UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

(Mark One)

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

For the fiscal year ended January 3, 2004

 

 

 

o

 

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 HEALTH SCIENCES, INC.

(Exact name of registrant as specified in its charter)

 

Utah

 

87-0500306

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer 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)

 

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $0.001 Per Share

 


 

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 ý No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes ý  No o

 

The aggregate market value of common stock held by non-affiliates of the registrant as of June 28, 2003 was approximately $218,470,525.

 

The number of shares outstanding of the registrant’s common stock as of February 27, 2004 was 19,276,474.

 

Documents incorporated by reference. The registrant incorporates information required by Part III (Items 10, 11, 12, 13, and 14) of this report by reference to the registrant’s definitive proxy statement to be filed pursuant to Regulation 14A for the April 21, 2004 Annual Shareholders Meeting.

 

On October 14, 2003, the registrant declared a two-for-one stock split of its common stock that was distributed in the form of a stock dividend on October 30, 2003 to shareholders of record as of October 24, 2003.  Outstanding common stock data in this report have been adjusted to reflect the stock split.

 

 



 

USANA HEALTH SCIENCES, INC.

 

FORM 10-K

 

For the Fiscal Year Ended January 3, 2004

 

INDEX

 

Part I

 

Item 1

Business

 

Item 2

Properties

 

Item 3

Legal Proceedings

 

Item 4

Submission of Matters to a Vote of Security Holders

 

 

 

 

Part II

 

 

 

Item 5

Market for Registrant’s Common Equity and Related Stockholder Matters

 

Item 6

Selected Financial Data

 

Item 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

 

Item 8

Financial Statements and Supplementary Data

 

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

Item 9A

Controls and Procedures

 

 

 

 

Part III

 

 

 

Item 10

Directors and Executive Officers of the Registrant

 

Item 11

Executive Compensation

 

Item 12

Security Ownership of Certain Beneficial Owners and Management

 

Item 13

Certain Relationships and Related Transactions

 

Item 14

Principal Accounting Fees and Services

 

 

 

 

Part IV

 

 

 

Item 15

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

 

 

 

Signatures

 

 

 

2



 

PART I

 

Item 1.  Business

 

General

 

USANA Health Sciences, Inc. (“USANA” or the “Company”) is a Utah corporation that develops and manufactures high-quality nutritional and personal care products.  We distribute our products through a network marketing system using independent distributors that we refer to as “Associates.”  As of January 3, 2004, we had approximately 88,000 active Associates in the United States, Canada, Australia, New Zealand, Hong Kong, Japan, Taiwan, South Korea, Singapore, and the United Kingdom.  We also sell products directly to “Preferred Customers” who purchase products for personal use and are not permitted to resell or distribute the products.  As of January 3, 2004, we had approximately 51,000 active Preferred Customers worldwide.  Sales to Preferred Customers accounted for approximately 15% of net sales during fiscal year 2003, which ended January 3, 2004.  For purposes of this report, we only count as active customers those Associates and Preferred Customers who have purchased product from USANA at any time during the most recent three-month period.

 

We maintain executive offices and principal facilities at 3838 West Parkway Boulevard, Salt Lake City, Utah 84120.  Our telephone number is (801) 954-7100.  We maintain a World Wide Web site at www.usanahealthsciences.com. The information on our Web site should not be considered part of this report on Form 10-K.

 

Core Business

 

Founded in 1992 by Myron W. Wentz, Ph.D., we are committed to continuous product innovation and sound scientific research.  Our primary product lines consist of USANAâ Nutritionals, a line of the highest quality supplements and food products, and Sensé – beautiful scienceâ(Sensé), our line of skin and personal care products.  The USANAâ Nutritionals product line accounted for approximately 69% of product sales in 2003.  Our top-selling products, USANAâ Essentials and Proflavanolâ, represented approximately 22% and 9%, respectively, of product sales in 2003.  The USANAâ Essentials are also provided in a convenient pillow pack format, HealthPak 100Ô, which represented an additional 9% of product sales in 2003.  The Sensé product line accounted for approximately 12% of product sales in 2003.  The remainder of our total sales in 2003 consisted of sales from combination packs containing various products from our two major product lines and sales aids that assist our Associates in building their business and selling products.  We market all of our products on the basis of high levels of bioavailability, safety, and quality.

 

We distribute our products through network marketing.  Our network marketing distribution system involves the sale of products directly to independent distributors (Associates) and consumers (Preferred Customers).  Our Associates purchase product not only for their own consumption, but are encouraged to build and manage their own sales force by recruiting, managing and training others to sell our products.  Associates are compensated for their own sales and a percentage of the sales (purchases) of their business group (downline).  We believe that network marketing is an effective way to distribute our products because network marketing allows person-to-person product education, which is not readily available through traditional distribution channels.  Network marketing appeals to a broad cross-section of people, particularly those seeking to supplement their other income, start a home-based business, or pursue entrepreneurial opportunities other than conventional full-time employment.  We consider our rewarding compensation plan and weekly Associate incentive payments to be attractive components of the USANA network marketing system.

 

Net sales reported for each operating region are determined by the location from which product shipments originate.  North America is our primary market; however, our other markets have continued to grow as a proportion of net sales in recent years. Sales in North America accounted for 67.6% of net sales in 2003.  Our key markets outside North America contributed to consolidated net sales in 2003 as follows:

 

•    Australia-New Zealand

 

14.8

%

•    Hong Kong

 

4.4

%

•    Japan

 

3.3

%

•    Taiwan

 

6.8

%

•    South Korea

 

1.8

%

•    Singapore

 

0.5

%

 

We entered two new markets during 2003.  Operations commenced in South Korea and Singapore in July and November 2003, respectively.  The South Korea market generated $3.5 million in sales for the third and fourth quarters of 2003 combined, and the Singapore market generated $0.9 million in sales for the fourth quarter of fiscal 2003.

 

3



 

On July 9, 2003, we completed the acquisition of Wasatch Product Development, Inc. (WPD), a company specializing in the manufacture of skin and personal care products for $5.3 million.  This acquisition contributed $1.8 million or 0.8% of consolidated net sales and $95,000 of earnings from operations for the year ended January 3, 2004.

 

On October 14, 2003, our Board of Directors approved a two-for-one split of common stock in the form of a stock dividend that was distributed on October 30, 2003, to shareholders of record as of October 24, 2003.

 

Recent Developments

 

In February 2004, the Company opened offices in Mexico in preparation for the launch of operations in that market.  The Company began selling personal care products in Mexico on March 1, 2004.  According to the World Federation of Direct Selling Associations, Mexico is the fourth largest market for direct selling in the world.

 

Also, in February 2004, the Company completed the acquisition of the net assets of FMG Productions, LLC, a Utah limited liability company (“FMG”), for $2.1 million in cash, through a newly formed wholly owned subsidiary of the Company, which will operate the business formerly conducted by FMG.  FMG produces video and audio promotional and training materials for large companies and sales organizations, including the Company.  The former employees of FMG, including its founders and primary creative directors, will continue to operate the business now owned by USANA.  The Company expects to realize future benefits from this acquisition primarily through the motivation and training of its independent Associates.

 

Business Segments

 

Our operations consist of two reportable business segments, Direct Selling and Contract Manufacturing.  The Direct Selling segment constitutes our principal line of business: developing, manufacturing, and distributing nutritional and personal care products through a network marketing system.  Operations within this segment are further distinguished by geography and include regions in North America, Australia-New Zealand, Hong Kong, Japan, Taiwan, South Korea, and Singapore.  Prior to the acquisition of WPD in 2003, we were principally engaged in operating activities related to the Direct Selling segment and therefore had only one reportable business segment, which was distinguished by geographic region.  Now, however, due to the acquisition of WPD, we have added Contract Manufacturing as a new business segment.  Operating activities for the Contract Manufacturing segment include the manufacture of premium personal care products, produced under the brand name of its customers, including manufacturing and packaging for the Company’s Sensé product line.  Segment information for each of the last three fiscal years is included in Note K of the audited consolidated financial statements included in this report.

 

Industry Overview

 

The nutrition industry includes many small- and medium-sized companies that manufacture and distribute products generally intended to maintain the body’s health and general well being.  The four major product categories within the nutrition industry are as follows:

 

                  Nutritional Supplements – products, such as vitamins and minerals, sports performance enhancers, meal replacements, dietary supplements, herbs and botanicals, and compounds derived from these substances,

 

                  Natural and Organic Foods – products, such as cereals, milk, non-dairy beverages, and frozen entrees,

 

                  Functional Foods – products with added ingredients or fortification specifically for health or performance purposes, and

 

                  Natural Personal Care – products combining nutrition with skin care.

 

In their August/September 2002 issue, the Nutrition Business Journal (“NBJ”) reported global sales in the nutrition industry of $150 billion in 2001 and forecasted 6 – 8% growth from 2002 - 2007.  NBJ also reported, in their May/June 2003 issue that U.S. nutrition industry sales were $58 billion in 2002.  According to NBJ, of the $58 billion, nutritional supplements contributed $18.7 billion, natural personal care $4.5 billion, functional foods $20.5 billion, and natural and organic foods $14.3 billion.

 

We believe that the following factors drive growth in the nutrition industry:

 

                  The general public’s heightened awareness and understanding of the connection between diet and health,

 

4



 

                  The aging population in most of our markets, particularly the baby-boomer generation, which tends to use more nutritional supplementation as it ages,

 

                  The worldwide trend toward preventive health care, and

 

                  Product introductions in response to new scientific findings.

 

Nutritional products are distributed through six major sales channels.  Each channel has changed in recent years, primarily due to advances in technology and communications that have resulted in improved product distribution and faster dissemination of information.  The major sales channels are as follows:

 

                  Mass market retailers, including mass merchandisers, drug stores, supermarkets, and discount stores,

 

                  Natural health food retailers,

 

                  Network marketing,

 

                  Mail order,

 

                  Healthcare professionals and practitioners, and

 

                  The Internet.

 

We distribute our products through the network marketing sales channel.  According to the World Federation of Direct Selling Associations, the network marketing industry generates $85.5 billion annually in worldwide sales with nearly 47.1 million independent distributors.  The United States remains the largest market for direct sales with $28.7 billion annually and over 13 million independent distributors. We believe that we are well positioned to capitalize on growth trends in direct sales as both a developer and manufacturer of nutritional supplements utilizing our network marketing distribution system.

 

Operating Strengths

 

Our principal objective is to be a leading developer, manufacturer, and distributor of science-based nutritional health and skin care products.  Our strategy to achieve this objective is to capitalize on our operating strengths, which include our development and sale of science-based products, our strong research and development capability, our in-house manufacturing capacity, an attractive compensation plan for Associates, and our experienced management team.

 

Science-based Products. We have developed a line of high-quality health products based upon a combination of published research, in vitro and in vivo testing, in-house and third-party clinical studies, and sponsored research.  We believe that the identification and delivery of essential vitamins, minerals, and other micro-nutrients, as well as macro-nutrients, will help individuals achieve and maintain long-term health.

 

Strong Research and Development. Dr. Wentz directs our research and development effort, supported by a team of 21 scientists and researchers, including five scientists holding Ph.D. degrees.  In our research and development laboratories, our scientists and researchers:

 

                  Investigate in vitro and in vivo activity of new natural extracts and formulated products,

 

                  Identify and research combinations of nutrients that may be candidates for new products,

 

                  Study the metabolic activity of existing and newly identified nutritional supplements,

 

                  Enhance existing products, as new discoveries in nutrition are made, and

 

                  Formulate products to meet regulatory requirements of international markets.

 

In addition, we continue to perform double-blind, placebo-controlled clinical studies intended to further evaluate the efficacy of our products.

 

5



 

In-house Manufacturing.  During 2003, we manufactured products that accounted for approximately 71% of product sales in our Direct Selling segment.  We believe that our ability to manufacture our own products is a significant competitive advantage for the following reasons:

 

                  We can better control the quality of raw materials and the purity and potency of finished products,

 

                  We can more reliably monitor the manufacturing process to reduce the risk of product contamination, and

 

                  We believe we can better manage the underlying costs associated with manufacturing nutritional supplements.

 

Attractive Associate Compensation Plan and Benefits. We are committed to providing a highly competitive compensation plan to attract and retain Associates, who constitute our sales force.  We believe the USANA Associate compensation plan is one of the most financially rewarding in the network marketing industry.  Associate incentives totaled approximately $79 million or 39.7% of net sales for the Direct Selling segment in 2003.  We pay Associate incentives weekly.  The USANA compensation plan is a global, seamless plan, meaning that Associates can recruit and be compensated each week for their business success in any market in which we conduct business.  To support our Associates, we sponsor events throughout the year, which offer information about our products and our network marketing system.  These meetings are designed to assist Associates in business development and to provide a forum for interaction with successful Associates and the USANA management team.

 

Experienced Management Team.  Our management team includes individuals with expertise in various scientific and managerial disciplines, including nutrition, product research and development, marketing, customer network development, information technology, finance, operations, and manufacturing.  The current executive management team has been in place for several years and is responsible for developing an infrastructure to support growth and international expansion, strengthening our financial condition, and improving internal controls.

 

Growth Strategy

 

We seek to grow our business by pursuing the following strategies:

 

Attract and Retain Associates and Preferred Customers. We recognize the need to continue to attract and retain Associates.  Over the last several years we have emphasized the partnership between the USANA management team and our Associates.  By focusing on improving communications and interactions with our top Associate leaders (IDC - -Independent Distributor Council), we have been able to create an atmosphere of teamwork and cooperation.  This focus has resulted in the Associate leadership taking a more active role in hosting the majority of training and opportunity meetings.  For example, each week in multiple locations, hundreds of Associate leaders are now hosting “Health & Freedom Thursdays” aimed at presenting the business opportunity to potential Associates and providing additional training and resources for existing Associates.  This increase in activity and involvement is assuring us that thousands are hearing about USANA each month, with meeting attendance numbers continuing to rise.  We have also continued to improve the quality and effectiveness of our sales tools that deliver our message.  These efforts aimed at attracting and retaining Associates contributed to a substantial increase in Associate enrollments in 2003.  As we endeavor to attract and retain Associates during 2004, we intend to target the Associate leadership base for growth in both existing and new markets, enhance our infrastructure to promote customer service levels, improve reward and recognition for our Associates, and develop more interactive online training for our Associates.

 

Enter New Markets. We believe that, in addition to the North American market, significant growth opportunities continue to exist in international markets.  We began operations in South Korea and Singapore in July and November 2003, respectively, and launched operations in Mexico during March of 2004.  New markets are selected following an assessment of several factors, including market size, anticipated demand for USANA products, receptivity to network marketing, and ease of entry, which includes consideration of possible regulatory restrictions on the products or network marketing system.  We have begun to register certain products with regulatory and government agencies in preparation for further international expansion.  Wherever possible, we expect to seamlessly integrate the Associate compensation plan in each market to allow Associates to receive commissions for global - not merely local - product sales.  The seamless downline structure is designed to allow an Associate to build a global network by creating downlines across national borders.  Associates are not required to establish new downlines or to re-qualify for higher levels of compensation in newly opened markets.  We believe this seamless compensation plan can significantly enhance our ability to expand internationally and we intend, where permitted, to integrate future markets into this seamless plan.

 

Introduce New Products. Using our research and development capabilities, we introduce innovative products and continuously enhance existing products.  Among the products introduced during 2003 were improved formulations for our children’s UsanimalsÔ and Body RoxÔ for teens and a new Wild Berry Nutrition Bar.  Our practice is to introduce new products throughout the year, primarily at company-sponsored events.

 

6



 

Pursue Strategic Acquisitions. We believe that attractive acquisition opportunities may arise in the future.  We intend to pursue strategic acquisition opportunities that would grow our customer base, expand product lines, enhance manufacturing and technical expertise, allow vertical integration, or otherwise complement our business or further our strategic goals.  For example, in 2003, we completed the acquisition of WPD as part of a vertical integration strategy.

 

Products

 

Our primary product lines within the Direct Selling segment consist of USANAâ Nutritionals and Sensé – beautiful scienceâ (Sensé).  The USANAâ Nutritionals product line is further categorized into three separate classifications: Essentials, Optimizers, and Macro Optimizers.  Prior to the third quarter of 2003, the USANAâ Nutritionals product line was comprised of the Essentials and Optimizers product categories.  At our Annual International Convention in September 2003, we announced that the L·E·A·N LifelongÔ brand name would be discontinued and that the weight management products associated with this brand were to be sold under the new Macro Optimizers classification within the USANAâ Nutritionals product line.  This transition was made to simplify the overall product story, which our Associates share with prospects. The change includes a shift away from a low-fat/weight loss positioning to a focus on low-glycemic carbohydrates, soy protein and dietary fiber, as well as the specific health benefits associated with these ingredients.  Various individual items within our primary product lines are also grouped and sold as combination packs.

 

USANAâ Nutritionals.

 

The Essentials include core vitamin and mineral supplements that provide a foundation of advanced nutrition for every age group.  To help meet the “essential” nutrient needs of children and teens during the years of development, when good nutrition is most important, USANA offers: UsanimalsÔ, a great-tasting formulation of vitamins, minerals, and antioxidants, in an easy-to-take chewable tablet for children 13 months to 12 years old, and Body RoxÔ, a nutritional supplement containing 31 essential vitamins, minerals, antioxidants, and cofactors for adolescents 12 to 18 years old.  USANAâ Essentials for adults is a combination of two products: Mega Antioxidant, a balanced, high-potency blend of 30 vitamins, antioxidants, and other important nutrients to support cellular metabolism and to counteract free-radical damage and Chelated Mineral, a complete spectrum of essential minerals, in balanced, highly bioavailable forms.  The USANAâ Essentials are also provided in a convenient pillow pack format, HealthPak 100Ô.

 

Optimizers are more targeted supplements designed to meet individual health and nutritional needs.  Products in this category include Proflavanolâ, Poly Câ, Procosaâ II, CoQuinoneâ 30, BiOmega-3Ô, E-PrimeÔ, Active CalciumÔ, PhytoEstrinÔ, Palmetto PlusÔ, Ginkgo-PSÔ, Garlic ECÔ, Visionexâ, and OptOmegaâ.

 

The Macro Optimizers include healthy convenience foods and other related products, including powdered drink mixes and nutrition bars that were previously sold under the L·E·A·N LifelongÔ brand name.  NutrimealÔ and Fibergyâ drink mixes, SoyaMaxÔ, and Nutrition Bar and Fibergy Bar are included in this product category.

 

Sensé - beautiful scienceâ

 

The Sensé product line includes premium, science-based personal care products that support healthy skin and hair by providing advanced topical nourishment, moisturization and protection.  Products in this line include Perfecting Essence, Gentle Daily Cleanser, Hydrating Toner, Daytime Protective Emulsion SPF 15, Eye Nourisher, Night Renewal (Replenishing Crème), Serum Intensive (Skin Revival Complex), Rice Bran Polisher, Nutritious Crème Masque, Revitalizing Shampoo, Nourishing Conditioner, Firming Body Nourisher, and Energizing Shower Gel.

 

In addition to these principal product lines, we have developed and sell to Associates materials and online tools designed to assist them in building their business and selling products.  These resource materials or sales aids include product brochures and business forms designed by us and printed by outside publishers.  We periodically contract with authors and publishers to produce or provide books, tapes, and other items dealing with health topics and personal motivation, which are made available to Associates. We also write and develop our own materials for audio and videotapes, which are produced by third parties.  New Associates are required to purchase a starter kit containing USANA training materials that assist Associates in starting and growing their business.  Associates do not earn commissions on the sale of sales aids or starter kits.

 

The Contract Manufacturing segment includes the manufacture of premium personal care products, produced under the brand name of its customers, including manufacturing and packaging for the Company’s Sensé product line.

 

7



 

We continually evaluate the profitability of each of our products and discontinue those products that do not meaningfully contribute to our profitability.  Historically, the elimination of certain products has not had a significant negative impact on our overall profitability.

 

The following table summarizes the approximate percentage of total product sales for the Direct Selling segment contributed by major product line for the last three fiscal years:

 

 

 

Sales By Product Line
Year Ended

 

Product Line

 

2001

 

2002

 

2003

 

USANAâ Nutritionals

 

 

 

 

 

 

 

Essentials *

 

32

%

33

%

34

%

Optimizers

 

35

%

33

%

29

%

Macro Optimizers

 

9

%

8

%

6

%

Sensé – beautiful scienceâ

 

13

%

13

%

12

%

Combination Packs

 

5

%

7

%

11

%

All Other

 

6

%

6

%

8

%

 


*   The Essentials category under the USANAâ Nutritionals product line includes USANAâ Essentials, HealthPak 100Ô, Body RoxÔ, and UsanimalsÔ.

 

Key Products

 

The following highlights sales data for our top-selling products as a percentage of Direct Selling segment product sales for the fiscal year ended January 3, 2004.

 

USANAâ Essentials

 

22

%

HealthPak 100Ô

 

9

%

Proflavanolâ

 

9

%

 

Research and Development

 

We are committed to continuous product innovation and improvement through sound scientific research.  The mission of the research and development team is to develop, for all age groups, advanced health products that reduce the risk of chronic degenerative disease and promote long-term health.  These research efforts are enhanced using a combination of published research, in vitro and in vivo testing, in-house and third-party clinical studies, and sponsored research.  We periodically consult with a panel of physicians who provide advice on product development.  In fiscal years 2001, 2002, and 2003, we expended $1.1 million, $1.0 million, and $1.4 million, respectively, on company-sponsored research and development activities.  We intend to continue to dedicate resources at similar levels for the research and development of new products and the reformulation of existing products.

 

We maintain a research and development program based upon established scientific research methodologies.  The modern research facilities located at our Salt Lake City headquarters are equipped to conduct analytical testing of raw ingredients, raw material extraction research, in vitro and in vivo testing, and human bioavailability studies.  In-house and third-party clinical studies are conducted on select products to further characterize benefits.  With the acquisition of our own skin care manufacturing facility in 2003, our research and development expertise has expanded to include formulation development and quality control analysis of skin and personal care products.

 

Manufacturing and Quality Assurance

 

All tablet manufacturing was conducted at our Salt Lake City, Utah, manufacturing facility.  The production process for tablet-based products includes identifying and evaluating suppliers of raw materials, acquiring raw materials, analyzing raw material quality, weighing or otherwise measuring the raw materials, mixing raw materials into batches, forming the mixtures into tablets, coating and sorting the tablets, analyzing tablet quality, packaging finished products, and analyzing finished product quality.

 

8



 

Our tablet manufacturing process uses automatic and semi-automatic equipment.  We conduct sample testing of raw materials and finished products for purity, potency, and composition conforming to strict specifications. Constructed in 1996, the tablet production facility is registered with the U.S. Food and Drug Administration (“FDA”) and Health Canada and has been inspected and certified by the Australian Therapeutic Goods Administration (“TGA”).  In the United States, the manufacture of nutritional supplements and related products requires compliance with food-level Good Manufacturing Practice regulations (“GMP’s”) of the FDA.  We believe that our processes comply with the FDA’s more demanding drug-level GMP’s.  The certification by the TGA also denotes compliance with that agency’s drug-level GMP’s.

 

In addition to tablet manufacturing, as a result of the acquisition of WPD we now manufacture premium personal care products, including products for third parties on a contract basis.  Prior to the acquisition of WPD, all personal care products associated with our Sensé product line were supplied by third-party manufacturers.  Manufacturing activities for our Sensé products are currently transitioning to the WPD facility in Draper, Utah.  In-house production of our Sensé products commenced during the fourth quarter 2003.  The production process for personal care products includes identifying and evaluating suppliers of raw materials, acquiring raw materials, analyzing raw material quality, weighing or otherwise measuring the raw materials, mixing raw materials into batches, analyzing liquid batch quality, packaging finished products, and analyzing finished product quality.

 

WPD’s manufacturing operation is registered with the FDA as a pharmaceutical facility, consistent with a facility that manufactures over-the-counter personal care products.  The WPD facility has standard kettles and technology for producing batches of personal care items and semi-automatic packaging equipment for packaging the end product.  The facility employs qualified staff to develop, implement and maintain a quality system that we believe is consistent with requirements under drug-level GMP’s.

 

We contract with third-party manufacturers and vendors for the production of some of our products.  These third-party vendors and manufacturers produce and, in most cases, package these products according to formulations developed by or in conjunction with our in-house product development team.  Products currently supplied through third parties include gelatin-capsuled supplements, powdered drink mixes, and nutrition food bars.

 

We conduct quality control processes in two in-house laboratories located in Salt Lake City, Utah.  In the microbiology laboratory, our analysts test for biological contamination of raw materials and finished goods.  In the analytical chemistry laboratory, analysts test for chemical contamination and accurate active ingredient levels of raw materials and finished products.  Both laboratories conduct stability tests on finished products to determine product shelf life.  Our laboratory staff also performs chemical assays on vitamin and mineral constituents under United States Pharmacopoeia methods and other internally validated methods.  In addition to the quality control and clinical laboratories, our headquarters facility also houses a laboratory designated for research and development.

 

Most of the raw ingredients used in the manufacture of our products, for both the Direct Selling and Contract Manufacturing segments, are available from a number of suppliers.  We have not generally experienced difficulty in obtaining necessary quantities of raw ingredients.  When supplies of certain raw materials have tightened, we have been able to find alternative sources of raw materials, as needed, and believe we will be able to do so in the future, if the need arises.

 

Like many nutritional supplement companies that manufacture products containing Coenzyme Q10 (CoQ10), we have recently experienced a shortage in supply of this key raw material component.  As awareness of the benefits derived from CoQ10 has increased, the products offered by nutritional supplement manufacturers containing this raw ingredient have been on the rise.  Due to the sharp increase in demand for CoQ10, a temporary shortage in supply of this enzyme has been experienced while suppliers re-tool their manufacturing facilities to increase production capacity in order to meet the growing demand.  USANA nutritional products that are affected by this raw material shortage include CoQuinoneâ 30 and Mega Antioxidant, which is also included in the USANAâ Essentials and HealthPak 100Ô.   We believe our current supply of CoQ10 on hand is sufficient to meet both outstanding orders and forecasted production requirements for the near term. We also believe this shortage will be a short-term phenomenon and expect that the supply will return to normal levels around mid-year 2004.  We have identified multiple sources to supply this raw ingredient to USANA and are confident that we can obtain the necessary quantities; however, it is likely that any quantities of CoQ10 acquired during this shortage will be purchased at higher prices, which would negatively impact gross margins for those products affected.

 

Our Salt Lake City, Utah manufacturing facility currently produces an average of 40 million tablets a month, using approximately 35% of capacity (assuming two eight-hour shifts per day, five days per week).  Our packaging equipment fills an average of 550,000 bottles, assembles 90,000 Essentials and packages 22,000 HealthPak 100 combinations each month.  Assuming two eight-hour shifts per day, five days per week, we use approximately 43% of our overall packaging capacity.

 

WPD currently produces an average of 3.5 million filled containers per annum, using approximately 50% of capacity (assuming two ten-hour shifts per day, six days per week).  The packaging facility is currently at 40% capacity (assuming two ten-hour shifts per day, six days per week).

 

9



 

Distribution and Marketing

 

We distribute products through a network marketing system and sell directly to Preferred Customers.  Network marketing is a form of person-to-person direct selling through a network of vertically organized independent distributors who purchase products at wholesale prices from the manufacturer and then make retail sales to consumers.  The emergence of readily available means of mass communication, such as personal computers, facsimiles, low-cost long distance telephone services, satellite conferencing, and the Internet, have contributed to the rapid growth of network marketing.  The concept of network marketing is based on the strength of personal recommendations that frequently come from friends, neighbors, relatives, and close acquaintances.  We believe that network marketing is an effective way to distribute our products because it allows person-to-person product education, which is not as readily available through other distribution channels.

 

A person who wishes to sell USANA products must join our independent sales force as an Associate.  A person becomes an Associate by completing an application under the sponsorship of an existing Associate.  The new Associate then becomes part of the sponsoring Associate’s downline sales organization.  New Associates must sign a written contract and agree to adhere to the USANA policies and procedures.  New Associates are also required to purchase a starter kit that includes a detailed manual, including the policies and procedures.  Starter kits are sold at our cost for a purchase price of approximately $49.  We also recently began offering starter kits in an electronic format at a lower price, which are also sold at our cost.

 

Subject to payment of an annual renewal fee, Associates may continue to distribute products until they voluntarily withdraw or are terminated.  Initial training of Associates about the products, the compensation plan, network marketing, and USANA is provided primarily by an Associate’s sponsor and others in their sales organization.  In addition, we develop and sell training materials and sales aids to assist Associates in building their business.  We also periodically sponsor and conduct regional, national, and international Associate events and intensive leadership training seminars.  Attendance at these sessions is voluntary, and we undertake no generalized effort to provide individualized training to Associates, although experience shows that the most effective and successful Associates participate in training activities.  Associates may not sell competitive products to other USANA Associates or solicit USANA Associates to participate in other network marketing opportunities.  Our policies and procedures also restrict Associates’ advertising and representations or claims concerning USANA products or the compensation plan.

 

The USANA compensation plan provides several opportunities for Associates to earn compensation, provided they are willing to consistently work at building, training, and retaining their downline organizations to sell USANA products to consumers. We believe this compensation plan is distinctive for its weekly distributions and equitable payouts, which are designed to create appropriate incentives for the sale of USANA products.  Each Associate must purchase and sell products in order to earn commissions and bonuses. Associates cannot simply recruit others for the purpose of developing a downline and earn income passively, depending solely on the efforts of the downline.

 

Associates can earn compensation primarily in three ways:

 

                  Purchasing products at wholesale prices from USANA and selling them to consumers at higher retail prices,

 

                  Generating sales volume points based on their sales activity and the sales activity of their downline sales organization, and

 

                  Participating in a leadership bonus pool based on certain performance requirements.

 

We also offer our Associates the opportunity to earn additional compensation through Company-sponsored promotions and contests.  Most of our products are assigned sales volume points.  Commission payments to Associates are based on total personal and downline sales volume points, with commissions paid weekly.  As an Associate successfully expands his or her downline sales organization and as those in the downline also successfully expand, the Associate can receive higher commissions.

 

We endeavor to seamlessly integrate this Associate compensation plan across all markets, in which USANA products are sold, allowing Associates to receive commissions for global - not merely local - product sales.  This seamless downline structure is designed to allow an Associate to build a global network by creating downlines across national borders.  Associates may expand their downline organizations into new markets without establishing new downlines or requalifying for higher levels of compensation in the newly opened markets. We believe this seamless compensation plan significantly enhances our ability to expand internationally and we intend, where permitted, to continue to integrate new markets into this plan.

 

Most Associates sell the products on a part-time basis and consume the products personally.  The sponsoring of new Associates results in creation of multiple levels within our network marketing structure.  Sponsored Associates are referred to as the “downline” of the

 

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sponsoring Associate.  Downline Associates may also sponsor new Associates, creating additional levels in their network, but also forming a part of the same downline as the original sponsoring Associate.  Associates interested in earning additional income who successfully expand their business network or downline can qualify for higher levels of compensation, as well as leadership bonuses, by attaining certain sales volume levels and demonstrating leadership abilities. Sponsoring new Associates is not required of Associates and we do not pay commissions based on recruiting or sponsorship activity.

 

We also sell directly to customers who purchase products only for personal consumption.  This program is our “Preferred Customer” program.  Preferred Customers may not resell or distribute the products.  We believe this program gives us access to a market that would otherwise be missed, by targeting customers who enjoy USANA products, but prefer not to maintain a sales, distribution, or other business relationship with USANA.  Although our policies prohibit Preferred Customers from engaging in retail sales of products purchased through the program, they may enroll as Associates at any time if they desire.  Only Associates are eligible to participate in the compensation plan.

 

Product Returns

 

Our product return policy allows retail customers to return the unused portion of any product to the Associate who sold them the product for a full cash refund.  We reimburse the Associate with product or credit on account upon receipt of proper documentation and the return of the remaining product.

 

All returned product within the first 30 days following purchase is refunded at 100% of the sales price to all non-Associate customers. This 30-day return policy is offered to Associates only on their first order.  All other returned product that is unused and resalable is refunded up to one year from the date of purchase at 100% of the sales price less a 10% restocking fee.  Returned product that was damaged during shipment to the customer is 100% refundable.  Return of product that was not damaged at the time of receipt by the Associate may result in cancellation of the Associate’s distributorship according to the terms of the Associate agreement.  During fiscal years 2001, 2002, and 2003, returns as a percentage of net sales were 1.4%, 1.7%, and 2.4%, respectively.

 

Major Customers

 

Substantially all of our sales are made to Preferred Customers and through independent Associates.  No single Associate accounted for 5% or more of net sales in any of the last three fiscal years. Associates are independent contractors and are not agents, employees, or legal representatives of USANA.  Our employees and affiliates cannot be Associates, although there is no prohibition on their family members becoming Associates as long as they do not reside in the same household as the employee or affiliate.  Associates may sell products only in markets where we have approved the sale of our products.

 

Sales made by the Contract Manufacturing segment to one customer accounted for 51% or, approximately $993,000, of segment revenues for the fiscal year 2003.  No other individual customer accounted for 10% or more of segment net revenues during the same time period.

 

Compliance by Associates

 

From time to time Associates fail to adhere to the USANA policies and procedures, including those governing the marketing of our products or making representations regarding the compensation plan.  We systematically review reports of alleged Associate misbehavior.  Infractions of the policies and procedures are reported to a compliance committee that determines what disciplinary action may be warranted in each case.  If we determine that an Associate has violated any of the USANA policies and procedures, we may take a number of disciplinary actions.  For example, we may terminate the Associate’s purchase and distribution rights completely or impose sanctions, such as warnings, fines, or probation.  We may also withdraw or deny awards, suspend privileges, withhold commissions until specific conditions are satisfied, or take other appropriate actions at our discretion. An in-house compliance department also routinely reviews Associate activities.

 

Information Technology

 

We believe that the ability to efficiently manage distribution, compensation, manufacturing, inventory control, and communications functions through the use of sophisticated and dependable information processing systems is critical to our success.  To optimally support our customer base and core business processes, our information technology resources consist of a customized, Web-enabled order-entry system and an Enterprise Resource Planning (ERP) system that was implemented in April 2003 to manage inventory, production planning, fulfillment, and financial information.  The new ERP system has complemented our existing, customized, order-entry system and has enhanced the management of our core business processes.  Our information systems are maintained by in-house staff and outside consultants.

 

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Regulatory Matters

 

Product Regulation. Numerous governmental agencies in the United States and other countries regulate the manufacturing, packaging, labeling, advertising, promoting, distributing, and the selling of nutrition, health, beauty, and weight management products.  In the United States, advertisement of our products is regulated by the Federal Trade Commission (“FTC”) under the FTC Act and, where such advertising is considered to be product labeling by the FDA.  The FDA regulates products under the Food, Drug, and Cosmetic Act (“FD&C”) and regulations promulgated under that act.  USANA products are also subject to regulation by, among others, the Consumer Product Safety Commission, the US Department of Agriculture, and the Environmental Protection Agency.  The manufacturing, labeling, and advertising of products are also regulated by various governmental agencies in each foreign country in which they are distributed. For example, in Australia we are subject to the Therapeutic Goods Administration and in Japan to the Ministry of Health, Labor and Welfare.

 

Our largest product group in terms of sales includes products that are regulated as dietary supplements under the FD&C.  Dietary supplements are also regulated in the United States under the Dietary Supplement Health and Education Act of 1994 (“DSHEA”).  We believe DSHEA provides a favorable regulatory climate to the dietary supplement industry.  Some of our drink, food bar, and other nutrition products are regulated as foods under the Nutrition Labeling and Education Act of 1990 (“NLEA”).  The NLEA establishes requirements for ingredient and nutritional labeling and labeling claims for foods.  Although we believe our product claims comply with the law, we may need to revise some product labeling at a future date if labeling requirements change.

 

Under these regulations, a dietary supplement that contains a new dietary ingredient (defined as an ingredient not on the market before October 15, 1994) must have a history of use or other evidence of safety establishing that it is reasonably expected to be safe.  The manufacturer must notify the FDA at least 75 days before marketing products containing new dietary ingredients and provide the FDA with the information upon which the manufacturer based its conclusion that the product has a reasonable expectation of safety.

 

The FDA issued final dietary supplement labeling regulations in 1997 that required a new format for product labels and necessitated revising dietary supplement product labels by March 23, 1999.  All companies in the dietary supplement industry were required to comply with these new regulations. We updated our product labels in 1997 in response to these new regulations.  On March 13, 2003, the FDA announced a proposal for new GMP’s specific to dietary supplements.  These GMP’s, if promulgated, may be significantly more rigorous than currently applicable GMP’s.  We believe that we currently manufacture our dietary supplement products according to the standards of the FDA’s pharmaceutical-level GMP’s.  However, we may be required to expend additional capital and resources on manufacturing controls in the future in order to comply with the law, if new GMP’s are adopted.

 

Other products we market include cosmetics and products deemed to be over-the-counter (“OTC”) drugs.  In general, our cosmetic products are not subject to pre-market approval by the FDA.  However, cosmetics are subject to regulation by the FDA under the FD&C adulteration and misbranding provisions.  Cosmetics also are subject to specific labeling regulations, including warning statements if the safety of a cosmetic is not adequately substantiated or if the product may be hazardous, as well as ingredient statements and other packaging requirements under the Fair Packaging and Labeling Act.  Cosmetics that meet the definition of a drug (i.e., that are intended to treat or prevent disease or affect the structure or function of the body), such as our sunscreens, are regulated as drugs.  OTC drug products may be marketed if they conform to the requirements of the OTC monograph that is applicable to that drug. Drug products not conforming to monograph requirements require an approved New Drug Application (“NDA”) before marketing.  Under these provisions, if the agency were to find that a product or ingredient of one of our OTC drug products is not generally recognized as safe and effective or is not included in a final monograph applicable to one of our OTC drug products, we will have to reformulate or cease marketing that product until it is the subject of an approved NDA or until the time, if ever, that the monograph is amended to include the product.  If the rule becomes final, we would have to stop marketing the product as currently formulated.  Whether or not an OTC drug product conforms to a monograph or is subject to an approved NDA, the drug must comply with other requirements under the FDCA, including GMP’s, labeling, and the FDCA’s misbranding and adulteration provisions.

 

Advertising of products is subject to regulation by the FTC under the FTC Act. Section 5 of the FTC Act prohibits unfair methods of competition and unfair or deceptive acts or practices in or affecting commerce.  Section 12 of the FTC Act provides that the dissemination of or causing to be disseminated any false advertisement pertaining to drugs or foods, which would include dietary supplements, is an unfair or deceptive act or practice.  Under the FTC’s Substantiation Doctrine, an advertiser is required to have a “reasonable basis” for all objective product claims before the claims are made.  Failure to adequately substantiate claims may be considered either deceptive or unfair practices.  Pursuant to this FTC requirement, we are required to have adequate substantiation for all material advertising claims made for our products.

 

In recent years the FTC has initiated numerous investigations of and actions against dietary supplement, weight management, and cosmetic products and companies.  The FTC has issued a guidance document to assist companies in understanding and complying with the substantiation requirement.  We have organized the documentation to support our advertising and promotional practices in compliance with these guidelines.

 

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The FTC may enforce compliance with the law in a variety of ways, both administratively and judicially, using compulsory process, cease and desist orders, and injunctions.  FTC enforcement can result in orders requiring, among other things, limits on advertising, corrective advertising, consumer redress, divestiture of assets, rescission of contracts, and such other relief as the agency deems necessary to protect the public.  Violation of these orders could result in substantial financial or other penalties.  We have not been notified that we were the subject of any action by the FTC, but any action in the future by the FTC could materially adversely affect our ability to successfully market our products.

 

The events of September 11, 2001 highlighted the need to enhance the security of the U.S. food supply.  Congress responded by passing the Public Health Security and Bioterrorism Preparedness and Response Act of 2002 (“Bioterrorism Act”).  We expect that several provisions of the Bioterrorism Act will place additional regulatory compliance issues upon us.  For example, one provision in the Bioterrorism Act requires the Secretary of Health and Human Services to develop regulations that mandate domestic and foreign facilities that manufacture, process, pack, or hold food for human or animal consumption in the United States to register with the FDA.  On November 24, 2003, we fulfilled this requirement by registering with the FDA.  Another provision of the Bioterrorism Act mandates that the FDA receive prior notification of all food importation.  Our OptOmega product is packaged outside of the United States and imported into the United States and therefore we are required to comply with this notification requirement.

 

In markets outside the United States, prior to commencing operations or marketing products, we may be required to obtain approvals, licenses, or certifications from a country’s ministry of health or comparable agency.  Approvals or licensing may be conditioned on reformulation of USANA products for the market or may be unavailable with respect to certain products or product ingredients. We must also comply with local product labeling and packaging regulations that vary from country to country. Foreign regulatory requirements have not placed a significant burden on our ability to operate in current foreign countries.

 

Recently, there has been a worldwide growing concern pertaining to the Bovine Spongiform Encephalopathy (BSE) pathogen or “Mad Cow Disease”.  Asian countries in general are exercising caution regarding imports that contain bovine animal products that may be potentially contaminated with the BSE pathogen and linked to the “Mad Cow Disease” concern.  In the nutritional supplement industry, products containing gelatin capsules, which are generally derived from bovine animal product sources are the main concern.  The Japanese government, specifically, has requested that we provide information to them regarding our source of gelatin that is used to manufacture gelatin-capsuled products and, as of the first week of fiscal year 2004, are holding all shipments with products containing gelatin until an investigation is conducted.  We are providing the requested information through our Japan office that demonstrates that our gelatin source is not derived from U.S. bovine sources linked to cows, but rather originates from bovine sources in India associated with the water buffalo and, therefore, none of our products are affected by the BSE pathogen.  While none of our products are affected by the BSE pathogen, we are currently evaluating other sources of gelatin, including porcine animal products derived from pigs.  The current restriction in Japan only applies to importing - not selling - products containing gelatin, and we believe that we have sufficient inventories in our Japanese warehouse to cover current and future demand for the near term.  We further expect this regulatory issue to be resolved quickly and anticipate no significant lost sales due to the temporary hold on shipments.

 

We cannot predict the nature of any future laws, regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business in the future. They could include, however, requirements for the reformulation of certain products to meet new standards, the recall or discontinuation of certain products that cannot be reformulated, additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling, and additional scientific substantiation.  Any or all of these requirements could have a material adverse effect on our business, financial condition, and results of operations.

 

Network Marketing Regulation. Laws and regulations in each country in which we operate prevent the use of deceptive or fraudulent practices that have sometimes been inappropriately associated with legitimate direct selling and network marketing activities. These laws include anti-pyramiding, securities, lottery, referral selling, anti-fraud and business opportunity statutes, regulations, and court cases. Illegal schemes, typically referred to as “pyramid,” “chain distribution,” or “endless chain” schemes, compensate participants primarily or solely for the introduction or enrollment of additional participants into the scheme.  Often these schemes are characterized by large up-front entry or sign-up fees, over-priced products of low value, little or no emphasis on the sale or use of products, high-pressure recruiting tactics, and claims of huge and quick financial rewards requiring little or no effort.  Generally these laws are directed at ensuring that product sales ultimately are made to consumers and that advancement within sales organizations is based on sales of the enterprise’s products, rather than investments in the organizations or other non-retail sales related criteria or activity.  Where required by law, we obtain regulatory approval of our network marketing system, or, where approval is not required or available, the favorable opinion of local counsel as to regulatory compliance.

 

 In addition to federal regulation in the United States, each state has enacted its own “Little FTC Act” to regulate sales and advertising.  Occasionally we receive requests to supply information regarding our network marketing plan to regulatory agencies. Although

 

13



 

we have from time to time modified our network marketing system to comply with interpretations of various regulatory authorities, we believe that our network marketing program is in compliance with laws and regulations relating to network marketing activities in our current markets.  Nevertheless, we remain subject to the risk that, in one or more of our present or future markets, the marketing system or the conduct of certain Associates could be found not to be in compliance with applicable laws and regulations.  Failure by an Associate or us to comply with these laws and regulations could have a material adverse effect on our business in a particular market or in general.  Any or all of these factors could adversely affect the way we do business and could affect our ability to attract potential Associates or enter new markets.  In the United States, the FTC has been active in its enforcement efforts against both pyramid schemes and legitimate network marketing organizations with certain legally problematic components, having instituted several enforcement actions resulting in signed settlement agreements and payment of large fines.  Although to our knowledge, we have not been the target of an FTC investigation, there can be no assurance that the FTC will not investigate us in the future.

 

We cannot predict the nature of any future law, regulation, interpretation, or application, nor can we predict what effect additional governmental legislation or regulations, judicial decisions, or administrative orders, when and if promulgated, would have on our business in the future.  It is possible that future developments may require that we revise our network marketing program.  Any or all of these requirements could have a material adverse effect on our business, results of operations, and financial condition.

 

Transfer Pricing Regulation. We have adopted transfer pricing agreements with our subsidiaries to regulate intercompany transfers. These agreements are subject to transfer pricing laws that regulate the flow of funds between the subsidiaries and the parent corporation for product purchases, management services, and contractual obligations, such as the payment of Associate incentives.  If the United States Internal Revenue Service or the taxing authorities of any other jurisdiction were to successfully challenge these agreements or require changes in our transfer pricing practices, we could become subject to higher taxes and our earnings would be adversely affected.  We believe that we operate in compliance with all applicable transfer pricing laws.  However, there can be no assurance that we will continue to be found to be operating in compliance with transfer pricing laws, or that those laws will not be modified, which may require changes in our operating procedures.

 

Competition

 

The business of developing and distributing nutritional and personal care products, such as those we sell and distribute is highly competitive.  Numerous manufacturers, distributors, and retailers compete for consumers and, in the case of other network marketing companies, for distributors.  We compete directly with other entities that develop, manufacture, market, and distribute products in each of our product lines.  We compete with these entities by emphasizing the underlying science, value, and high quality of our products, as well as the convenience and financial benefits afforded by our network marketing system and compensation plan.  However, many of our competitors are substantially larger and have greater financial resources and broader name recognition.  Our markets are highly sensitive to the introduction of new products that may rapidly capture a significant share of those markets.

 

The nutritional supplement market is characterized by:

 

                  Large selections of essentially similar products that are difficult to differentiate,

 

                  Retail consumer emphasis on value pricing,

 

                  Constantly changing formulations based on evolving scientific research,

 

                  Low entry barriers resulting from low brand loyalty, rapid change, widely available manufacturing, low regulatory requirements, and ready access to large distribution channels, and

 

                  A lack of uniform standards regarding product ingredient sources, potency, purity, absorption rate, and form.

 

Similar factors are also characteristic of products comprising our other product lines.  There can be no assurance that we will be able to effectively compete in this intensely competitive environment.  In addition, nutritional and personal care products can be purchased in a wide variety of channels of distribution, including retail stores.  Our product offerings in each product category are relatively few compared to the wide variety of products offered by many of our competitors and are often premium priced.  As a result, our ability to remain competitive depends in part upon the successful introduction of new products and enhancements of existing products.

 

We also compete with other network marketing organizations for the time, attention, and commitment of new and current Associates.  Our ability to remain competitive depends, in significant part, on our success in recruiting and retaining Associates.  We believe that we offer a rewarding Associate compensation plan and attractive Associate benefits and services.  To the extent practicable, our Associate compensation plan is designed to be seamless, permitting international expansion without re-qualification or re-entry

 

14



 

requirements.  We also pay Associate incentives weekly, reducing the time an Associate must wait between purchase and sale of products and payment of commissions.  However, there can be no assurance that our programs for recruiting and retaining Associates will be successful.  The pool of individuals interested in the business opportunities presented by network marketing tends to be limited in each market and is reduced to the extent other network marketing companies successfully recruit these individuals into their businesses.  Although we believe that we offer an attractive opportunity for our Associates, there can be no assurance that other network marketing companies will not be able to recruit our existing Associates or deplete the pool of potential Associates in a given market.

 

We believe that the leading network marketing company in the world, based on total sales, is Amway Corporation and its affiliates, and that Avon Products, Inc. is the leading direct seller of beauty and related products worldwide.  Leading competitors in the nutritional network marketing and nutritional product industry include Nu Skin Enterprises, Inc., Market America, Inc., Nature’s Sunshine Products, Inc., Herbalife, Inc., NBTY, and Weider Nutrition.  We believe there are other manufacturers of competing product lines that may launch direct selling enterprises, which will compete with us in certain product lines and for Associates.  There can be no assurance that we will be able to successfully meet the challenges posed by this increased competition.

 

Intellectual Property

 

Trademarks. We have developed and we use registered trademarks in our business, particularly relating to the corporate and product names.  We own 12 trademarks registered with the United States Patent and Trademark Office.  We also have one pending application to register a trademark in the United States. Federal registration of a trademark enables the registered owner of the mark to bar the unauthorized use of the registered mark in connection with a similar product in the same channels of trade by any third party anywhere in the United States, regardless of whether the registered owner has ever used the trademark in the area where the unauthorized use occurs.  We have filed applications and own trademark registrations, and we intend to register additional trademarks, in foreign countries where USANA products are or may be sold in the future.  Protection afforded to registered trademarks in some jurisdictions may not be as extensive as the protection available in the United States.

 

We also claim ownership and protection of certain product names, unregistered trademarks, and service marks under common law.  Common law trademark rights do not provide the same level of protection afforded by registration of a trademark.  In addition, common law trademark rights are limited to the geographic area in which the trademark is actually used.  We believe these trademarks, whether registered or claimed under common law, constitute valuable assets, adding to recognition of USANA and the marketing of USANA products.  We therefore believe that these proprietary rights have been and will continue to be important in enabling us to compete.

 

Trade Secrets. We own certain intellectual property, including trade secrets, that we seek to protect, in part, through confidentiality agreements with employees and other parties, although some employees involved in research and development activities have not entered into these agreements.  Even where these agreements exist, there can be no assurance that these agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known to or independently developed by competitors.  Our proprietary product formulations are generally considered trade secrets, but are not otherwise protected under intellectual property laws.

 

Patents.  During 2002, we were issued two patents, which will continue in force for 17 years from the date of issue.  These patents are process patents and relate to the method of extracting an antioxidant from olives and the waste products of olive oil production.  In 2003, we entered into a licensing agreement with a vendor to make olive extract using our patented process.  Currently, it is very difficult to determine the exact future benefit of these patents.  However, we believe that the patents have the potential for significant revenue in the future through new product development and royalties from licensing.

 

Products within the Contract Manufacturing segment are developed on behalf of customers and are labeled under customer brand names.  We currently do not possess intellectual property claims for this segment.

 

We intend to protect our legal rights concerning intellectual property by all appropriate legal action.  Consequently, we may become involved from time to time in litigation to determine the enforceability, scope, and validity of any of the foregoing proprietary rights.  Any patent litigation could result in substantial cost and divert the efforts of management and technical personnel.

 

Seasonality

 

We believe that the impact of seasonality on results of operations is not material for either the Direct Selling or Contract Manufacturing segments.

 

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Backlog

 

Products sold within the Direct Selling segment are typically shipped within 72 hours after the receipt of the order.  As of February 27, 2004, there was no significant backlog.  The backlog of orders for the Contract Manufacturing segment amounted to approximately $1.5 million as of February 27, 2004.

 

Working Capital Practices

 

We maintain sufficient amounts of inventory in stock for our Direct Selling segment in order to provide a high level of service to Associates and Preferred Customers.  Substantial inventories are required to meet the needs of our dual role as manufacturer and distributor.  Our Contract Manufacturing segment maintains adequate amounts of commodity inventory (that which can be used for various customers) and minimal quantities of specialty inventory (that which is ordered specifically for the needs of individual customers) to meet customer demand.

 

Environment

 

We are not aware of any instance in which we have contravened federal, state, or local provisions enacted for or relating to protection of the environment or in which we otherwise may be subject under environmental laws to liability for environmental conditions that could materially affect operations.

 

Employees

 

As of February 27, 2004, we had 576 employees worldwide, as measured by full time equivalency.  Our employees are not currently represented by a collective bargaining agreement and we have not experienced work stoppages as a result of labor disputes.  We believe our relationship with our employees is good.

 

Additional Available Information

 

We make available, free of charge at our corporate web site copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports as soon as reasonably practicable after such material is electronically filed with, or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act.  This information may also be obtained from the SEC’s on-line database located at www.sec.gov.

 

Item 2. Properties

 

Our corporate headquarters are located in Salt Lake City, Utah in a building of 192,000 square feet on a company-owned 16-acre parcel.  The allocation of this space is as follows: approximately 56,000 square feet for manufacturing, packaging and distribution; approximately 71,000 square feet of warehouse space; and approximately 65,000 square feet occupied by executive and administrative personnel, customer services, research and development, and three laboratories.  During 2003, we completed construction that expanded our manufacturing capacity by converting a portion of our existing warehouse into additional manufacturing space.

 

We believe that our worldwide facilities are suitable and adequate in relation to our present and immediate future needs.  Total current monthly lease commitments for the properties under lease total approximately $245,000.  All properties are part of the Direct Selling segment with the exception of the Draper, Utah facility used by the Contract Manufacturing segment.

 

The following table summarizes information related to our worldwide facilities as of January 3, 2004.

 

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Location

 

Nature of Use

 

Square
Feet

 

Held

 

 

 

 

 

 

 

 

 

Salt Lake City, UT  USA

 

Corporate headquarters/manufacturing/call center/ warehouse/distribution center

 

192,000

 

Owned

 

Tooele, UT  USA

 

Call center

 

12,000

 

Leased

 

Draper, UT USA

 

Office/manufacturing/warehouse/distribution center

 

27,000

 

Leased

 

Ontario, Canada

 

Central office/warehouse/distribution center

 

18,000

 

Leased

 

Sydney, Australia

 

Central office/call center/warehouse/distribution center

 

20,000

 

Leased

 

Auckland, New Zealand

 

Central office/warehouse/distribution center

 

4,000

 

Leased

 

Causeway Bay, Hong Kong

 

Central office/call center

 

6,900

 

Leased

 

Kwai Chung, Hong Kong

 

Warehouse/distribution center

 

4,000

 

Leased

 

Causeway Bay, Hong Kong

 

Sensé Salon

 

1,500

 

Leased

 

Tokyo, Japan

 

Central office/call center

 

12,000

 

Leased

 

Yokohama, Japan

 

Warehouse/distribution center

 

11,200

 

Leased

 

Taipei, Taiwan

 

Central office/call center

 

6,912

 

Leased

 

Taipei, Taiwan

 

Warehouse/distribution center

 

7,117

 

Leased

 

Kaohsiung, Taiwan

 

Satellite office

 

5,300

 

Leased

 

Seoul, South Korea

 

Central office/call center

 

1,226

 

Leased

 

Seoul, South Korea

 

Warehouse/distribution center

 

397

 

Leased

 

Singapore

 

Central office/call center/warehouse/distribution center

 

1,463

 

Leased

 

 

Item 3. Legal Proceedings

 

From time to time we become a party to lawsuits and claims that arise in the ordinary course of business relating to employment, intellectual property, and other matters.  We believe such claims, individually or in the aggregate, will not result in a material adverse effect on our business, financial position, or results of operations.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of shareholders during the quarter ended January 3, 2004.

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

 

Note: Common stock data has been adjusted to reflect the two-for-one split of common stock in the form of a stock dividend, which was distributed on October 30, 2003.

 

Market Information

 

Our common stock trades on The NASDAQ National Market System under the symbol “USNA.”  The following table contains the reported high and low sale prices for our common stock as reported on The NASDAQ National Market System for the periods indicated:

 

2002

 

High

 

Low

 

First Quarter

 

$

0.95

 

$

0.60

 

Second Quarter

 

$

3.95

 

$

0.58

 

Third Quarter

 

$

3.65

 

$

2.21

 

Fourth Quarter

 

$

6.00

 

$

2.98

 

 

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2003

 

High

 

Low

 

First Quarter

 

$

9.98

 

$

5.58

 

Second Quarter

 

$

25.70

 

$

9.58

 

Third Quarter

 

$

28.22

 

$

16.79

 

Fourth Quarter

 

$

39.49

 

$

22.93

 

 

On February 27, 2004, the high and low sales prices of our common stock as reported by NASDAQ were $30.50 and $29.96, respectively.

 

Shareholders

 

As of February 27, 2004, we had approximately 587 holders of record of the common stock and an estimated 14,100 beneficial owners, including shares of common stock held in street name.

 

Dividends

 

We have never declared or paid cash dividends on our common stock.  Future cash dividends, if any, will be determined by the Board of Directors and will be based on earnings, available capital, financial condition, and other factors deemed relevant by the Board of Directors.

 

Share Repurchases

 

From January 2000, through the end of 2002, the Board of Directors authorized the repurchase of 4,000,000 shares of our common stock in the open market.  Over these three fiscal years, we expended a total of $10.9 million to purchase 3,209,402 shares under this plan.  During the year ended January 3, 2004, we purchased 472,300 shares for a total of $8.2 million.  In February 2004, the Board of Directors authorized the repurchase of up to an additional 681,702 shares, for a total of 1,000,000 shares currently available for repurchase.  Subsequent to the year ended January 3, 2004 and through February 27, 2004, we purchased 193,100 shares for a total of $5.6 million.

 

Item 6. Selected Financial Data

 

The selected consolidated financial data set forth below with respect to the consolidated statements of earnings and consolidated balance sheets for each of the last five fiscal years are derived from our audited consolidated financial statements for the relevant periods.  The data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the audited consolidated financial statements and related notes thereto included in this report.

 

18



 

 

 

Fiscal Year (1)

 

 

 

1999

 

2000

 

2001

 

2002

 

2003

 

 

 

(in thousands, except per share data)

 

Consolidated Statements of Earnings Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

134,312

 

$

123,180

 

$

114,280

 

$

133,776

 

$

200,013

 

Cost of sales

 

30,099

 

36,344

 

32,802

 

33,392

 

44,422

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

104,213

 

86,836

 

81,478

 

100,384

 

155,591

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Associate incentives

 

57,044

 

47,032

 

43,912

 

51,174

 

78,675

 

Selling, general, and administrative

 

31,778

 

32,939

 

32,286

 

35,382

 

44,413

 

Restructuring and impairment (2)

 

4,400

 

 

 

 

 

Research and development

 

1,377

 

1,410

 

1,080

 

1,035

 

1,384

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

94,599

 

81,381

 

77,278

 

87,591

 

124,472

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

9,614

 

5,455

 

4,200

 

12,793

 

31,119

 

Other income (expense), net

 

(48

)

(677

)

(692

)

(221

)

192

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

9,566

 

4,778

 

3,508

 

12,572

 

31,311

 

Income taxes

 

3,665

 

1,911

 

1,309

 

4,069

 

10,494

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

5,901

 

$

2,867

 

$

2,199

 

$

8,503

 

$

20,817

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.24

 

$

0.15

 

$

0.11

 

$

0.45

 

$

1.09

 

Diluted

 

$

0.24

 

$

0.14

 

$

0.11

 

$

0.41

 

$

0.98

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

24,316

 

19,574

 

19,356

 

18,884

 

19,018

 

Diluted

 

24,946

 

19,780

 

19,412

 

20,647

 

21,319

 

Dividends per share

 

 

 

 

 

 

 

 

 

As of

 

 

 

Jan. 1,
2000

 

Dec. 30,
2000

 

Dec. 29,
2001

 

Dec. 28,
2002

 

Jan. 3,
2004

 

 

 

(in thousands, except other data)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,411

 

$

2,900

 

$

2,465

 

$

6,686

 

$

18,965

 

Working capital

 

(1,281

)

2,308

 

350

 

1,228

 

18,330

 

Current assets

 

15,048

 

16,927

 

14,189

 

18,907

 

38,249

 

Total assets

 

36,773

 

35,492

 

35,354

 

39,113

 

65,127

 

Long-term debt, less current maturities

 

7,500

 

8,000

 

6,000

 

2,572

 

 

Stockholders’ equity

 

12,919

 

12,873

 

14,527

 

18,093

 

44,371

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Active Associates

 

72,000

 

61,000

 

56,000

 

66,000

 

88,000

 

Active Preferred Customers

 

26,000

 

43,000

 

41,000

 

45,000

 

51,000

 

Total Active Customers

 

98,000

 

104,000

 

97,000

 

111,000

 

139,000

 

 


(1)          The Company’s fiscal year ends on the Saturday closest to December 31.  The 1999, 2000, 2001, and 2002 fiscal years were 52-week years.  Fiscal year 2003 was a 53-week year.

 

(2)     A restructuring charge was recorded in the third quarter of 1999 that included the impact of a substantial reduction in United Kingdom operations, liquidation of associated assets in the United Kingdom, and reduction of staff outside of the United Kingdom.

 

19



 

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the audited consolidated financial statements and notes thereto appearing elsewhere in this report.

 

Overview

 

We develop and manufacture high-quality nutritional and personal care products that are distributed through network marketing. Net sales are primarily dependent upon the efforts of a network of independent Associates who purchase products and sales materials.  As of January 3, 2004, we had approximately 88,000 active Associates in the United States, Canada, Australia, New Zealand, Hong Kong, Japan, Taiwan, South Korea, Singapore, and the United Kingdom.  We also sell products directly to Preferred Customers who purchase products for personal use and are not permitted to resell or distribute the products.  As of January 3, 2004, we had approximately 51,000 active Preferred Customers worldwide. For purposes of this report, we only count as active customers those Associates and Preferred Customers who have purchased product from USANA at any time during the most recent three-month period. Prior to 2002, we defined our active customers as those Associates and Preferred Customers who purchased product from USANA at any time during the most recent 12-month period. We have adopted the three-month methodology because we believe it is a more meaningful measurement of our network marketing system.  The change in this measure has no impact on our financial condition or results of operations.

 

As discussed more fully in Segment Information Note K of the audited consolidated financial statements included in this report, we have two reportable segments: Direct Selling and Contract Manufacturing.  The Direct Selling segment constitutes our principal line of business: developing, manufacturing, and distributing nutritional and personal care products through a network marketing system. The Contract Manufacturing segment includes the manufacture of premium personal care products, produced under the brand name of its customers, including manufacturing and packaging for the Company’s Sensé product line of skin and personal care products.

 

We recognize revenue when products are shipped and title passes to our customers.  In 2003, sales in the eight primary geographic regions within our Direct Selling segment contributed to consolidated net sales as follows:

 

    United States

 

45.5

%

    Canada

 

22.1

%

    Australia-New Zealand

 

14.8

%

    Hong Kong

 

4.4

%

    Japan

 

3.3

%

    Taiwan

 

6.8

%

    South Korea

 

1.8

%

    Singapore

 

0.5

%

 

Sales from the Contract Manufacturing segment accounted for the remaining 0.8% of consolidated net sales in 2003.

 

As we expand our business into additional international markets, we expect international operations to account for an increasing percentage of net sales.

 

Cost of sales primarily consists of expenses related to raw materials, labor, quality assurance, and overhead directly associated with the production and distribution of products and sales materials, as well as duties and taxes associated with product exports.  As international sales increase as a percentage of net sales, cost of sales could increase slightly, reflecting additional duties, freight and other expenses associated with international growth.

 

Associate incentive expenses are incurred only by the Direct Selling segment and represent the most significant expense for this segment at 39.7% of net segment sales in 2003.  Associate incentives include commissions and leadership bonuses that are paid weekly based on sales volume points.  Certain promotions and contests are also reported as Associate incentives.  Most products are assigned a sales volume point value independent of the product’s price.  Associates earn commissions based on sales volume points generated in their downline sales organization. Starter kits and sales aids have no sales volume point value and commissions are not paid on the sale of these items.

 

We closely monitor the amount of Associate incentives paid as a percentage of net sales and may from time to time adjust the Associate compensation plan to prevent Associate incentives from having a significant adverse effect on earnings.  This must be done while continuing to maintain an appropriate incentive for Associates.

 

20



 

Selling, general, and administrative expenses include wages and benefits, depreciation and amortization, rents and utilities, Associate 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.  Our Founder and Chairman of the Board of Directors, Dr. Wentz, does not receive any compensation for his services in the capacity of CEO and he has in the past declined to accept any stock options or other awards under any stock option or stock incentive plan that he might otherwise have been entitled to receive as an executive officer.  If Dr. Wentz were paid a salary, or if someone other than Dr. Wentz were to be retained as Chief Executive Officer and paid a customary salary and benefits, selling, general, and administrative expenses would increase as a result of the compensation paid. Selling, general, and administrative expenses also include significant depreciation and amortization expense incurred as a result of continued investments in computer and telecommunications equipment and systems to support international expansion.  We anticipate that significant additional capital investments will be required in future periods to promote and support anticipated growth in sales and the increasing size of our customer base.

 

Research and development expenses include costs incurred in developing new products, enhancing existing products, and formulating products for introduction into international markets.

 

The Company is in the practice of providing guidance concerning anticipated net sales.  Based on information currently available to the Company, we expect annual net sales in the range of $245 to $255 million for fiscal year 2004.

 

Results of Operations

 

The following table summarizes operating results as a percentage of net sales, respectively, for the periods indicated:

 

 

 

Fiscal Year

 

 

 

2001

 

2002

 

2003

 

Consolidated Statements of Earnings Data:

 

 

 

 

 

 

 

Net sales

 

100.0

%

100.0

%

100.0

%

Cost of sales

 

28.7

 

25.0

 

22.2

 

Gross profit

 

71.3

 

75.0

 

77.8

 

Operating expenses:

 

 

 

 

 

 

 

Associate incentives

 

38.4

 

38.3

 

39.3

 

Selling, general, and administrative

 

28.3

 

26.4

 

22.2

 

Research and development

 

0.9

 

0.8

 

0.7

 

Total operating expenses

 

67.6

 

65.5

 

62.2

 

 

 

 

 

 

 

 

 

Earnings from operations

 

3.7

 

9.5

 

15.6

 

Other income (expense), net

 

(0.6

)

(0.2

)

0.1

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

3.1

 

9.3

 

15.7

 

Income taxes

 

1.2

 

3.0

 

5.3

 

 

 

 

 

 

 

 

 

Net earnings

 

1.9

%

6.3

%

10.4

%

 

Fiscal Year 2003 compared to Fiscal Year 2002

 

Net Sales.  Net sales increased 49.5%, or $66.2 million, to $200.0 million for 2003, from $133.8 million in 2002.  This increase was composed of $64.4 million associated with our Direct Selling segment and $1.8 million associated with our Contract Manufacturing segment acquired in July 2003.

 

The following table summarizes the growth in net sales by segment and geographic region for the fiscal years ended December 28, 2002 and January 3, 2004.

 

21



 

 

 

Sales By Segment and Region
(in thousands)
Year Ended

 

Change from
Prior Year

 

Percent
Change

 

Segment / Region

 

2002

 

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

70,062

 

52.4

%

$

91,033

 

45.5

%

$

20,971

 

29.9

%

Canada

 

31,712

 

23.7

%

44,187

 

22.1

%

12,475

 

39.3

%

Australia-New Zealand

 

17,606

 

13.2

%

29,508

 

14.8

%

11,902

 

67.6

%

Hong Kong

 

7,098

 

5.3

%

8,850

 

4.4

%

1,752

 

24.7

%

Japan

 

4,955

 

3.7

%

6,537

 

3.3

%

1,582

 

31.9

%

Taiwan

 

2,343

 

1.7

%

13,619

 

6.8

%

11,276

 

481.3

%

South Korea

 

 

0.0

%

3,515

 

1.8

%

3,515

 

N/A

 

Singapore

 

 

0.0

%

920

 

0.5

%

920

 

N/A

 

Segment Total

 

133,776

 

100.0

%

198,169

 

99.2

%

64,393

 

48.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contract Manufacturing

 

 

0.0

%

1,844

 

0.8

%

1,844

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

133,776

 

100.0

%

$

200,013

 

100.0

%

$

66,237

 

49.5

%

 

The increase in net sales contributed by the Direct Selling segment can be primarily attributed to the following factors:

 

                  A 24% increase in the active Associate base and a 13% increase in the active Preferred Customer base for the year ended 2003 in markets that have been open longer than one year,

 

                  A $11.3 million increase in net sales in Taiwan due to a full year of operations,

 

                  Stronger foreign currencies relative to the U.S. dollar, which positively affected the translation of sales in foreign markets by approximately $10.8 million, and

 

                  An additional week of reported sales in 2003 that added approximately $4.0 million (fiscal year 2002 was a 52-week year and fiscal year 2003 was a 53-week year).

 

We commenced operations in South Korea and Singapore in July and November 2003, respectively.  These new markets provided an increase of approximately 9% to the active Associate base and contributed $3.5 million and $0.9 million in net sales, respectively for the fiscal year ended January 3, 2004.

 

Additionally, the acquisition of WPD, effective July 1, 2003 contributed $1.8 million to the increase in consolidated net sales.

 

The following tables summarize the growth in active customers for the Direct Selling segment by geographic region as of the dates indicated:

 

22



 

Active Associates By Region

 

Region

 

As of
December 28, 2002

 

As of
January 3, 2004

 

Change from
Prior Year

 

Percent
Change

 

United States

 

28,000

 

42.4

%

35,000

 

39.8

%

7,000

 

25.0

%

Canada

 

16,000

 

24.2

%

19,000

 

21.6

%

3,000

 

18.8

%

Australia-New Zealand

 

11,000

 

16.7

%

13,000

 

14.8

%

2,000

 

18.2

%

Hong Kong

 

4,000

 

6.1

%

4,000

 

4.5

%

 

0.0

%

Japan

 

2,000

 

3.0

%

3,000

 

3.4

%

1,000

 

50.0

%

Taiwan

 

5,000

 

7.6

%

8,000

 

9.1

%

3,000

 

60.0

%

South Korea

 

 

0.0

%

4,000

 

4.5

%

4,000

 

N/A

 

Singapore

 

 

0.0

%

2,000

 

2.3

%

2,000

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

66,000

 

100.0

%

88,000

 

100.0

%

22,000

 

33.3

%

 

We believe that various factors contributed to the increase in the 2003 active Associate base, including general enthusiasm created by international expansion, ongoing communication with Associate leaders in the field, improved infrastructure to enhance the Associate service level, and company-sponsored events and promotions held to motivate Associates.

 

Active Preferred Customers By Region

 

Region

 

As of
December 28, 2002

 

As of
January 3, 2004

 

Change from
Prior Year

 

Percent
Change

 

United States

 

27,000

 

60.0

%

31,000

 

60.8

%

4,000

 

14.8

%

Canada

 

13,000

 

28.9

%

15,000

 

29.4

%

2,000

 

15.4

%

Australia-New Zealand

 

4,000

 

8.9

%

4,000

 

7.8

%

 

0.0

%

Hong Kong

 

1,000

 

2.2

%

1,000

 

2.0

%

 

0.0

%

Japan

 

 

** 

0.0

%

 

** 

0.0

%

 

N/A

 

Taiwan

 

 

** 

0.0

%

 

** 

0.0

%

 

N/A

 

South Korea

 

 

0.0

%

 

** 

0.0

%

 

N/A

 

Singapore

 

 

0.0

%

 

** 

0.0

%

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

45,000

 

100.0

%

51,000

 

100.0

%

6,000

 

13.3

%

 


**Active Preferred Customer count is less than 500.

 

Total Active Customers By Region

 

Region

 

As of
December 28, 2002

 

As of
January 3, 2004

 

Change from
Prior Year

 

Percent
Change

 

United States

 

55,000

 

49.5

%

66,000

 

47.5

%

11,000

 

20.0

%

Canada

 

29,000

 

26.1

%

34,000

 

24.5

%

5,000

 

17.2

%

Australia-New Zealand

 

15,000

 

13.6

%

17,000

 

12.2

%

2,000

 

13.3

%

Hong Kong

 

5,000

 

4.5

%

5,000

 

3.6

%

 

0.0

%

Japan

 

2,000

 

1.8

%

3,000

 

2.1

%

1,000

 

50.0

%

Taiwan

 

5,000

 

4.5

%

8,000

 

5.8

%

3,000

 

60.0

%

South Korea

 

 

0.0

%

4,000

 

2.9

%

4,000

 

N/A

 

Singapore

 

 

0.0

%

2,000

 

1.4

%

2,000

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

111,000

 

100.0

%

139,000

 

100.0

%

28,000

 

25.2

%

 

Gross Profit. Consolidated gross profit improved to 77.8% of net sales in 2003 from 75.0% in 2002.  Direct Selling’s gross profit improved to 78.3% of net sales for the segment in 2003 from 75.0% in 2002.  Gross profit for the Contract Manufacturing segment was 28.8% of net segment sales for 2003.

 

23



 

The increase in gross profit for the Direct Selling segment can be attributed primarily to:

 

                  Cost improvement in procurement and production activities,

 

                  A change in pricing that creates greater incentives for our Associates that generally contributes to a higher gross profit margin, and

 

                  Leverage benefits of variable costs on a rising sales base.

 

Recently, we have experienced an increase in the purchase price for one of our key raw materials Coenzyme Q10 (CoQ10), due to a general increase in demand among nutritional supplement companies that manufacture products containing this ingredient and a corresponding shortage among suppliers as they re-tool their facilities to increase their production capacity in order to accommodate the rising demand.  USANA nutritional products that are affected by the raw material shortage include CoQuinoneâ 30 and Mega Antioxidant, which is also included in the USANAâ Essentials and HealthPak 100Ô.  We believe this shortage will be a short-term phenomenon and expect that the supply will return to normal levels around mid-year 2004.  We have multiple sources to supply this raw ingredient and are confident that we can obtain the necessary quantities; however, it is likely that any quantities acquired during this shortage will be purchased at higher prices, which would negatively impact gross margins for those products affected.  In 2004, we expect to achieve only marginal improvement in our gross profit percentage when compared to 2003.

 

Associate Incentives.  Expenses related to Associate incentives are incurred only by the Direct Selling segment and represent the most significant cost as a percentage of net sales for this segment.  Associate incentives increased to 39.7% of net segment sales in 2003 from 38.3% in 2002.  This increase can be attributed to:

 

                  A change in pricing that creates greater incentives for our Associates,

 

                  An increase in the commission payout rate in the Australia-New Zealand market with no corresponding increase in the price at which we sell our products,

 

                  The elimination of payment processing fees charged to customers in our North America and Australia-New Zealand markets, and

 

                  Additional spending for special Associate promotions and contests during 2003.

 

We believe that Associate incentives, as a percentage of net sales for the Direct Selling segment during 2004 will remain at a level consistent with the 2003 Associate incentives expense.

 

Selling, General, and Administrative.  Selling, general, and administrative expenses decreased to 22.2% of net sales in 2003 from 26.4% in 2002.  The decrease as a percentage of net sales can be primarily attributed to the increase in net sales during 2003.

 

While selling, general, and administrative expenses decreased as a percentage of net sales from 2002 to 2003, in absolute terms, these expenses increased $9.0 million or 25.5% in 2003, the majority of which can be attributed to the Direct Selling segment.  The acquisition of the Contract Manufacturing segment added $435,000 to the absolute dollar increase in selling, general, and administrative expenses.  The increase in selling, general, and administrative expenses contributed by the Direct Selling segment can be primarily attributed to the following factors:

 

                  Increased spending in our more mature markets to support growing sales and an increasing customer base,

 

                  Increased spending in our new markets of Taiwan, South Korea, and Singapore of approximately $1.1 million, $1.9 million, and $0.3 million, respectively,

 

                  Increased spending on certain expenses, including employee and management performance incentives, Associate related expenses, and insurance costs, and

 

                  Higher translated U.S. dollars of foreign currency expenses, totaling $1.2 million, as a result of a weaker U.S. dollar.

 

24



 

Selling, general, and administrative expense in 2002 included one-time costs totaling $0.4 million associated with a proposed sale of assets transaction, which was abandoned by the Company.

 

We believe that selling, general, and administrative expenses will decrease in 2004 as a percentage of net sales when compared to 2003.  We believe this decrease will likely occur as a result of leverage benefits on a rising sales base.  We do, however, expect that these expenses will rise in absolute terms as a result of increased variable costs related to higher sales, a growing customer base, and additional costs associated with the opening of Mexico in the first quarter of 2004.

 

Other Income (Expense).  Other income (expense) changed from other expense of $221,000 in 2002 to other income of $192,000 in 2003.  This increase in net other income of $413,000 can be primarily attributed to lower interest expense and higher interest income.  These improvements are due to the retirement of debt during the first quarter of 2003.

 

Income Taxes.  As a result of increased revenue and profitability in our foreign markets during 2003, we generated significant tax benefits in the current year, yielding an effective tax rate of 33.5%.  We expect that the effective tax rate for 2004 will be approximately 34% due to the following:

 

                  The utilization of a foreign tax credit carryforward in the tax year 2003 that is not expected to occur again in the tax year 2004, and

 

                  An increase in the federal income tax rate in the United States from 34% to 35% on anticipated earnings growth.

 

Net Earnings.  Net earnings increased to 10.4% of net sales in 2003 from 6.3% in 2002.  The increase in net earnings can primarily be attributed to the following:

 

                  Increased net sales,

 

                  Significant improvements in our gross profit margin, and

 

                  Improved leverage on a rising sales base.

 

Diluted earnings per share were $0.98 for 2003, an increase of $0.57 from diluted earnings of $0.41 per share in 2002. Diluted earnings per share calculations have been adjusted to reflect the two-for-one split of the Company’s stock effected in October 2003.

 

Fiscal Year 2002 compared to Fiscal Year 2001

 

Net Sales.  Net sales increased 17.1% or $19.5 million to $133.8 million in 2002, from $114.3 million in 2001.

 

The following table summarizes the growth in net sales by market for the fiscal years ended December 29, 2001 and December 28, 2002.  Sales data for the United States includes products shipped directly from the U.S. headquarters to customers in the United Kingdom and Japan.

 

 

 

Sales By Region
(in thousands)
Year Ended

 

Change from
Prior Year

 

Percent
Change

 

Region

 

2001

 

2002

 

 

United States

 

$

66,140

 

57.9

%

$

70,062

 

52.4

%

$

3,922

 

5.9

%

Canada

 

28,013

 

24.5

%

31,712

 

23.7

%

3,699

 

13.2

%

Australia-New Zealand

 

14,299

 

12.5

%

17,606

 

13.2

%

3,307

 

23.1

%

Hong Kong

 

5,208

 

4.6

%

7,098

 

5.3

%

1,890

 

36.3

%

Japan

 

620

 

0.5

%

4,955

 

3.7

%

4,335

 

699.2

%

Taiwan

 

 

0.0

%

2,343

 

1.7

%

2,343

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

114,280

 

100.0

%

$

133,776

 

100.0

%

$

19,496

 

17.1

%

 

The increase in consolidated net sales was primarily the result of the following:

 

25



 

                  A 18% increase in the active Associate base in 2002,

 

                  A $4.3 million increase in net sales in Japan due to a full year of operations,

 

                  An overall price increase in the Australia-New Zealand market that added $2.1 million in net sales, and a price increase on two key products, USANAâ Essentials and HealthPak 100Ô in North America that contributed an additional $1.0 million to net sales, and

 

                  Stronger foreign currencies relative to the U.S. dollar, which positively affected the translation of sales in foreign markets by approximately $0.5 million.

 

During the fourth quarter of 2002, we commenced operations in Taiwan.  The Taiwan market added a significant number of new enrollments to the Associate base and contributed $2.3 million in sales for the fiscal quarter and year ended December 28, 2002.

 

The following tables summarize the growth in active customers by geographic region as of the dates indicated:

 

Active Associates By Region

 

Region

 

As of
December 29, 2001

 

As of
December 28, 2002

 

Change from
Prior Year

 

Percent
Change

 

United States

 

28,000

 

50.0

%

28,000

 

42.4

%

 

0.0

%

Canada

 

15,000

 

26.8

%

16,000

 

24.2

%

1,000

 

6.7

%

Australia-New Zealand

 

9,000

 

16.1

%

11,000

 

16.7

%

2,000

 

22.2

%

Hong Kong

 

3,000

 

5.3

%

4,000

 

6.1

%

1,000

 

33.3

%

Japan

 

1,000

 

1.8

%

2,000

 

3.0

%

1,000

 

100.0

%

Taiwan

 

 

0.0

%

5,000

 

7.6

%

5,000

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

56,000

 

100.0

%

66,000

 

100.0

%

10,000

 

17.9

%

 

We believe that various factors contributed to the increase in 2002 Associate enrollments, including the following: general Associate enthusiasm created by the new Taiwan market, improved communication with Associate leaders in the field, improved infrastructure to enhance the Associate service level, and company-sponsored events held to motivate Associates.

 

Active Preferred Customers By Region

 

Region

 

As of
December 29, 2001

 

As of
December 28, 2002

 

Change from
Prior Year

 

Percent
Change

 

United States

 

24,000

 

58.5

%

27,000

 

60.0

%

3,000

 

12.5

%

Canada

 

12,000

 

29.3

%

13,000

 

28.9

%

1,000

 

8.3

%

Australia-New Zealand

 

4,000

 

9.8

%

4,000

 

8.9

%

 

0.0

%

Hong Kong

 

1,000

 

2.4

%

1,000

 

2.2

%

 

0.0

%

Japan

 

 

** 

0.0

%

 

** 

0.0

%

 

N/A

 

Taiwan

 

 

0.0

%

 

** 

0.0

%

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

41,000

 

100.0

%

45,000

 

100.0

%

4,000

 

9.8

%

 


**  Active Preferred Customer count is less than 500.

 

26



 

Total Active Customers By Region

 

Region

 

As of
December 29, 2001

 

As of
December 28, 2002

 

Change from
Prior Year

 

Percent
Change

 

United States

 

52,000

 

53.6

%

55,000

 

49.5

%

3,000

 

5.8

%

Canada

 

27,000

 

27.8

%

29,000

 

26.1

%

2,000

 

7.4

%

Australia-New Zealand

 

13,000

 

13.5

%

15,000

 

13.6

%

2,000

 

15.4

%

Hong Kong

 

4,000

 

4.1

%

5,000

 

4.5

%

1,000

 

25.0

%

Japan

 

1,000

 

1.0

%

2,000

 

1.8

%

1,000

 

100.0

%

Taiwan

 

 

0.0

%

5,000

 

4.5

%

5,000

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

97,000

 

100.0

%

111,000

 

100.0

%

14,000

 

14.4

%

 

Gross Profit. Gross profit increased to 75.0% of net sales in 2002 from 71.3% in 2001.  The increase in gross profit as a percentage of net sales can be attributed to the following factors:

 

                  Cost improvement gained in procurement and production activities,

 

                  The price increase in the Australia-New Zealand market and price increases on USANAâ Essentials and HealthPak 100Ô in North America, and

 

                  Leverage benefits of semi-variable costs on a rising sales base.

 

Associate Incentives.  Associate incentives remained relatively constant as a percent of net sales at 38.3% in 2002, compared to 38.4% in 2001.

 

Selling, General, and Administrative.  Selling, general, and administrative expenses decreased to 26.4% of net sales in 2002 from 28.3% in 2001.  The decrease as a percentage of net sales can be primarily attributed to the increase in net sales during 2002.

 

While selling, general, and administrative expenses decreased as a percentage of net sales from 2001 to 2002, in absolute terms, these expenses increased $3.1 million or 9.6%.  The absolute dollar increase in selling, general, and administrative expenses can be attributed to the following factors:

 

                  Employee and management performance incentives of $1.7 million,

 

                  Spending in our new Taiwan market of $0.7 million,

 

                  Costs related to the aborted transaction involving the proposed sale of assets totaling $0.4 million, and

 

                  Variable costs associated with the rising sales base.

 

Other Income (Expense).  Net other expenses decreased by $471,000.  This decrease was a result of a reduction in interest expense of $473,000 in 2002, compared to 2001.  Lower interest rates and reduced debt levels throughout 2002 were the contributing factors to the lower interest expense.

 

Income Taxes.  As a result of increased revenue and profitability in our foreign markets during 2002, we generated significant tax benefits, yielding an effective tax rate of 32.4%.

 

Net Earnings.  Net earnings increased to 6.3% of net sales in 2002 from 1.9% in 2001.  The increase in net earnings can primarily be attributed to the following:

 

                  Improved operating margins,

 

                  Increased sales,

 

27



 

                  Lower interest expense, and

 

                  Lower effective income tax rates.

 

Diluted earnings per share were $0.41 for 2002, an increase of $0.30 from diluted earnings of $0.11 per share in 2001.  Diluted earnings per share calculations have been adjusted to reflect the two-for-one split of the Company’s stock effected in October 2003.

 

Quarterly Financial Information

 

The following tables set forth unaudited quarterly operating results for each of the last eight fiscal quarters, as well as percentages of net sales for certain data for the periods indicated.  This information has been prepared on a basis consistent with the consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, that management considers necessary for a fair presentation of the data.  Quarterly results are not necessarily indicative of future results of operations.  This information should be read in conjunction with the audited consolidated financial statements and notes thereto that are included elsewhere in this report.

 

 

 

Quarter Ended

 

 

 

March 30,
2002

 

June 29,
2002

 

Sept. 28,
2002

 

Dec. 28,
2002

 

March 29,
2003

 

June 28,
2003

 

Sept. 27,
2003

 

Jan. 3,
2004

 

 

 

(in thousands, except per share data)

 

Consolidated Statements of Earnings Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

28,622

 

$

32,068

 

$

34,787

 

$

38,299

 

$

40,864

 

$

47,157

 

$

52,506

 

$

59,486

 

Cost of sales

 

7,711

 

8,359

 

8,430

 

8,892

 

9,220

 

10,417

 

11,364

 

13,421

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

20,911

 

23,709

 

26,357

 

29,407

 

31,644

 

36,740

 

41,142

 

46,065

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Associate incentives

 

10,730

 

12,205

 

13,429

 

14,810

 

16,097

 

18,662

 

20,332

 

23,584

 

Selling, general, and administrative

 

8,055

 

8,560

 

9,099

 

9,668

 

9,572

 

10,574

 

11,926

 

12,341

 

Research and development

 

199

 

240

 

260

 

336

 

334

 

373

 

379

 

298

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

18,984

 

21,005

 

22,788

 

24,814

 

26,003

 

29,609

 

32,637

 

36,223

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

1,927

 

2,704

 

3,569

 

4,593

 

5,641

 

7,131

 

8,505

 

9,842

 

Other income (expense), net

 

(96

)

34

 

(141

)

(18

)

34

 

(228

)

525

 

(139

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

1,831

 

2,738

 

3,428

 

4,575

 

5,675

 

6,903

 

9,030

 

9,703

 

Income taxes

 

714

 

1,000

 

1,085

 

1,270

 

2,100

 

2,554

 

2,974

 

2,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

$

1,117

 

$

1,738

 

$

2,343

 

$

3,305

 

$

3,575

 

$

4,349

 

$

6,056

 

$

6,837

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.06

 

$

0.09

 

$

0.13

 

$

0.18

 

$

0.19

 

$

0.23

 

$

0.32

 

$

0.35

 

Diluted

 

$

0.06

 

$

0.08

 

$

0.11

 

$

0.16

 

$

0.17

 

$

0.20

 

$

0.28

 

$

0.32

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

19,328

 

19,196

 

18,646

 

18,340

 

18,624

 

19,088

 

19,058

 

19,285

 

Diluted

 

19,342

 

21,254

 

21,216

 

20,750

 

21,048

 

21,450

 

21,384

 

21,389

 

 

28



 

 

 

Quarter Ended

 

 

 

March 30,
2002

 

June 29,
2002

 

Sept. 28,
2002

 

Dec. 28,
2002

 

March 29,
2003

 

June 28,
2003

 

Sept. 27,
2003

 

Jan. 3,
2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statements of Earnings as a Percentage of Net Sales:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

Cost of Sales

 

26.9

 

26.1

 

24.2

 

23.2

 

22.6

 

22.1

 

21.6

 

22.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

73.1

 

73.9

 

75.8

 

76.8

 

77.4

 

77.9

 

78.4

 

77.4

 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Associate Incentives

 

37.5

 

38.1

 

38.6

 

38.7

 

39.4

 

39.6

 

38.7

 

39.6

 

Selling, general and administrative

 

28.1

 

26.7

 

26.2

 

25.2

 

23.4

 

22.4

 

22.7

 

20.7

 

Research and development

 

0.7

 

0.7

 

0.7

 

0.9

 

0.8

 

0.8

 

0.7

 

0.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

66.3

 

65.5

 

65.5

 

64.8

 

63.6

 

62.8

 

62.1

 

60.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings from operations

 

6.8

 

8.4

 

10.3

 

12.0

 

13.8

 

15.1

 

16.3

 

16.6

 

Other income (expense), net

 

(0.3

)

0.1

 

(0.4

)

(0.0

)

0.1

 

(0.5

)

1.0

 

(0.2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

 

6.5

 

8.5

 

9.9

 

12.0

 

13.9

 

14.6

 

17.3

 

16.4

 

Income taxes

 

2.5

 

3.1

 

3.1

 

3.3

 

5.1

 

5.4

 

5.7

 

4.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

4.0

%

5.4

%

6.8

%

8.7

%

8.8

%

9.2

%

11.6

%

11.6

%

 

We may experience variations in the results of operations from quarter to quarter as a result of factors that include the following:

 

                  The recruiting and retention of Associates,

 

                  The opening of new markets,

 

                  The timing of company-sponsored Associate events,

 

                  Fluctuations in currency exchange rates,