fantastic event in Paris a month or so ago, where we had great attendance and great guest count, which was great to see. Usually, you don't have so many guests at an early launch of a meeting. So that means they were bringing a lot of people that hopefully will get rolling. And we've just started to see some good things after that meeting, so we're very optimistic. Timothy S. Ramey - D.A. Davidson & Co., Research Division: I didn't get my invitation to that, but I will look for it.

In the mail somewhere. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Dave, it will be great if we could kind of argue that North America is back to a growth trajectory and some of the innovation, the personalization, the apps and so on, makes me hopeful for that. But how would you react to that comment? Have we got the right recipe for growth in the North American region at this point?

I think we've -- I do feel like we've turned things but we need to just continue to make additional adjustments to grow that momentum, not into just a little bit of momentum, but to get it really cranking. And we've got a good trust relationship going with the field right now, which is, I think the most critical thing. But with the other -- this cool factor with what we've been launching, I think people are starting to talk. And we really believe that we can get a lot of excitement and momentum rolling but it keeps -- it takes the tweaking of a number of good things to get all cylinders firing great. Good attendance in meetings. Good response to the convention. I mean to re-change your whole look and feel and not get hardly a complaint is unusual because change is really tough. People are excited about the new USANA, and we feel that energy. So we're looking forward to getting it rolling a lot faster. And that's is going to take time, because it's a big ship to move.

The next question comes from Frank Camma from Sidoti. Frank A. Camma - Sidoti & Company, LLC: Just a quick question. You had last quarter, you had called out Philippines as particularly strong growth. I was just wondering what happened in this quarter in that market?

If you look at the last several quarters, Frank, Philippines has been knocking the cover off the ball. They have been doing very well for several quarters in a row now. So it's just kind of a continuation of that thing. Frank A. Camma - Sidoti & Company, LLC: So the flooding that occurred there didn't really have any issues on your business?

We have not seen that. Frank A. Camma - Sidoti & Company, LLC: Oh great. Were there any markets that -- you mentioned that in Greater China that the growth was pretty balanced. were there any markets in particular outside the Greater China that really did well, exclusive of what you -- Philippines?

I think Mexico has been running pretty consistent as well. Frank A. Camma - Sidoti & Company, LLC: Was there anything unique about Mexico that would have accounted for that?

Yes. Well we [indiscernible] but it's general momentum thing that we've seen in the field down there. Sometimes it's hard to put your finger on things like -- it's a very optimistic Associate base down there. We're pleased with the top line in the U.S. But I think as Dave mentioned, we've got some work to do. The customer accounts we need to see moving in the right direction, but we're working on it.

And as I've mentioned in my opening comments this -- underlying business was nothing really unusual, which is nice to not have any extreme events or one-time event. It just seems to be nice building momentum as the underlying business, the general business, which is great to see. Frank A. Camma - Sidoti & Company, LLC: Good, good. Just a final question, was a clarification, really. You mentioned that on a long-term basis, I know you don't -- obviously, not giving guidance for next year, but you're looking at operating margins in the 14% to 15% range and that was based off of reinvesting some money back into the business. Can you just clarify that a little bit? Like, specifically how you -- why that would occur if you've -- traditionally, you been expanding the operating income margin pretty nicely?

Yes. I think the 2 primary focus you see is continued investment in this personalization strategy, as well as going back and investing in some of these more mature markets where we see a little bit more stagnant customer counts. I mean those are the real emphasis that you see. We also just -- even though we haven't got the final prices in, we expect the general inflation and the cost of the raws, I think the drought had some impact there. We've seen some pressure, but we still haven't got all that information in. But the general concept here is, Frank, is that what we think the business and the long-term growth of the business is dependent on us going back and reinvesting that money back in the business, either through the Associates or the infrastructure of the company.

The next question comes from Rommel Dionisio from Wedbush Securities.

Guys, could I just touch base on the active Preferred Customers by region? I just noticed a drop-off on a sequential basis and the year-over-year basis in Asia Pacific in particular. With that market, sort of posting 22% of sales growth. Could you just help me reconcile that number?

For whatever reason, Rommel, we really see the Preferred Customer just resonate better in North America, 80% of preferred customers in North America and all -- we all think it's important. I think we do have some Associates over in Asia Pacific that act like Preferred Customers like we do here. But I think it's just a different mentality with how we -- with how they approach the...

The barrier to go from Preferred Customers to distributor is so small that a lot of people just decided it's safer to go to the distributor level, just in case somewhere down the road they changed their minds and they decided they want to build a business, but for an extra $20, $25, they're willing to invest that to be Preferred Customers or discount buyers but take that distributor status. So that if they find that they are referring products as they enjoyed them and like them to their friends, family, people they meet, then they can decide to start a business because they're already there and ready to go.

Okay. And then just one quick follow-up, any update on the weight management? I know you guys mentioned recently that you may look to expand the product line sometime next year. Any update on that?

Nothing to update at this time. We know it's a big market, so we continue to look at it. But we want to make sure do it right. We can do it with personalization and so, I don't know when it will get done but we're working on it. I don't think it will be too soon. We've got a lot to put together. Personalization adds some complexities which will add some costs as we talked about with the earnings line as we invest in more technology and IT because we want to be the best at it and own that space. And so it's going to take some investment, some time to redo our weight management with that personalization in mind.

The last question comes from Scott Van Winkle from Cannacord Genuity.

Thinking on the Preferred Customer question that Rommel had, if you look at the North America number, it was up year-over-year and it's been quite sometime since Preferred Customers were up year-over-year in North America. Is that an indication of kind of the healthy turn that we're seeing in the market?

That or the elections, I don't know. No. We're starting to see -- we're seeing that the renewed confidence and excitement. And I think that gets our Associates active and it's great to see the Preferred Customer go up in this region since it is a significant part of our business. Where Asia Pacific, it's a pretty small part of our business. So up or down, it doesn't really have as much of effect. So it's starting to see a turn here in North America. We hope when we see that preferred customer count turn -- and we need to really get the active Associate count number moving here, and we know that. And that's what we're focused on. We've got a number of strategies we're working on to bring in more people, but keep them longer. And so we hope personalization will be a huge factor in that.

With the matching bonus, I mean, you've got experience for almost a year with playing with that in the U.S., obviously in a different model prior than the lifetime one now. Has that had any impact on retention? I would assume that the sponsoring distributor is more engaged?

Well we're actually coming up on 6 months. And about 3 weeks, we'll be 6 months since the new Lifetime Matching Bonus. And we gave -- or grandfathered people of the choice of staying with the old matching bonus or switching to the new matching bonus. So we still have some of each on each plan until November 17. So it's really too early for us to make any predictions or really make any conclusions from it. But we believe it's moving us in the right direction and we're starting to see that in general from the market. So we'll need a little more time to evaluate when the other one actually ends in 3 weeks -- and we're -- to one plan only, the new plan.

Okay. And then looking at the productivity in North America, can you put your finger on one specific driver? Is it better tools, or is it the shrinking associate count is really taking off the lower productivity Associates? Is there one thing we can kind of point to on the productivity side?

Each time we've gone through a cycle that I've seen in the business, it's really when the leaders become reengaged, get active, have the confidence and the trust and get -- not just managing their business, but get active in building their business. We can see the difference in their actions by what they're doing. They talk a lot about managing their groups, but then there's the times when they're leading by example. When they are leading by example, that's when we know that the duplication will happen. And we're starting to see that because the people have the confidence. They're excited about personalization. And so I think, that's the bigger factor than anything. And I've seen this a couple of times as we've gone through cycles over the years where we flatten out for a little while, but then we take off into new wave of momentum which we've done a couple of times. Usually about a 6-year cycle, 6 or 7-year cycle on each.

Okay. And then the another question is about Greater China, and you talk about your strategy starting to take effect. I mean, a big sequential increase and very robust year-over-year growth in Greater China, was there -- was something this quarter that created a catalyst? I know there was a price increase. But it seemed like a lot more than a price increase that drove this kind of jump off we saw in Q3 in that market?

We're doing, we've been -- had some meetings and done some trainings to really -- to get people focused on the mainland part of Greater China. And nothing really large helped -- happened in this quarter, but just a number of events will continue to grow and build on. And we think we'll see more and more momentum as we make that transition in our strategy -- we put it together and finalize it to get China growing to the level we know. Because it's going to be our the biggest market. We know that. It's going to be huge. And it's taken some time and some effort, but I think we're starting to see the beginnings of it. and we're excited about that.

Scott, I think the other thing to note is on a year-over-year basis and understand that the Q3 of 2011 was a little bit softer than we typically see because the runup in Q2 was the communication strategies with Hong Kong and China.

Yes, pull forward. But even with the pull forward -- it was $45 million last year, 60 over 45 is a darn good number. And then last question would be on the new markets. The Philippines, which you talk about has been flying here for the last 3 quarters. That market started real slow, too. What was the inflection point in a market like Philippines that might give you a maybe a roadmap for what's going to happen in a Thailand?

That's the beautiful thing about this business when you have momentum. I mean yes, Philippines took a while to get going. But when you have momentum, it feeds off of itself. When you go from one leader, one diamond to 5 diamonds, it really magnifies or multiplies what's potential there. So we needed to develop some leaders in France. We needed to get some more leaders in Thailand. And when we do that, we'll get one, but until we start to get multiples, then that's when you get that multiplying effect. It takes a little time to build leadership and to sift through to find the people that have that hunger and will build a huge business. So we will keep looking and sifting through to find those leaders in both areas and then we'll have to multiply them when we do get them.

And Dave, how many people were at that Paris meeting? Is it a couple hundred at this kind of stage or 100?

I've heard 500 to 600. I was unable to attend. So 500 to 600 people.

Thank you. There are currently no further questions. Please go ahead with any other points you wish to raise.

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.

Thank you. Ladies and gentlemen, this does conclude the USANA Health Sciences Third Quarter Earnings Conference Call. Thank you for your participation. You may now disconnect.