USANA Health Sciences, Inc. — FY2018 Form 10-K
Period clarification: The request identifies “2017 Q4,” but the supplied filing is the annual report for the fiscal year ended December 29, 2018. Fiscal 2018 and 2017 were each 52-week years. The filing also reports fourth-quarter results.
Business context and reporting period
USANA develops and sells nutrition, personal-care, and wellness products through direct selling in 24 markets. It reported 616,000 active Customers at year-end, up 9.0% from 565,000. Mainland China represented approximately half of sales and active Customers; 90.2% of net sales were generated outside the United States. The company reports one operating segment, with geographic results presented by region.
Key financial metrics
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $1,189.2 million | $1,047.3 million |
| Gross profit / margin | $988.5 million / 83.1% | $867.9 million / 82.9% |
| Operating earnings / margin | $188.4 million / 15.8% | $132.5 million / 12.7% |
| Net earnings | $126.2 million | $62.5 million |
| Diluted EPS | $5.12 | $2.53 |
| Operating cash flow | $152.1 million | $123.8 million |
| Cash and cash equivalents | $214.3 million | $247.1 million |
| Cash, cash equivalents and held-to-maturity securities | $277.9 million | $247.1 million |
| Working capital | $243.6 million | $199.0 million |
| Total assets / stockholders’ equity | $554.5 million / $391.1 million | $519.3 million / $363.2 million |
There was no outstanding debt at year-end. The company had a $75 million bank credit line, due April 2021, with no balance outstanding; bank guarantees reduced available borrowing capacity. Fiscal 2018 investing cash outflow was $69.0 million, including purchases of $86.4 million of held-to-maturity securities and $11.4 million of property and equipment. Financing cash outflow was $105.3 million, principally reflecting share repurchases.
Material changes versus the prior comparable period
- Sales rose 13.6% ($142.0 million); management attributed the increase primarily to customer growth in Asia Pacific. Favorable currency movements added an estimated $12.2 million; sales grew 12.4% excluding currency impact.
- Asia Pacific sales increased 18.0% to $956.6 million. Greater China sales rose 19.7% to $654.4 million. Americas and Europe sales declined 1.8% to $232.7 million; customer declines in the United States and Mexico partly offset new-market sales.
- Net earnings more than doubled, while the effective tax rate fell to 34.1% from 53.6%. The comparison is affected by the 2017 one-time, non-cash $30.1 million Tax Act charge and higher 2017 China investigation-related costs. Excluding the specified tax-reform and investigation items, management reported adjusted 2018 net earnings growth of 26.8%; adjusted diluted EPS was $5.16 versus $4.06.
- Gross margin improved 20 basis points. Associate incentives declined to 44.2% of sales from 44.9%, and SG&A declined to 23.1% from 25.3% of sales, although SG&A increased $10.0 million in dollars.
- Active Customers increased by 51,000 overall, led by Asia Pacific growth of 60,000; Americas and Europe customers fell by 9,000. Inventory increased to $81.9 million from $62.9 million, with management citing Celavive-related inventory among operating cash flow factors.
Fourth-quarter 2018 sales were $299.0 million, net earnings were $32.3 million, and diluted EPS was $1.32. Fourth-quarter 2017 included a net loss of $5.9 million and diluted loss per share of $0.24, primarily reflecting the Tax Act charge.
Outlook, management commentary, risks and unusual items
- Outlook: The filing gives no quantitative 2019 revenue or earnings guidance. Management plans to focus on customer growth, customer experience and technology, product launches, social sharing, and growth in existing markets, particularly China. It also plans new product and customer initiatives in selected Americas and Europe markets.
- China regulatory exposure: A Chinese government 100-day review of health-product and direct-selling companies began in January 2019. During the review, authorities suspended review of direct-selling license applications and instructed companies not to hold large distributor meetings. BabyCare held licenses in Beijing, Jiangsu, Shaanxi, and Tianjin; final approvals for certain additional jurisdictions were uncertain and might require reapplication.
- Internal investigation: USANA’s voluntary investigation of BabyCare, focused on FCPA compliance and expense reimbursement practices, was described as substantially complete. The company continued cooperating with the SEC and DOJ, but could not predict the outcome, duration, or potential costs or penalties. Management said the subject amounts were not believed quantitatively material, but potential governmental action and additional expenses remained possible.
- Legal matters: A shareholder class action related to the China allegations was dismissed with prejudice in October 2018. The company disclosed other ordinary-course proceedings and contingencies; management did not believe them collectively or individually likely to materially harm results, liquidity, or financial condition, while noting some reasonably possible matters could not be estimated.
- Other risks: China concentration and licensing, direct-selling regulation, customer and Associate retention, foreign exchange, product and advertising regulation, supply-chain and manufacturing continuity, data privacy and cybersecurity, and tax uncertainty. China held $156.1 million of the company’s $191.0 million in international cash and cash equivalents; remittances can be delayed by Chinese requirements.
- Capital allocation and other items: USANA repurchased 900,000 shares for $105.4 million during 2018; $70.2 million remained authorized at year-end. It repurchased a further 283,600 shares for $30.0 million through February 22, 2019. The former nutrition-bar supplier settlement produced $4.8 million cash in 2018 after a $2.7 million impairment had been recorded in 2017.
- Accounting and controls: USANA adopted ASC 606 in 2018; the filing says adoption did not materially affect the financial statements. Adoption of the new lease standard in 2019 was expected to add $18 million to $25 million in right-of-use assets and lease liabilities. Management and KPMG concluded internal control over financial reporting was effective at year-end; KPMG gave an unqualified opinion on the financial statements.
Most important facts for investors to verify
- Whether China’s regulatory review, license approvals, and direct-selling rules affect BabyCare’s operations, customer growth, or ability to expand.
- Developments and any resulting costs, penalties, or disclosures from the China investigation and continuing SEC/DOJ cooperation.
- Whether Asia Pacific growth can offset continuing customer and sales weakness in the United States and broader Americas and Europe region.
- Cash generation and liquidity after substantial repurchases, including the location and transferability of international cash and the terms and availability of the credit line.
- The comparability of reported earnings and EPS, including the effects of the 2017 tax charge, investigation costs, currency movements, and management’s non-GAAP adjustments.
- Execution and returns from 2019 product, technology, customer-experience, and market initiatives, as well as inventory levels and Celavive performance.