================================================================================ 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 April 3, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ____________ Commission file number: 0-21116 USANA, INC. (Exact name of registrant as specified in its charter) Utah 87-0500306 (State or other jurisdiction (I.R.S. Employer of 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 May 10, 1999 was 13,073,238. [Note: 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 for periods prior to August 3, 1998 have been adjusted to reflect the stock split.] ================================================================================ USANA, INC. FORM 10-Q For the Quarterly Period Ended April 3, 1999 INDEX
Page -------- PART I . FINANCIAL INFORMATION Item 1 Financial Statements Consolidated Balance Sheets......................................................................... 3 Consolidated Statements of Earnings................................................................. 4 Consolidated Statements of Stockholders' Equity..................................................... 5 Consolidated Statements of Cash Flows............................................................... 6 Notes to Consolidated Financial Statements.......................................................... 7-9 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................. 10-16 Item 3 Quantitative and Qualitative Disclosures About Market Risk............................................ 17 PART II. OTHER INFORMATION Item 1 Legal Proceedings..................................................................................... 17 Item 5 Other Information..................................................................................... 17-18 Item 6 Exhibits and Reports on Form 8-K...................................................................... 19 Signatures....................................................................................................... 20
2 USANA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)
Unaudited ---------- January 2, April 3, 1999 1999 ----------------------------- ASSETS Current Assets Cash and cash equivalents........................................................................ $ 2,617 $ 3,376 Accounts receivable, net......................................................................... 294 481 Current maturities of notes receivable........................................................... 547 979 Inventories, net (Note A)....................................................................... 10,543 10,629 Prepaid expenses and other current assets........................................................ 1,912 2,128 Deferred income taxes............................................................................ 1,233 1,268 ------- ------- Total current assets... ...................................................................... 17,146 18,861 Property and Equipment, net (Note B)............................................................... 22,751 22,411 Notes Receivable, less current maturities.......................................................... 5 5 Other Assets....................................................................................... 55 56 ------- ------- $39,957 $41,333 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable................................................................................. $ 4,211 $ 1,565 Other current liabilities (Note C)............................................................... 4,505 6,260 ------- ------- Total current liabilities..................................................................... 8,716 7,825 Deferred Income Taxes.............................................................................. 624 661 Stockholders' Equity Common stock, no par value; authorized 50,000 shares; issued and outstanding 13,047 shares at January 2, 1999 and 13,051 shares at April 3, 1999............................ 9,131 9,183 Accumulated other comprehensive loss............................................................. (182) (132) Retained earnings................................................................................ 21,668 23,796 ------- ------- Total stockholders' equity.................................................................... 30,617 32,847 ------- ------- $39,957 $41,333 ======= =======
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 ------------------------ March 28, April 3, 1998 1999 --------- -------- Net sales................................................................................... $26,164 $31,323 Cost of sales............................................................................... 5,486 6,383 ------- ------- Gross profit.............................................................................. 20,678 24,940 Operating expenses Distributor incentives.................................................................... 11,762 13,909 Selling, general and administrative....................................................... 5,432 7,244 Research and development.................................................................. 355 356 ------- ------- Total operating expenses............................................................... 17,549 21,509 ------- ------- Earnings from operations.................................................................... 3,129 3,431 Other income (expense) Interest income........................................................................... 55 47 Interest expense.......................................................................... (13) (6) Other, net................................................................................ 4 (7) ------- ------- Total other income (expense)........................................................... 46 34 ------- ------- Earnings before income taxes................................................................ 3,175 3,465 Income taxes................................................................................ 1,239 1,337 ------- ------- NET EARNINGS.............................................................................. $ 1,936 $ 2,128 ======= ======= Earnings per share (Note D)................................................................. Earnings per share--basic................................................................. $0.15 $0.16 ======= ======= Weighted average shares outstanding--basic................................................ 12,827 13,050 ======= ======= Earnings per share--diluted............................................................... $0.14 $0.16 ======= ======= Weighted average shares outstanding--diluted.............................................. 13,771 13,557 ======= =======
The accompanying notes are an integral part of these statements. 4 USANA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Quarters ended March 28, 1998 and April 3, 1999 (in thousands)
Accumulated Common stock other ---------------- Retained comprehensive Shares Amount Earnings income/loss Total ------ ------- -------- -------------- -------- For the quarter ended March 28, 1998 Balance at December 27, 1997................................... 12,812 $7,167 $12,171 $ (80) $19,258 Comprehensive income Net earnings for the quarter................................. -- -- 1,936 -- 1,936 Foreign currency translation adjustment...................... -- -- -- 35 35 ------- Comprehensive income...................................... -- -- -- -- 1,971 Common stock issued under stock option plan.................... 22 80 -- -- 80 ------ ------ ------- ----- ------- Balance at March 28, 1998...................................... 12,834 $7,247 $14,107 $ (45) $21,309 ====== ====== ======= ===== ======= For the quarter ended April 3, 1999 Balance at January 2, 1999..................................... 13,047 $9,131 $21,668 $(182) $30,617 Comprehensive income Net earnings for the year.................................... -- -- 2,128 -- 2,128 Foreign currency translation adjustment...................... -- -- -- 50 50 ------- Comprehensive income...................................... -- -- -- -- 2,178 Common stock issued under stock option plan, including tax benefit of $13............................................ 4 52 -- -- 52 ------ ------ ------- ----- ------- Balance at April 3, 1999....................................... 13,051 $9,183 $23,796 $(132) $32,847 ====== ====== ======= ===== =======
The accompanying notes are an integral part of these statements. 5 USANA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Unaudited ------------------------- March 28, April 3, 1998 1999 ------------------------- Increase in cash and cash equivalents CASH FLOWS FROM OPERATING ACTIVITIES Net earnings........................................................................... $ 1,936 $ 2,128 Adjustments to reconcile net earnings to net cash provided by Operating activities Depreciation and amortization....................................................... 713 1,109 Deferred income taxes............................................................... (130) 3 Provision for inventory obsolescence................................................ (170) 87 Provision for doubtful accounts..................................................... -- 122 Changes in assets and liabilities Accounts receivables............................................................. (6) (344) Inventories...................................................................... (1,872) (76) Prepaid expenses and other assets................................................ 189 (81) Accounts payable................................................................. 1,362 (2,617) Other current liabilities........................................................ 1,722 1,782 ------- ------- Total adjustments............................................................. 1,808 (15) ------- ------- Net cash provided by operating activities..................................... 3,744 2,113 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Receipts on notes receivable........................................................... 7 8 Increase in notes receivable........................................................... (152) (440) Purchase of property and equipment..................................................... (2,338) (785) Proceeds from sale of property and equipment........................................... -- 22 ------- ------- Net cash used in investing activities......................................... (2,483) (1,195) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from sale of common stock................................................. 81 38 ------- ------- Net cash provided by financing activities..................................... 81 38 Effect of exchange rate changes on cash..................................................... 35 (197) ------- ------- Net increase in cash and cash equivalents..................................... 1,377 759 Cash and cash equivalents at beginning of year.............................................. 2,608 2,617 ------- ------- Cash and cash equivalents at end of year.................................................... $ 3,985 $ 3,376 ======= ======= Supplemental disclosures of cash flow information Cash paid during the year for Interest............................................................................... $ 13 $ 6 Income taxes........................................................................... 1,337 535
The accompanying notes are an integral part of these statements. 6 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except per share data) 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 April 3, 1999, and results of operations for the quarters ended April 3, 1999 and March 28, 1998. 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 January 2, 1999. The results of operations for the quarter ended April 3, 1999 may not be indicative of the results that may be expected for the fiscal year ending January 1, 2000. NOTE A - INVENTORIES Inventories consist of the following:
January 2, April 3, 1999 1999 --------- --------- (in thousands) Raw materials........................................................ $ 3,043 $ 2,390 Work in process...................................................... 1,534 2,029 sFinished goods...................................................... 6,592 6,919 --------- --------- 11,169 11,338 Less allowance for inventory obsolescence............................ 626 709 --------- --------- $10,543 $10,629 ========= =========
NOTE B - PROPERTY AND EQUIPMENT Property and equipment consist of the following:
January 2, April 3, 1999 1999 ----------- ---------- (in thousands) Buildings............................................................ $ 7,414 $ 7,414 Laboratory and production equipment.................................. 2,697 2,759 Computer equipment and software...................................... 11,075 11,444 Furniture and fixtures............................................... 2,024 2,062 Automobiles.......................................................... 320 321 Leasehold improvements............................................... 461 472 Land improvements.................................................... 542 542 ----------- ---------- 24,533 25,014 Less accumulated depreciation and amortization....................... 5,681 6,802 ----------- ---------- 18,852 18,212 Land................................................................. 2,548 2,548 Deposits and projects in process..................................... 1,351 1,651 ----------- ---------- $22,751 $22,411 =========== ==========
7 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) (In thousands, except per share data) NOTE C - OTHER CURRENT LIABILITIES Other current liabilities consist of the following:
January 2, April 3, 1999 1999 --------- --------- (in thousands) Accrued compensation and related items............................... $ 964 $ 822 Distributor incentives............................................... 1,140 1,327 Income taxes......................................................... 429 1,225 Sales taxes.......................................................... 845 960 Deferred revenue..................................................... 34 80 All other............................................................ 1,093 1,846 --------- --------- $4,505 $6,260 ========= =========
NOTE D - EARNINGS PER SHARE On July 21, 1998, the Company announced that its Board of Directors approved a 2-for-1 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 was required. Basic earnings per share are based on the weighted average number of shares outstanding for each period. Diluted earnings per common 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 March 28, 1998 ----------------------------------------------------------------------- Earnings (000's) Shares (000's) Earnings (Numerator) (Denominator) Per Share ------------------- ------------------ --------------- Basic EPS Net earnings.................................... $1,936 12,827 $0.15 =============== Effect of dilutive securities Stock options................................... - 944 ------------------- ------------------ Diluted EPS Net earnings.................................... $1,936 13,771 $0.14 =================== ================== ===============
For the Quarter Ended April 3, 1999 ----------------------------------------------------------------------- Earnings (000's) Shares (000's) Earnings (Numerator) (Denominator) Per Share ------------------- ------------------ ---------------- Basic EPS Net earnings.................................... $2,128 13,050 $0.16 ================ Effect of dilutive securities Stock options................................... - 507 ------------------- ------------------ Diluted EPS Net earnings.................................... $2,128 13,557 $0.16 =================== ================== ================
During the first quarter of 1999, options to purchase 90 shares of stock were not included in the computation of EPS, because their exercise price was greater than the average market price of the shares. 8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) (In thousands, except per share data) NOTE E - SEGMENT INFORMATION The Company's chief operating decision makers utilize information about geographic operations in determining the allocation of resources and in assessing the performance of the Company. Management considers the geographic segments of the Company to be the only reportable operating segments. Segment profit or loss is based on profit or loss from operations before income taxes and includes a management fee charged by the domestic operation to each of the foreign entities. All other intersegment transactions are eliminated from the following segment information. Interest revenues and expenses, income taxes, and equity in the earnings of subsidiaries, while significant, are not included in the Company's determination of segment profit or loss in assessing the performance of a segment. Financial information summarized by geographic segment for the quarters ended March 28, 1998 and April 3, 1999 is listed below:
Australia/ Quarter ended New United All March 28, 1998 Domestic Canada Zealand Kingdom Others Totals -------------- -------- ------- ---------- ------- ------ -------- (in thousands) Revenues from external customers......................... $16,619 $7,969 $1,576 $ -- $ -- $26,164 Earnings before income taxes............................. $ 2,087 $ 898 $ 190 $ -- $ -- $ 3,175 Long-lived assets........................................ $15,132 $ 144 $ 823 $ -- $ -- $16,099 Total assets............................................. $27,019 $1,051 $3,434 $ -- $ -- $31,504
Australia/ Quarter ended New United All April 3, 1999 Domestic Canada Zealand Kingdom Others Totals ------------- -------- ------- ---------- -------- ------- ------ (in thousands) Revenues from external customers......................... $17,059 $7,099 $6,473 $ 692 $ -- $31,323 Earnings before income taxes............................. $ 1,623 $1,361 $1,083 $ (600) $ (2) $ 3,465 Long-lived assets........................................ $20,285 $ 243 $1,020 $ 924 $ -- $22,472 Total assets............................................. $32,509 $2,289 $4,067 $2,462 $ 6 $41,333
9 Item 2. 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. General 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 April 3, 1999, the Company had approximately 118,000 current distributors in the United States, Canada, Australia, New Zealand and the United Kingdom. The Australia/New Zealand and the United Kingdom markets initiated operations on February 12, 1998 and November 30, 1998, respectively. The Company defines a current distributor as a distributor who has made a purchase in the most recent twelve-month period. The Company has experienced significant growth since its inception. From 1993 to 1998, net sales of the Company grew from $3.9 million to $121.6 million, while net earnings increased from a loss of $312,000 to net earnings of $9.5 million. The Company's three primary product lines consist of nutritional, personal care and weight management products. Nutritional products accounted for approximately 78% of the Company's net sales for the quarter ended April 3, 1999. The Company's top selling products, USANA Essentials and Proflavanol, represented approximately 41% and 17%, respectively, of net sales for the quarter ended April 3, 1999. No other products accounted for more than 10% of net sales during the quarter. USANA's personal care line includes skin, hair and body, and dental care products. The Company's weight management line includes a dietary supplement tablet, food bars, meal entrees, instructional videos and other products developed to provide a comprehensive approach to weight management, proper diet, nutrition and healthy living. The Company introduced its weight management line in its Australia/New Zealand market in February 1999. 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 quarter ended April 3, 1999. 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 April 3, 1999, the Company had approximately 30,000 Preferred Customers. The Company recognizes revenue when products are shipped and title passes to independent distributors and Preferred Customers. During the first quarter of 1999, sales in the Company's four primary markets, the United States, Canada, Australia/New Zealand and the United Kingdom, were 54.5%, 22.6%, 20.7% and 2.2%, 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 expenses related to 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. In the first quarter of 1999, 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 cost of sales could increase slightly, reflecting additional duties, freight and other expenses associated with international expansion. Distributor incentives are the Company's most significant expense and represented 44.4% of net sales for the quarter ended April 3, 1999. 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 in their downline. Generally, 10 distributor kits, sales aids and logo merchandise, such as items of clothing and luggage, have no sales volume point value and therefore the Company pays no commissions on the sale of these items. 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. 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, Myron W. Wentz, PhD, 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 increasing size of the distributor and Preferred Customer 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 as cost of sales over an average of 12 months, beginning with the month the products become available for sale. The fiscal year end of the Company is the Saturday closest to December 31 of each year. Results Of Operations Quarters Ended April 3, 1999 and March 28, 1998 Net Sales. Net sales increased 19.7% to $31.3 million for the quarter ended April 3, 1999, an increase of $5.1 million from the $26.2 million reported in the comparable quarter in 1998. The increase in net sales is primarily the result of a 42.3% increase in the Company's customer base. Customers of the Company include both independent distributors and Preferred Customers. The Company's current distributor base increased 28.3% to 118,000 at April 3, 1999 compared to 92,000 at March 28, 1998. Preferred Customers grew 150.0% to 30,000 at April 3, 1999 compared to 12,000 at March 28, 1998. Successful distributor events and new product introductions also contributed to sales growth in the first quarter of 1999. The following tables illustrate the growth in sales and customers by market for the quarters ended March 28, 1998 and April 3, 1999:
Sales By Market (in millions) Quarter Ended --------------------------------------------------------- Growth over % Market March 28, 1998 April 3, 1999 Prior Year Growth - ------ --------------------- ---------------------- -------------- ---------- United States.................. $16.6 63.5% $17.0 54.5% $ 0.4 2.6% Canada......................... 8.0 30.5 7.1 22.6 (0.9) (10.9%) Australia/New Zealand.......... 1.6 6.0 6.5 20.7 4.9 310.7% United Kingdom................. - - 0.7 2.2 0.7 - ------- -------- ------- ------- ---------- Consolidated................... $26.2 100.0% $31.3 100.0% $ 5.1 19.7% ======= ======== ======= ======= ==========
11
Current Distributors By Market As of As of Growth over % Market March 28, 1998 April 3, 1999 Prior Year Growth - ------ -------------------------- ------------------------- ------------- ---------- United States.................. 57,000 62.0% 58,000 49.1% 1,000 1.8% Canada......................... 30,000 32.6 31,000 26.3 1,000 3.3% Australia/New Zealand.......... 5,000 5.4 27,000 22.9 22,000 440.0% United Kingdom................. - - 2,000 1.7 2,000 - ------------- ----------- --------- --------- ------------ Consolidated................... 92,000 100.0% 118,000 100.0% 26,000 28.3% ============= =========== ========= ========= ============
Preferred Customers By Market As of As of Growth over % Market March 28, 1998 April 3, 1999 Prior Year Growth - ------ -------------- ------------- ---------- ------ United States.................. 8,000 66.7% 18,000 60.0% 10,000 125.0% Canada......................... 4,000 33.3 8,000 26.7 4,000 100.0% Australia/New Zealand.......... - - 4,000 13.3 4,000 - United Kingdom................. - - - - - - --------- ---------- --------- -------- ----------- Consolidated................... 12,000 100.0% 30,000 100.0% 18,000 150.0% ========= ========== ========= ======== ===========
Total Customers By Market As of As of Growth over % Market March 28, 1998 April 3, 1999 Prior Year Growth - ------ ------------------ ---------------- ----------- ------- United States.................. 65,000 62.5% 76,000 51.4% 11,000 16.9% Canada......................... 34,000 32.7 39,000 26.4 5,000 14.7% Australia/New Zealand.......... 5,000 4.8 31,000 20.9 26,000 520.0% United Kingdom................. - - 2,000 1.3 2,000 - --------- --------- --------- --------- ----------- Consolidated................... 104,000 100.0% 148,000 100.0% 44,000 42.3% ========= ========= ========= ========= ===========
Cost of Sales. Cost of sales increased 16.4% to $6.4 million for the first quarter ended April 3, 1999, an increase of $0.9 million from the $5.5 million reported in the comparable quarter for 1998. This increase is primarily due to the increase in net sales. As a percentage of net sales, cost of sales decreased to 20.4% for the first quarter ended April 3, 1999 from 21.0% in the comparable quarter for 1998. The decrease in cost of sales as a percentage of net sales can be primarily attributed to volume-based efficiencies in production and procurement activities. This decrease in cost of sales as a percentage of net sales was partially offset by additional costs such as freight and duties associated with exporting products to the Company's Australia/New Zealand and United Kingdom markets and also an increase in the sale of distributor kits. Distributor kits have a significantly lower gross profit margin than other products sold by the Company. When a new market is opened, the Company initially experiences a higher demand for distributor kits in that market. 12 Distributor Incentives. Distributor incentives increased 18.3% to $13.9 million for the first quarter ended April 3, 1999, an increase of $2.1 million from the $11.8 million reported in the comparable quarter in 1998. The increase in distributor incentives for the first quarter of 1999 can be attributed to the increase in commissionable sales. As a percentage of net sales, distributor incentives decreased to 44.4% in the first quarter of 1999 from 45.0% in the comparable quarter of 1998. The decrease in distributor incentives as a percentage of net sales can primarily be attributed to three factors: . The introduction of a new level in the distributor compensation plan, . An increase in the proportion of distributor kits sold on which no distributor incentives are paid and . The implementation of the Company's repricing strategy in the third quarter of 1997, which was not fully implemented throughout the first quarter of 1998. The new level in the distributor compensation plan is now the lowest compensated level in the Company's network marketing system. The Company believes this new level will assist in distributor retention efforts by paying these distributors earlier on reduced downline requirements; however, this level does pay at a lower rate than other levels in the Company's network marketing system. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 33.4% to $7.2 million for the quarter ended April 3, 1999, an increase of $1.8 million from the $5.4 million reported in the comparable quarter of 1998. As a percentage of net sales, selling, general and administrative expenses increased to 23.1% in the first quarter of 1999 from 20.8% in the comparable quarter of 1998. The increase in selling, general and administrative expenses can be attributed to several factors: . Higher relative costs associated with international expansion, primarily related to commencing operations in the United Kingdom, . Increased depreciation and amortization expense as a result of substantial investments in current and prior periods in computer and telecommunications equipment to support growth and international expansion, . Increased costs including, but not limited to, employee compensation as a result of building a Company infrastructure to meet strategic objectives and . Higher variable expenses such as increases in customer service staffing levels and discount fees on credit cards in association with growth in sales and the increased number of distributors and Preferred Customers. The Company expects to see continued pressure on selling, general and administrative expenses as a percentage of net sales throughout 1999. Research and Development. Research and development expenses remained flat totaling $356,000 for the quarter ended April 3, 1999 compared to $355,000 for the comparable quarter in 1998. The Company continues to keep abreast of the latest research in nutrition and degenerative diseases and is committed to developing new products, reformulating existing products and maintaining its involvement in numerous clinical studies. Net Earnings. Net earnings increased 9.9% to $2.1 million for the quarter ended April 3, 1999, an increase of $0.2 million from the $1.9 million reported in the comparable quarter of 1998. The increase in net earnings is primarily the result of higher 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 6.8% profit margin in the first quarter of 1999 compared to 7.4% in the comparable quarter of 1998. Diluted earnings per share increased 14.3% to $0.16 for the quarter ended April 3, 1999, an increase of $0.02 from $0.14 in the comparable quarter of 1998. 13 Liquidity and Capital Resources The Company has financed its growth primarily from cash flows from operations. In the first quarter of 1999, the Company generated net cash from operations of $2.1 million compared to $3.7 million in the comparable quarter of 1998. Cash and cash equivalents increased to $3.4 million at April 3, 1999 from $2.6 million at January 2, 1999. Working capital was $11.0 million at April 3, 1999 compared to $8.4 million at January 2, 1999. The Company does not extend credit to its customers, but requires payment prior to shipping, which eliminates significant receivables. The Company invested $0.8 million in property and equipment for the quarter ended April 3, 1999 compared to $2.3 million for the comparable period in 1998. Inventory increased modestly to $10.6 million at April 3, 1999 from $10.5 million at fiscal year end 1998. At April 3, 1999 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 April 3, 1999, the Company was in compliance with these covenants. There was no outstanding balance on the line of credit as of April 3, 1999. The Company is in the process of negotiating the extension of this line of credit through May 31, 2000. A significant percentage of the Company's net sales is generated from the sale of products outside the United States. The Company intends to continue to expand its foreign operations. The foreign operations of the Company expose it 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 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 21.1%, 30.8%, 42.5% and 45.5% of the Company's net sales in 1996, 1997, 1998 and for the quarter ended April 3, 1999, respectively. As additional foreign markets are opened, the Company expects foreign sales to represent an increasing percentage of net sales in future periods. The Company enters into forward and option contracts to hedge certain commitments denominated in foreign currencies, including intercompany cash transfers. Transaction hedging activities seek to protect operating results and cash flows from the potentially adverse effects of currency exchange fluctuations. During 1998 and the first quarter of 1999, the Company advanced funds to its President, CEO and Chairman, Dr. Wentz. On April 28, 1999, the Company entered into an arrangement with Dr. Wentz to provide him up to $5.0 million, including all amounts advanced to date. A total of $1.9 million has been advanced to Dr. Wentz through April 30, 1999. The obligation is evidenced by the Promissory Note and Redemption Agreement and shares of stock have been pledged to secure the payment of amounts provided under the agreement. The Company expects additional advances up to the $5.0 million maximum to be made in the second and third quarters of 1999. The arrangement calls for repayment of the borrowed amounts to be made by redemption of shares of common stock beneficially owned by Dr. Wentz. All shares redeemed through this arrangement will be cancelled. The Company's redemption of these shares pursuant to the agreement will reduce the number of shares outstanding, resulting in higher earnings per share than would have otherwise been achieved. This arrangement also allows Dr. Wentz to achieve some liquidity in his ownership interest in the Company without creating an oversupply of available shares in the market. See Item 5, Other Information, below. The Company believes that its current cash balance, 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. The Company believes it may draw on its line of credit to advance funds to Dr. Wentz under its agreement with him. The Company also believes cash flows from operations will enable the line to be fully retired by fiscal year end 1999. 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 14 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 Company is aware of the risks associated with the operation of information technology and non-information technology systems as the millennium (year 2000) approaches. The "Year 2000 problem" is pervasive and complex, with the possibility that it will affect many technology systems and is the result of the rollover of the two digit year value from "99" to "00". Systems 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 assessing its state of readiness, including the readiness of third parties with which the Company interacts, with respect to the Year 2000 problem. The assessment will also include an evaluation of the costs to the Company to correct Year 2000 problems related to its own systems, which, if uncorrected, could have a material adverse effect on the business, financial condition or results of operations of the Company. As a part of this assessment, the Company will also determine the known risks related to the consequences of failure to correct any Year 2000 problems identified by the Company and contingency plans, if any, that should be adopted by the Company should any identified Year 2000 problems not be corrected. The Company will use, if necessary, both internal and external resources to reprogram, or replace and test its software for Year 2000 acceptability. 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 the purchase and installation of an Enterprise Resource Planning system (ERP system) could assist in achieving overall efficiencies. The ERP system will replace all of the Company's existing resource planning systems except for the Distribution System. The Company has begun installing the ERP system and expects the installation to be complete during the third 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 Distribution 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. Based on the most recent assessment, the Company believes that with modifications to existing software and conversions to new software, any Year 2000 problems that it may have with its own systems can be mitigated. 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 does not believe that inflation has had a material impact on its historical operations or profitability. 15 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 The statements contained in this Report on Form 10-Q that are not purely historical are "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 the Company's 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 the Company's financial performance, revenue and expense levels in the future and the sufficiency of its 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 the Company's Annual Report on Form 10-K under the headings "Description of Business" and "Risk Factors." The fact that some of the risk factors may be the same or similar to the Company's past reports filed with the Securities and Exchange Commission means only that the risks are present in multiple periods. The Company believes that many of the risks detailed here and in the Company's SEC filings are part of doing business in the industry in which the Company operates and competes 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 the Company assumes 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 the business, financial condition, performance, development, and results of operations of the Company include: . The Company's dependence upon a network marketing system to distribute its products; . Activities of its independent distributors; . Rigorous government scrutiny of network marketing practices; . Potential effects of adverse publicity regarding nutritional supplements or the network marketing industry; . Reliance on key management personnel, including the Company's President, Chief Executive Officer and Chairman of the Board of Directors, Dr. Wentz; . Extensive government regulation of the Company's products and manufacturing; . Risks related to the Company's expansion into international markets; . Failure of the Company to sustain or manage growth including the failure to continue to develop new products; . The possible adverse effects of increased distributor incentives as a percentage of net sales; . The Company's reliance on information technology; . 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; . The loss of product market share or distributors to competitors; . Potential adverse effect of taxation and transfer pricing regulation or exchange rate fluctuations or . The Company's inability or failure to identify and to manage its Year 2000 risks. 16 Quantitative and Qualitative Disclosures About Market Risk The Company conducts its business in several countries and intends to continue to expand its foreign operations. The net sales are affected by fluctuations in interest rates, currency exchange rates and other uncertainties inherent in doing business and selling product in more than one currency. In addition, the operations of the Company are exposed to significant 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 U.S. laws and regulations relating to foreign trade and investment. Fluctuations in foreign currency exchange rates may favorably or adversely affect the Company's reported earnings and, accordingly, the comparability of its 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. When the value of the U.S. dollar is high in comparison with the other currencies in which sales are made, this will have a negative impact on net sales. To protect against these risks, the Company enters into forward and option contracts to hedge certain commitments denominated in foreign currency, including intercompany cash transfers. 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 cash management and investment policies have minimized these risks. However, there can be no assurance that these practices will be successful in eliminating all or substantially all of the risks encountered by the Company in connection with its foreign currency transactions. 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 involving the Company's rights to continue to sell is popular Proflavanol product. These actions have been disclosed by the Company it its reports filed with the SEC in prior periods. After the various motions to dismiss had been pending for some time, the U.S. District Court for the District of Connecticut ordered that the motions be re-filed as motions for summary judgment, together with statements of uncontested facts. All parties, including USANA, have re-filed their motions to dismiss as motions for summary judgment, and International Nutrition Company has opposed those motions. The motions are now fully briefed and awaiting ruling by the Court. USANA intends to vigorously defend its right to continue to provide the Proflavanol brand product to its customers. Item 5. Other Information Transactions with the President and CEO On April 28, 1999, the Company agreed to provide up to $5.0 million to its President, CEO and Chairman, Dr. Wentz, pursuant to a Promissory Note and Redemption Agreement ("Agreement"). As of April 30, 1999, the Company had advanced $1.9 million under this arrangement. Repayment of amounts advanced under the Agreement, together with interest at prime rate, will be made through the surrender and redemption of shares of the Company's common stock beneficially owned by Dr. Wentz, held by Gull Holdings Ltd. ("Gull"). Dr. Wentz is the sole shareholder of Gull. Gull has pledged shares to secure the payment and redemption as contemplated by the Agreement. Payment must be made by redemption of shares on August 31, 1999 in the amount of $2.5 million. The balance of unpaid principal and accrued interest will be paid by redemption on December 31, 1999. Dr. Wentz may make up to two interim payments by redemption of shares prior to August 31, 1999. Up to two additional interim payments may also be made during the period from September1, 1999 to December 31, 1999. The number of shares subject to redemption at the time of each payment will be determined by the 17 average closing price of the Company's common stock as reported by NASDAQ for the five trading days preceding a payment date. Redemption of shares in satisfaction of the Agreement will be anti-dilutive to other shareholders, reducing the total number of issued and outstanding shares by the number of shares redeemed. This arrangement also provides some liquidity of Dr. Wentz's investment in the Company without creating an overhang in the market and without increasing the supply of available shares when such an act may otherwise drive down the market price of the Company's common stock. This arrangement also permits Dr. Wentz to continue toward completion of his Sanoviv project. The interest rate charged to Dr. Wentz is the same rate applicable under the Company's line of credit agreement with its bank. The Company expects that amounts, if any, drawn under the line of credit for this purpose, will be repaid in full by the end of fiscal year 1999. The arrangement was reviewed by the Audit Committee and approved by the independent directors of the Company. A copy of the Agreement and the related Stock Pledge Agreement are filed with this Report as exhibits. 18 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. Form 10-Q For The Quarter Ended April 3, 1999 Exhibit Index
Exhibit Number Description - ------ ----------- 3.1 Articles of Incorporation [Incorporated by reference to the Company's Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993] 3.2 Bylaws [Incorporated by reference to the Company's Registration Statement on Form 10, File No. 0-21116, effective April 16, 1993] 4.1 Specimen Stock Certificate for Common Stock, no par value [Incorporated by reference to the Company's 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 the Company's 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 the Company's 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 the Company's 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 the Company's Report on Form 10-Q for the period ended June 27, 1998] 10.5 Promissory Note and Redemption Agreement dated April 28, 1999 10.6 Stock Pledge Agreement dated April 28, 1999 11.1 Computation of Net Income per Share (included in Notes to Consolidated Financial Statements) 22.1 Subsidiaries of the Company [Incorporated by reference to the Company's Annual Report on Form 10-K for fiscal year 1998] 27.1 Financial Data Schedule
(b) Reports on Form 8-K. The Company filed no current reports on Form 8-K during the quarter ended April 3, 1999. 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: May 17, 1999 By: /s/ Gilbert A. Fuller ------------ ------------------------------ Gilbert A. Fuller Vice President and Chief Financial Officer 20