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 March 29, 1997.
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 of (I.R.S. Employer
incorporation or organization) Identification No.)
3838 Parkway Blvd.
Salt Lake City, UT 84120
(Address of principal executive offices, Zip Code)
(801)954-7100
(Registrants' 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 Section 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 of common stock of the Company, without par value,
outstanding as of April 28, 1997 was 6,355,119.
USANA, INC.
Index to Financial Statements and Exhibits
Filed with the Quarterly Report of the Company on Form 10-Q
For the Quarter Ended March 29, 1997
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements: Page No.
--------------------- --------
Consolidated Balance Sheets 3
Consolidated Statements of Earnings 4
Consolidated Statements of Cash Flow 5
Notes to Consolidated Financial Statements 6-8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 8-15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 16
Signature 17
2
USANA, INC. & SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
Unaudited
As of March 29, 1997 December 28, 1996
- ------------------------------ ------------------ -----------------
ASSETS:
Current Assets:
Cash and cash equivalents $ 1,340,586 $ 1,130,487
Accounts receivable, net 33,529 55,149
Income tax receivable 0 405,503
Inventories (Note 3) 5,454,689 6,399,128
Prepaid expenses and other current assets 651,705 661,359
Current maturities of notes receivable 27,898 27,212
Deferred income taxes 365,308 361,000
----------- -----------
Total current assets 7,873,715 9,039,838
Property and equipment, at cost (Note 4) 11,639,528 11,549,813
Other assets 156,676 489,189
----------- -----------
Total Assets $19,669,919 $21,078,840
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 3,696,384 $ 4,709,028
Short-term borrowings 0 1,500,000
Other current liabilities 2,357,900 2,373,533
----------- -----------
Total current liabilities 6,054,284 8,582,561
Deferred income taxes 129,062 129,000
Stockholders' equity:
Common stock, no par value:
Authorized -- 50,000,000 shares, issued
and outstanding 6,351,119 as of March 29,
1997 and December 28, 1996 6,768,844 6,768,844
Cumulative foreign currency translation adjustment 5,797 9,786
Retained earnings 6,711,932 5,588,649
----------- -----------
Total stockholders' equity 13,486,573 12,367,279
----------- -----------
Total liabilities and stockholders' equity $19,669,919 $21,078,840
=========== ===========
The accompanying notes are an integral part of these statements.
3
USANA, INC. & SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
Unaudited
Quarter Ended March 29, 1997 March 31, 1996
- --------------------------- -------------- --------------
Net sales $17,654,299 $10,554,160
Cost of sales 3,759,050 2,037,758
----------- -----------
Gross profit 13,895,249 8,516,402
Operating Expenses:
Distributor incentives 8,348,321 4,816,435
Selling, general, and administrative 3,402,603 1,836,926
Research and development 280,234 127,785
----------- -----------
Total operating expenses 12,031,158 6,781,146
----------- -----------
Earnings from operations 1,864,091 1,735,256
Other income (expense):
Interest income 11,628 49,834
Interest expense (7,550) (384)
Gain on sale of property and equipment 7,571 5,784
Other, net 10,307 7,348
----------- -----------
Total other income 21,956 62,582
----------- -----------
Earnings before income taxes 1,886,047 1,797,838
Income taxes 762,764 678,880
----------- -----------
NET EARNINGS $ 1,123,283 $ 1,118,958
=========== ===========
Earnings per common and common equivalent share $ 0.18 $ 0.18
=========== ===========
Weighted average number of common and
common equivalent shares outstanding 6,392,619 6,280,119
=========== ===========
The accompanying notes are an integral part of these statements.
4
USANA, INC. & SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
QUARTER ENDED March 29, 1997 March 31, 1996
- --------------------------------------- -------------- --------------
NET CASH FLOW FROM OPERATING ACTIVITIES:
Net earnings $ 1,123,283 $ 1,118,958
Adjustments to reconcile net earnings to
net cash provided by (used in) operating activities:
Depreciation and amortization 410,419 135,478
Provision for doubtful accounts 0 0
Gain on sale of property and equipment (7,571) (5,784)
Deferred income taxes (4,246) 101
Changes in operating assets and liabilities:
Accounts receivable 21,620 11,232
Income tax receivable 405,503 0
Inventories 944,439 (554,183)
Prepaid expenses and other assets 334,930 (123,930)
Accounts payable (1,012,644) 356,684
Other current liabilities (15,633) (335,743)
----------- -----------
Net cash provided by operating activities 2,200,100 602,813
NET CASH FLOW FROM INVESTING ACTIVITIES:
Collection on note receivable 6,551 0
Purchase of property and equipment (1,549,952) (1,239,404)
Proceeds from the sale of property and equipment 1,057,389 9,400
----------- -----------
Net cash used in investing activities (486,012) (1,230,004)
NET CASH FLOW FROM FINANCING ACTIVITIES:
Principal payments on long-term obligations 0 (2,616)
Payment on short-term borrowings (1,500,000) 0
----------- -----------
Net cash used in financing activities (1,500,000) (2,616)
Effect of exchange-rate changes on cash and
cash equivalents (3,989) 16,726
----------- -----------
Net increase (decrease) in cash and cash equivalents 210,099 (613,081)
Cash and cash equivalents at beginning of period 1,130,487 2,976,406
----------- -----------
Cash and cash equivalents at end of period $ 1,340,586 $ 2,363,325
=========== ===========
The accompanying notes are an integral part of these statements.
5
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
NOTES TO THE FINANCIAL STATEMENTS
1. INTERIM FINANCIAL INFORMATION
The unaudited interim consolidated financial information of USANA, Inc.
and Subsidiary (the "Company") has been prepared in accordance with Article 10
of the Securities and Exchange Commission's Regulation S-X. Certain
information and footnotes 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 and results of operations as of March 29, 1997, and for
quarters ended March 29, 1997, and March 31, 1996. These 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-KSB for the
year ended December 28, 1996. The results of operations for the quarter ended
March 29, 1997, may not be indicative of the results that may be expected for
the fiscal year ending December 27, 1997.
2. GENERAL
[NOTE: In 1996, the Company adopted a 52/53 week fiscal year. Commencing
with the fiscal year 1996, the fiscal year end of the Company was changed from
December 31 of each year to the Saturday closest to December 31. The fiscal
year for 1996 was, therefore, changed from December 31 to December 28, 1996.
Each quarterly period is composed of 13 weeks.]
The Company develops, manufactures, packages and markets its own line of
nutritionals, antioxidants, weight loss products, and natural skin and hair
care products. USANA products are distributed through a network marketing
organization of independent distributors.
USANA was incorporated July 20, 1992, as a wholly-owned subsidiary of
Gull Laboratories, Inc. ("Gull"), a manufacturer of diagnostic test kits
listed on the American Stock Exchange with the symbol "GUL." USANA was
subsequently spun off from Gull as an independent corporation in January 1993.
From its inception, the Company has carried on a significant program of
research and development. The Company has continued to increase its R&D
budget, spending $280,234 in the first quarter of 1997 as compared to $127,785
in the first quarter of 1996. The Company expects to spend approximately $1
million for research activities in 1997.
USANA distributes its products through a network marketing organization.
Net sales, as reported herein, include the revenues generated by selling the
Company's products, including sales aids, to the independent distributors.
Cost of sales incorporates the expenses of materials, depreciation, labor,
overhead and other costs directly associated with producing USANA's products.
Distributor incentives reflect all cash payments made to distributors,
6
including commissions and bonuses. Selling, general and administrative
expenses include the cost of operating the Company's customer service call
center, along with other marketing and administrative expenses. R&D reflects
only research and development activities.
3. INVENTORIES
Inventories consist of the following:
March 29, 1997 December 28, 1996
-------------- --------------
Raw materials $1,435,391 $2,487,907
Work in process 665,961 455,315
Finished goods 3,353,337 3,455,906
---------- ----------
$5,454,689 $6,399,128
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
March 29, 1997 December 28, 1996
-------------- -----------------
Building $ 5,324,237 $ 5,034,304
Laboratory and production equipment 1,286,444 2,337,358
Computer equipment 2,778,235 2,347,347
Furniture and fixtures 1,179,823 684,481
Automobiles 285,039 285,039
----------- -----------
10,853,778 10,688,529
Less accumulated depreciation
and amortization 1,276,360 1,196,779
----------- -----------
9,577,418 9,491,750
Land 1,772,785 1,772,785
Land improvements 289,325 285,278
----------- -----------
$11,639,528 $11,549,813
5. EARNINGS PER COMMON SHARE
Earnings per common share is computed on the weighted average number of
common and common equivalent shares outstanding. Weighted average number of
common and common equivalent shares outstanding were 6,392,619 and 6,280,119
at March 29, 1997, and March 31, 1996, respectively.
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard (SFAS) No. 128, "Earnings per
Share." The statement is effective for financial statements for periods
ending after December 15, 1997, and changes the method in which earnings per
share will be determined. The effect of adopting SFAS No. 128 has not yet
been determined by the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS QUARTERLY REPORT ON FORM 10Q
CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE
SECURITIES LITITGATION REFORM ACT OF 1995, AND THE COMPANY DESIRES TO TAKE
ADVANTAGE OF THE "SAFE HARBOR" PROVISIONS THEREOF. THEREFORE, THE COMPANY IS
INCLUDING THIS STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE
PROTECTIONS OF SUCH SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING
STATEMENTS. THE FORWARD-LOOKING STATEMENTS IN THIS REPORT REFLECT THE
COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL
PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS
AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED HEREIN, THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED. IN
THIS REPORT, THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS,"
"FUTURE," " PROJECTED" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING
STATEMENTS. READERS ARE CAUTIONED TO CONSIDER THE SPECIFIC RISK FACTORS
DESCRIBED BELOW [SEE PART I ITEM 2. MANAGMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CERTAIN FACTORS THAT MAY
AFFECT OPERATING RESULTS] AND NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE
HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-L
OOKING SATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE
DATE HEREOF.
Results of Operations
Quarters ended March 29, 1997 and March 31, 1996
- ------------------------------------------------
Net sales for the quarter ended March 29, 1997 totaled $17,654,299 compared to
net sales of $10,554,160 for the quarter ended March 31, 1996, an increase of
$7,100,139 or 67.3 percent. The increase in sales is attributable primarily
to the growth in the Company's independent distributor base in the United
States and Canada, success of regional conventions, and restored goodwill from
the completion of the customer service software conversion.
The Company's cost of sales as a percentage of net sales increased to 21.3
percent for the quarter ended March 29, 1997 from 19.3 percent for the quarter
ended March 31, 1996. The increase in the cost of sales percentage is a
result of sales mix which included a greater number of lower margin products
in 1997 than in 1996.
Distributor incentives of $8,348,321 (47.3 percent of net sales) for the
quarter ended March 29, 1997 represented an increase of $3,531,886 from the
incentives totaling $4,816,435 (45.6 percent of net sales) paid during the
quarter ended March 31, 1996. The increase in distributor incentives was
primarily a result of significantly higher sales. The higher distributor
incentives as a percentage of net sales was partially due to the sales mix
which included fewer sales aids, on which no commissions are paid, and also
certain inefficiencies resulting from the implementation of the new customer
service software.
Selling, general and administrative expenses during the quarter ended March
29, 1997 totaled $3,402,603 or 19.3 percent of net sales, compared to
$1,836,926 or 17.4 percent of net sales for the quarter ended March 31, 1996.
The increase in cost was primarily a result of the need for more support
services and facilities to accommodate the growth in sales volume and the
increased number of independent distributors. SG&A expenses were higher as a
percentage of net sales because of the Company's investment in senior
management talent to facilitate future growth, inefficiencies related to
implementing new customer service software, and friction costs related to
moving into its new manufacturing and administrative building. Management
anticipates no adverse future earnings impact from the software conversion or
the move into new facilities. The Company believes expenditures made relating
to acquiring management talent, updating its customer service software and
adding additional capacity to be key contributing factors to its future
growth.
Research and development expenditures of $280,234 or 1.6 percent of net sales
for the quarter ended March 29, 1997 represented an increase of 119.3 percent
over the quarter ended March 31, 1996 expenditures of $127,785 (1.2 percent of
net sales). The increase in research and development expenditures is
evidence of the Company's continued efforts to remain at the forefront of the
nutritional industry. The Company expects to continue expending funds and
resources in research and development at higher levels than last year.
Net earnings totaled $1,123,283 during the quarter ended March 29, 1997,
compared to $1,118,958 during the quarter ended March 31, 1996. In the
quarter ended March 31, 1997, net earnings were adversely affected by three
factors (as previously mentioned); the costs associated with settling into the
new facility, the addition of senior management in the latter half of 1996,
and the implementation of the customer service software. Both the
implementation of the customer service software and the costs associated with
settling into the new facilities are not expected to have an adverse impact on
future net earnings. Furthermore, the relative costs associated with senior
management salaries will diminish as sales grow.
Net earnings per common and common equivalent share for the quarter ended
March 31, 1997 were $.18, the same as the quarter ended March 31, 1996.
The Company's quarter to quarter (March 29, 1997 to December 28, 1996) sales
comparison resulted in an increase of $1,821,214, or approximately 12
percent, to $17,654,299. First quarter earnings increased to $1,123,283 from
$989,795 in the fourth quarter of fiscal 1996, representing an increase of 13
percent.
Liquidity and Capital Resources
At March 29, 1997, current assets of the Company were approximately $7.9
million and current liabilities totaled approximately $6.1 million, resulting
in net working capital of $1.8 million compared to net working capital of
approximately $457,000 at December 28, 1996. The Company's current ratio was
1.30 to 1 at March 29, 1997, as compared to 1.05 to 1 at December 28, 1996.
The increase is primarily due to cash generated from operations.
During the first quarter of 1997, the Company spent approximately $1.5 million
on capital expenditures. To assist the Company in funding the aforementioned
acquisitions, USANA entered into a sale lease-back agreement with an
unrelated, third-party leasing company. The agreement called for the sale of
approximately $1,000,000 of book value of equipment held by the Company. The
proceeds of one million dollars were received on March 13, 1997.
The Company's management demonstrated strong progress in its efforts to
decrease inventory levels. Inventory decreased by $944,439 (14.8 percent)
from the amount reported at December 28, 1996, of $6,399,128 to $5,454,689 at
March 29, 1997.
In November of 1996, the Company entered into a line of credit agreement with
a bank for $2,500,000. In February of 1997, the line of credit was increased
to $3,500,000. 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 percent. The line of
credit is collateralized by certain receivables, inventories, and equipment.
The line of credit agreement also contains restrictive convenants requiring
the Company to maintain certain financial ratios. As of March 29, 1997, the
Company is in compliance with these convenants. The Company paid off the
balance of $1,500,000 that existed at December 28, 1996, and there was no
outstanding balance as of March 29, 1997. The line of credit agreement
expires in May 1997; however, the Company is currently pursuing negotiations
to extend the line of credit.
The Company believes that its current cash balances, the available line of
credit and anticipated extension thereof, and cash provided by operations will
be sufficient to cover its needs for the remainder of the year.
Certain Factors That May Affect Operating Results
When used in this report, the terms "believes," "anticipates," "expects," and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those projected, including those
discussed below. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The
Company undertakes no obligation to publicly release the result of any
revisions to forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
Important factors that may cause results to differ from expectations include
the following:
Reliance Upon Independent Distributor Network. The Company's products are
distributed exclusively through an extensive network marketing system of indepen
dent distributors. These distributors are independent contractors who
purchase products directly from the Company for their own use or for resale at
retail prices. Distributors typically work at the distribution of the
Company's products on a part-time basis and may engage in other business
activities. The Company has a large number of distributors and a relatively
small corporate staff to implement its marketing programs and provide
motivational support. The Company's continued growth and success depends to a
significant degree on its ability to retain and motivate its distributors and
to attract new distributors by continuing to offer new products of superior
quality and new marketing programs. Distributor agreements with the Company
may be voluntarily terminated
by distributors at any time. There is typically significant turnover in
distributors from year to year. Because the Company's revenue is directly
dependent upon the efforts of non-employee, independent distributors and
future growth in sales volume will depend in large part upon an increase in
the number of new distributors and/or improved productivity of the Company's
distributors; turnovers, decreases in the size of the distributor force,
seasonal or other decreases in purchase volume, costs associated with training
new distributors and other expenses associated with these problems, may
combine to reduce the revenues and profitability of the Company.
Government Scrutiny of Network Marketing Practices. Network marketing
systems such as the Company's are frequently subject to laws and regulations
directed at ensuring that product sales are made to consumers of the products
and that compensation, recognition and advancement within the marketing
organization are based on the sale of products rather than "investment" in the
sponsoring company. In the U.S., these laws and regulations include the
federal securities laws, regulations and statutes administered by the Federal
Trade Commission ("FTC") and various state anti-pyramid and business
opportunity laws. Similar laws may also govern the Company's activities in
foreign countries. Although the Company believes that it is in compliance
with all such laws and regulations, the Company remains subject to the risk
that, in one or more of its present or future markets, its marketing system
could be found not to be in compliance with applicable laws or regulations.
Failure by the Company to comply with these laws and regulations could have an
adverse material effect on the Company or a distributor in a particular market
or in general.
Distributors' Actions. The Company's distributors are required to sign
the Company's Distributor Application and Agreement which requires them to
abide by the USANA Policies and Procedures. Although these Policies and
Procedures prohibit distributors from making certain claims regarding the
products or income potential from the distribution of those products,
nonetheless, in certain instances distributors may from time to time create
promotional materials which do not accurately describe the Company's marketing
program or may make statements regarding potential earnings, product claims or
other matters not in accordance with the Company's policies or contrary to
applicable laws and regulations concerning these matters. Although the
Company has not been sued by regulatory authorities, legal actions against
distributors or others affiliated with the Company could lead to increased
regulatory scrutiny of the Company and its network marketing system. In order
to assure itself that its Policies and Procedures and the practices of its
independent distributors conform to law and fairly protect the interests of
consumers, the Company attempts to carefully monitor against
misrepresentations by distributors. There can be no assurance that the
Company will be able to completely accomplish this objective. In addition,
distributors could make predictive statements about the Company's operations
or other unauthorized remarks regarding USANA which the Company may be unable
to control. Publicity resulting from such activities of distributors can also
make it more difficult for the Company to sponsor and retain distributors or
may adversely affect the Company's ability to expand into new markets or in
other ways.
Government Regulation-Products and Manufacturing. The manufacturing,
processing, formulation, packaging, labeling and advertising of the Company's
products are subject to regulation by federal agencies, including the Food
and Drug Administration (the "FDA"), the FTC, the Consumer Product Safety
Commission, the United States Department of Agriculture, the United States
Postal Service and the United States Environmental Protection Agency. These
activities are also subject to regulation by various agencies of the
countries, states and other localities in which the Company's products are
sold. In October 1994 the "Dietary Supplement Health and Education Act of
1994" ("DSHEA") was enacted. The DSHEA defines dietary supplements (which
include vitamins, minerals, nutritional supplements and herbs) and provides a
regulatory framework to ensure safe, quality dietary supplements, and the
dissemination of accurate information about such products. Dietary
supplements are regulated as foods under the DSHEA and the FDA is generally
prohibited from regulating the active ingredients in dietary supplements as
food additives, or as drugs unless product claims trigger drug status. The
DSHEA provides for specific nutritional labeling requirements for dietary
supplements effective January 1, 1997. The DSHEA permits substantiated,
truthful and non-misleading statements of nutritional support to be made in
labeling, such as statements describing general well-being from consumption of
a dietary ingredient or the role of a nutrient or dietary ingredient in
affecting or maintaining structure or function of the body. In addition, the
DSHEA authorizes the FDA to promulgate current Good Manufacturing Practices
("GMP") specific to the manufacture of dietary supplements to be modeled after
food GMP's. The Company currently manufactures its dietary supplement
products pursuant to food GMP's.
The Company cannot determine what effect currently proposed FDA
regulations or changed or amended regulations, when and if promulgated, will
have on its business in the future. Such regulations could, among other
things, require expanded or different labeling, the recall or discontinuance
of certain products, additional record keeping and expanded documentation of
the properties of certain products and scientific substantiation. In
addition, the Company cannot predict whether new legislation regulating its
activities will be enacted, which new legislation could have a material
adverse effect on the Company.
Product Liability. As a manufacturer and distributor, the Company could
become exposed to product liability claims. The Company has not had any such
claims to date. Although the Company maintains product liability insurance
which it believes to be adequate for its needs, there can be no assurance that
the Company will not be subject to claims in the future or that its insurance
coverage will be adequate.
Competition. The business of distributing and marketing nutritional
supplements, vitamins and minerals, personal care products, weight management
items, and other nutritional products offered by the Company is highly
competitive. Numerous manufacturers, distributors and retailers compete
actively for consumers and for distributors. The Company competes directly
with other entities that manufacture, market and distribute nutritional and
personal care products in each of its product lines. The Company competes
with these entities by emphasizing the value and high quality of its products
as well as the convenience and financial benefits afforded by its network
marketing system. However, many of the Company's competitors are
substantially larger than the Company and have greater financial resources and
broader name recognition. The market is highly sensitive to the introduction
of new products that may rapidly capture a significant share of the market.
12
As a result, the Company's ability toremain competitive depends in part upon
the successful introduction of new products. The Company is also subject to
significant competition from other marketing organizations for the recruitment
of distributors. The Company's ability to remain competitive depends, in
significant part, on the Company's success in recruiting and retaining
distributors. There can be no assurance that the Company's programs for
recruiting and retaining distributors will be successful. The Company competes
for the time, attention and commitment of its independent distributor force. The
pool of individuals interested in the business opportunities presented by direct
selling tends to be limited in each market, and it is reduced to the extent
other network marketing companies successfully recruit these individuals into
their businesses. Although management believes the Company offers an attractive
opportunity for distributors, there can be no assurance that other marketing
companies will not be able to recruit the Company's existing distributors or
deplete the pool of potential distributors in a given market.
Expansion Into Foreign Markets. The Company has announced its intentions
to expand into markets outside North America. However, there can be no
assurance that the Company can open markets on a timely basis or that such new
markets will prove to be profitable. Significant regulatory and legal
barriers must be overcome before marketing can begin in any foreign market.
Also, before marketing has commenced, it is difficult to assess the extent to
which the Company's products and sales techniques will be successful in any
given country. In addition to significant regulatory barriers, the Company
may also expect problems related to entering new markets with different
cultural bases and legal systems from those encountered elsewhere. Expansion
of the Company's operations into new markets may require substantial working
capital and capital requirements associated with regulatory compliance. There
can be no assurance that the Company will be able to obtain necessary permits
and approvals or that it will have sufficient capital to finance its expansion
efforts in a timely manner.
Risks Associated With Rapid Growth. Since commencing operations after
the spin-off from Gull in 1992, the Company has experienced rapid growth. The
management challenges imposed by, and encountered by the Company as a result
of this growth include significant growth in the number of employees and
distributors, needed expansion of facilities and acquisition of capital
equipment and information systems to accommodate growth and additions and
modifications to the Company's product lines, and expansion into new markets.
To effectively manage these and other changes resulting from rapid growth, the
Company may be required to hire additional management and operations personnel
and to improve its operational, financial, information and management
systems. If the Company is unable to manage growth effectively or to hire or
retain qualified personnel, its business and results of operations may be
adversely affected. Moreover, the capital expenditures and personnel expenses
associated with such growth may adversely affect the Company's results of
operations.
Risks Associated with Material Supplies. The Company has short term
contracts with some suppliers of raw material used in its products. Normally,
materials used in manufacturing the Company's products are purchased on
account or by purchase order. The Company has very few long term agreements
for the supply of such materials. There is a risk that any of the Company's
suppliers or manufacturers could discontinue selling their products to the
Company. Although the Company believes that it could establish alternate
13
sources for most of itsproducts, any delay in locating and establishing
relationships with other sources could result in product shortages and back
orders for the products, with a resulting loss of revenues to the Company.
For example, in the fourth quarter of 1996, the Company experienced difficulty
in obtaining sufficient quantities of Vitamin E Succinate Powder, an ingredient
required for the manufacture of several of its products. It is expected that
the supplier's shortage will continue during 1997. As a consequence, the
Company has been required to alter its product or to substitute a different
product from another source. This and similar future product or ingredient
shortages may adversely affect the Company's results of operations.
Control by Principal Shareholder. Gull Holdings, Ltd., an Isle of Man
limited company wholly-owned by Dr. Myron Wentz, is the beneficial owner of
approximately 63 percent of the issued and outstanding shares of common stock
of the Company. There are no cumulative voting rights under the Company's
Articles of Incorporation and, therefore, this shareholder possesses the
ability to elect all of the directors of the Company, to increase its
authorized capital, to dissolve or merge the Company or to sell its assets and
generally to exert substantial control over the business and operations of the
Company.
Reliance on Personnel. The Company's success depends to a significant
extent upon certain members of senior management, including Dr. Wentz, Jeb
McCandless, Dallin Larsen, Gilbert Fuller, Mark Petersen and David Wentz. The
Company does not maintain key man life insurance policies on any of these
persons and there can be no assurance that such policies will be obtained in
the future or that if obtained they can adequately compensate the Company for
the loss of such individuals. The Company has no employment contracts with
any of these persons. The loss of any senior manager or other key employee
could have an adverse effect upon the Company's business, financial condition
and operating results.
Effect of Exchange Rate Fluctuations. The Company has a Canadian
subsidiary and has commenced efforts to expand its marketing organization into
other foreign countries. As a result, exchange rate fluctuations may have a
significant effect on its sales and the Company's gross margins. Further, if
exchange rates fluctuate dramatically, it may become uneconomical for the
Company to establish or continue activities in certain countries.
Anti-Takeover Protection. The Utah Control Shares Act (the "Control
Shares Act") provides that any person or entity that acquires 20 percent or
more of the outstanding voting shares of a publicly-held Utah corporation is
denied voting rights with respect to the acquired shares, unless a majority of
the disinterested shareholders of the corporation elects to restore such
voting rights. The provisions of the Control Shares Act may discourage
companies or persons interested in acquiring a significant interest in or
control of the Company, regardless of whether such acquisition may be in the
interest of the Company's shareholders.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On March 6, 1996, International Nutrition Company ("INC") filed a patent
infringement action against eighteen defendants, including USANA, alleging
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infringement of U.S. patent number 4,698,360. The complaint, filed in the
United States District Court for the District of Connecticut, alleges that
USANA's Proflavanol [R] product violates the patent. The complaint seeks
preliminary and permanent injunctions against USANA that would prohibit
further sales of the Proflavanol [R] product. INC also seeks monetary
damages, including any profits lost by INC as a result of the alleged
infringement, damages suffered by INC resulting from the alleged
infringement, and attorneys' fees and costs incurred by INC. Having conducted
a thorough investigation of the patent and the allegations made in the
complaint, USANA believes that its manufacture and sale of the Proflavanol [R]
product does not infringe any valid claim of the asserted patent. USANA
intends to vigorously defend its right to continue providing its Proflavanol
[R] product to its customers and distributors. There can be no assurance,
however, that USANA will succeed in its defense of this matter.
On April 17, 1996, an unidentified party filed a request with the United
States Patent and Trademark Office (PTO) to reexamine the validity of the
patent now being asserted against USANA. On June 27, 1996, the PTO granted
that request, and stated that a substantial new question of patentability had
been raised. On January 13, 1997, the Patent Examiner responsible for the
reexamination issued a written Office Action rejecting the validity of each of
the claims of the patent based on a number of grounds. The owner of the
patent has denied those rejections, and a final determination as to the
patent's validity has not yet been issued by the PTO. However, if the PTO's
rejection of the patent stands, INC would be precluded from proceeding with
its lawsuit against USANA.
On March 21, 1997, the Federal Judge responsible for the lawsuit stayed the
action until the PTO rules on the validity of the patent. Also, the Judge
stayed the action until another lawsuit in France is resolved. That lawsuit
does not involve USANA, but involves the question of whether INC has any
ownership rights in the '360 patent. On March 25, 1997, the French court in
that action ruled that INC does not own the '360 patent. If that ruling is
upheld, INC may be barred from proceeding with the patent infringement action
against USANA.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Item 601 Exhibit No. and Description
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27 Financial Data Schedule
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.
April 28, 1997 /s/ Gilbert A. Fuller
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Gilbert A. Fuller
Vice President of Finance and
Principal Financial Officer
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