Business context and reporting period
USANA Health Sciences, Inc. develops and manufactures nutrition and personal-care products sold internationally through independent direct-selling Associates. This 10-Q reports the quarter and six months ended June 29, 2013; the filing’s year-over-year comparisons are to periods ended June 30, 2012. Amounts below are in millions of dollars unless stated otherwise. The filing describes unaudited interim results and cautions they may not indicate full-year results.
At quarter-end, the company reported approximately 254,000 active Associates and 70,000 active Preferred Customers. Associates accounted for 91% of product sales in the first half.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $189.1 | $160.9 | $358.2 | $315.0 |
| Gross profit | $157.2 | $132.8 | $296.1 | $259.7 |
| Operating earnings | $36.5 | $25.2 | $63.0 | $46.0 |
| Net earnings | $24.2 | $16.7 | $42.0 | $30.5 |
| Diluted EPS | $1.72 | $1.11 | $2.99 | $2.01 |
| Operating cash flow | Not separately stated for quarter | $47.3 | $43.9 |
Gross margin was 83.1% in Q2 2013 versus 82.6% a year earlier, and 82.6% for the first half versus 82.4%. Associate incentives were 41.1% of Q2 sales and 41.2% of first-half sales, down 3.0 and 2.9 percentage points, respectively, year over year. SG&A as a share of sales was described as relatively flat; SG&A increased $6.2 million in Q2 and $10.6 million in the first half.
At June 29, cash and cash equivalents were $96.1 million, current assets $166.0 million, current liabilities $74.6 million, and working capital $91.4 million. Cash increased from $70.8 million at December 29, 2012. No amount was drawn on the credit line in the first half, and no balance was outstanding at quarter-end. The company reported compliance with its credit covenants. The line’s commitment was increased from $60 million to $75 million on July 18, 2013. First-half capital expenditures were $3.0 million; the company planned up to $25 million of capital expenditures for 2013. It repurchased 414,000 shares for $18.1 million in the first half.
Material changes versus prior comparable periods
- Q2 sales rose 17.5% and first-half sales rose 13.7%. Greater China was the largest regional growth contributor: sales increased 36.3% in Q2 and 23.8% for the first half.
- Management attributed growth to higher active Associate and Preferred Customer counts in many markets and increased sales volume per Associate. Active Associates grew 8.1% year over year, while Preferred Customers grew 6.1% overall; Greater China Preferred Customers declined 42.9%.
- Q2 net earnings increased 44.6%; diluted EPS increased 55.0%, reflecting higher earnings and fewer diluted shares following repurchases. First-half net earnings rose from $30.5 million to $42.0 million.
- Lower payouts under the Lifetime Matching Bonus program reduced Associate incentives as a share of sales. Production efficiencies supported gross-margin improvement, partly offset by changes in market and product mix.
- First-half cash from operations increased to $47.3 million, primarily due to higher earnings and tax-related cash benefits, partly offset by higher inventory. Inventory rose to $41.7 million from $36.5 million at year-end.
Outlook, commentary, risks and unusual items
- Management expected gross margins to decline in the second half because of reduced production-efficiency benefits, the 2013 pricing initiative, and anticipated pressure on sales from initiatives to be announced at the August convention. It also expected Associate incentive expense to rise beginning in Q3 as new initiatives were introduced; these initiatives were expected to pressure second-half results, with management viewing them as a potential source of longer-term growth.
- The worldwide cross-border purchasing policy was preceded by an estimated $7.0 million of incremental Q2 sales. Management expected the policy to negatively affect results in certain markets. The filing also identified approximately $11.0 million of first-half 2012 sales ahead of price increases and nearly $4.0 million from a 2012 promotion as prior-period benefits not repeated in 2013.
- Price reductions in Canada were estimated to have reduced Q2 sales by $1.8 million. Sales growth in Hong Kong included cross-border-policy-related advance purchases; without them, management said Hong Kong sales would have declined year over year.
- USANA launched in Colombia in early July 2013 and reported receiving three additional direct-selling licenses in Mainland China. Management planned elevated 2013 capital spending, principally for China and international development.
- The company said cash, operating cash flow, and available credit should cover ordinary operating and capital needs for the foreseeable future, while noting adverse conditions or unusual spending could require financing. Foreign-currency movements are a risk; approximately 78% of first-half sales were outside the United States.
- On July 23, 2013, the company disclosed a formal SEC investigation that appears to concern possible late-2012 stock trading by certain directors, including the Chairman. The company and certain directors and executives received subpoenas and were cooperating. Management, based on counsel’s advice, said an adverse outcome for the company was remote and expected no material financial impact.
- Other stated risks include dependence on Associates and the network-marketing model, regulation, China expansion, compensation-plan changes, competition, supply and raw-material constraints, product liability, currency exposure, and debt-covenant compliance.
Most important facts for investors to verify
- Whether sales growth—especially in Greater China—persists after the estimated $7.0 million of advance purchases and the cross-border policy’s expected market effects.
- Whether second-half margin and earnings pressure from pricing, lower production-efficiency benefits, and higher Associate incentives develops as management anticipated.
- Whether customer trends remain healthy, particularly the decline in Greater China Preferred Customers and the flat Associate count in North America/Europe.
- Progress and spending on the Colombia launch, China expansion, and the planned capital expenditure program of up to $25 million.
- Developments in the SEC investigation, including any change to the company’s assessment of potential consequences.
- Cash generation, inventory levels, share repurchases, and continued compliance with credit-facility covenants.