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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 27, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21116
USANA, INC.
(Exact name of registrant as specified in its charter)
UTAH 87-0500306
(State or other jurisdiction of (I.R.S. Employer
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 [X] No [_]
The number of shares outstanding of the registrant's common stock as of July 31,
1998 was 12,990,238.
On July 21, 1998, the registrant declared a two-for-one stock split of its
common stock, no par value, that was distributed in the form of a stock dividend
on August 3, 1998 to shareholders of record as of July 31, 1998. Outstanding
common stock data in this report have been adjusted to reflect the stock split.
================================================================================
USANA, INC.
Index to Consolidated Financial Statements and Exhibits
Filed with the Quarterly Report of the Company on Form 10-Q
For the Quarter Ended June 27, 1998
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PART I. FINANCIAL INFORMATION
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Page
- --------------------------------------------------------------------------------
ITEM 1. FINANCIAL STATEMENTS:
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS 3
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CONSOLIDATED STATEMENTS OF EARNINGS - 4
QUARTER ENDED
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF EARNINGS - 5
SIX MONTHS ENDED
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CONSOLIDATED STATEMENTS OF CASH FLOWS 6
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 10
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- --------------------------------------------------------------------------------
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 17
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18
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ITEM 5. OTHER INFORMATION 18
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 19
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SIGNATURES 20
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2
USANA, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands)
As of As of
December 27, June 27,
1997 1998
---------------------- ---------------------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 2,608 $ 5,809
Accounts receivable, net 98 152
Inventories (Note A) 6,516 8,531
Prepaid expenses and other current assets 1,165 1,821
Current maturities of notes receivable 30 238
Deferred income taxes 856 1,155
---------------------- ---------------------
Total current assets 11,273 17,706
Property and equipment, at cost (Note B) 13,911 16,251
Other assets
Deposits on machinery 1,093 37
Notes receivable, less current maturities 16 5
Other 76 88
---------------------- ---------------------
Total assets $ 26,369 $ 34,087
====================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 3,212 $ 3,549
Other current liabilities (Note C) 3,492 6,051
---------------------- ---------------------
Total current liabilities 6,704 9,600
Deferred income taxes 407 432
Stockholders' equity
Common stock, no par value:
Authorized -- 50,000 shares, issued and outstanding 12,812
as of December 27, 1997 and 12,967 as of June 27, 1998 7,167 8,023
Cumulative foreign currency translation adjustment (80) (479)
Retained earnings 12,171 16,511
---------------------- ---------------------
Total stockholders' equity 19,258 24,055
---------------------- ---------------------
Total liabilities and stockholders' equity $ 26,369 $ 34,087
====================== =====================
The accompanying notes are an integral part of these statements.
3
USANA, Inc. and Subsidiaries
Consolidated Statements of Earnings
(in thousands, except per share amounts)
(Unaudited)
Quarter Quarter
Ended Ended
June 28, June 27,
================= ==================
1997 1998
================= ==================
Net sales $ 21,046 $ 30,913
Cost of sales 4,394 6,408
----------------- ------------------
Gross profit 16,652 24,505
Operating expenses:
Distributor incentives 9,807 13,930
Selling, general, and administrative 3,971 6,318
Research and development 299 373
----------------- ------------------
Total operating expenses 14,077 20,621
----------------- ------------------
Earnings from operations 2,575 3,884
Other income (expense):
Interest income 32 62
Other, net 10 (41)
----------------- ------------------
Total other income 42 21
----------------- ------------------
Earnings before income taxes 2,617 3,905
Income taxes 955 1,501
----------------- ------------------
Net earnings $ 1,662 $ 2,404
================= ==================
Earnings per share - basic (Note D) $ 0.13 $ 0.19
================= ==================
Weighted average shares outstanding - basic (Note D) 12,705 12,895
================= ==================
Earnings per share - diluted (Note D) $ 0.13 $ 0.17
================= ==================
Weighted average shares outstanding - diluted (Note D) 13,285 14,064
================= ==================
The accompanying notes are an integral part of these statements.
4
USANA, Inc. and Subsidiaries
Consolidated Statements of Earnings
(in thousands, except per share amounts)
(Unaudited)
Six Months Six Months
Ended Ended
June 28, June 27,
================= ==================
1997 1998
================= ==================
Net sales $ 38,700 $ 57,077
Cost of sales 8,153 11,894
----------------- ------------------
Gross profit 30,547 45,183
Operating expenses:
Distributor incentives 18,156 25,692
Selling, general and administrative 7,373 11,751
Research and development 579 727
----------------- ------------------
Total operating expenses 26,108 38,170
----------------- ------------------
Earnings from operations 4,439 7,013
Other income (expense):
Interest income 43 110
Interest expense (8) (6)
Other, net 29 (37)
----------------- ------------------
Total other income 64 67
----------------- ------------------
Earnings before income taxes 4,503 7,080
Income taxes 1,718 2,740
----------------- ------------------
Net earnings $ 2,785 $ 4,340
================= ==================
Earnings per share - basic (Note D) $ 0.22 $ 0.34
================= ==================
Weighted average shares outstanding - basic (Note D) 12,704 12,842
================= ==================
Earnings per share - diluted (Note D) $ 0.21 $ 0.31
================= ==================
Weighted average shares outstanding - diluted (Note D) 13,346 13,902
================= ==================
The accompanying notes are an integral part of these statements.
5
USANA, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Six Months Six Months
Ended Ended
June 28, June 27,
==================== ====================
1997 1998
==================== ====================
Increase in cash and cash equivalents
Cash flows from operating activities
Net earnings $ 2,785 $ 4,340
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 795 1,839
Loss / (gain) on sale of property and equipment (15) 42
Provision for doubtful accounts - 141
Provision for inventory obsolescence 65 (70)
Deferred income taxes 179 (274)
Changes in assets and liabilities:
Receivables 22 (195)
Income taxes receivable 405 -
Inventories 1,049 (2,142)
Prepaid expenses and other assets (809) 163
Accounts payable (1,657) 355
Other current liabilities 729 2,622
-------------------- --------------------
Total adjustments 763 2,481
-------------------- --------------------
Net cash provided by operating activities 3,548 6,821
Cash flows from investing activities
Receipts on notes receivable 13 15
Increase in notes receivable - (212)
Purchase of property and equipment (2,049) (4,171)
Proceeds from the sale of property and equipment 1,060 51
-------------------- --------------------
Net cash used in investing activities (976) (4,317)
Cash flows from financing activities
Net proceeds from the sale of common stock 9 856
Increase in line of credit 605 -
Decrease in line of credit (2,105) -
-------------------- --------------------
Net cash (used in) provided by financing activities (1,491) 856
Effect of exchange rate changes on cash (22) (159)
-------------------- --------------------
Net increase in cash and cash equivalents 1,059 3,201
Cash and cash equivalents at beginning of period 1,130 2,608
-------------------- --------------------
Cash and cash equivalents at end of period $ 2,189 $ 5,809
==================== ====================
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 8 $ 6
Income taxes $ 1,364 $ 2,861
The accompanying notes are an integral part of these statements.
6
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation
The unaudited interim consolidated financial information of USANA, 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 generally accepted accounting
principles 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
June 27, 1998, and results of operations for the quarters and six months ended
June 27, 1998 and June 28, 1997. 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 December
27, 1997, as amended. The results of operations for the quarter and six months
ended June 27, 1998 may not be indicative of the results that may be expected
for the fiscal year ending January 2, 1999.
Recent Developments
On July 21, 1998, the Company's Board of Directors announced a two-for-one
stock split distributed in the form of a stock dividend to shareholders of
record for each share of common stock outstanding as of July 31, 1998. The
distribution of the new shares occurred on August 3, 1998. Unless otherwise
specifically stated herein, the number of shares of common stock of the Company
have been adjusted to reflect the stock split in this Form 10-Q.
NOTE A - INVENTORIES
Inventories consist of the following: (in thousands)
December 27, 1997 June 27, 1998
-------------------------------------------
Raw materials $2,313 $2,211
Work in process 904 1,693
Finished goods 3,519 4,777
-------------------------------------------
6,736 8,681
Less allowance for inventory obsolescence 220 150
-------------------------------------------
$6,516 $8,531
===========================================
NOTE B - PROPERTY AND EQUIPMENT
Property and equipment consist of the following: (in thousands)
December 27, 1997 June 27, 1998
-------------------------------------------
Building $ 5,437 $ 5,458
Laboratory and production equipment 1,480 1,954
Computer equipment 5,809 8,556
Furniture and fixtures 1,313 1,514
Automobiles 321 355
Leasehold improvements 86 389
Land improvements 289 289
-------------------------------------------
14,735 18,515
Less accumulated depreciation and amortization 2,597 4,037
-------------------------------------------
12,138 14,478
Land 1,773 1,773
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$13,911 $16,251
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7
NOTE C - OTHER CURRENT LIABILITIES
Other current liabilities consist of the following: (in thousands)
December 27, 1997 June 27, 1998
----------------------------------------
Employee compensation and related items $ 763 $ 971
Distributor incentives 685 1,496
Income taxes 729 608
Sales taxes 658 725
Deferred revenue 165 276
Deferred convention registration fees - 655
All other 492 1,320
----------------------------------------
$ 3,492 $ 6,051
========================================
NOTE D - EARNINGS PER SHARE
On July 21, 1998, the Company announced that its Board of Directors
approved a two-for-one stock split effected in the form of a stock dividend that
was distributed on August 3, 1998 to all shareholders of record on July 31,
1998. All stock option agreements and commitments of the Company payable in
stock provide for the issuance of additional shares in the event of a stock
split or similar event. This action did not change the par value of the common
stock or the total number of shares the Company is authorized to issue. No
amendment to the Company's Articles of Incorporation will be required.
Basic earnings per share are based on the weighted average number of shares
outstanding for each period. Diluted earnings per share are based on shares
outstanding (computed under basic EPS) and potentially dilutive shares.
Potential shares included in dilutive earnings per share calculations include
stock options granted but not exercised.
For the Quarter Ended June 28, 1997
----------------------------------------------------------------
Earnings (000's) Shares (000's) Earnings
(Numerator) (Denominator) Per Share
--------------------- -------------------- ---------------
Basic EPS
Net earnings $ 1,662 12,705 $0.13
==========
Effect of dilutive securities
Stock options - 580
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Diluted EPS
Net earnings $ 1,662 13,285 $0.13
================ ================ ==========
During the second quarter of 1997, options to purchase 1,050,000 shares of
stock at $7.83 a share were outstanding. They were not included in the
computation of EPS for such period because their exercise price was greater than
the average market price of the shares.
For the Quarter Ended June 27, 1998
----------------------------------------------------------------
Earnings (000's) Shares (000's) Earnings
(Numerator) (Denominator) Per Share
--------------------- -------------------- ---------------
Basic EPS
Net earnings $ 2,404 12,895 $0.19
==========
Effect of dilutive securities
Stock options - 1,169
---------------- ---------------
Diluted EPS
Net earnings $ 2,404 14,064 $0.17
================ =============== ==========
8
NOTE D - EARNINGS PER SHARE (Continued)
For the Six Months Ended June 28, 1997
-------------------------------------------------------------
Earnings (000's) Shares (000's) Earnings
(Numerator) (Denominator) Per Share
------------------ -------------------- ---------------
Basic EPS
Net earnings $ 2,785 12,704 $0.22
==========
Effect of dilutive securities
Stock options - 642
---------------- ---------------
Diluted EPS
Net earnings $ 2,785 13,346 $0.21
================ =============== ==========
For the Six Months Ended June 27, 1998
------------------------------------------------------------
Earnings (000's) Shares (000's) Earnings
(Numerator) (Denominator) Per Share
----------------- -------------------- ---------------
Basic EPS
Net earnings $ 4,340 12,842 $0.34
==========
Effect of dilutive securities
Stock options - 1,060
---------------- ---------------
Diluted EPS
Net earnings $ 4,340 13,902 $0.31
================ =============== ==========
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q.
Overview
USANA develops and manufactures high-quality nutritional, personal care and
weight management products. The Company distributes its products through a
network marketing system. As of June 27, 1998, the Company had approximately
102,000 current distributors in the United States, Canada, Australia and New
Zealand. The Company defines a current distributor as a distributor who has made
a purchase in the most recent twelve-month period. From 1993 to 1997, net sales
of the Company grew from $3.9 million to $85.2 million, while net earnings
increased from a loss of $312,000 to net earnings of $6.6 million.
The Company's three primary product lines consist of nutritional, personal
care and weight management products. Nutritional products accounted for
approximately 80% of the Company's net sales for the six months ended June 27,
1998. The Company's top-selling products, USANA Essentials and Proflavanol(R),
represented approximately 42% and 20%, respectively, of net sales for the six
months ended June 27, 1998. USANA's personal care line includes skin, hair and
body, and dental care products. The Company's weight management line includes a
dietary supplement in tablet form, food bars, meal entrees, instructional videos
and other products developed to provide a comprehensive approach to weight
management, proper diet, nutrition and healthy living. In June 1998, the Company
introduced several new products, including CoQuinone(TM), Procosamine(TM), the
USANA Dental Care System and an in-home water distillation system. In addition
to its primary product lines, the Company also sells distributor kits and sales
aids, which accounted for approximately 3% of the Company's net sales for the
six months ended June 27, 1998.
Net sales of the Company are primarily dependent upon the efforts of a
network of independent distributors who purchase products and sales materials.
The Company also offers a Preferred Customer program specifically designed for
customers who desire to purchase USANA's products for personal consumption,
while choosing not to become independent distributors. As of June 27, 1998, the
Company had approximately 16,000 Preferred Customers. The Company recognizes
revenue when products are shipped and title passes to independent distributors
and Preferred Customers. For the six months ended June 27, 1998, sales in the
Company's three primary markets, the United States, Canada and Australia/New
Zealand, were 60.6%, 28.5% and 10.9%, respectively, of net sales of the Company.
As the Company expands into additional international markets, the Company
expects international operations to account for an increasing percentage of its
net sales.
Cost of sales primarily consists of raw materials, labor, quality assurance
and overhead directly associated with the procurement and production of USANA's
products and sales materials as well as duties and taxes associated with product
exports. For the six months ended June 27, 1998, products manufactured by the
Company accounted for approximately 75% of its net sales. As international sales
increase as a percentage of net sales, the Company expects that its overall
costs of sales could increase slightly, reflecting additional duties, freight
and other expenses associated with international expansion.
10
Distributor incentives are the Company's most significant expense and
represented 45.0% of net sales for the six months ended June 27, 1998.
Distributor incentives include commissions and leadership bonuses, and are paid
weekly based on sales volume points. Each product sold by the Company is
assigned a sales volume point value independent of the product's price.
Distributors earn commissions based on sales volume points generated by their
downline. Generally, distributor kits, sales aids and logo merchandise, such as
hats, t-shirts and luggage, have no sales volume point value and therefore
the Company pays no commissions for the sale of those items. The Company
believes distributor incentives will remain relatively constant as a percentage
of net sales for the remainder of 1998.
The Company closely monitors the amount of distributor incentives paid as a
percentage of net sales and may from time to time adjust its distributor
compensation plan to prevent distributor incentives from having a significant
adverse effect on earnings, while continuing to maintain an appropriate
incentive for its distributors. For example, in the third quarter of 1997, the
Company introduced a repricing strategy across its product lines that created a
spread between the price a distributor pays for the product and the sales volume
point value associated with the product. This new pricing strategy had the
effect of reducing the amount of total distributor incentives paid as a
percentage of net sales. At the same time, the Company changed its leadership
bonus program, increasing the payout from 2.0% to 3.0% of total sales volume
points.
Selling, general and administrative expenses include wages and benefits,
depreciation and amortization, rents and utilities, distributor events,
promotion and advertising and professional fees along with other marketing and
administrative expenses. Wages and benefits represent the largest component of
selling, general and administrative expenses. The Company expects to add human
resources and associated infrastructure as operations expand. The
President, Chief Executive Officer and Chairman of the Board of Directors of the
Company, Dr. Wentz, does not receive a salary, and the Company does not
anticipate that Dr. Wentz will take a salary for the foreseeable future.
However, if Dr. Wentz were to take a salary, selling, general and administrative
expenses would increase. Depreciation and amortization expense has increased as
a result of substantial investments in computer and telecommunications equipment
and systems to support international expansion. The Company anticipates that
additional capital investments will be required in future periods to promote and
support growth in sales and the Company's distributor base.
Research and development expenses include costs incurred in developing new
products, supporting and enhancing existing products and reformulating products
for introduction in international markets. The Company capitalizes product
development costs after market feasibility is established. These costs are
amortized over an average of 12 months, beginning with the month these products
are available for sale.
In 1996, the Company changed from a calendar year to a 52-53 week fiscal
year. The Company's current fiscal year ends January 2, 1999, and on the
Saturday closest to December 31 of each fiscal year thereafter. References to a
particular fiscal year are to the fiscal year ending on such Saturday for fiscal
years 1996 and later, and to the year ended December 31 for fiscal years 1995
and earlier.
Results of Operations
Quarters Ended June 27, 1998 and June 28, 1997
Net Sales. Net sales increased 46.9% to $30.9 million for the quarter ended
June 27, 1998, an increase of $9.9 million from $21.0 million for the comparable
period in 1997. Approximately 90% of the growth in net sales for this period was
attributable to increases in total unit sales. The increase in unit sales is
primarily the result of a 39.7% increase in the Company's independent
distributor base and continued growth in its Preferred Customer program, which
was introduced in the third quarter of 1997. As of June 27, 1998, the Company
had approximately 102,000 current distributors compared to an estimated 73,000
current distributors at June 28, 1997. Approximately 38% of the growth in the
distributor base was associated with the opening of the Australia/New Zealand
market in February 1998. As of June 27, 1998, the Company had approximately
16,000 Preferred Customers. New product introductions in the third quarter of
1997, sales incident to the Company's annual international convention and the
product price increase in the third quarter of 1997 also contributed to sales
growth for the second quarter of 1998.
11
Net sales for the quarter ended June 27, 1998 included approximately $1 million
from product sales incident to the Company's annual international convention in
June 1998. The convention was held during the third quarter of 1997 and sales
incident to the 1997 annual international convention were not included in the
results of operations of the Company for the quarter ended June 28, 1997.
The following table illustrates the growth in sales by region for the
quarters ended June 28, 1997 and June 27, 1998:
Sales Growth by Region
(in millions)
Quarters Ended
--------------------------------------
Growth Over %
Region June 28, 1997 June 27, 1998 Prior Year Growth
- ------- ------------- ------------- ---------- ------
United States $14.6 69.5% $18.0 58.2% $ 3.4 23.3%
Canada 6.4 30.5 8.3 26.9 1.9 29.7%
Australia / - - 4.6 14.9 4.6 -
New Zealand
----- ------ ----- ------ -----
Consolidated $21.0 100.0% $30.9 100.0% $ 9.9 46.9%
===== ====== ===== ====== =====
Cost of Sales. Cost of sales increased 45.8% to $6.4 million for the
quarter ended June 27, 1998, an increase of $2.0 million from $4.4 million for
the comparable period in 1997. As a percentage of net sales, cost of sales
decreased to 20.7% for the quarter ended June 27, 1998 from 20.9% in the
comparable period in 1997. The decrease in cost of sales as a percentage of net
sales can be attributed primarily to the price increase introduced in the third
quarter of 1997 and volume-based efficiencies in production and procurement
activities. These factors were partially offset for the quarter ended June 27,
1998 by additional costs such as freight and duties associated with exporting
products to Australia/New Zealand, and a change in the sales mix to include
a higher percentage of distributor kits which have a significantly lower gross
profit margin. When a new market is opened, the Company typically experiences a
higher demand for distributor kits in that market.
Distributor Incentives. Distributor incentives increased 42.0% to $13.9
million for the quarter ended June 27, 1998, an increase of $4.1 million from
$9.8 million for the comparable period in 1997. As a percentage of net sales,
distributor incentives decreased to 45.1% for the quarter ended June 27, 1998
from 46.6% in the comparable period in 1997. The decrease in distributor
incentives as a percentage of net sales can be attributed primarily to
implementation of the Company's repricing strategy and a change in the sales
mix that resulted from increased demand for distributor kits in the
Australia/New Zealand market. To a lesser extent, the sale of sales aids and
logo merchandise at the Company's annual international convention in June 1998
also contributed to this decrease because no distributor incentives are paid for
the sale of those items. The decrease in distributor incentives as a percentage
of net sales was partially offset by an increase in the Company's leadership
bonus program from 2.0% to 3.0% of the sales volume points generated.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 59.1% to $6.3 million for the quarter ended
June 27, 1998, an increase of $2.3 million from $4.0 million for the comparable
period in 1997. As a percentage of net sales, selling, general and
administrative expenses increased to 20.4% for the quarter ended June 27, 1998
from 18.9% for the comparable period in 1997. The increase in selling, general
and administrative expenses can be attributed primarily to three factors: (i)
higher variable expenses such as discount fees on credit cards and increases in
customer service staffing levels to accommodate growth in sales and the number
of distributors and Preferred Customers; (ii) increased depreciation and
amortization expense of approximately 1% as a percentage of net sales as a
result of substantial investments in prior periods in
12
computer and telecommunications equipment to support growth and international
expansion; and (iii) higher relative costs associated with international
expansion, primarily related to commencing operations in Australia/New Zealand
in February 1998.
Research and Development. Research and development expenses increased 24.7%
to $373,000 for the quarter ended June 27, 1998, an increase of $74,000 from
$299,000 for the comparable period of 1997. Increases in research and
development expenses for the quarter ended June 27, 1998 were primarily the
result of new product development, the initiation of several clinical studies
and the reformulation of existing products.
Net Earnings. Net earnings increased 44.6% to $2.4 million for the quarter
ended June 27, 1998, an increase of $0.7 million from $1.7 million for the
comparable period in 1997. The improvement in net earnings was primarily the
result of increased sales. Net earnings reflect the combined effect of decreased
cost of sales, decreased distributor incentives, and increased selling, general
and administrative expenses relative to net sales, which resulted in a 7.8%
profit margin for the quarter ended June 27, 1998 compared to 7.9% for the
comparable period in 1997. Diluted earnings per share increased 30.8% to $0.17
for the quarter ended June 27, 1998, an increase of $0.04 compared to $0.13 per
share for the comparable period in 1997.
Six Months Ended June 27, 1998 and June 28, 1997
Net Sales. Net sales increased 47.5% to $57.1 million for the six months
ended June 27, 1998, an increase of $18.4 million from $38.7 million for the
comparable period in 1997. Approximately 90% of the growth in net sales for this
period was attributable to increases in total unit sales. The increase in unit
sales is primarily the result of a 39.7% increase in the Company's independent
distributor base and continued growth in its Preferred Customer program, which
was introduced in the third quarter of 1997. As of June 27, 1998, the Company
had approximately 102,000 current distributors compared to an estimated 73,000
at June 28, 1997. Approximately 38% of the growth in the distributor base was
associated with the opening of the Australia/New Zealand market in February
1998. As of June 27, 1998, the Company had approximately 16,000 Preferred
Customers. New product introductions in the third quarter of 1997, sales
incident to the Company's annual international convention and the product price
increase in the third quarter of 1997 also contributed to sales growth for the
six months ended June 27, 1998. Net sales for the six months ended June 27, 1998
included approximately $1 million from product sales incident to the Company's
annual international convention in June 1998. The convention was held during the
third quarter of 1997 and sales incident to the 1997 annual international
convention were not included in the results of operations of the Company for the
six months ended June 28, 1997.
The following table illustrates the growth in sales by region for the six
months ended June 28, 1997 and June 27, 1998:
Sales Growth by Region
(in millions)
Six Months Ended
---------------------------- Growth over %
Region June 28, 1997 June 27, 1998 Prior Year Growth
- ------------------ --------------- --------------- ------------- ------
United States $27.3 70.5% $34.6 60.6% $ 7.3 26.7%
Canada 11.4 29.5 16.3 28.5 4.9 43.0%
Australia/New Zealand - - 6.2 10.9 6.2 -
----- ------ ----- ------ ----- -----
Total $38.7 100.0% $57.1 100.0% $18.4 47.5%
===== ====== ===== ====== =====
Cost of Sales. Cost of sales increased 45.9% to $11.9 million for the six
months ended June 27, 1998, an increase of $3.7 million from $8.2 million for
the comparable period in 1997. As a percentage of net sales, cost of sales
decreased to 20.8% for the six months ended June 27, 1998, from 21.1% for the
comparable period in 1997. The decrease in cost of sales as a percentage of net
sales can be attributed primarily to the price increase introduced in the third
quarter of 1997 and volume-based efficiencies in production and procurement
activities. These factors were partially offset for the six
13
months ended June 27, 1998 by additional costs such as freight and duties
associated with exporting products to Australia/New Zealand, and a change in the
sales mix to include a higher percentage of distributor kits which have a
significantly lower gross profit margin. When a new market is opened, the
Company typically experiences a higher demand for distributor kits in that
market.
Distributor Incentives. Distributor incentives increased 41.5% to $25.7
million for the six months ended June 27, 1998, an increase of $7.5 million from
$18.2 million for the comparable period in 1997. As a percentage of net sales,
distributor incentives decreased to 45.0% for the six months ended June 27,
1998, from 46.9% for the comparable period in 1997. The decrease in distributor
incentives as a percentage of net sales can be attributed primarily to the
implementation of the Company's repricing strategy and a change in the sales mix
that resulted from increased demand for distributor kits in the Australia/New
Zealand market. To a lesser extent, the sale of sales aids and logo merchandise
at the Company's annual international convention in June 1998 also contributed
to this decrease because no distributor incentives are paid for the sale of
those items. The decrease in distributor incentives as a percentage of net sales
was partially offset by an increase in the Company's leadership bonus program
from 2.0% to 3.0% of the sales volume points generated.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 59.4% to $11.8 million for the six months
ended June 27, 1998, an increase of $4.4 million from $7.4 million for the
comparable period in 1997. As a percentage of net sales, selling, general and
administrative expenses increased to 20.6% for the six months ended June 27,
1998, from 19.1% for the comparable period in 1997. The increase in selling,
general and administrative expenses can be attributed primarily to three
factors: (i) higher variable expenses such as discount fees on credit cards and
increases in customer service staffing levels to accommodate growth in sales and
the number of distributors and Preferred Customers; (ii) increased depreciation
and amortization expense of approximately 1% as a percentage of net sales as a
result of substantial investments in prior periods in computer and
telecommunications equipment to support growth and international expansion; and
(iii) higher relative costs associated with international expansion, primarily
related to commencing operations in Australia/New Zealand in February 1998.
Research and Development. Research and development expenses increased 25.6%
to $727,000 for the six months ended June 27, 1998, an increase of $148,000 from
$579,000 for the comparable period in 1997. Increases in research and
development expenses for the six months ended June 27, 1998 were primarily the
result of new product development, the initiation of several clinical studies
and the reformulation of existing products.
Net Earnings. Net earnings increased 55.8% to $4.3 million for the six
months ended June 27, 1998, an increase of $1.5 million from $2.8 million for
the comparable period in 1997. The improvement in net earnings was primarily the
result of increased sales. Net earnings reflect the combined effect of decreased
cost of sales, decreased distributor incentives, and increased selling, general
and administrative expenses relative to net sales, which resulted in a 7.6%
profit margin for the six months ended June 27, 1998 compared to 7.2% for the
comparable period in 1997. Diluted earnings per share increased 47.6% to $0.31
for the six months ended June 27, 1998, an increase of $0.10 compared to $0.21
per share for the comparable period in 1997.
Liquidity and Capital Resources
The Company has financed its growth primarily from cash flows from
operations. For the six months ended June 27, 1998, the Company generated net
cash from operations of $6.8 million compared to $3.5 million for the comparable
period in 1997. Cash and cash equivalents at June 27, 1998 were $5.8 million
compared to $2.6 million at December 27, 1997. Working capital was $8.1 million
at June 27, 1998, compared to $4.6 million at December 27, 1997. The Company
does not have significant receivables because it does not extend credit to its
customers and requires payment prior to shipping.
The Company invested approximately $4 million in property and equipment for
the six months ended June 27, 1998, compared to approximately $2 million for the
comparable period in 1997. Inventory increased approximately $2
14
million to $8.5 million at June 27, 1998 from $6.5 million at December 27, 1997.
The increase in inventory can be attributed primarily to the commencement of
operations in the Australia/New Zealand market, including the extended transit
times of shipments to this market. As of June 27, 1998, the Company had invested
approximately $4 million to fund operations in Australia/New Zealand.
At June 27, 1998, the Company had $5.0 million available under its line of
credit, which expires May 31, 1999. The interest rate is computed at the bank's
prime rate, or at the option of the Company, the LIBOR base rate plus 2.25%.
Certain receivables, inventories and equipment collateralize the line of
credit. The line-of-credit agreement also contains restrictive covenants
requiring the Company to maintain certain financial ratios. As of June 27, 1998,
the Company was in compliance with these covenants. There was no outstanding
balance on the line of credit as of June 27, 1998.
A significant percentage of the Company's net sales are generated from the
sale of products outside the United States. The Company intends to continue to
expand its foreign operations. The Company is exposed to risks of 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
U.S. laws and regulations relating to foreign trade and investment. In addition,
the Company's results of operations and the value of its foreign assets are
affected by fluctuations in foreign currency exchange rates, which may favorably
or adversely affect reported earnings and, accordingly, the comparability of
period-to-period results of operations. Changes in currency exchange rates may
affect the relative prices at which the Company and foreign competitors sell
their products in the same market. Sales outside the United States represented
12.3%, 21.1%, 30.8% and 39.4% of the Company's net sales in 1995, 1996, 1997 and
for the six months ended June 27, 1998, respectively. The Company enters into
forward foreign exchange contracts to hedge certain commitments denominated in
foreign currency, including intercompany cash transfers. The Company generally
does not use derivative instruments to manage currency fluctuations. Transaction
hedging activities seek to protect operating results and cash flows from the
potentially adverse effects of currency exchange fluctuations.
The Company 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 next 12 months. In the event the Company
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. The Company may also require or seek additional financing, including
through the sale of its equity securities to finance future expansion into new
markets, capital acquisitions associated with the growth of the Company, and for
other reasons. Any financing which involves the sale of equity securities or
instruments convertible into such securities could result in immediate and
possibly significant dilution to existing shareholders.
Year 2000 Issues
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company is in the process of ensuring that its internal computer
systems are Year 2000 compliant. Many existing computer programs and databases
use only two digits to identify the year in the date field (e.g., 98 would
represent 1998). These programs and databases were developed and designed
without considering the impact of the upcoming millennium. If not corrected,
many computer systems may fail or create erroneous results at the turn of the
century. This phenomenon and associated issues are referred to as the "Year
2000" problem. Based on a recent assessment, the Company presently believes that
with modifications to existing software and conversions to new software, the
Year 2000 problem can be mitigated. The Company intends to use both internal and
external
15
resources to reprogram, or replace, and test its software for Year 2000
modifications. However, if such modifications or conversions are not made, or
are not completed timely, the Year 2000 problem could have a material impact on
the operations of the Company. The Company has initiated formal communications
with all of its significant suppliers to determine the extent to which the
Company is vulnerable to those third parties' failure to remediate their own
Year 2000 problems.
Independent of the Year 2000 problem, the Company determined in late 1997
that overall efficiencies could be achieved by the purchase and installation of
the ERP system. The ERP system will replace all of the Company's existing
resource planning systems except for the Distributor System. The Company has
begun installing the ERP system and expects the installation to be complete
during the first quarter of 1999. The third-party vendor of the ERP system
has certified that its software is Year 2000 compliant according to the
Information Technology Association of America. Therefore, assuming the
successful installation of the ERP system, the Company does not expect any
material Year 2000 compliance issues related to its primary internal business
information systems. The Company intends to replace the Distributor System
with two new systems in 1999 and to integrate it with the ERP system. With
respect to third-party providers whose services are critical to the Company, the
Company intends to monitor the efforts of such providers as they become Year
2000 compliant.
The Company is presently not aware of any Year 2000 issues that have been
encountered by any such third party which could materially affect the Company's
operations. Notwithstanding the foregoing, there can be no assurance that the
Company will not experience operational difficulties as a result of Year 2000
issues, either arising out of internal operations, or caused by third-party
service providers, which individually or collectively could have an adverse
impact on business operations or require the Company to incur unanticipated
expenses to remedy any problems.
Inflation
The Company believes that inflation has not had a material impact on its
historical operations or profitability.
Seasonality
The Company believes that the impact of seasonality on its results of
operations is not material, although historically growth has been slower in the
fourth quarter of each year. This could change as new markets are opened and
become a more significant part of the Company's business. In addition, the
significant growth experienced by the Company since its inception may make it
difficult to accurately determine seasonal trends.
Forward-Looking Statements
Certain statements in Management's Discussion and Analysis of Financial
Condition and Results of Operations and certain other sections of this Quarterly
Report are forward-looking. These may be identified by the use of forward-
looking words or phrases such as "believes," "expects," "anticipates," "should,"
"plans," "estimates," and "potential," among others. These forward-looking
statements are based on the Company's reasonable current expectations. The
Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for
such forward-looking statements. In order to comply with the terms of safe
harbor, the Company notes that a variety of factors could cause the Company's
actual results and experience to differ materially from the anticipated results
or other expectations expressed in such forward-looking statements. The risks
and uncertainties that may affect the business, financial condition,
performance, development, and results of operations of the Company include: (1)
the Company's dependence upon a network marketing system to distribute its
products; (2) activities of its independent distributors; (3) rigorous
government scrutiny of network marketing practices; (4) potential effects of
adverse publicity regarding nutritional supplements or the network marketing
industry; (5) reliance on key management personnel, including the Company's
President, Chief Executive Officer and Chairman of the Board of Directors, Myron
Wentz; (6) extensive government regulation of the Company's products and
manufacturing; (7) risks related to the Company's expansion into international
markets; (8) failure of the Company to sustain or manage growth including the
failure to continue to develop new products; (9) the possible adverse effects of
increased distributor incentives as a percentage of net sales; (10) the
Company's reliance on information technology; (11) the adverse effect of the
Company's loss of a high level sponsoring distributor together with a group of
leading distributors in that person's downline; (12) the loss of product market
share or distributors to competitors; (13) potential adverse effect of taxation
and transfer pricing regulation or exchange rate fluctuations; or (14) the
Company's inability to manage its Year 2000 risks. A more complete discussion of
risk factors is included in the Company's Annual Report on Form 10-K, as
amended, under the caption "Risk Factors".
16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company 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:
The U.S. Proceeding. On March 6, 1996, International Nutrition Company
("INC") filed a patent infringement action (the "U.S. Proceeding") against a
number of defendants, including USANA, alleging infringement of U.S. patent
number 4,698,360 (the "`360 patent"). The complaint, filed in the United States
District Court for the District of Connecticut, alleges that USANA's
Proflavanol(R) product infringes the `360 patent. The complaint seeks
preliminary and permanent injunctions against the manufacture, sale and use of
Proflavanol(R), as well as damages in an unspecified amount, costs and
attorneys' fees. If INC were to prevail in its claim for injunctive relief,
USANA would be prohibited from using, selling, offering to sell, manufacturing
or importing any infringing product. If liability were established, damages in
the case could range from a reasonable royalty to lost profits, and if
willfulness is established, could also include treble damages, as well as
attorneys' fees. Having conducted a thorough investigation of the `360 patent
and the allegations made in the complaint, USANA believes that its manufacture
and sale of Proflavanol(R) does not infringe any valid claim of the `360 patent.
Reexamination Proceeding. On April 17, 1996, an unidentified party filed a
request (the "Reexamination Proceeding") with the United States Patent and
Trademark Office ("PTO") to reexamine the validity of the `360 patent. The
request for reexamination was granted and the Reexamination Proceeding was
conducted by the PTO. The U.S. Proceeding was stayed pending the outcome of the
Reexamination Proceeding. On August 22, 1997, the PTO granted a Certificate of
Reexamination for the `360 patent, confirming the validity of each of the claims
of the `360 patent over the prior art cited as part of the Reexamination
Proceeding.
The French Proceeding. INC claims an ownership interest in the `360 patent
from Societe Civile d'Investigation Pharmacologique d'Aquitane ("SCIPA"), who
took a one-half interest in the patent from the inventor, Jack Masquielier. The
other half of the `360 patent was conveyed by Mr. Masquelier to a company known
as Horphag Research Ltd. ("Horphag"). In October 1995, Horphag sued SCIPA, INC
and others in Bordeaux, France (the "French Proceeding"), alleging that SCIPA's
transfer of its one-half interest in the `360 patent to INC violated Horphag's
right of preemption under French law and the provisions of the agreement by
which Horphag and SCIPA acquired their ownership interests in the `360 patent.
Horphag's complaint in the French Proceeding requested that the French court
order that the assignment from SCIPA to INC be declared null and void, and that
the court issue an order declaring that INC has no ownership interest in the
`360 patent. USANA purchases its raw ingredients for Proflavanol(R) from Indena,
a licensee of Horphag.
On March 21, 1997, the court in the U.S. Proceeding ordered that the action
not proceed until resolution of the French Proceeding. On March 25, 1997, the
trial court in Bordeaux issued a decision declaring that under French law, INC
has no interest in the `360 patent, because of the principle of preemption.
Specifically, the French trial court held that SCIPA, through whom INC claims
ownership rights in the `360 patent, had an obligation to offer its one-half
interest in the patent to Horphag before selling it to INC. Because SCIPA did
not offer its interest to Horphag, the French trial court nullified the
assignment from SCIPA to INC, finding that SCIPA has again become a joint owner
of the `360 patent. INC appealed the decision of the trial court.
On May 28, 1998, the Court of Appeals in Bordeaux affirmed the decision of
the trial court that INC has no ownership interest in the `360 patent.
Specifically, the decision holds that INC does not now hold and never has held
any ownership rights in the `360 patent. The appellate court also found that
recent attempts by Mr. Masquelier to assign an interest in the `360 patent to
INC are null and void because he had no ownership interest in the `360 patent
and therefore could not assign such an interest to INC. The French appellate
decision also rejected INC's argument that it purchased an interest in the `360
patent in good faith, without knowledge of Horphag's one-half interest.
17
There can be no assurance, however, that USANA will succeed in its defense
of this matter. On July 10, 1998, USANA filed a motion to dismiss the INC
complaint, alleging that, based on the French decisions, INC has no standing to
sue. Alternatively, USANA has alleged that under U.S. law, even if INC were a
co-owner of the `360 patent, it owns at most a one-half interest and cannot
bring suit to enforce the patent unless the other co-owner voluntarily agrees to
join in such suit as a plaintiff. The other owner of the `360 patent, Horphag,
has not voluntarily joined the U.S. Proceeding as a plaintiff and, in fact, is a
defendant in this proceeding. Therefore, USANA believes the litigation must be
dismissed. No hearing has been set on USANA's motion to dismiss, although INC
has indicated it will oppose the motion. USANA intends to vigorously defend its
right to continue providing its Proflavanol(R) product to its customers.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At its Annual Meeting of Shareholders on June 23, 1998, the following
actions were submitted and approved by vote of the majority of the issued and
outstanding shares of the Company:
(1) Election of five directors;
(2) Approval of the Board of Directors' selection of Grant Thornton LLP as
the Company's independent certified public accountants; and
(3) Approval of the amendments to the Company's 1995 Long-term Stock
Investment and Incentive Plan coincident with the consolidation of the
Director Stock Option Plan and the Long-term Stock Investment and
Incentive Plan without increasing the aggregate number of shares
available for issuance under the combined plans.
The shares voted on at the June 23, 1998 Annual Meeting of Shareholders
have not been adjusted to reflect the stock split as previously mentioned
herein. A total of 5,412,234 shares (approximately 84%) of the issued and
outstanding shares of the Company 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:
- ------------------------------------------------------------------------------------------
Abstaining/
Name For Against Withheld
- ------------------------------------------------------------------------------------------
Dr. Myron W. Wentz 5,402,302 1,338 8,594
- ------------------------------------------------------------------------------------------
David A. Wentz 5.401,102 2,538 8,594
- ------------------------------------------------------------------------------------------
Ronald S. Poelman 5,402,302 1,338 8,594
- ------------------------------------------------------------------------------------------
Dr. Ned M. Weinshenker 5,401,402 2,238 8,594
- ------------------------------------------------------------------------------------------
Robert Anciaux 5,402,302 1,338 8,594
- ------------------------------------------------------------------------------------------
2. For the ratification of Grant Thornton LLP as the independent certified
accountants of the Company as follows:
- --------------------------------------------------------------------
For Against Abstaining
- --------------------------------------------------------------------
5,404,207 1,730 6,297
- --------------------------------------------------------------------
3. For the amendment and consolidation of the Stock Option Plans:
- --------------------------------------------------------------------------------
For Against Abstaining Broker Non-Votes
- --------------------------------------------------------------------------------
5,261,290 28,283 8,056 114,605
- --------------------------------------------------------------------------------
ITEM 5. OTHER INFORMATION
Stockholder Proposals for 1999 Annual Meeting
As set forth in the Company's Proxy Statement for its 1998 Annual Meeting
of Shareholders, shareholder proposals submitted pursuant to Rule 14a-8 under
the Securities Exchange Act of 1934, as amended ("Exchange Act"), for inclusion
in the Company's proxy materials for its 1999 Annual Meeting of Shareholders
must be received by the Secretary of the Company at the principal offices of the
Company no later than December 31, 1998.
In addition, in accordance with recent amendments to Rules 14a-4, 14a-5 and
14a-8 under the Exchange Act, written notice of shareholder proposals submitted
outside the procedures of Rule 14a-8 for consideration at the 1999 Annual
Meeting of Shareholders must be received by the Company on or before April 13,
1999 in order to be considered timely for purposes of Rule 14a-4. The persons
designated in the Company's proxy statement and management proxy card will be
granted discretionary authority with respect to any shareholder proposal with
respect to which the Company does not receive timely notice.
Stock Split
The Company's Board of Directors authorized a two-for-one stock split in
the form of a stock dividend, wherein one share of Common Stock was issued on
August 3, 1998 to shareholders of record for each share of Common Stock
outstanding as of July 31, 1998.
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
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.
10.2 Loan Modification Agreement by and between Seafirst Bank and the
Company dated as of May 28, 1998.
10.3 Employment Agreement dated June 1, 1997 by and between the Company
and Gilbert A. Fuller.
10.4 Amended and Restated Long Term Stock Investment and Incentive Plan.
21 Subsidiaries
27 Financial Data Schedule
(b) Report on Form 8-K.
No current reports on Form 8-K were filed by the Company for the quarter
ended June 27, 1998.
19
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, INC.
Date: August 11, 1998 By: /s/ Gilbert A. Fuller
--------------- ----------------------
Gilbert A. Fuller
Vice President and Chief
Financial Officer
20