Business context and reporting period
USANA Health Sciences, Inc. develops and manufactures nutrition and personal-care products sold internationally through independent network-marketing Associates. This unaudited Form 10-Q covers the quarter and six months ended June 28, 2014; comparisons are with the periods ended June 29, 2013. Amounts below are in U.S. dollars; financial amounts are in millions unless otherwise noted.
At quarter-end, USANA reported approximately 283,000 active Associates and 79,000 active Preferred Customers. Associates accounted for about 90% of product sales in the first half. The filing metadata says “2013 Q2,” but the filing itself is for 2014 Q2.
Financial performance and liquidity
- Second-quarter revenue: $188.3 million, down 0.5% from $189.1 million. Gross profit was $153.4 million; operating earnings were $29.1 million; net earnings were $19.3 million. Diluted EPS was $1.36.
- First-half revenue: $370.7 million, up 3.5% from $358.2 million. Gross profit was $302.0 million; operating earnings were $54.2 million; net earnings were $35.8 million. Diluted EPS was $2.50.
- Margins: Second-quarter gross margin was 81.5%, versus 83.1%; first-half gross margin was 81.5%, versus 82.6%. Associate incentives were 43.1% of quarterly sales and 43.2% of first-half sales, compared with 41.1% and 41.2%, respectively, in the prior-year periods.
- Cash flow: First-half operating cash flow was $31.3 million, versus $47.3 million. Capital expenditures were $10.1 million, versus $3.0 million. Cash and cash equivalents ended the period at $118.3 million, down from $137.3 million at year-end 2013.
- Balance sheet and liquidity: Current assets were $201.9 million and current liabilities were $88.7 million; working capital was $113.2 million, down from $133.2 million at year-end. The company had no outstanding borrowings under its $75 million credit facility; $3.9 million of availability was reserved for bank guarantees. It was in compliance with the facility’s covenants.
- Capital returns and investment: USANA repurchased approximately 682,000 shares for $49.1 million in the first half. It reported $46.1 million of cash repurchases in financing cash flows and $3.0 million of unsettled repurchase trades. Through August 1, it repurchased a further 430,000 shares for $30.9 million. The planned China manufacturing facility is expected to require approximately $40 million in total investment, including about $24 million in 2014.
Material changes and management commentary
Management attributed essentially flat quarterly sales despite year-over-year growth of 11.4% in active Associates and 12.9% in active Preferred Customers largely to the 2013 price discounts, $7.0 million of prior-year sales ahead of a policy change restricting Associate purchases to their local markets, and $3.3 million of unfavorable currency effects. For the first half, Asia Pacific sales growth drove consolidated revenue higher, partly offset by declines in the Americas and Europe.
Quarterly sales increased 13.9% in Southeast Asia Pacific but declined 4.3% in Greater China and 4.7% in the Americas and Europe. Mainland China grew strongly, while Hong Kong sales fell; the prior-year comparison included the $7.0 million pre-policy-change sales. The United States also declined, reflecting price pressure and fewer active customers. Customer counts and several other operating indicators improved, but management said price discounts would continue to temper their near-term sales impact.
Management said the 2013 strategic changes—including price reductions, customer-order rewards, and higher and simplified Associate compensation—were intended to support customer loyalty and growth. It identified higher relative Associate incentives, lower gross margins, production inefficiencies, freight costs, and currency movements as pressures on quarterly earnings. First-half SG&A increased $2.4 million, partly due to support for a higher sales base, new markets, and personalization initiatives.
Outlook, risks, and unusual items
The filing gives no specific revenue or earnings guidance. Management expected existing cash, operating cash flow, and available credit to meet ordinary operating and capital needs for the foreseeable future, while cautioning that adverse conditions or unusual spending could require financing. The China facility was expected to become operational in the latter half of 2015. Management noted a change in unearned-revenue trends following the purchase-policy change and anticipated that it could begin recognizing breakage in the near future.
Key risks include retaining Associates and Preferred Customers; changes to the compensation plan; China and other international expansion; foreign-exchange exposure (80.3% of first-half sales were outside the United States); product, marketing, and network-selling regulation; supplier and raw-material dependence; competition; and compliance with credit covenants. The company reported ordinary-course legal matters but did not expect them, individually or collectively, to materially harm its financial condition, liquidity, or results. The SEC notified USANA in May 2014 that it had concluded its investigation and did not intend to recommend enforcement action against the company.
The company adopted no new revenue-recognition standard during the period; it was evaluating ASU 2014-09, which it expected to adopt in 2017. Management stated that disclosure controls were effective at June 28, 2014 and that there had been no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether customer growth translates into sustained sales growth after accounting for price discounts and the prior-year Hong Kong comparison.
- Whether higher Associate incentive costs and lower gross margins persist, and their effect on earnings and cash generation.
- Progress, remaining costs, and timing for the China manufacturing facility, including the expected 2014 spending.
- The pace of share repurchases relative to operating cash flow, liquidity, and the remaining authorization.
- Exposure to currency movements, China-market execution, and the credit facility’s covenant requirements.