The increase in gross profit was partially offset by the compression of gross margins as a result of weaker foreign currencies relative to the U. S. dollar.
These benefits were partially offset by the 9.0% decline in net sales during the second quarter of 2001 when compared to the same period in 2000.
Diluted earnings per share increased by $0.01 to $0.05 for the second quarter of 2001 from $0.04 reported in the comparable quarter of 2000.
The value initiative was introduced in February 2000 and late March 2000 in the North American and Australia-New Zealand markets, respectively. Sales to Japan under the direct export program totaled $1.2 million during the six months ended June 30, 2001.
The following tables illustrate the change in sales and customers by market for the six months ended July 1, 2000 and June 30, 2001 (sales and customer information for the United Kingdom and Japan are incorporated in the numbers for the United States):
Gross Profit. Gross profit decreased to 70.9% of net sales for the six months ended June 30, 2001 from 72.5% for the comparable period in 2000. The decrease in gross profit can be attributed to:
| | • | The value initiative, which reduced prices by an average of 24% while the cost and quality of the product remained virtually unchanged, and |
| | | |
| | • | The compression of gross margins as a result of weakening foreign currencies relative to the U. S. dollar. |
Associate Incentives. Associate incentives decreased to 38.2% of net sales for the six months ended June 30, 2001 from 39.2% for the comparable period in 2000. The decrease in Associate incentives as a percentage of net sales can primarily be attributed to the value initiative. In addition to reducing prices by an average of 24%, the value initiative also incorporated a reduction in the ratio of sales volume points to the wholesale price on customer product purchases. Associate incentives are paid on the amount of sales volume points generated.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to 28.0% of net sales for the six months ended June 30, 2001 from 26.7% for the comparable period in 2000. The increase in selling, general and administrative expenses as a percentage of net sales can be primarily attributed to lower sales in the first six months of 2001 compared to the same period in 2000. USANA has made a company-wide effort to better manage costs and was able to reduce selling, general and administrative expenses in absolute terms during the first six months of 2001 by $1.1 million despite spending $1.4 million on our Japanese market.
Other Income (Expense). Foreign currency exchange losses (a component of Other, net) totaled $286,000 for the six months ended June 30, 2001 from a $33,000 gain for the comparable period in 2000. The increase is due to the negative effect of weaker foreign currencies on intercompany loans with our foreign subsidiaries. Additional discussion on our foreign currency risk is included in Item 3, “QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK,” on page 19. The increase in other income (expense) was partially offset by a $103,000 decrease in interest expense for the first six months of 2001 when compared to the same period in 2000.
Net Earnings. Net earnings decreased to 1.7% of net sales for the six months ended June 30, 2001 from 2.8% for the comparable period in 2000. The decrease in net earnings can be attributed to:
| | • | Lower sales in the first six months of 2001 when compared to the same period in 2000, |
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| | • | Compressed gross margins as a result of the value initiative and weakening foreign currencies, and |
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| | • | Foreign currency exchange losses. |
Diluted earnings per share decreased $0.08 to $0.10 for the first six months of 2001 from $0.18 reported in the comparable period of 2000.
Liquidity and Capital Resources
USANA has historically financed growth with cash flows from operations. In the first six months of 2001, USANA generated net cash flows from operations of $6.2 million compared to $1.9 million for the comparable period in 2000. Cash and cash equivalents increased to $3.2 million at June 30, 2001 from $2.9 million at December 30, 2000.
On June 30, 2001, USANA had negative net working capital of $444,000 compared to positive net working capital of $2.3 million at December 30, 2000. The change in net working capital was primarily the result of investments in property and equipment and a $1.0 million increase in current maturities of long-term debt.
USANA invested $5.0 million in property and equipment during the first six months of 2001 compared to $2.4 million during the comparable period in 2000. Three significant projects comprise the majority of the $5.0 million invested in property and equipment during the first six months of 2001. During this period we spent $2.0 million on expanded warehouse space, $1.3 million on improved technology systems, and $607,000 on capital assets for Japan. We expect an additional $1.3 million will be spent on the above projects during the remainder of 2001.
USANA does not extend credit to its customers, but requires payment prior to shipping, which eliminates significant receivables.
During 1999, USANA entered into agreements with a financial institution to provide up to $25 million in secured credit facilities consisting of a $10 million 5-year term loan and a $15 million 3-year revolving line of credit. The credit facilities were amended in March 2001. The amended credit facilities reduced the revolving line of credit to $12.5 million and do not require USANA to make quarterly principal payments on the term loan until March 2002. The credit facilities contain restrictive covenants requiring USANA to maintain certain financial ratios. As of June 30, 2001, USANA was in compliance with these covenants. As of June 30, 2001, $8.0 million was outstanding on the 5-year term loan and $6.2 million was outstanding on the line of credit.
USANA believes that its current cash balances, the available line of credit and cash provided by operations will be sufficient to cover its needs in the ordinary course of business for the foreseeable future. If USANA experiences 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. USANA may also require or seek additional financing through the sale of its equity securities to finance future expansion into new markets, finance capital acquisitions associated with the growth of USANA, and for other reasons. Any financing which involves the sale of equity securities or instruments convertible into equity securities would 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 such forward-looking statements for the reasons detailed in our most recent Annual Report on Form 10-K, pages 25 through 30. 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 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, |
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| | • | High turnover of Associates, |
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| | • | Our reliance on information technology, |
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| | • | Our dependence upon a network marketing system to distribute our products, |
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| | • | The fluctuation in the value of foreign currencies against the US dollar, |
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| | • | Activities of our independent Associates, |
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| | • | Rigorous government scrutiny of network marketing practices, |
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| | • | Potential effects of adverse publicity regarding nutritional supplements or the network marketing industry, |
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| | • | Reliance on key management personnel, including our President, Chief Executive Officer and Chairman of the Board of Directors, Myron W. Wentz, Ph.D., |
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| | • | Extensive government regulation of the Company’s products and manufacturing, |
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| | • | Risks related to our expansion into international markets, |
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| | • | Failure of USANA to sustain or manage growth including the failure to continue to develop new products, |
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| | • | The adverse effect of USANA’s loss of a high level sponsoring Associate together with a group of leading Associates in that person’s downline, |
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| | • | The loss of product market share or Associates to competitors, |
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| | • | Potential adverse effects of taxation and transfer pricing regulations, |
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| | • | Our reliance on outside suppliers for raw materials, |
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| | • | Intellectual property risks particularly applicable to our business, or |
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| | • | Product liability claims and other manufacturing activity risks. |
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 and other uncertainties inherent in doing business and selling product in more than one currency. In addition, USANA’s 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 it has operations as well as, to a lesser extent, changes in United States laws and regulations relating to foreign trade and investment.
Foreign Currency Risks. USANA conducts business in several countries and intends to continue to expand its foreign operations. Sales outside the United States represented 45.0% and 41.6% of net sales for the six months ended July 1, 2000 and June 30, 2001, 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. Consequently, USANA’s reported sales and earnings are impacted positively by a weakening of the U.S. dollar and negatively by a strengthening of the U.S. dollar. 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. Changes in currency exchange rates affect the relative prices at which USANA sells its products.
USANA seeks to reduce its exposure to fluctuations in foreign exchange rates by creating offsetting positions through the use of foreign currency exchange contracts. We do not use such financial instruments for trading or speculative purposes. We regularly monitor our foreign currency risks and periodically take measures to reduce the impact of foreign exchange fluctuations on our operating results. As of June 30, 2001 and during the six months then ended, USANA had no hedging instruments in place to offset exposure to the Canadian Dollar, Australian Dollar, New Zealand Dollar, Hong Kong Dollar, Japanese Yen, British Pound or Euro, to which, in aggregate, USANA had significant exposure. In future periods, when USANA has foreign currency exchange contracts in place, we will present the appropriate information.
As a last recourse for hedging foreign currency risk, USANA may elect to adjust prices in non-U.S. markets to reflect changes in foreign currency exchange rates. However, there can be no assurance that these practices will be successful in eliminating all or substantially all of the risks encountered in connection with our foreign currency transactions.
Interest Rate Risks. USANA currently carries $8.0 million in long-term debt at an effective interest rate of 5.75%. This long-term debt matures at the rate of $2.0 million in 2002, $3.4 million in 2003 and $2.6 million in 2004. We also have a revolving line of credit with $6.2 million outstanding at June 30, 2001 with a weighted average interest rate of 6.83%. The interest rate is computed at the bank’s Prime Rate or LIBOR adjusted by features specified in our loan agreements, with fixed rate term options of up to six months. A hypothetical 100 basis point increase in interest rates on all of the above debt would result in an annual after tax increase in interest expense of approximately $88,000, which would not materially affect earnings.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
USANA is party to certain litigation in the United States Federal District Court for the District of Connecticut, which is also affected by two related actions as follows:
On March 6, 1996, International Nutrition Company (“INC”) filed a patent infringement action against eighteen defendants, including USANA, alleging infringement of U.S. patent number 4,698,360. The complaint alleges that USANA’s Proflavanolâ product violates the patent. USANA believes that its manufacture and sale of the Proflavanol product does not infringe any valid claim of the asserted patent.
On March 21, 1997, the federal judge in the District Court action ordered that it be stayed until another lawsuit in France was resolved. The French lawsuit did not involve USANA, but involved the question of whether INC has any ownership rights in the patent. On March 25, 1997, the French trial court ruled that INC did not own the patent. INC appealed this decision to the Bordeaux Higher Court of Appeals. On May 28, 1998, the French appellate court rendered a decision and held that INC does not now and never has held any ownership rights in the patent. The appellate court also confirmed that Horphag Research Ltd. (“Horphag”) is a one-half owner of the patent.
On March 18, 2000, the United States District Court granted the defendants’ Motion for Summary Judgment holding that even if INC had a one-half ownership in the patent, it could not bring suit to enforce the claims without all the co-owners voluntarily joining as plaintiffs. Consequently, because Horphag, a co-owner refused to voluntarily join as a plaintiff the complaint had to be dismissed. In addition, the District Court concluded that comity should be extended to the decision of the Bordeaux Higher Court of Appeals on the issue of ownership of the patent and therefore held that the purported assignment to INC of an interest in the patent was of no effect and that INC did not own an interest in the patent. The District Court also rejected INC’s claim of ownership based on an October 1996 “confirmatory assignment” from the inventor. As a result, the District Court dismissed the first count of the complaint. In addition, the District Court dismissed the second count of the complaint because its unfair competition allegations were predicated on INC’s ownership of the patent.
On May 8, 2000, INC filed an appeal of the District Court’s decision with the United States Court of Appeals for the Federal Circuit. On July 16, 2001, the United States Court of Appeals for the Federal Circuit handed down its decision. The decision reviewed and affirmed the decision of the District Court, dismissing the claims of INC against USANA and the other defendants.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our Annual Meeting of Shareholders on May 24, 2001, the following actions were submitted and approved by vote of the majority of the issued and outstanding shares of USANA:
(1) Election of five directors, and
(2) Selection of Grant Thornton LLP as our independent certified public accountants.
A total of 8,592,357 shares (approximately 88%) 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: |
| Name | Number of Shares For | | Number of Shares Abstaining/Withheld | |
|
| |
| |
| Myron W. Wentz, PhD | 8,470,491 | | 58,866 | |
| David A. Wentz | 8,445,301 | | 84,056 | |
| Ronald S. Poelman | 8,453,850 | | 75,507 | |
| Robert Anciaux | 8,457,789 | | 71,568 | |
| Denis E. Waitley, PhD | 8,452,999 | | 76,358 | |
| 2. | For the ratification of the Board’s selection of Grant Thornton LLP as the independent certified public accountants of USANA as follows: |
| Number of Shares For | Number of Shares Against | | Number of Shares Abstaining/Withheld | |
|
| |
| |
| 8,474,849 | 43,340 | | 11,168 | |
Item 5. OTHER INFORMATION
On June 19, 2001, Jerry G. McClain was appointed to our board of directors. Mr. McClain is a seasoned accounting professional with more than 25 years of public accounting experience. He will serve as the third member of our audit committee. Mr. McClain currently serves as the CFO of Cerberian, Inc. He previously worked for Ernst & Young serving in several cities throughout the world. Mr. McClain is a CPA and a graduate from the University of Southern Mississippi and Oklahoma State University where he received a B.S. in accounting and an M.B.A. respectively.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
| | Exhibit
Number | Description |
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| | 3.1 | | Articles of Incorporation [Incorporated by reference to Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993] | |
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| | 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 | | Business Loan Agreement by and between Bank of America National Trust and Savings Association, d/b/a Seafirst Bank (“Seafirst Bank” and the Company [Incorporated by reference to Report on Form 10-Q for the period ended June 27, 1998] | |
| | | | | |
| | 10.2 | | Loan Modification Agreement by and between Seafirst Bank and the Company [Incorporated by reference to Report on Form 10-Q for the period ended June 27, 1998] | |
| | | | | |
| | 10.3 | | Employment Agreement dated June 1, 1997 by and between the Company and Gilbert A. Fuller [Incorporated by reference to Report on Form 10-Q for the period ended June 27, 1998] | |
| | | | | |
| | 10.4 | | 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] | |
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| | 10.5 | | Promissory Note and Redemption Agreement dated April 28, 1999 [Incorporated by reference to Report on Form 10-Q for the period ended April 3, 1999] | |
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| | 10.6 | | Stock Pledge Agreement dated April 28, 1999 [Incorporated by reference to Report on Form 10-Q for the period ended April 3, 1999] | |
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| | 10.7 | | Redemption Agreement dated July 30, 1999 [Incorporated by reference to Report on Form 8-K, filed September 24, 1999] | |
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| | 10.8 | | Amended Term Note dated March 26, 2001 [Incorporated by reference to Report on Form 10-K, filed March 30, 2001] | |
| | | | | |
| | 10.9 | | Amended Revolving Note dated March 26, 2001 [Incorporated by reference to Report on Form 10-K, filed March 30, 2001] | |
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| | 10.10 | | Amended Credit Agreement dated March 26, 2001 [Incorporated by reference to Report on Form 10-K, filed March 30, 2001] | |
| | | | | |
| | 11.1 | | Computation of Net Earnings per Share (included in Notes to Consolidated Financial Statements | |
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| | 99.1 | | Press Release dated September 21, 1999. [Incorporated by reference to Report on Form 8-K, filed September 24, 1999] | |
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(b) Reports on Form 8-K.
The Company filed no current reports on Form 8-K during the quarter ended June 30, 2001.
SIGNATURES
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.
USANA HEALTH SCIENCES, INC.
| Date: August 9, 2001 | By: | /s/ Gilbert A. Fuller |
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| | | | Gilbert A. Fuller |
| | | | Senior Vice President and |
| | | | Chief Financial Officer |
