USANA Health Sciences, Inc. (USNA) Q1 2013 Earnings Report, Transcript and Summary

Welcome to the USANA Health Sciences First Quarter Earnings Conference Call on the 24th of April 2013. [Operator Instructions] I will now hand the conference over to Patrique Richards. Please go ahead.

Good morning, everyone. We appreciate you joining us this morning to review our first quarter results. Today's conference call is being broadcast live via webcast and can be accessed directly from our website at www.usanahealthsciences.com. Shortly following the call, a replay will be available. 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 those regarding our personalization initiative, our strategies for each of our regions and our outlook for 2013. 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 Paul Jones, our Chief Financial Officer. Today we'll begin with a review of our operational progress and highlights during the quarter. Then Paul will provide a more detailed look at our first quarter financial results and the financial outlook for 2013. I will now turn the call over to Dave.

Thanks, Pat. Good morning, everyone. The first quarter of 2013 was a strong start to the year and marked the company's fifth straight quarter of both record sales and earnings per share. During the quarter, our management team continued to execute our 2013 strategic initiative, which include: Generating worldwide customer growth, advancing our personalization initiative, growing our greater China region and driving new market expansion. This morning I will provide an update on our progress in these areas and also discuss our regional results. Expanding our loyal customer base of product users and business builders is a significant goal of ours for 2013 and beyond. During the quarter, we executed a number of strategies to accomplish this goal. We continue to focus on training our Associate leaders, particularly on personal development and leadership skills. Our management team actively participated in a variety of Associate events, meetings and calls in each of our regions. We also train our leaders on our personalization strategy at these events in how to use the True Health Assessment and True Health Companion to customize the USANA experience for current and prospective customers. The True Health Assessment is an app that contains a short interactive questionnaire for our Associates to evaluate their health needs and the needs of their customers. The app is very intuitive and asks you about your lifestyle, daily activities, eating habits, health goals and more. The app gives you a list of your top health risk areas, a customized lifestyle plan and a personalized nutrition program. The True Health Companion 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, remind you of your fitness goals, provide you with endless healthy recipes and remind you to take your supplements. Both of these applications were made available worldwide during the quarter in the associates' respective languages. Additionally, the True Health Assessment now allows the Associate to immediately enroll a new customer, activate an ownership for the customer and order and pay for the customers' products. These capabilities make these apps the ultimate sales and marketing tool for our Associates. During the quarter, we also offered an iPad promotion in North America, which focused on enrolling new customers through the True Health Assessment, as well as promoting our ownership program and MyHealthPak products. Under this promotion, new Associates who completed the health assessment and made an ownership commitment received a free iPad. This promotion generated a lot of excitement and provided management with an excellent opportunity to educate Associates in how to use the app to market USANA customers. Another strategy we put in place to expand our customer base focuses on several of our mature markets, specifically, Canada, Australia and New Zealand. During the quarter, we implemented price reductions in these markets to better align our product pricing with the economic and competitive environment. Our management team adopted this strategy after evaluating considerable market research and meeting with our Associate leaders. Although this initiative is in the early stages and will likely result in some short-term pressure on our top and bottom line results in these markets, we expected to generate much greater potential for our customers' growth over the long term. The Lifetime Matching Bonus program is another tool that allows us to target customer growth. This bonus is a key incentive for our sales force because it's perpetual and sets our Associates to create long term and sustainable sales organizations. During the fourth quarter of 2012, we completed our phase out the old matching bonus program and phase-in of the Lifetime Matching Bonus. The lower payout of the Lifetime Matching Bonus will allow us to continue implementing customized incentive in each of our regions to promote consistent and steady customer growth. Our team is confident that the successful execution of these strategies will drive consistent customer growth for USANA in 2013 and beyond. Turning now to our regional results. During the quarter, we continue to generate solid sales growth in Asia. Sales increased 11.2% in greater China and 9.5% in Southeast Asia Pacific. The greater China growth was driven by strong sales growth in mainland China. The number of active Associates in the region increased 4.8%, which were again led by Associate growth in mainland China. In addition, we generated $3.7 million sales from our Asia Pacific convention, which took place in Hong Kong during March, but was held in Australia last year. Keep in mind that by comparison, the first quarter of 2012 included an estimated $9 million surge in sales ahead of the announced price increases in Hong Kong. These price increases contributed an estimated 2.2 to sales this quarter. By all measures, our AP convention was a major success. We had over 8,000 Associates in attendance, who received recognitions for their impressive efforts, as well as education in several areas, including personalization and the use of the True Health Assessment. We announced our Asia Pacific incentive trip, which is designed to encourage Associates to build their business in a solid sustainable way and has generated a lot of enthusiasm from the field. This year's convention was so popular that in the 5 days following the event, our 2014 AP convention sold out its 13,000 seats, which is an excellent indicator of the enthusiasm of our Associates in this region. During the quarter, we were also pleased to receive government approval in mainland China with direct sale licenses in 3 additional provinces and municipalities. We believe these approvals demonstrate USANA's successful efforts to comply with the direct selling laws in mainland China, as well as our strong government relations. In addition to the receipt of these new licenses, we will expand 2 of our branches and renovate certain branches in major cities in the coming year. Growth in greater China continues to be a major focal point of ours 2013 and beyond. Sales growth in Southeast Asia Pacific was again driven by double-digit sales and Associate growth in the Philippines. Although sales in Australia and New Zealand were flat during the quarter due to our pricing initiative, the number of active Associates in these markets increased 14.3% and the number of preferred customers also showed solid year-over-year growth. We believe that the increases in our customer base in Australia and New Zealand is due to a combination of a promotion that we offered during the quarter, our pricing initiative and momentum that appears to be building in these markets. Turning now to North America. Sales for the region increased 9.4% as a result of double-digit sales growth in both Mexico and the U.S. Our sales growth in Mexico was driven by a 9.1% increase in Associate count and price increases that were implemented during the quarter. The sales growth in U.S. was driven by increased Associate productivity, as well as price increases on certain of our products that were implemented during the quarter. While we continue to see our operating trend improve in North America, particularly on the top line, we recognize the need for additional improvement in customer accounts in the U.S. and Canada and we will continue to focus these markets. During the quarter, we held regional events and management tours in each of these markets and have phenomenal attendance at each event. We also have region-specific incentives planned for 2013 in the U.S. and Canada, aimed at generating customer growth. We also held a regional event in Mexico during the quarter with record attendance. The most exciting announcement at this event was the news that USANA will open in Colombia in the third quarter of this year. Colombia will be our 19th market worldwide and marks our initial entrance into South America. Colombia is the fourth leading direct sales market in Latin and South America and the 16th largest overall direct sales market. More importantly, Colombia should be an excellent market for USANA in light of our strong business in Mexico and our Associates' ties and connections to Columbia. In closing, I'm pleased with the underlying strength of our business and excited about the initiatives we have planned in 2013 for each of our regions. I fully expect our business to continue to produce excellent results as the year progresses. With that, Paul will review our financials and discuss our updated guidance.

Thanks, Dave. I'll begin with our first quarter financial results and then discuss our updated financial guidance before turning the call over for questions. Sales for the first quarter increased 9.7%. Our active Associate base increased 4.6% during the quarter, primarily as a result of customer growth in several markets in Asia Pacific, as well as solid results in the U.S. and Mexico. Notable items that contributed to net sales growth include Associate growth in Asia Pacific, increased productivity from Associates in North America, a net positive impact of approximately $1.1 million from price changes in 2012 and 2013, sales of $1.1 million from our newest markets, and favorable changes in currency exchange rates that contributed just under $1 million to the top line for the quarter. Gross margins declined 20 basis points year-over-year, largely due to changes in the sales mix by market. These increases were partially offset by production efficiencies and a net benefit from price changes implemented over the last year. Although we had a small year-over-year positive impact from price changes made over the last year, I believe the remainder of 2013 will yield a more neutral to slightly negative impact from the price reductions implemented near the end of the first quarter. Associate incentives expense for the quarter decreased to 41.3% of net sales compared to 44.1% in the prior-year quarter. This decrease can primarily be attributed to the change to the Lifetime Matching Bonus program launched in the second quarter of 2012. The phase-out of the old matching bonus and the phase-in of the new Lifetime Matching Bonus occurred over a 6-month period and was completed during the fourth quarter of 2012. Price increases implemented over the last year also reduced our Associate incentives expense. These benefits were partially offset by spending on contests and promotions that we ran during the quarter. Looking forward, we expect Associate incentives to grow to around 42.5% of net sales as the long-term benefits of the new Lifetime Matching Bonus are realized by our Associates. And as we implement additional region-specific promotions, SG&A in the first quarter was 25.1% of net sales, an increase of 40 basis points from the first quarter of 2012. This year-over-year increase can primarily be attributed to increased wages and benefits, costs associated with the opening of our new markets, increased regional Associate trainings and meetings and increased public relations and marketing activities. Our effective tax rate for the quarter was 33% of pre-tax income, which is an improvement of 150 basis points from 34.5% in the prior year. We expect our effective tax rate for the year to range between 33% and 33.5%. Net earnings for the first quarter increased to $17.8 million, an improvement of 29.3% compared with the prior-year period. This increase was due to higher net sales and lower relative Associate incentive expense for the quarter. Earnings per share for the quarter increased 42.2% to a record $1.28 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 $18.1 million to repurchase 414,000 shares, and there's approximately 13.6 million remaining under our authorized repurchase program. Turning to the balance sheet, we continue to generate strong cash from operations and ended the quarter with $71 million in cash. Cash generated from operations in the first quarter totaled $20.3 million. As I am sure you have probably noticed, our inventory was up nearly 18% from year end. The increase in inventory primarily relates to the introduction of longer lead times in our operations process, as well as a strategic decision to increase inventories in Greater China due to increased sales and future expectations of business in this region. I'd now like to provide some details on our updated guidance for 2013. We continue to believe that net sales will be in the range of $700 million to $720 million for the year. Our top line expectations are based on the general momentum in the business and projections surrounding the implementation of the strategies Dave has just reviewed. Diluted earnings per share for the year is expected to be between $5.25 and $5.40. We are taking our EPS outlook up due to better-than-expected first quarter earnings per share results, a more favorable outlook on gross margins than we had previously modeled, a lower diluted share count due to our share buyback program over the last year, our EPS estimate now reflects a diluted share count of 13.8 million shares for the full year 2013. With that, I will now ask the operator to facilitate the question-and-answer session.

[Operator Instructions] The first question comes from John San Marco from Janney Capital Markets.

What drove the quarter-over-quarter decline in active Associates in Greater China?

Probably a number of things. But we had a new system that we're implementing over in Greater China, updating our computer systems. We had a number of difficulties and challenges with those systems. We may have had a number of people getting in and placing small, onetime orders as they were checking into the system or struggling with the system and getting frustrated. So we feel we probably had some people and some customers that were small, onetime orders that made that number larger. And now we're on a run rate that makes sense with where we should be.

Got it. And are those -- the systems issues, will they be contained in the first quarter?

They are behind us already. So it was a painful period, as all computer system upgrades are. We had to move the systems in China to our platform and our database and all that. So it was a painful experience like it's been for the company over the last 20 years whenever we had to do a major upgrade. But you suffer through it for a few months, and then you keep move on and keep going.

Got it. And how many of the active Associates in that segment are from BabyCare?

We typically don't break out those by country, but we have seen a good increase in the Associates that are going to BabyCare. We are seeing some significant growth in China itself.

Okay. And then what was the revenue contribution from -- I'm sorry if I missed this, from new markets opened in North America, in Europe?

The new markets in Europe?

Just over about -- in Europe, just about $1 million. If we're looking all of our new markets from last year combined, it's just over $1 million.

Got it. Okay. And I think the new markets -- certainly last year, were ramping slower than you anticipated. And I guess the maybe even in the quarter, that was a little slower than you would've anticipated when you launched. Number 1, is that true? And then number 2, what are the plans to sort of ramp those more rapidly?

We're definitely not happy with how fast we're going there. We always want to go faster. We are seeing some progress in some areas. But some markets take a year or 2 to mature and develop and get the leadership that it needs to take that market and drive it. So we don't expect it to happen overnight. Some markets are fast like that, but most markets take a year or 2 to develop, build leadership and then you'll see the sustainable growth. So early on, we're never happy because we always want it faster. And we're definitely not happy with it so far. We're going to keep putting efforts into creating the long-term strong business in those new markets.

Got it. But from your perspective, there is no need for a new game plan. You've got the right game plan. It's just a matter of patience?

Yes. These new markets are the smaller markets. I mean when we look at the big markets, it's North America, it's China. Those are the big markets. And so adding these, they add additional regions and opportunity, But we're not going to grow the company based on just adding new markets.

Great. And then last question. Thank you for the details on the inventory growth during the quarter. I was wondering if you could just address the same issue but over the longer term? I guess it's been several years now. Days of inventory has sort of leaked higher [ph]. Just wondering why we've seen less efficient use of inventory and whether there's an opportunity to improve on that?

We do see an opportunity to improve in that right now. As we mentioned earlier, our desire -- because of such a low carrying cost and because our high desire and our major focus is customer service, we have chosen to increase our lead times in some of our inventory carrying costs. We believe in 2012, we were a little bit lower than we'd like to be in some of that. I think what we will see over the next year as we would see that drop from the $43 where it's at down to $2.5 million from where it's at on a consistent basis. We just want to make sure that we have -- in the greater China region, we have those markets taken care of as we go forward.

Got it. And you'll be able to reduce that inventory without impacting lead times?

Yes, we will.

The next question comes from Tim Remy from Davidson & Co. Timothy S. Ramey - D.A. Davidson & Co., Research Division: A couple of questions on -- just to revisit John's question, I think I recall, we talked about this computer glitch. And it seems to me that was last -- was it last December? So I mean, it really was a 4Q event that perhaps had some lingering impacts into the 1Q. How would you characterize that?

It took a few months to get things running as smoothly and as fast as people are used to around the world. And so we definitely had our struggles, but people understood that it was creating the foundation for the future. And so they tolerated it, as we all have to when we're running into those computer glitches inside or outside of companies. And yes, there was a lot of testing of the system, a lot of skepticism as they waited to say, "Okay, now it's good to go." First quarter we've had 0 issues that I've heard off. It's all been up and running smoothly back to our normal USANA standards. A lot of the -- sorry, Tim, a lot of those changes happened in October and November. We saw some hit in December. But fourth quarter was really when we saw the bulk of those challenges and we should be through those. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay. So we shouldn't really think about this as something to wrap against in terms of the comp in the 4Q of this year. Or do you think -- I mean, if you're characterizing the orders as smallish, not real sticky to the model, that may or may not be an important comp issue?

I don't think it's an issue that you need to worry about going forward. It's something that's really behind us. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay. And then I noticed on your 10-K, you had 13.5 million shares outstanding as of March 1. Share repurchase has been spectacular, particularly doing that and maintaining a cash level. You just mentioned 13.8 million shares for all of '13. Would you say that the dilution factor right now is somewhere around that 300,000 shares? Or have you got a handle on that, Paul?

Yes, that's a fully diluted. And yes, we do believe it's around that 300,000.

Okay. That's correct. Timothy S. Ramey - D.A. Davidson & Co., Research Division: So your guidance doesn't include any further share repurchase?

No. It does not. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Okay, great. And then just on the SG&A expense that was higher, you touched on that but I'd love a little further color on how that might shape up for the rest of the year, and what the factors were made it higher in the 1Q?

Well, wages and benefits and -- really, it comes down to a couple of strategies. We're looking at -- as we mentioned last quarter, investment into our IT infrastructure and helping that to get us ramped up and moving. We're also -- we had some increased expenses from the AP convention, which was very successful and a large turnout for that event. And then we've had our regional meetings that have contributed to that. So we would anticipate that we would see some leverage out of that SG&A but I think what we've anticipated for the year overall will be in there. Same range. Timothy S. Ramey - D.A. Davidson & Co., Research Division: Did you say a number for the year overall? If you did, I missed it. Or about the same range about 25%?

Yes. We think it'll be down just a little [indiscernible] basis points but real close to where we're at.

The next question comes from Rommel Dionisio from Wedbush Securities.

You guys had some really nice acceleration in the U.S. business the last few quarters. And I wonder if we could just talk about the impact of personalization MyHealthPak has really had on that segment of the business. I know you guys spent a lot of time and attention on that at the convention last summer. So could you just talk through that and discuss the impact of that?

We're seeing a number of things around. In the U.S. we're seeing an optimism, general lifting of the economy. I guess the most part, product users are able to buy more products than they used to. We're seeing them make larger purchases. To have more discretionary income, I guess, would be the main thing. But we would have a wave of leaders that I are, I won't say health fanatics but they take all the products there, serious, into more athletes, sports, focused on that and we're seeing them purchase much larger quantities of products for personal use, and selling those products to customers who are very product focused. And spending more money than they used to while times were tough and the economy was hard. And we feel this wave of energy, they're using the True Health Assessment to help people take more products. With the True Health Assessment in front of them, it gives them a recommended products by ranking, and we're seeing people order 1 further down on that product list than probably normally would've because they're seeing products personalized for themselves by that iPad app. And so, it feels good to have that product focus and increased product usage.

That's great. Maybe one quick follow-up. The price reduction you guys have talked about in Australia and New Zealand and some other markets, maybe I missed this, but did you guys talk about the magnitude of that reduction?

Yes. We touched on this last quarter. We anticipate that the price reductions in Australia and New Zealand area were about 14% aggregate overall. That was implemented partway through the first quarter and we've seen probably about a 6% or so of impact on overall sales. So it's a partial impact. We'll see a little more impact on that as was mentioned earlier to the net sales going forward. But -- and Canada was a 10% to 11% price discount increase.

[Operator Instructions] The next question comes from Scott Van Winkle from Cannacord Genuity.

A quick follow-up on that sequential decline in distributors in greater China. I just want to make sure I understand. The revenue was up a little sequentially while distributors were down sequentially. So was it in the new Associates coming on and small initial orders that were kind of lost in the shuffle. Is that what was indicated?

That's what we are believing and that's what we're seeing. I mean, the numbers were off a little bit from the normal order sizes. And so, that, coupled with some -- maybe some incentives from people who were reaching the end of Matching Bonus, the number of different little factors I think all added up to. A number of customers either dabbling, trying small orders and not being there the next quarter. But the sales revenues are that consistent growing [indiscernible] So that's where we're focusing our attention rather than that anomaly.

And then I know, it's a small market, but looking at the North Asia, I would've thought with the currency headwinds you had, particularly in Japan, that number would've been a little lower than what you reported. Was it Korea that you said? I apologize. Was it Korea that was real strong this quarter in those 2 markets?

Yes. Korea remains strong and we are still working with Japan. But Korea is where our strength is.

And then any additional color on Southeast Asia? It's been a really strong grower, a little slower this quarter in your first sequential decline in Associates and quite some time from Q4 to Q1? Anything additional you can add in Southeast Asia?

Well, some of the decline there we saw was really in the Philippines area, still strong market, very positive about that market. But it's not uncommon when you see a real strong sales push like we saw in the fourth quarter to see some drop off a little bit, especially going after the holidays and looking very confident that that's going to continue to grow as we've seen in the past.

Philippines is going so hot and fast. I mean, that pace was just an unbelievable pace. Though we're still seeing 10,000 people come to quarterly events, the energy is high and great leadership there. So we still have great expectations. Just how fast can it fly is the question.

Got you. And then on North America, the comment about kind of larger, average order size. If you look at revenue growth versus Associate growth in North America, the disparity between the 2, is that mostly average order size, you think, this quarter?

Absolutely. And you're seeing a reengagement of some of the Associate leaders in the North American, U.S. and Mexico areas. And so, combining those 2, we're seeing a larger share of pocket size, pocket purchase from each of those.

Okay. And then follow-up on Tim's question about the share count. So the ending fully diluted share count at the end of that March quarter was around 13.8%? Is that what I...

Yes.

Okay. And then last question. Sorry for the multiple questions. The volume incentive guidance for returning to 42.5, if I remember correctly, I think you were talking 43 last quarter. And maybe I had that wrong or maybe it's what I thought the indication was. Can you talk about maybe anything you've seen different in that incentive expense than maybe where you thought you were a few months ago as you went through, cycling through the Matching Bonus switchover?

No. We anticipated that we would see this drop a little bit before it. That incentive line ebbs and flows a little bit. As we see the Lifetime Matching Bonus continue to take home kicking, we'll see that grow a little bit. It also gives us -- it puts us in a great position where we can do, as Dave has talked about, some regional promotions to drive growth and to do some real strategic issues to help those different areas from a growth standpoint. We anticipate it will stay around -- it will end around 42.5 and that's where we said it would be, the 42. That's consistent with what we've been saying.

Great. And one other question, events. Regional events, is there any change this year versus last -- obviously you moved Australia, but as far as the number of events, any change year-over-year?

We've taken the production value up some. We've added some more recognition and starting to do some our local recognition. And as we're in Chicago, people are saying they traveled just because they were going to be recognized to events that they wouldn't normally go to. So good attendance, good production value were people are just amazed with the quality of the USANA [indiscernible] keeps doing a better and better job. And events are going well. I mean, event in Mexico was insane. The largest event we've had in the North America outside of the international convention down in Mexico. It was a ton of energy and a lot of excitement for Colombia announcement. It was on fire. They were dancing in the alleyways.

We have no more questions at this time. Are there any further points you wish to raise?

No. Thank you for your questions and for your participation on today's conference call. Do you have any remaining questions? Please feel free to contact Investor Relations at (801) 954-7961.

Thank you. This concludes the conference call. Thank you for participating. You may now disconnect.