UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2005
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
USANA HEALTH SCIENCES, INC.
(Exact name of registrant as specified in its charter)
Utah
87-0500306
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
3838 West Parkway Blvd., Salt Lake City, Utah 84120
(Address of principal executive offices, Zip Code)
(801) 954-7100
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o
The number of shares outstanding of the registrant’s common stock as of July 29, 2005 was 18,833,182.
For the Quarterly Period Ended July 2, 2005
INDEX
PART I. FINANCIAL INFORMATION
Item 1
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Earnings – Quarter Ended
Consolidated Statements of Earnings – Six Months Ended
Consolidated Statement of Stockholders’ Equity and Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3
Quantitative and Qualitative Disclosures About Market Risk
Item 4
Controls and Procedures
PART II. OTHER INFORMATION
Unregistered Sales of Equity Securities and Use of Proceeds.
Submission of Matters to a Vote of Security Holders.
Item 6
Exhibits.
Signatures
2
Item 1. Financial Statements
USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES
(in thousands)
January 1,
July 2,
2005
(unaudited)
ASSETS
Current assets
Cash and cash equivalents
$
15,067
20,428
Inventories, net
17,722
22,044
Prepaid expenses and other current assets
5,808
5,180
Deferred income taxes
2,226
2,431
Total current assets
40,823
50,083
Property and equipment, net
23,194
23,233
Goodwill
5,690
Other assets
1,957
2,812
71,664
81,818
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable
5,106
4,814
Other current liabilities
17,644
20,706
Total current liabilities
22,750
25,520
Long-term liabilities
1,071
1,495
Stockholders’ equity
Common stock, $0.001 par value; authorized 50,000 shares, issued and outstanding 18,953 as of January 1, 2005 and 18,816 as of July 2, 2005
19
Additional paid-in capital
11,853
12,135
Retained earnings
34,496
41,914
Accumulated other comprehensive income
1,475
735
Total stockholders’ equity
47,843
54,803
The accompanying notes are an integral part of these statements.
3
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
Quarter Ended
July 3,
2004
Net sales
67,246
82,015
Cost of sales
16,195
19,499
Gross profit
51,051
62,516
Operating expenses:
Associate incentives
25,556
31,911
Selling, general and administrative
13,656
15,168
Research and development
607
689
Total operating expenses
39,819
47,768
Earnings from operations
11,232
14,748
Other income (expense):
Interest income
36
93
Interest expense
—
(3
)
Other, net
(37
(157
Other income (expense), net
(1
(67
Earnings before income taxes
11,231
14,681
Income taxes
3,818
5,138
Net earnings
7,413
9,543
Earnings per common share
Basic
0.39
0.50
Diluted
0.36
0.48
Weighted average common shares outstanding
19,199
18,948
20,523
19,821
4
Six Months Ended
129,021
158,593
31,253
37,509
97,768
121,084
49,168
61,461
26,918
30,017
1,185
1,288
77,271
92,766
20,497
28,318
86
197
62
(96
148
98
20,645
28,416
7,019
9,945
13,626
18,471
0.71
0.97
0.66
0.93
19,288
19,008
20,688
19,896
5
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
Six Months Ended July 3, 2004 and July 2, 2005
Accumulated
Additional
Other
Common Stock
Paid-in
Retained
Comprehensive
Shares
Value
Capital
Earnings
Income (Loss)
Total
For the Six Months Ended July 3, 2004
Balance at January 3, 2004
19,470
14,187
28,935
1,230
44,371
Comprehensive income
Foreign currency translation adjustment, net
(88
13,538
Common stock retired
(524
(4,505
(10,392
(14,897
Common stock issued under stock option plan, including tax benefit of $1,372
224
1,865
Balance at July 3, 2004
19,170
11,547
32,169
1,142
44,877
For the Six Months Ended July 2, 2005
Balance at January 1, 2005
18,953
(740
17,731
(353
(3,948
(11,053
(15,001
Common stock issued under stock option plan, including tax benefit of $2,679
216
4,230
Balance at July 2, 2005
18,816
6
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization
2,255
2,824
(Gain) loss on sale of property and equipment
(2
174
56
Allowance for inventory valuation
553
43
Changes in operating assets and liabilities:
Inventories
(34
(4,545
Prepaid expenses and other assets
(246
(734
(1,144
(261
1,688
6,105
Total adjustments
3,244
3,493
Net cash provided by operating activities
16,870
21,964
Cash flows from investing activities
Acquisition, net of cash acquired
(2,140
Purchases of property and equipment
(5,349
(2,688
Proceeds from the sale of property and equipment
21
Net cash used in investing activities
(7,468
(2,684
7
Cash flows from financing activities
Proceeds from stock options exercised
493
1,551
Redemption of common stock
Net cash used in financing activities
(14,404
(13,450
Effect of exchange rate changes on cash and cash equivalents
(165
(469
Net (decrease) increase in cash and cash equivalents
(5,167
5,361
Cash and cash equivalents, beginning of period
18,965
Cash and cash equivalents, end of period
13,798
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest
5,727
5,944
Non-cash activities
In February 2004, the Company acquired FMG Productions (FMG), LLC for $2,140 in cash, which included $80 for
professional fees directly associated with the acquisition.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation
The unaudited interim consolidated financial information of USANA Health Sciences, Inc. and Subsidiaries (the “Company” or “USANA”) has been prepared in accordance with Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying interim consolidated financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position as of July 2, 2005, and results of operations for the quarters and six months ended July 3, 2004 and July 2, 2005. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 1, 2005. The results of operations for the quarter and six months ended July 2, 2005 may not be indicative of the results that may be expected for the fiscal year ending December 31, 2005.
NOTE A – STOCK-BASED COMPENSATION
The Company has applied the disclosure provisions of Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — An Amendment of FASB Statement No. 123,” for the quarters and six months ended July 3, 2004 and July 2, 2005. Issued in December 2002, SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. As permitted by SFAS No. 148, the Company continues to account for stock options under APB Opinion No. 25, under which no compensation has been recognized.
The following table illustrates the effects on net earnings and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, to stock-based compensation:
As reported
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects
(440
(466
(664
(914
Pro forma
6,973
9,077
12,962
17,557
Earnings per share - basic
0.67
0.92
Earnings per share - diluted
0.34
0.46
0.63
0.88
9
Weighted average assumptions used to determine the Black-Scholes fair value for options granted during the periods indicated:
Expected volatility
*
72%
76%
Risk free interest rate
3.87%
4.02%
Expected life
5.25 yrs.
10 yrs.
Expected dividend yield
0%
Weighted average fair value of options granted**
42.64
29.72
* No grants were issued during the quarter ended July 3, 2004.
** All options during the periods indicated have been granted at the market value on the date of grant, which is established by averaging the closing price of the Company’s common stock over the five trading days preceding the date of grant.
Option pricing models require the input of highly subjective assumptions including the expected stock price volatility. Additionally, the Company’s employee stock options have characteristics significantly different from those of traded options, including long vesting schedules and changes in the subjective input assumptions that can materially affect the fair value estimate. Management believes the best assumptions available were used to value the options under the Black-Scholes option pricing model and that the resulting option values were reasonable as of the dates the options were granted.
NOTE B – INVENTORIES
Inventories consist of the following:
Raw materials
8,846
11,747
Work in progress
3,123
3,671
Finished goods
7,897
8,436
19,866
23,854
Less allowance for inventory valuation
2,144
1,810
10
Prepaid expenses and other current assets consist of the following:
Prepaid expenses
1,599
1,553
Miscellaneous receivables, net
3,734
3,129
Other current assets
475
498
Cost of property and equipment and their estimated useful lives is as follows:
Years
Building
40
9,400
Laboratory and production equipment
5-7
8,706
9,187
Sound and video library
600
Computer equipment and software
3-5
22,580
23,440
Furniture and fixtures
2,530
2,588
Automobiles
206
204
Leasehold improvements
2,568
2,522
Land improvements
15
931
47,521
48,872
Less accumulated depreciation and amortization
26,459
28,402
21,062
20,470
Land
1,899
Deposits and projects in process
233
864
NOTE E – GOODWILL
Goodwill represents the excess of the purchase price paid of acquired entities over the fair market value of the net assets acquired. As of July 2, 2005, goodwill totaled $5,690, comprised of $4,267 associated with the July 1, 2003 acquisition of Wasatch Product Development, Inc. (WPD) and $1,423 in connection with the February 1, 2004 acquisition of FMG. No events have occurred subsequent to either acquisition that have resulted in an impairment of the original goodwill amounts initially recorded from the transactions. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill must be tested at least annually and if the carrying amount of goodwill exceeds its fair value, an impairment loss must be recognized in an amount equal to that excess.
During June 2005, an independent third party conducted the annual impairment test of goodwill related to the acquisition of WPD. The fair market value of the net assets of WPD was estimated using widely accepted valuation methods, including both a market approach and an income approach. In determining the fair market value as part of the impairment test, certain assumptions were used to project future results that management believes are reasonable, given current facts and circumstances; however, there
11
can be no assurance that, under the assumptions used, these projections will materialize. Based upon the results of the independent appraisal, the fair market value of the net assets of WPD has been determined to be in excess of the carrying amount of the net assets, and, therefore, no impairment loss for goodwill has been recognized.
There were no changes in the carrying amount of goodwill for the acquired subsidiaries for the six months ended July 2, 2005:
Consolidated
WPD
FMG
4,267
1,423
Goodwill acquired
Impairment adjustments
NOTE F – OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
2,379
3,115
Accrued employee compensation
4,696
3,968
1,901
3,789
Sales taxes
1,986
1,923
Associate promotions
429
1,619
Deferred revenue
1,825
1,814
Provision for returns and allowances
1,284
1,292
Accrued loss on foreign currency forwards
425
All other
2,719
3,186
12
NOTE G – COMMON STOCK AND EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of shares outstanding for each period. Weighted average shares redeemed have been included in the calculation of weighted average shares outstanding for basic earnings per share. Diluted earnings per common share are based on shares outstanding (computed under basic EPS) and potentially dilutive shares. Shares included in dilutive earnings per share calculations include stock options granted that are in the money but have not yet been exercised.
For the Quarter Ended
Earnings available to common shareholders
Basic EPS
Common shares outstanding entire period
Weighted average common shares:
Issued during period
180
211
Canceled during period
(451
(216
Weighted average common shares outstanding during period
Earnings per common share - basic
Diluted EPS
Weighted average shares outstanding during period - basic
Dilutive effect of stock options
1,324
873
Weighted average shares outstanding during period - diluted
Earnings per common share - diluted
Options to purchase 390 shares of stock were not included in the computation of EPS for the quarter ended July 3, 2004 due to their exercise price being greater than the average market price of the shares.
13
For the Six Months Ended
104
163
(286
(108
1,400
888
Options to purchase 290 shares of stock were not included in the computation of EPS for the six months ended July 3, 2004 due to their exercise price being greater than the average market price of the shares.
During the six months ended July 2, 2005 and July 3, 2004 the Company expended $15,001 and $14,897 to purchase 353 and 524 shares, respectively, under the Company’s share repurchase plan. The purchase of shares under this plan reduces the number of shares issued and outstanding.
NOTE H – SEGMENT INFORMATION
The Company’s operations are distinguished by markets served and method of distribution employed and are classified into two reportable business segments: Direct Selling and Contract Manufacturing. These operating segments are evaluated regularly by management in determining the allocation of resources and in assessing the performance of the Company. Management evaluates performance based on net sales and the amount of operating income or loss. Segment profit or loss is based on profit or loss from operations before income taxes. Interest income and expense, as well as income taxes, while significant, are not included in the Company’s determination of segment profit or loss in assessing the performance of a segment.
Direct Selling
The Direct Selling segment comprises the Company’s principal line of business: developing, manufacturing, and distributing nutritional and personal care products. Products are distributed through a network marketing system using independent distributors referred to as “Associates.” Products are also sold directly to “Preferred Customers” who purchase products for personal use and are not permitted to resell or distribute the products.
14
NOTE H – SEGMENT INFORMATION - CONTINUED
Historically, selected financial information for the Direct Selling segment has been reported for seven operating geographic regions including North America, Australia-New Zealand, Hong Kong, Japan, Taiwan, South Korea, and Singapore. To simplify the presentation of selected financial information, these formerly segregated regions have been aggregated into two geographic regions: North America and Pacific Rim. North America includes the United States, Canada, and Mexico. All other entities outside of North America are located within the Pacific Rim region, which includes Australia-New Zealand, Hong Kong, Japan, Taiwan, South Korea, and Singapore.
Contract Manufacturing
Operations for the Contract Manufacturing segment are located in Draper, Utah. Operating activities for this segment include the manufacture of premium personal care products, and primarily exist for the production of the Company’s Sensé™ line of skin and personal care. In addition to the production of the Sensé product line, contract manufacturing services are provided to a limited number of customers in the personal care marketplace, which helps offset operating expenses associated with this segment. In both the second quarters of 2004 and 2005, we had one external customer that accounted for more than ten percent of segment sales. Financial data for the Contract Manufacturing segment has been modified to include a reasonable markup on the intersegment sale of the Sensé product line consistent with what we believe is typical of the industry.
Financial information summarized by operating segment and geographic region for the quarters ended July 3, 2004 and July 2, 2005 is listed below:
Revenues
from External
Intersegment
before Income
Customers
Taxes
Quarter ended July 3, 2004:
North America
42,415
11,598
11,389
Pacific Rim
21,711
912
281
Segment Total
64,126
12,510
11,670
3,120
256
254
Reportable Segments Total
12,766
11,924
Unallocated and Other *
(12,766
(693
Consolidated Total
* “Unallocated and Other” includes certain corporate items and eliminations that are not allocated to the operating segments.
Quarter ended July 2, 2005:
52,264
15,316
15,284
27,548
1,382
(424
79,812
16,698
14,860
2,203
2,395
221
19,093
15,081
(19,093
(400
Financial information summarized by operating segment and geographic region for the six months ended July 3, 2004 and July 2, 2005 is listed below:
Long-lived
Assets
Total Assets
Six months ended July 3, 2004:
82,701
20,921
22,018
37,733
55,049
41,666
1,584
(1,686
2,902
17,294
124,367
22,505
20,332
40,635
72,343
4,654
907
103
5,923
9,510
23,412
20,435
46,558
81,853
(23,412
210
(14,308
(16,904
32,250
64,949
16
Six months ended July 2, 2005:
101,522
33,251
31,613
37,550
68,688
52,939
2,659
(820
2,909
18,778
154,461
35,910
30,793
40,459
87,466
4,132
5,160
764
6,361
12,720
41,070
31,557
46,820
100,186
(41,070
(3,141
(15,085
(18,368
31,735
17
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of USANA’s financial condition and results of operations should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes thereto contained in this quarterly report.
General
USANA Health Sciences, Inc. develops and manufactures high-quality nutritional and personal care products. We market all of our products on the basis of high levels of bioavailability, safety, and quality. We distribute our products through a network marketing system using independent distributors that we refer to as “Associates.” As of July 2, 2005, we had 125,000 active Associates worldwide. We also sell products directly to “Preferred Customers” who purchase products for personal use and are not permitted to resell or distribute the products. As of July 2, 2005, we had 66,000 active Preferred Customers worldwide. The majority of sales in the Direct Selling segment come from Associates. During the second quarter of 2005 sales to Associates accounted for approximately 86% of net sales for the Direct Selling segment. For purposes of this report, we only count as active customers those Associates and Preferred Customers who have purchased product from USANA at any time during the most recent three-month period.
The fiscal year end of USANA is the Saturday closest to December 31 of each year. Fiscal year 2004 ended on January 1, 2005, and fiscal year 2005 will end on December 31, 2005.
As discussed more fully in Note H – Segment Information, beginning on page 14 to the consolidated financial statements, we have two reportable segments: Direct Selling and Contract Manufacturing. The Direct Selling segment constitutes our principal line of business: developing, manufacturing, and distributing nutritional and personal care products through a network marketing system. The Contract Manufacturing segment primarily consists of manufacturing and packaging the Company’s Sensé™ product line of skin and personal care products, but also includes the manufacture of premium personal care products, produced for a limited number of third-party customers, under their independent brand names.
Our primary product lines within the Direct Selling segment consist of USANAâNutritionals and Sensé – beautiful scienceâ(Sensé). The USANAâNutritionals product line is further categorized into three separate classifications: Essentials, Optimizers, and Macro Optimizers. Additionally, we offer combination packs, which generally contain a variety of products from each product line.
USANAâ Nutritionals.
The Essentials include core vitamin and mineral supplements that provide a foundation of advanced nutrition for every age group. To help meet the “essential” nutrient needs of children and teens during the years of development, when good nutrition is most important, USANA offers: UsanimalsÔ, a formulation of vitamins, minerals, and antioxidants, in an easy-to-take chewable tablet for children 13 months to 12 years old; and Body RoxÔ, a nutritional supplement containing 31 essential vitamins, minerals, antioxidants, and cofactors for adolescents 12 to 18 years old. USANAâEssentials for adults is a combination of two products: Mega Antioxidant, a balanced, high-potency blend of 30 vitamins, antioxidants, and other important nutrients to support cellular metabolism and to counteract free-radical damage; and Chelated Mineral, a complete spectrum of essential minerals, in balanced, highly bioavailable forms. The USANAâEssentials are also available in a convenient pillow pack format, HealthPak 100Ô.
The Optimizers are more targeted supplements designed to meet individual health and nutritional needs. Products in this category include Proflavanolâ, Poly Câ, ProcosaâII, CoQuinoneâ 30, BiOmega-3Ô, E-PrimeÔ, Active CalciumÔ, PhytoEstrinÔ, Palmetto PlusÔ, Ginkgo-PSÔ, Garlic ECÔ, Visionexâ, and OptOmegaâ.
The Macro Optimizers include healthy convenience foods and other related products. NutrimealÔ, Fibergyâ, and SoyaMaxÔpowdered drink mixes, and nutrition and fiber bars, are included in this product category.
18
Sensé - beautiful scienceâ
The Sensé™ product line includes premium, science-based personal care products that support healthy skin and hair by providing advanced topical nourishment, moisturization, and protection. This line is formulated with our patent-pending, self-preserving technology, which uses a unique blend of botanicals, antioxidants, and active ingredients to keep products fresh, without adding parabens, the most common preservative used in cosmetics and skin care products. Products in this line include Perfecting Essence, Gentle Daily Cleanser, Hydrating Toner, Daytime Protective Emulsion SPF 15, Eye Nourisher, Night Renewal, Serum Intensive, Rice Bran Polisher, Nutritious Crème Masque, Revitalizing Shampoo, Nourishing Conditioner, Firming Body Nourisher, Energizing Shower Gel, and Intensive Hand Therapy.
All Other
In addition to these principal product lines, we have developed and sell to Associates materials and online tools designed to assist them in building their businesses and selling products. These resource materials or sales tools include product brochures and business forms designed internally and printed by outside publishers. We periodically contract with authors and publishers to produce or provide books, tapes, and other items dealing with health topics and personal motivation, which are sold to Associates. We also write and develop our own materials for CDs and DVDs, which are produced by our wholly-owned subsidiary, FMG Productions. New Associates are required to purchase a starter kit containing USANA training materials that assist the Associates in starting and growing their businesses. Associates do not earn commissions on the sale of sales tools or starter kits.
The following table summarizes the approximate percentage of total product revenue for the Direct Selling segment contributed by major product line for the six months ended as of the dates indicated:
Sales By Product Line *
Product Line
USANAâNutritionals
Essentials **
38
%
37
Optimizers
34
35
Macro Optimizers
Sensé – beautiful scienceâ
* Combination Pack sales have been allocated to their respective product lines based on the weighted average price of the product components that compose each pack.
** The Essentials category under the USANAâNutritionals product line includes USANAâEssentials, HealthPak 100Ô, Body RoxÔ, and UsanimalsÔ.
The following highlights sales data for our top-selling products as a percentage of Direct Selling segment product sales for the six months ended as of the dates indicated.
Key Product
USANAâEssentials
25
22
HealthPak 100 ™
Proflavanolâ
Quarters Ended July 3, 2004 and July 2, 2005
Net Sales. Net sales increased 22.0% to $82.0 million for the quarter ended July 2, 2005, an increase of $14.8 million from $67.2 million for the comparable quarter in 2004. The change consisted of a $15.7 million increase in the Direct Selling segment, and a $0.9 million decrease in the Contract Manufacturing segment.
The following table summarizes the changes in net sales by segment and geographic region for the fiscal quarters ended July 3, 2004, and July 2, 2005.
Sales By Segment and Region
Change from
Percent
Segment / Region
July 3, 2004
July 2, 2005
Prior Year
Change
United States
27,821
41.4%
33,067
40.3%
5,246
18.9%
Canada
12,378
18.4%
15,287
18.6%
23.5%
Mexico
2,216
3.3%
3,910
4.8%
1,694
76.4%
North America Total
63.1%
63.7%
9,849
23.2%
Australia-New Zealand
8,471
12.6%
11,241
13.7%
2,770
32.7%
Hong Kong
2,750
4.1%
3,377
627
22.8%
Japan
2,176
3.2%
2,620
444
20.4%
Taiwan
3,898
5.8%
5,381
6.6%
1,483
38.0%
South Korea
1,804
2.7%
1,323
1.6%
(481
(26.7)%
Singapore
2,612
3.9%
3,606
4.4%
994
38.1%
Pacific Rim Total
32.3%
33.6%
5,837
26.9%
95.4%
97.3%
15,686
24.5%
4.6%
(917
(29.4)%
100.0%
14,769
22.0%
The increase in net sales contributed by the Direct Selling segment can be primarily attributed to the following factors:
• A 20.2% increase in the number of active Associates and a 11.9% increase in the number of active Preferred Customers for the second quarter of 2005, which includes strong growth in the Company’s two newest markets, Singapore and Mexico, and
• Stronger foreign currencies relative to the U.S. dollar, which positively affected the translation of sales in foreign markets by $3.1 million.
The decrease in net sales of our Contract Manufacturing segment can be attributed to an increased focus on the manufacture of our Sensé™ line.
Based on information currently available to the Company, we expect consolidated net sales between $82 and $84 million for the third quarter of 2005. We expect consolidated net sales between $325 and $330 million for fiscal year 2005.
20
The following tables summarize the growth in active customers for the Direct Selling segment by geographic region as of the dates indicated:
Active Associates By Region
(rounded to the nearest thousand)
As of
Region
40,000
38.5%
46,000
36.8%
6,000
15.0%
20,000
19.2%
22,000
17.6%
2,000
10.0%
5,000
9,000
7.2%
4,000
80.0%
65,000
62.5%
77,000
61.6%
12,000
18.5%
13,000
12.5%
16,000
12.8%
3,000
23.1%
4.0%
0.0%
3.8%
8,000
7.7%
9.6%
50.0%
2.9%
(1,000
(33.3)%
39,000
37.5%
48,000
38.4%
104,000
125,000
21,000
20.2%
We believe that various factors contributed to the year-over-year second quarter increase in the number of active Associates, including the enthusiasm surrounding the new self-preserving Sensé™ product line, ongoing communication with Associate leaders in the field, and company-sponsored events and promotions held to motivate Associates.
Active Preferred Customers By Region
36,000
61.0%
41,000
62.1%
13.9%
27.1%
18,000
27.3%
**
1,000
1.5%
N/A
52,000
88.1%
60,000
90.9%
15.4%
8.5%
7.6%
1.7%
(100.0)%
7,000
11.9%
9.1%
(14.3)%
59,000
66,000
** Active Preferred Customer Count is less than 500
Total Active Customers By Region
76,000
46.6%
87,000
45.5%
11,000
14.5%
22.1%
20.9%
11.1%
3.1%
10,000
5.3%
117,000
71.8%
137,000
71.7%
17.1%
11.0%
16.7%
3.7%
2.6%
(16.7)%
2.5%
25.0%
5.5%
6.3%
33.3%
1.8%
1.1%
4.7%
28.2%
54,000
28.3%
17.4%
163,000
191,000
28,000
17.2%
Gross Profit. Consolidated gross profit increased to 76.2% of net sales for the quarter ended July 2, 2005, from 75.9% for the comparable quarter in 2004. The increase in consolidated gross profit can be attributed to a decrease in the impact the Contract Manufacturing segment had on the overall total. We believe that consolidated gross profit margins will improve modestly in the third quarter of 2005.
Gross profit in the Direct Selling segment for the quarter ended July 2, 2005 was 78.5% of net segment sales, compared to 78.8% for the same quarter in 2004. Lower gross profits in our Direct Selling segment during the second quarter of 2005 can be attributed to higher costs of raw materials. As an example, we have continued to experience higher purchase prices on the raw material Coenzyme Q10 due to a persistent shortage in supply. We have qualified multiple sources to supply this raw ingredient and are confident that we can obtain the quantities necessary to meet production requirements.
The Contract Manufacturing segment generated no gross profit from its third-party customers in the second quarter of 2005, compared to gross profit of 16.3% in the second quarter of 2004. The decline in gross profit margin from third-party customers at our Contract Manufacturing segment can, in great part, be attributed to inefficiencies and additional costs associated with expediting production to recover from the backlog of Sensé™ products.
Associate Incentives. Expenses related to Associate incentives are incurred only by the Direct Selling segment and represent the most significant cost as a percentage of net sales for this segment. Associate incentives increased slightly to 40.0% of net segment sales during the second quarter of 2005, compared to 39.9% for the same period in the prior year.
Beginning in the third quarter of 2005, we will increase the investment in our Associates. We will reward our top-performing Associates by offering a variety of contests, promotions, and other incentives that will assist them in growing their respective business. We believe that this initiative will both accelerate the rate at which we bring new Associates into the USANA business and support continued growth in net sales. We anticipate that this initiative will result in Associate incentives increasing to approximately 41% of net sales in our Direct Selling segment for the foreseeable future.
Selling, General and Administrative Expenses. Selling, general and administrative expense decreased to 18.5% of net sales for the quarter ended July 2, 2005 from 20.3% for the comparable quarter in 2004. The decrease in selling, general and administrative expenses as a percentage of net sales can be attributed to operating leverage generated on an increasing sales base.
In absolute terms, selling, general and administrative expenses increased by $1.5 million for the quarter ended July 2, 2005 when compared to second quarter of 2004. The absolute increase in selling, general and administrative expenses can be primarily attributed to an increase in spending in many of our markets to support growing sales and an increasing number of Associates.
We believe that selling, general and administrative expenses, as a percentage of net sales, will be modestly higher in the third quarter of 2005. This anticipated increase can be attributed to planned expenditures associated with our Annual International Convention and initial costs related to our planned market opening in the fourth quarter of this year.
Net Earnings. Net earnings increased 28.7% to $9.5 million for the quarter ended July 2, 2005, an increase of $2.1 million from $7.4 million for the comparable quarter in 2004. The increase in net earnings can be attributed primarily to higher net sales and lower relative selling, general and administrative expenses.
Diluted earnings per share improved to $0.48 for the second quarter of 2005, an increase of $0.12, or 33.3%, from the $0.36 reported for the comparable quarter in 2004. We expect earnings per share for the third quarter 2005 to be in the range of $0.47 to $0.49, and between $1.88 and $1.92 for the full year 2005.
Net Sales. Consolidated net sales increased 22.9% to $158.6 million for the six months ended July 2, 2005, an increase of $29.6 million from $129.0 million for the comparable six-month period in 2004. The change consisted of a $30.1 million increase in the Direct Selling segment, and a $0.5 million decrease in the Contract Manufacturing segment.
The following table summarizes the changes in net sales by segment and geographic region for the six months ended July 3, 2004 and July 2, 2005.
54,922
42.6%
64,270
40.5%
9,348
17.0%
24,815
30,149
19.0%
5,334
21.5%
2,964
2.3%
7,103
4.5%
4,139
139.6%
64.1%
64.0%
18,821
16,747
13.0%
21,885
13.8%
30.7%
5,207
6,417
1,210
4,392
3.4%
5,118
726
16.5%
7,627
5.9%
10,445
2,818
36.9%
3,074
2.4%
2,368
(706
(23.0)%
4,619
3.6%
6,706
4.2%
2,087
45.2%
33.4%
11,273
96.4%
97.4%
30,094
24.2%
(522
(11.2)%
29,572
22.9%
• An increase in the number of active Associates and Preferred Customers,
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• Stronger foreign currencies relative to the U.S. dollar, which positively affected the translation of sales in foreign currencies by $5.0 million, and
• The launch of the new self-preserving Sensé™ product line in the third quarter of 2004.
The decrease in net sales of our Contract Manufacturing segment can be attributed to an increased focus on the manufacture of our Sensé line.
Gross Profit. Consolidated gross profit increased to 76.3% of net sales for the six months ended July 2, 2005 from 75.8% for the comparable period in 2004. The increase in consolidated gross profit margins for the six months ended July 2, 2005 can primarily be attributed to a decrease in the impact the Contract Manufacturing segment had on the overall total and, to a lesser extent, modest improvements in gross profit margin in our Direct Selling segment.
The Direct Selling segment’s gross profit margin modestly improved to 78.4% during the first six months of 2005, compared to 78.2% for the six months ended July 3, 2004. The modest improvement in gross profit margin for the Direct Selling segment can primarily be attributed to leverage benefits on semi-variable costs offset, in great part, by the higher cost of raw materials.
Gross profit in the Contract Manufacturing segment from third-party customers decreased to 0.5% of net sales for the six months ended July 2, 2005 from 10.0% for the comparable period in 2004. The primary reasons for reduced gross profit margins from third-party customers of the Contract Manufacturing segment are the same as those for the second quarter of 2005 and are discussed on page 22 in the quarterly “Results of Operations” section.
Associate Incentives. Associate incentives increased to 39.8% of net segment sales for the six months ended July 2, 2005, compared to 39.5% in the comparable period of 2004. The modest increase in Associate incentives relative to net segment sales can be attributed to a higher payout rate of base commissions on sales volume points generated during the first six months of 2005.
Selling, General and Administrative Expenses. Selling, general and administrative expense decreased to 18.9% of net sales for the six months ended July 2, 2005 from 20.9% for the comparable period in 2004. The decrease, as a percentage of net sales, can be primarily attributed to operating leverage generated on an increasing sales base.
In absolute terms, selling, general and administrative expenses increased by $3.1 million for the six months ended July 2, 2005, when compared to the first six months of 2004. The absolute increase in selling, general and administrative expenses can be attributed to an increase in spending in many of our markets to support growing sales and an increasing number of Associates.
Income Taxes. Income taxes totaled 35.0% of earnings before income taxes for the first six months of 2005, compared to 34.0% for the first six months of 2004. The increase in the effective tax rate by 1.0% in the first six months of 2005 was primarily attributable to the new American Jobs Creation Act. This legislation caused a 20.0% phase out of the Extraterritorial Income Exclusion, which was only partially offset by a new 3.0% deduction for Qualified Production Activities.
The effective tax rate in the first six months of 2004 was based on an estimate of a 34.0% effective tax rate for the year. The final effective tax rate was adjusted down to 31.7% at the end of 2004 due to the favorable settlement of a foreign tax audit during 2004 and a favorable adjustment for Research and Experimentation Credit in 2004, both of which are not anticipated to recur in 2005. We expect the effective tax rate for the full year 2005 to be 35.0%.
Net Earnings. Net earnings increased 35.6% to $18.5 million for the six months ended July 2, 2005, an increase of $4.9 million from $13.6 million for the comparable period in 2004. The increase in net earnings can be primarily attributed to higher net sales and lower relative selling, general and administrative expenses. Modest improvements in our consolidated gross profit margin also contributed to improved net earnings.
Diluted earnings per share improved to $0.93 for the first six months of 2005, an increase of $0.27, or 40.9%, from the $0.66 reported for the comparable period in 2004.
24
Liquidity and Capital Resources
We have continually financed growth with cash flows from operations. In the first six months of 2005, net cash flows from operating activities totaled $22.0 million, compared to $16.9 million for the same period in 2004. Cash and cash equivalents increased to $20.4 million at July 2, 2005 from $15.1 million at January 1, 2005. Additionally, net working capital increased to $24.6 million at July 2, 2005, compared to $18.1 million at January 1, 2005. The increase in cash and cash equivalents and net working capital during the first six months of 2005 can be primarily attributed to strong cash flows from operations, offset, in great part, by the purchase of shares under the Company’s Share Repurchase Plan totaling $15.0 million.
As of July 2, 2005, our credit facilities consisted of a $10 million line of credit, with no amounts outstanding. The credit facility contains restrictive covenants requiring that we maintain certain financial ratios. As of July 2, 2005, we were in compliance with these covenants.
We believe that current cash balances, cash provided by operations, and amounts available under the line of credit will be sufficient to cover our capital needs in the ordinary course of business for the foreseeable future. If we experience an adverse operating environment or unusual capital expenditure requirements, additional financing may be required. However, no assurance can be given that additional financing, if required, would be available on favorable terms. We might also require or seek additional financing for the purpose of expanding new markets, growing our existing markets, and for other reasons. Such financing may include the sale of additional equity securities. Any financing which involves the sale of equity securities or instruments convertible into equity securities could result in immediate and possibly significant dilution to existing shareholders.
Forward-Looking Statements
The statements contained in this report that are not purely historical are considered to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act. These statements represent our expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. They may be identified by the use of words or phrases such as “believes,” “expects,” “anticipates,” “should,” “plans,” “estimates,” and “potential,” among others. Forward-looking statements include, but are not limited to, statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations regarding our financial performance, revenue and expense levels in the future and the sufficiency of our existing assets to fund future operations and capital spending needs. Readers are cautioned that actual results could differ materially from the anticipated results or other expectations expressed in these forward-looking statements for the reasons detailed in our most recent Annual Report on Form 10-K at pages 30 through 36. The fact that some of the risk factors may be the same or similar to our past reports filed with the Securities and Exchange Commission means only that the risks are present in multiple periods. We believe that many of the risks detailed here and in the Company’s other SEC filings are part of doing business in the industry in which we operate and compete and will likely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen their significance. The forward-looking statements contained in this report are made as of the date of this report and we assume no obligation to update them or to update the reasons why actual results could differ from those projected in such forward-looking statements. Among others, risks and uncertainties that may affect our business, financial condition, performance, development and results of operations include:
• Our ability to attract and maintain a sufficient number of Associates,
• High turnover of Associates,
• Our dependence upon a network marketing system to distribute our products,
• Activities of our independent Associates,
• Risks related to our planned expansion into new international markets, including delays in commencement of sales in any new market, delays in compliance with local marketing or other regulatory requirements, or changes in target markets,
• Rigorous government scrutiny of network marketing practices,
• Potential political events that may negatively affect economic conditions,
• Potential effects of adverse publicity regarding nutritional supplements or the network marketing industry,
• Reliance on key management personnel, including our Founder, Chairman of the Board of Directors, and Chief Executive Officer Myron W. Wentz, Ph.D.,
• Extensive government regulation of our products and manufacturing,
• Potential inability to sustain or manage growth, including the failure to continue to develop new products,
• An increase in the amount of Associate incentives paid,
• Our reliance on the use of information technology,
• The adverse effect of the loss of a high-level sponsoring Associate together with a group of leading Associates in that person’s downline,
• The loss of product market share or Associates to competitors,
• Potential adverse effects of taxation and transfer pricing regulations,
• The fluctuation in the value of foreign currencies against the U.S. dollar,
• Our reliance on outside suppliers for raw materials,
• Shortages of raw materials used in certain of our products,
• Product liability claims and other manufacturing activity risks,
• Intellectual property risks particularly applicable to our business,
• Liability claims associated with our “Athlete Guarantee” program, and
• Disruptions to shipping channels used to distribute products to international warehouses.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We conduct our business in several countries and intend to continue to expand our foreign operations. Net sales, earnings from operations, and net earnings are affected by fluctuations in currency exchange rates, interest rates, economic conditions, and other uncertainties inherent in doing business and selling product in more than one currency. In addition, our operations are exposed to risks associated with changes in social, political, and economic conditions inherent in foreign operations, including changes in the laws and policies that govern foreign investment in countries where we have operations, as well as, to a lesser extent, changes in United States laws and regulations relating to foreign trade and investment.
Foreign Currency Risks. Consolidated net sales outside the United States represented 53.8% and 56.9% of net sales for the six months ended July 3, 2004 and July 2, 2005, respectively. Inventory purchases are transacted primarily in U.S. dollars from vendors located in the United States. The local currency of each international subsidiary is considered the functional currency, with all revenue and expenses translated at weighted average exchange rates for reported periods. In general, our reported sales and earnings are affected positively by a weakening of the U.S. dollar and negatively by a strengthening of the U.S. dollar. Changes in currency exchange rates affect the relative prices at which we sell our products. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, results of operations, or financial condition.
26
We seek to reduce exposure to fluctuations in foreign exchange rates by creating offsetting positions through the use of foreign currency exchange contracts. We do not use derivative financial instruments for trading or speculative purposes. Our strategy includes entering into foreign currency exchange contracts to hedge expected net cash flow from certain of our international markets, which are primarily represented by intercompany cash transfers. All forward and option contracts we had in place to hedge expected net cash flows from our international markets were fulfilled in February 2005, and there were no contracts in place as of July 2, 2005. These contracts were in place to offset exposure to the Canadian Dollar, Australian Dollar, New Zealand Dollar, and New Taiwan Dollar.
Following are the average exchange rates of foreign currency units to one U.S. dollar for each of our foreign markets for the periods ended as of the dates indicated:
Canadian Dollar
1.36
1.24
1.34
1.23
Australian Dollar
1.40
1.30
1.35
1.29
New Zealand Dollar
1.59
1.54
Hong Kong Dollar
7.80
7.79
Japanese Yen
109.74
107.59
108.43
106.06
New Taiwan Dollar
33.30
31.39
33.31
31.43
Korean Won
1,162.47
1,008.72
1,166.37
1,015.54
Singapore Dollar
1.70
1.66
1.65
Mexican Peso **
11.41
10.95
11.32
11.07
** The six-month 2004 Mexican Peso exchange rate represents the average for the first four months of Mexico operations that commenced in March 2004.
Interest Rate Risks. As of July 2, 2005, we had no outstanding debt and, therefore, we currently have no direct exposure to interest rate risk. It may become necessary to borrow in the future in order to meet our financing needs, as circumstances require. In the event that it becomes necessary to finance with debt, there can be no assurance that we will be able to borrow at favorable rates.
Item 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a- 15(e) under the Securities Exchange Act of 1934, as amended). Based on the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended July 2, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
27
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Purchases made for each fiscal month during the quarter ended July 2, 2005 are summarized in the following table:
Issuer Purchases of Equity Securities
(amounts in thousands, except per share data)
Approximate Dollar
Total Number of Shares
Value of Shares that
Number of
Purchased as Part of
May Yet Be
Average Price
Publicly Announced
Purchased Under the
Period
Purchased
Paid per Share
Plans or Programs
Plans or Programs *
April 3, 2005 through May 7, 2005
(Fiscal April)
273
42.44
28,414
May 8, 2005 through June 4, 2005
(Fiscal May)
44
43.09
26,518
June 5, 2005 through July 2, 2005
(Fiscal June)
42.19
24,999
353
42.50
* As announced in two publicly issued press releases, the Board of Directors approved an increase in the dollar amount that may be purchased under the Company’s share repurchase plan from $4,100 to to $40,000 during the fiscal month of April 2005.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Shareholders on April 20, 2005, the following actions were submitted and approved by vote of the shareholders:
(1) Election of five directors, and
(2) Ratification of the Board’s selection of Grant Thornton LLP as our independent certified public accountants of USANA for fiscal year 2005.
A total of 17,266,440 shares (approximately 90%) of the issued and outstanding shares of USANA were represented by proxy or in person at the meeting. These shares were voted on the matters described above as follows:
1. For the directors as follows:
Number of Shares
Name
For
Abstaining/Withheld
Myron W. Wentz, PhD
17,169,548
96,892
Ronald S. Poelman
17,184,018
82,422
Robert Anciaux
17,225,460
40,980
Denis E. Waitley, PhD
17,153,053
113,387
Jerry G. McClain
17,183,110
83,330
28
2. For the ratification of the Board’s selection of Grant Thornton LLP as the independent certified public
accountants of USANA for fiscal year 2005 as follows:
Against
17,169,817
90,770
5,852
29
Item 6. EXHIBITS
Exhibit Number
Description
3.1
Articles of Incorporation [Incorporated by reference to Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993]
3.2
Bylaws [Incorporated by reference to Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993]
3.3
Amendment to Articles of Incorporation to change name and increase par value [Incorporated by reference to Report on Form 10-Q for the period ended July 1, 2000]
4.1
Specimen Stock Certificate for Common Stock, no par value [Incorporated by reference to Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993]
10.1
Amended and Restated Long-Term Stock Investment and Incentive Plan [Incorporated by reference to Report on Form 10-Q for the period ended June 27, 1998]*
10.2
2002 USANA Health Sciences, Inc. Stock Option Plan [Incorporated by reference to Registration Statement on Form S-8, filed July 18, 2002]*
10.3
Credit Agreement by and between Bank of America, N.A. and USANA Health Sciences, Inc. [Incorporated by reference to Report on Form 10-Q for the period ended July 3, 2004]
11.1
Computation of Net Income per Share (included in Notes to Consolidated Financial Statements)
31.1
Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
32.2
Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
* Denotes a management contract or compensatory plan or arrangement.
30
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
August 8, 2005
/s/ Gilbert A. Fuller
Gilbert A. Fuller
Chief Financial Officer(Principal Financial and Accounting Officer)
31