USANA Health Sciences, Inc. (USNA) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the USANA's Health Sciences Fourth Quarter Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, February 5, 2014. I would now like to turn the conference over to Patrique Richards. Please go ahead, sir.

Good morning, everyone. We appreciate you joining us this morning to review our fourth quarter and year-end results. Today's conference call is being broadcast live by webcast, 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 strategies and outlook for 2014. We caution you that these statements should be considered in conjunction with disclosures, including specific risk factors and financial data contained in our most recent filings with the SEC. I'm joined this morning by Kevin Guest, President of the Americas, Europe and South Pacific; Dave Wentz, our Chief Executive Officer; and Paul Jones, our Chief Financial Officer. Dave will begin with a review of our operational progress during the fourth quarter and our strategies for 2014. Paul will then follow with a more detailed look at our fourth quarter financial results and outlook for 2014. I'll now turn the call over to Dave.

Thanks, Pat. I'm pleased to announce another excellent quarter and year for USANA. This marks our 11th consecutive year of record sales and our fourth consecutive year of record earnings. As we indicated in our release yesterday, our operating results for the fourth quarter were better than expected and cap off the year of significant achievements for USANA. Net sales for the quarter increased 10.5% year-over-year to $186.3 million, while earnings per share increased approximately 11%. The strength of our fourth quarter results is directly related to the initiatives we implemented at our International Convention during the third quarter. When we last spoke with you in late October, we indicated that while these initiatives would pressure our operating results in the short term, we believe they would improve USANA's long-term growth potential. The initiatives did generate modest pressure on our operating margins, but they have been adopted by our customers more quickly than we anticipated. This accelerated adoption rate is what led to a better-than-expected fourth quarter. The improvements we made to our business at our annual International Convention in August are designed to: first, simplify a customer's experience with USANA; second, reward loyal product users through lower product prices; and third, make our compensation plan more rewarding for our Associates. To measure the success of these initiatives, we track several business indicators, including active customer count, unit volume, the portion of our total business taking place on our Auto Order program and the number of Associates who earn a commission check. During the short time since launching these initiatives, we have seen meaningful improvements in each of these indicators. For example, while our number of Active Associates increased 7.3% and Preferred Customers increased 21.9% on a year-over-year basis, our number of Active Associates has increased 8.2% and Preferred Customers increased 9.9% on a sequential basis over the third quarter of 2013. Our worldwide unit volume for the fourth quarter increased nearly 20% on a year-over-year basis, which is a significant increase and offsets the financial impact of the strategic price discounts that we announced at our convention. Leading up to our convention, less than 30% of our total business was taking place on our Auto Order program. Following our convention, the portion of our total business on Auto Order has increased to nearly 42%. Additionally, the number of Associates who have received a commission check from USANA in the fourth quarter increased 59% on a year-over-year basis, including many receiving their first check with USANA. This increase is also significant to our business because we know how crucial it is for Associates to see success with USANA as quickly as possible. Following one of the initiatives that we implemented in our convention is designed to make it easier for Associates to advance in rank or title with USANA. While rank advancement is a sign of success for the Associate, it is also a powerful motivator. We've seen increase in rate advancement ranging from 10% to 20% at every level amongst our Active Associates. The growth measured by each of these indicators has been more rapid than we anticipated when we implemented them and has created momentum in our business. That momentum led to our strong fourth quarter results and has continued into 2014. Speaking of 2014, we are implementing several strategies to continue the momentum. First and perhaps most importantly, we will continue our efforts to train and educate our sales force and customers on how to capitalize on the initiatives implemented last summer in order to increase the success of USANA. In this regard, we are increasing Associate events and meetings where Associates will interact with management and other Associate leaders. While the short-term growth that we have experienced under each of our strategies is encouraging, I believe it will take several years for us to realize our full growth potential from these initiatives, and our management team is quite excited about the direction of our company and the opportunity it provides our shareholders. We will also continue to advance our personalization initiative in 2014. As I've explained before, personalization is a meaningful undertaking that will eventually encompass every aspect of our business. In 2013, we personalized our business model by implementing strategic changes to our product pricing and compensation plan. In 2014, we will continue to apply personalization to our digital presence by enhancing our technology systems specifically to provide personalization and ease-of-use for our customers. During 2014, we will also continue to execute our growth strategy in Greater China, which focuses on Mainland China. We will continue to emphasize the value of our products and business opportunity and continue to improve our systems and infrastructure in China to make it easier and more enjoyable for customers to do business with us there. We recently announced our investment of approximately $40 million in a new state-of-the-art manufacturing and production facility in Beijing, China, and anticipate that this facility will become operational during the latter half of 2015. In 2014, we will also renovate several of our branch locations in China to make them more modern and customer friendly. We continue to believe that China is currently the most significant growth opportunity for USANA. Before turning the call over to Paul, I'd like to emphasize that 2013 was an exceptional year for USANA. We made significant improvements to our business that provide a foundation for long-term, sustainable growth. I'm confident in the strength of our underlying business in all of our regions, and believe we are well positioned for continued growth in 2014. With that, I will turn the call over to Paul to review our regional and financial results.

Thanks, Dave. Good morning, everyone. I'll start by taking you through our regional results and will then turn to the income statement. As Dave mentioned, net sales for the fourth quarter increased 10.5% to $186.3 million. This growth was led by our Asia Pacific region, where net sales increased by 13% to $121.8 million for the quarter. Sales growth in both our Greater China and Southeast Asia Pacific regions continued to grow -- continued to the growth in Asia Pacific. Although USANA generated nearly 15% sales growth in Greater China, top line results were dampened by lower sales in Hong Kong. We continue to make solid progress in Mainland China due to our active product offering available there and the emergence of new Associates and customers in China. The 13.2% sales increase in our Southeast Asia Pacific region was driven by sales and customer growth in Singapore, Australia, New Zealand and Malaysia. Our MyHealthPak product continues to drive our growth in Singapore, which services our entire Asia Pacific region with this product offering. We believe that both the pricing initiative we announced in early 2013 and the initiatives launched at our International Convention have been particularly successful in Australia, New Zealand and are contributing to sales and customer growth in those markets. As we anticipated, our fourth quarter results in the Philippines reflect the challenging operating conditions in that market. Although our results have been disrupted in the Philippines over the last few quarters, we expect this market to grow in 2014 and remain a solid contributor to the region. In our North Asia region, South Korea continued to gain ground with nearly 6% sales growth and an increase in active customers. Turning now to the Americas and Europe, sales for this region continued to improve and increased 6.1%, which was largely the result of double-digit local currency sales and growth -- customer growth in Mexico and Canada. Our results in Canada are particularly impressive considering our operating trend over the last few years in that market. Like Australia-New Zealand, we believe that our results in Canada are being driven by the pricing initiative we announced in early 2013 and the initiatives we implemented at our convention. While sales in the U.S. grew modestly during the fourth quarter, our team continues their efforts to generate customer growth in this important market. Going forward, we believe that the initiatives we implemented in 2013 will gain traction in the U.S. and provide the foundation for sustainable customer growth. Let's now turn to the income statement. Gross margins declined 20 basis points year-over-year due mostly to the price decreases and discounts we began offering following our 2013 International Convention held in August, as well as the negative impact of changes in currency. This decline was partially offset by production efficiencies and favorable changes in product and sales mix by market. Associate incentives expense for the quarter increased 280 basis points year-over-year to 45% of net sales compared to 42.2% in the prior year quarter. This increase can be attributed to the compensation plan changes and also the price changes introduced at our annual convention. The increased payout was partially offset by the change to the Lifetime Matching Bonus program, which was introduced in the second quarter of 2012 but not fully phased in until mid-fourth quarter of 2012. SG&A in the fourth quarter was 21.3% of net sales, a decrease of 190 basis points from the fourth quarter of 2012. This relative decrease is due to leverage gains from higher net sales. On an absolute basis, SG&A increased as a result of the costs associated with supporting a higher sales base and spending associated with our newest market of Colombia. Our effective tax rate for the fourth quarter of 29.8% was 470 basis points lower than the fourth quarter of 2012 due primarily to state tax benefits recognized in the fourth quarter of 2013. Net earnings for the fourth -- for the quarter were $20.3 million, an increase of 9.9% compared with the prior year period. This increase was due to higher net sales, lower relative SG&A expense and a meaningfully lower effective tax rate. These benefits were partially offset by higher Associate incentives expense and lower gross margins. Earnings per share for the quarter increased 11% to $1.41 per diluted share. This increase can be attributed to higher net earnings with minimal change in shares outstanding. We did not repurchase any shares during the quarter, but we do have approximately $13.6 million remaining under our board-authorized repurchase program. Turning to the balance sheet. We continued to generate strong cash from operations and ended the quarter with $137.3 million in cash. Cash generated from operations in the fourth quarter totaled $35.3 million. Before addressing our guidance, I'd like to address our anticipated capital expenditures in 2014. As Dave noted, we are building a world-class manufacturing facility in Beijing to support our growing China business. We estimate that spending for this facility will be approximately $31 million in 2014 with a total cost of approximately $40 million to complete the facility. The renovation of several of our branch locations will add an estimated $3 million in CapEx. With our investments in China and expected CapEx spending to support our personalization and growth initiatives around the world, our total anticipated CapEx spend is expected to be just north of $40 million in 2014. Now let's discuss our initial guidance for 2014. With our long-term growth initiatives in place and given the current momentum we are seeing in our business, we expect that net sales will be in the range of $790 million to $810 million for the year. Diluted earnings per share for the year is expected to be in the range of $5.80 to $5.95. Our guidance includes the estimated impact from the initiatives implemented in the second half of 2013, which will make the -- make for challenging profitability comparisons on a year-over-year basis. For the full year 2014, we estimate the following: gross margins of 82.5%, Associate incentive expense of 43.5%, operating margin around 16% and an effective tax rate of 34%. Our expectation is that our growth during 2014 will accelerate as the year progresses, particularly after the customer -- customary seasonal pressure associated with Chinese New Year during the first quarter and as we generate increased leverage from the initiatives we implemented during 2013. In conclusion, I am confident in the financial strength of USANA's business and believe that we are well positioned to deliver another year of record results in 2014. With that, I will now ask the operator to facilitate the question-and-answer session.

[Operator Instructions] And our first question comes from the line of Scott Van Winkle with Canaccord Genuity.

Paul, can you go through that -- the guidance again? Did I hear an 82.5% gross margin, 43.5% volume? And then I'm sorry, I missed the rest.

43.5% on the incentive expense, operating margin around 16% and then a 34% tax rate.

Okay. So Dave, you mentioned the 3 metrics you're using to kind of measure the strategies you put in place over the last year. If there's one that's more important than the others with the pricing efforts and the Preferred Customer discount, is it the Preferred Customer acceleration? Is that -- would that be the best indicator of seeing a payoff there?

The most important indicator to me is seeing the Auto Orders go up dramatically, when Auto Orders the longevity of our customers. That's what I see as the compounding factor that will continue to grow and grow over the years.

Got you. And then you mentioned either 52% of distributors receiving checks or growth to 52%. Can you repeat that metric?

We have a 59% increase in year-over-year people receiving checks. You need people.

Okay. So how does that stack compare with active distributors on a year-over-year basis? Is that the same? Or is that a kind of a different metric?

A different metric. We're getting checks to people a lot sooner, a lot more checks, smaller checks so that they have success sooner. They don't have to wait as long to get a check. That's been the closest because when they're receiving that, they have a sign of success, which inspires them to go on and do more and more and grow faster. So we're trying to get checks in people's hands faster.

Okay. And then if I could turn to Mainland China. It sounds like the transition continued given that Hong Kong was down. Was Hong Kong down sequentially or just year-over-year?

Hong Kong was down both sequentially and year-over-year, consistent with what we had anticipated. And we anticipate continuing to see some tapering in Hong Kong and some -- and our continued organic growth in China over the next year.

Can you put some numbers to the Mainland China growth? I know you mentioned a quick number at the end of the last call.

Yes, we -- over the last quarter, we saw triple-digit increases in -- over the last year, we saw triple-digit increases in Mainland China and a double-digit decrease in Hong Kong. We anticipate that trend to continue.

Okay. And then -- in Mainland China, is -- had the USANA brand kind of taken over prominence? Or is it still BabyCare?

It is -- we're combining that -- those brands. You have BabyCare, who is the entity, and we certainly have the registered USANA products that have been there for a couple of years now that are gaining some real traction. So we're combining those brands and getting some traction on both of them.

Okay. So, I mean, did distributors kind of associated with both maybe where -- depending on where they're focused?

Yes, we're trying to combine both of them just like the Sensé brand, the foods brands, the nutritional brands. We have different logos and brands for each of these, but they all work together and people can pick and choose where they want to focus.

Okay. And then on the U.S., why the U.S. trail Canada and Mexico, you think? Or -- and then another point is on the Preferred Customer growth in the U.S. Was that stronger than maybe the distributor growth in the U.S?

The Preferred Customer growth was stronger in the U.S. Part of the difference in the growth would be attributed to some of the changes we did in pricing early in 2013. We were working on getting parity between markets. We had some significant price decreases in Canada, which has sparked some growth, and we did not have those same changes in the U.S.

Okay, great. And then a couple of more, if I could, please. So Paul, could you talk a little bit more about the SG&A and why was -- there was so much leverage? You got a couple of 100 basis points year-over-year. Is there a different level of spending or staffing or maybe not, some events in the fourth quarter?

Really, it had to do with the sales, the strength of our sales in that fourth quarter. It was more than we had anticipated, and that leverage helped us out. There was some spending that wasn't there that we had anticipated in some staffing, but primarily it was really due to sales.

Yes. And then there was a big jump in accrued liability from the balance sheet. Is that a fourth quarter phenomenon?

Yes, a lot of that had to do with the timing of commissions for payout to Associates and the sales. So it was -- a lot of it was timing in the fourth quarter, related items to that.

Okay. And then one more, if I could. I apologize. The lack of any share repurchase over the last quarter, is that kind of a function of all the big CapEx coming next year? I mean, you've got $140 million of cash, you're going to spend $40 million with the weakness in this whole kind of group of direct sellers I thought maybe you'd kind of step in the market. Can you give us a little indication of your thoughts there?

Sure. We -- as we looked at it, we're certainly looking at the best opportunity to continue to grow share value, and that's certainly an option. But we are looking forward at the factors that we have coming up from our CapEx. And so -- and we're also looking at the best opportunities for the use of that cash, and certainly that's something that the board is looking -- we're looking at going forward depending on what happens.

Our next question comes from the line of Rommel Dionisio with Wedbush securities.

I wonder if you guys could just talk about the personalization initiatives that you guys have been putting in place the last several quarters. And what effect was there? I mean, how is that helping your Auto Order business, which is up nicely, I think you attributed it, Dave. Yes, I think let's talk about that.

Well, the changes that we made that have increased the Auto Order significantly are that we are giving greater discounts for being on Auto Order. But also, we are giving a percentage there of their initial order back over the -- their next 2 Auto Orders to get them in the habit of being on Auto Order. From the product standpoint, personalization is focused on getting the right products into peoples' hands. We've moved away greatly from packs, where our people used to get a pack of these 8 items. Whether they needed 4 of them or 8 of them, they all got that same pack. And so going through products was a little tougher when they didn't receive products that were right for them. So we're moving to personalize initial orders so that they're consuming or selling those products because they're getting the ones they want and not just a pack of products that they're not sure they want to use or they have the right customer base to sell those products to. For instance, if you're getting the children's vitamin in your initial pack, you don't have any children and none of your neighbors have any children to sell them to, it makes it rather difficult. And so it's a very personalized initial order that they -- then makes somebody put their Auto Order, which is very personalized. And that's a large portion, getting them to go through those products and continue ordering on Auto Order, beyond the incentivized initial 2 and that -- well, you had the ongoing discount forever on Auto Order if you just get that regular subscription service set up.

I'm showing we have no further questions at this time. Please continue with any closing remarks.

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

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