UNITED STATESSECURITIES 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 October 1, 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
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The number of shares outstanding of the registrant’s common stock as of October 28, 2005 was 18,632,798.
For the Quarterly Period Ended October 1, 2005
INDEX
PART I. FINANCIAL INFORMATION
Item 1
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Earnings – Quarter Ended
Consolidated Statements of Earnings – Nine 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
Item 6
Exhibits
Signatures
2
Item 1. Financial Statements
USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES
(in thousands)
January 1,
October 1,
2005
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents
$
15,067
31,321
Inventories, net
17,722
25,518
Prepaid expenses and other current assets
5,808
3,892
Deferred income taxes
2,226
2,719
Total current assets
40,823
63,450
Property and equipment, net
23,194
22,737
Goodwill
5,690
Other assets
1,957
2,864
71,664
94,741
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable
5,106
6,938
Other current liabilities
17,644
19,308
Total current liabilities
22,750
26,246
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 18,933 as of October 1, 2005
19
Additional paid-in capital
11,853
14,146
Retained earnings
34,496
51,956
Accumulated other comprehensive income
1,475
879
Total stockholders’ equity
47,843
67,000
The accompanying notes are an integral part of these statements.
3
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
(unaudited)
Quarter Ended
October 2,
2004
Net sales
68,673
82,225
Cost of sales
16,732
19,760
Gross profit
51,941
62,465
Operating expenses:
Associate incentives
26,210
32,545
Selling, general and administrative
13,141
14,756
Research and development
450
551
Total operating expenses
39,801
47,852
Earnings from operations
12,140
14,613
Other income (expense):
Interest income
56
143
Interest expense
—
(8
)
Other, net
(569
37
Other income (expense), net
(513
172
Earnings before income taxes
11,627
14,785
Income taxes
3,631
4,743
Net earnings
7,996
10,042
Earnings per common share
Basic
0.42
0.53
Diluted
0.39
0.51
Weighted average common shares outstanding
19,052
18,867
20,296
19,755
4
Nine Months Ended
197,694
240,818
47,985
57,269
149,709
183,549
75,378
94,006
40,059
44,773
1,635
1,839
117,072
140,618
32,637
42,931
142
340
(11
(507
(59
(365
270
32,272
43,201
10,650
14,688
21,622
28,513
1.13
1.50
1.05
1.44
19,209
18,961
20,557
19,849
5
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
Nine Months Ended October 2, 2004 and October 1, 2005
Accumulated
Additional
Other
Common Stock
Paid-in
Retained
Comprehensive
Shares
Value
Capital
Earnings
Income (Loss)
Total
For the Nine Months Ended October 2, 2004
Balance at January 3, 2004
19,470
14,187
28,935
1,230
44,371
Comprehensive income
Foreign currency translation adjustment, net
144
21,766
Common stock retired
(760
(6,287
(15,364
(21,651
Common stock issued under stock option plan, including tax benefit of $2,287
352
3,241
Balance at October 2, 2004
19,062
11,141
35,193
1,374
47,727
For the Nine Months Ended October 1, 2005
Balance at January 1, 2005
18,953
(596
27,917
(353
(3,948
(11,053
(15,001
Common stock issued under stock option plan, including tax benefit of $3,551
333
6,241
Balance at October 1, 2005
18,933
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
3,430
4,353
(Gain) loss on sale of property and equipment
(1
7
(341
(255
Allowance for inventory valuation
1,173
1,296
Changes in operating assets and liabilities:
Inventories
(3,741
(9,079
Prepaid expenses and other assets
253
667
2,809
1,836
6,187
5,427
Total adjustments
9,769
4,252
Net cash provided by operating activities
31,391
32,765
Cash flows from investing activities
Acquisitions, net of cash acquired
(2,140
Purchases of property and equipment
(6,174
(3,668
Proceeds from the sale of property and equipment
29
17
Net cash used in investing activities
(8,285
(3,651
Cash flows from financing activities
Proceeds from stock options exercised
954
2,690
Retirement of common stock
Net cash used in financing activities
(20,697
(12,311
Effect of exchange rate changes on cash and cash equivalents
71
(549
Net increase in cash and cash equivalents
2,480
16,254
Cash and cash equivalents, beginning of period
18,965
Cash and cash equivalents, end of period
21,445
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest
8
6,280
11,002
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.
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 October 1, 2005, and results of operations for the quarters and nine months ended October 2, 2004 and October 1, 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 nine months ended October 1, 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 nine month periods ended October 2, 2004 and October 1, 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 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 using the intrinsic value method under APB Opinion No. 25, under which no compensation expense 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
(480
(491
(1,184
(1,406
Pro forma
7,516
9,551
20,438
27,107
Earnings per share - basic
1.06
1.43
Earnings per share - diluted
0.37
0.48
0.99
1.37
9
Weighted average assumptions used to determine the Black-Scholes fair value for options granted during the periods indicated:
Expected volatility
75%
*
72%
Risk free interest rate
3.57%
3.93%
3.87%
Expected life
5.6yrs.
9.1yrs.
5.25yrs.
Expected dividend yield
0%
Weighted average fair value of options granted**
27.69
29.30
42.64
* No grants were issued during the quarter ended October 1, 2005.
** 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
13,825
Work in progress
3,123
3,515
Finished goods
7,897
10,815
19,866
28,155
Less allowance for inventory valuation
2,144
2,637
10
Prepaid expenses and other current assets consist of the following:
Prepaid expenses
1,599
994
Miscellaneous receivables, net
3,734
2,433
Other current assets
475
465
Cost of property and equipment and their estimated useful lives is as follows:
Years
Buildings
40
9,400
9,491
Laboratory and production equipment
5-7
8,706
9,418
Sound and video library
600
Computer equipment and software
3-5
22,580
23,370
Furniture and fixtures
2,530
2,623
Automobiles
206
205
Leasehold improvements
2,568
2,540
Land improvements
15
931
47,521
49,178
Less accumulated depreciation and amortization
26,459
29,246
21,062
19,932
Land
1,899
Deposits and projects in process
233
906
11
NOTE E – OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
2,379
3,073
Accrued employee compensation
4,696
4,533
1,901
2,604
Sales taxes
1,986
2,045
Associate promotions
429
945
Deferred revenue
1,825
1,614
Provision for returns and allowances
1,284
942
Accrued loss on foreign currency forwards
425
All other
3,552
NOTE F – 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 during the quarters and nine months ended October 2, 2004, and October 1, 2005, 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 diluted earnings per share calculations include stock options 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
273
266
Canceled during period
(691
(352
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
1,244
888
Weighted average shares outstanding during period - diluted
Earnings per common share - diluted
Options to purchase 190 shares of stock were not included in the computation of EPS for the quarter ended October 2, 2004, due to their exercise price being greater than the average market price of the shares.
12
For the Nine Months Ended
160
198
(421
(190
1,348
Options to purchase 193 shares of stock were not included in the computation of EPS for the nine months ended October 2, 2004, due to their exercise price being greater than the average market price of the shares.
During the nine months ended October 1, 2005, and October 2, 2004, the Company expended $15,001 and $21,651 to purchase 353 and 760 shares, respectively, which reduced the number of shares issued and outstanding for these periods.
NOTE G – SEGMENT INFORMATION
The Company operates 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.
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.
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.
13
Contract Manufacturing
Operations for the Contract Manufacturing segment are located in Draper, Utah. Operating activities for this segment 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 external customers. For the nine months ended October 2, 2004, and October 1, 2005, we had one and three external customers, respectively, that each accounted for more than ten percent of segment third-party 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 October 2, 2004 and October 1, 2005 is listed below:
Net Salesfrom ExternalCustomers
IntersegmentSales
Earningsbefore IncomeTaxes
Quarter ended October 2, 2004:
North America
43,648
11,416
11,440
Pacific Rim
22,196
911
158
Segment Total
65,844
12,327
11,598
2,829
696
178
Reportable Segments Total
13,023
11,776
Unallocated and Other *
(13,023
(149
Consolidated Total
* “Unallocated and Other” includes certain corporate items and eliminations that are not allocated to the operating segments.
14
Quarter ended October 1, 2005:
53,861
17,065
16,260
26,689
1,466
(419
80,550
18,531
15,841
1,675
1,423
27
19,954
15,868
(19,954
(1,083
Financial information summarized by operating segment and geographic region for the nine months ended October 2, 2004 and October 1, 2005 is listed below:
Long-livedAssets
Total Assets
Nine months ended October 2, 2004:
126,349
32,337
33,458
37,426
65,600
63,862
2,495
(1,528
2,769
15,553
190,211
34,832
31,930
40,195
81,153
7,483
1,603
281
5,988
10,891
36,435
32,211
46,183
92,044
(36,435
61
(14,207
(16,759
31,976
75,285
Nine months ended October 1, 2005:
155,383
50,316
47,873
38,549
83,924
79,628
4,125
(1,239
2,861
16,639
235,011
54,441
46,634
41,410
100,563
5,807
6,583
791
6,444
12,423
61,024
47,425
47,854
112,986
(61,024
(4,224
(16,563
(18,245
31,291
NOTE H – SUBSEQUENT EVENTS
On September 20, 2005, we announced our cash purchase of a manufacturing facility in China. The closing date of this acquisition was October 2, 2005. The amount paid for this facility was $1,404.
16
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 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, whom we refer to as “Associates.” As of October 1, 2005, we had approximately 127,000 active Associates worldwide. We also sell products directly to “Preferred Customers,” who purchase our products for personal use and are not permitted to resell or distribute the products. As of October 1, 2005, we had approximately 68,000 active Preferred Customers worldwide. The majority of sales in the Direct Selling segment come from Associates. For the nine months ended October 2, 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 products from USANA at any time during the most recent three-month period.
Our fiscal year end 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 G – Segment Information, beginning on page 13 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 contract manufacturing services provided to a limited number of third-party customers.
Our primary product lines within the Direct Selling segment consist of USANA® Nutritionals and Sensé – beautiful science® (Sensé). The USANA® Nutritionals 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.
USANA®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 especially important, USANA offers: Usanimals™, a formulation of vitamins, minerals, and antioxidants, in an easy-to-take chewable tablet for children 13 months to 12 years old; and Body Rox™, a nutritional supplement containing 31 essential vitamins, minerals, antioxidants, and cofactors for adolescents 12 to 18 years old. USANA® Essentials 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 USANA® Essentials are also provided in a convenient pillow pack format, HealthPak 100™.
Optimizers are more targeted supplements designed to meet individual health and nutritional needs. Products in this category include Proflavanol®,Poly C®, Procosa® II, CoQuinone® 30, BiOmega-3™, E-Prime™, Active Calcium™, PhytoEstrin™, Palmetto Plus™, Ginkgo-PS™, Garlic EC™, Visionex®, and OptOmega®.
The Macro Optimizers include healthy, low-glycemic convenience foods and other related products. Nutrimeal™, Fibergy®, and SoyaMax™ drink mixes, and Nutrition and Fibergy Bars™ are included in this product category. At our Annual International Convention held in September, we announced and introduced our new RESET™ Weight Management Program and
accompanying RESET™ kit. The RESET kit is conveniently packaged in a self-contained box with everything needed to complete a five-day regimen, which is designed to assist in losing weight, and alleviating carbohydrate and sugar cravings.
Sensé - beautiful science®
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, 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 our 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, which contains USANA training materials that assist the Associates in starting and growing their business. 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 nine months ended as of the dates indicated:
Sales By Product Line *
Product Line
USANA® Nutritionals
Essentials **
39%
38%
Optimizers
34%
Macro Optimizers
10%
9%
Sensé – beautiful science®
13%
15%
4%
* 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 USANA®Nutritionals product line includes USANA® Essentials, HealthPak 100™, Body Rox™, and Usanimals™.
18
The following highlights sales data for our top-selling products as a percentage of Direct Selling segment product sales for the nine months ended as of the dates indicated:
Key Product
USANA® Essentials
24%
23%
HealthPak 100 ™
11%
Proflavanol®
Quarters Ended October 2, 2004 and October 1, 2005
Net Sales. Net sales increased 19.7% to $82.2 million for the quarter ended October 1, 2005, an increase of $13.5 million, from $68.7 million for the comparable quarter in 2004. During the current quarter, net sales in the Direct Selling segment increased by $14.7 million, while net sales in the Contract Manufacturing segment declined by $1.2 million, when compared with the same period in 2004.
The following table summarizes the changes in net sales by segment and geographic region for the fiscal quarters ended October 2, 2004 and October 1, 2005.
Sales By Segment and Region
Change from
Percent
Segment / Region
October 2, 2004
October 1, 2005
Prior Year
Change
United States
28,827
42.0%
35,181
42.8%
6,354
22.0%
Canada
12,553
18.3%
15,231
18.5%
2,678
21.3%
Mexico
2,268
3.3%
3,449
4.2%
1,181
52.1%
North America Total
63.6%
65.5%
10,213
23.4%
Australia-New Zealand
9,056
13.2%
11,341
13.8%
2,285
25.2%
Hong Kong
2,837
4.1%
2,971
3.6%
134
4.7%
Japan
2,356
3.4%
2,562
3.1%
8.7%
Taiwan
3,903
5.7%
4,885
6.0%
982
South Korea
1,366
2.0%
1,250
1.5%
(116
(8.5)%
Singapore
3.9%
3,680
4.5%
1,002
37.4%
Pacific Rim Total
32.3%
32.5%
4,493
20.2%
95.9%
98.0%
14,706
22.3%
(1,154
(40.8)%
Consolidated
100.0%
13,552
19.7%
The increase in net sales contributed by the Direct Selling segment can be primarily attributed to the following factors:
• A 14.4% increase in the number of active Associates and a 13.3% increase in the number of active Preferred Customers for the third quarter of 2005;
• Stronger foreign currencies relative to the U. S. dollar, which positively affected the translation of sales in foreign currencies by $2.6 million; and
• Sales growth in the U.S. resulting from record sales of $2.1 million at our annual International Convention held in September 2005, compared to $1.6 million in sales at the 2004 event.
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 $86 and $88 million for the fourth quarter of 2005 and between $327 and $329 million for fiscal year 2005. These estimates are based on the assumption that we will receive local government approval to commence operations in our new market during the fourth quarter.
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
43,000
38.8%
50,000
39.4%
7,000
16.3%
21,000
18.9%
16.5%
0.0%
6,000
5.4%
8,000
6.3%
2,000
33.3%
70,000
63.1%
79,000
62.2%
9,000
12.9%
14,000
12.6%
16,000
14.3%
5,000
4,000
(1,000
(20.0)%
7.2%
13,000
10.3%
62.5%
3,000
2.7%
1.6%
(33.3)%
7.1%
50.0%
41,000
36.9%
48,000
37.8%
17.1%
111,000
127,000
14.4%
We believe that various factors contributed to the year-over-year third quarter increase in the number of active Associates, including 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.
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Active Preferred Customers By Region
36,000
60.0%
63.2%
19.4%
26.6%
17,000
25.0%
1,000
1.7%
53,000
88.3%
61,000
89.7%
15.1%
8.3%
8.8%
20.0%
**
(100.0)%
N/A
11.7%
60,000
68,000
13.3%
**Active Preferred Customer count is less than 500.
Total Active Customers By Region
46.2%
93,000
47.7%
17.7%
37,000
21.6%
38,000
19.5%
4.6%
28.6%
123,000
71.9%
140,000
71.8%
19,000
11.1%
22,000
11.2%
15.8%
3.5%
2.1%
(2,000
2.9%
2.6%
5.3%
6.7%
44.4%
1.8%
1.0%
28.1%
55,000
28.2%
14.6%
171,000
195,000
24,000
14.0%
Gross Profit. Consolidated gross profit increased to 76.0% of net sales for the quarter ended October 1, 2005, from 75.6% for the comparable quarter in 2004. The increase in consolidated gross profit can be attributed to the lower margin Contract Manufacturing segment being a smaller portion of our overall business. We believe that our consolidated gross profit margins will improve modestly in the fourth quarter of 2005.
Gross profit in the Direct Selling segment for the quarter ended October 1, 2005, was 77.7% of net segment sales, compared with 78.4% for the same quarter in 2004. Lower gross profits in our Direct Selling segment can be attributed to higher costs of raw materials and an increase in the provision for inventory valuation as a result of growth in inventory levels. However, we have begun to experience relief on the rising purchase price of the raw material Coenzyme Q10, which has continually increased since the latter part of 2003 due to a persistent shortage in supply.
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The Contract Manufacturing segment generated no gross profit from its third-party customers in the third quarter of 2005, compared to gross profit of 10.5% in the third quarter of 2004. The decline in gross profit margin from third-party customers can primarily be attributed to production inefficiencies.
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 to 40.4% of net segment sales during the third quarter of 2005, compared to 39.8% for the third quarter of 2004. The increase in Associate incentives relative to net segment sales can be attributed to a higher payout rate of base commissions generated during the quarter.
Additionally, we experienced an increase in Associate promotions during the quarter as we began our initiative to increase rewards to our top-performing Associates through contests, promotions, and other incentives designed to assist them in growing their respective businesses. 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 17.9% of net sales for the quarter ended October 1, 2005, from 19.1% for the comparable quarter in 2004. The decrease, as a percentage of net sales, can be attributed to leverage generated on our increasing sales base.
In absolute terms, our selling, general and administrative expenses increased by $1.6 million for the quarter ended October 1, 2005, when compared with the third quarter of 2004. This 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 our selling, general and administrative expenses, as a percentage of net sales during the fourth quarter 2005, will be higher than those in the third quarter 2005 due to initial costs related to our planned market opening in the fourth quarter of 2005.
Other Income (Expense). Other income (expense) changed from net other expense of $513,000 in the third quarter of 2004, to net other income of $172,000 in the third quarter of 2005. The change in net other income (expense) of $685,000 can be primarily attributed to a change from foreign currency losses of $576,000 for the third quarter of 2004, to slight foreign currency gains in the third quarter of 2005. Foreign currency gains and losses are recognized on the changes in the fair value of foreign exchange contracts as well as the impact of fluctuating exchange rates on intercompany transactions with our international affiliates. Additionally, interest income increased during the current quarter as a result of higher average balances in cash and cash equivalents.
Net Earnings. Net earnings increased 25.6% to $10.0 million for the third quarter of 2005, an increase of $2.0 million from $8.0 million for the comparable quarter in 2004. The increase in net earnings can be primarily attributed to higher net sales, lower selling, general and administrative expenses relative to net sales, and a considerable improvement in net other income.
Diluted earnings per share improved to $0.51 for the third quarter of 2005, an increase of 30.8%, from the $0.39 reported in the same period of the prior year. We expect earnings per share for fiscal year 2005 to be between $1.94 and $1.96, assuming that we receive local government approval to commence operations in our new market during the fourth quarter.
Net Sales. Consolidated net sales increased 21.8% to $240.8 million for the nine months ended October 1, 2005, an increase of $43.1 million from $197.7 million for the comparable period in 2004. This net increase consisted of a $44.8 million increase in the Direct Selling segment, and a $1.7 million decrease in the Contract Manufacturing segment.
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The following table summarizes the changes in net sales by segment and geographic region for the nine months ended October 2, 2004 and October 1, 2005.
Net Sales By Segment and Region
83,749
42.4%
99,451
41.3%
15,702
18.7%
37,368
45,380
18.8%
8,012
21.4%
5,232
10,552
4.4%
5,320
101.7%
63.9%
64.5%
29,034
23.0%
25,803
13.1%
33,226
7,423
28.8%
8,044
9,388
1,344
16.7%
6,748
7,680
3.2%
932
11,530
5.8%
15,330
6.4%
3,800
33.0%
4,440
2.2%
3,618
(822
(18.5)%
7,297
3.7%
10,386
4.3%
3,089
42.3%
33.1%
15,766
24.7%
96.2%
97.6%
44,800
23.6%
3.8%
2.4%
(1,676
(22.4)%
43,124
21.8%
• An increase in the number of active Associates and Preferred Customers;
• Stronger foreign currencies relative to the U.S. dollar, which positively affected the translation of sales in foreign currencies by $7.5 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 76.2% of net sales for the nine months ended October 1, 2005, from 75.7% for the comparable period in 2004. This increase in consolidated gross profit margins for the nine months ended October 1, 2005 can primarily be attributed to a decrease in the impact that the Contract Manufacturing segment had on the total.
On a segment basis, the Direct Selling gross profit margin decreased slightly to 78.2% for the nine months ended October 1, 2005, compared with 78.3% for the same period in 2004. This modest decline in gross profit margin can primarily be attributed to the higher cost of raw materials.
The Contract Manufacturing segment generated no gross profit from its third-party customers in the first nine months of 2005, compared with gross profit of 10.2% in the comparable period of 2004. This decline in gross profit margin from third-party customers at our Contract Manufacturing segment can, in great part, be attributed to production inefficiencies and additional costs associated with our efforts to expedite production of our Sensé products in the face of a backlog of orders.
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Associate Incentives. Expenses related to Associate incentives are incurred only by the Direct Selling segment and represent the most significant cost as a percent of net sales for the segment. Associate incentives increased to 40.0% of net segment sales for the nine months ended October 1, 2005, compared with 39.6% for the comparable period in 2004. This increase in Associate incentives relative to net segment sales can primarily be attributed to a higher payout rate of base commissions during the nine months ended October 1, 2005.
Selling, General and Administrative Expenses. Selling, general and administrative expense decreased to 18.6% of net sales for the nine months ended October 1, 2005, from 20.3% for the comparable period in 2004. The decrease, as a percentage of net sales, can be attributed to the leverage generated on our increasing sales base.
In absolute terms, our selling, general and administrative expenses increased by $4.7 million for the nine months ended October 1, 2005, compared with the first nine months of 2004. This absolute increase can be attributed to an increase in spending in many of our markets to support growing sales and an increasing number of Associates.
Other Income (Expense). Other income (expense) changed from net other expense of $365,000 for the nine months ended October 2, 2004, to net other income of $270,000 for the comparable period in 2005. This change in net other income (expense) of $635,000 can be attributed to a decrease in foreign currency losses of approximately $485,000, and, to a lesser extent, an increase in interest income.
Income Taxes. Income taxes totaled 34.0% of earnings before income taxes for the first nine months of 2005, compared to 33.0% for the first nine months of 2004. This increase in the effective tax rate by 1.0% in the first nine 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 nine months of 2004 was based on an estimate of a 33.0% 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 now expect the effective tax rate for the full year 2005 to be 34.0%, based on current tax accrual at the end of the quarter ended October 1, 2005.
Net Earnings. Net earnings increased 31.9% to $28.5 million for the nine months ended October 1, 2005, an increase of $6.9 million, from $21.6 million for the comparable period in 2004. The increase in net earnings can be primarily attributed to higher net sales, lower selling, general and administrative expenses relative to net sales, and, to a lesser extent, to an improvement in our net other income.
Diluted earnings per share improved to $1.44 for the first nine months of 2005, an increase of 37.1%, from $1.05 for the comparable period in 2004.
Liquidity and Capital Resources
We continue to finance our growth with cash flows from operations. In the first nine months of 2005, net cash flows from operating activities totaled $32.8 million, compared with $31.4 million for the same period in 2004. Cash flows from operating activities for the nine months ended October 1, 2005, although strong, were negatively impacted by increased inventory levels totaling $9.1 million, compared with a $3.7 million increase in the same period of the prior year. The increase in inventory can primarily be attributed to the following:
• Purchase of additional quantities of key raw materials that we anticipated would be in short supply or would increase in price;
• Increased inventory related to our launch of RESET™;
• Increased Sensé™ inventory to limit potential stock-outs or back-orders; and
24
• Increased inventory relating to our planned new market opening.
Cash and cash equivalents increased to $31.3 million at October 1, 2005, from $15.1 million at January 1, 2005. Net working capital increased to $37.2 million at October 1, 2005, compared with $18.1 million at January 1, 2005. The net increase in cash and cash equivalents and net working capital during the nine months ended October 1, 2005 can be primarily attributed to strong cash flows from operations. This increase in working capital was partially offset by our purchase of shares, totaling $15.0 million during the first nine months of 2005.
As of October 1, 2005, our credit facilities consisted of a $10 million line of credit, with no amounts currently outstanding. The credit facility contains restrictive covenants requiring that we maintain certain financial ratios. As of October 1, 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 are 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, growth, 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;
• Our planned expansion into 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;
25
• Potential natural disasters 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 the Company’s 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 US 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 that are inherent in doing business and selling product in more than one currency. In addition, our operations are exposed to risks that are associated with changes in social, political, and economic conditions that are 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 56.3% of net sales for the nine months ended October 2, 2004 and October 1, 2005, respectively. Inventory purchases are transacted primarily in U.S. dollars from suppliers located in the United States. The local currency of each international subsidiary is considered the functional currency, with all revenue and expenses being 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 that these fluctuations may have 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 in this regard includes entering into foreign currency exchange contracts to hedge against expected net cash flow from certain of our international markets, which are primarily represented by intercompany cash transfers. As of October 1, 2005, option contracts were in place to offset our exposure to the Canadian Dollar, Australian Dollar, New Zealand Dollar, New Taiwan Dollar, and Mexican Peso.
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
1.31
1.20
1.33
1.22
Australian Dollar
1.41
1.32
1.30
New Zealand Dollar
1.53
1.45
Hong Kong Dollar
7.80
7.77
7.79
Japanese Yen
109.98
111.20
108.95
107.72
New Taiwan Dollar
33.89
32.29
33.50
31.72
Korean Won
1,154.54
1,028.89
1,162.43
1,019.95
Singapore Dollar
1.71
1.67
1.70
1.66
Mexican Peso *
11.44
10.72
11.28
10.95
* The nine-month 2004 Mexican Peso exchange rate represents the average for the first seven months of Mexico operations that commenced in March 2004.
Interest Rate Risks. As of October 1, 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. In the event that it becomes necessary to borrow money, 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 our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow them to make timely decisions regarding any required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and that management necessarily is required to apply its judgment in evaluating the costs and benefits 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 have concluded that these 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 October 1, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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.
28
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:
November 3, 2005
/s/ Gilbert A. Fuller
Gilbert A. Fuller
Chief Financial Officer(Principal Financial and Accounting Officer)