UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)

 

 

x

 

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

 

For the quarterly period ended July 1, 2006

 

OR

 

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

 

(I.R.S. Employer

of incorporation or organization)

 

Identification No.)


3838 West Parkway Blvd., Salt Lake City, Utah 84120
(Address of principal executive offices, Zip Code)


(801) 954-7100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x     No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer  o

 

Accelerated filer  x

 

Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o     No  x

The number of shares outstanding of the registrant’s common stock as of August 3, 2006 was 17,803,855.

 




USANA HEALTH SCIENCES, INC.

FORM 10-Q

For the Quarterly Period Ended July 1, 2006

INDEX

 

 

 

 

 

 

PART I.   FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1

 

Financial Statements

 

 

 

 

Consolidated Balance Sheets

 

 

 

 

Consolidated Statements of Earnings—Quarter Ended

 

 

 

 

Consolidated Statements of Earnings—Six Months Ended

 

 

 

 

Consolidated Statement of Stockholders’ Equity and Comprehensive Income

 

 

 

 

Consolidated Statements of Cash Flows

 

 

 

 

Notes to Consolidated Financial Statements

 

 

Item 2

 

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

 

 

Item 3

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

Item 4

 

Controls and Procedures

 

 

 

 

 

 

 

 

 

PART II.   OTHER INFORMATION

 

 

 

 

 

 

 

Item 1A

 

Risk Factors

 

 

Item 2

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

Item 4

 

Submission of Matters to a Vote of Security Holders

 

 

Item 6

 

Exhibits

 

 

 

 

 

 

 

Signatures

 

 

 

2




PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

December 31,

 

July 1,

 

 

 

2005

 

2006

 

 

 

 

 

(unaudited)

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

10,579

 

$

9,173

 

Inventories

 

22,223

 

20,458

 

Prepaid expenses and other current assets

 

6,024

 

6,048

 

Deferred income taxes

 

3,004

 

2,532

 

Total current assets

 

41,830

 

38,211

 

 

 

 

 

 

 

Property and equipment, net

 

23,302

 

23,777

 

 

 

 

 

 

 

Goodwill

 

5,690

 

5,690

 

 

 

 

 

 

 

Other assets

 

2,886

 

2,612

 

 

 

$

73,708

 

$

70,290

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

4,955

 

$

6,303

 

Other current liabilities

 

21,601

 

24,479

 

Total current liabilities

 

26,556

 

30,782

 

 

 

 

 

 

 

Long-term liabilities

 

1,414

 

69

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Common stock, $0.001 par value; authorized 50,000 shares, issued and outstanding 18,343 as of December 31, 2005 and 17,723 as of July 1, 2006

 

18

 

18

 

Additional paid-in capital

 

9,161

 

7,420

 

Retained earnings

 

35,720

 

31,211

 

Accumulated other comprehensive income

 

839

 

790

 

Total stockholders’ equity

 

45,738

 

39,439

 

 

 

 

 

 

 

 

 

$

73,708

 

$

70,290

 

 

The accompanying notes are an integral part of these statements.

3




USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except per share data)

(unaudited)

 

 

Quarter Ended

 

 

 

July 2,

 

July 1,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Net sales

 

$

82,015

 

$

93,911

 

 

 

 

 

 

 

Cost of sales

 

19,499

 

22,276

 

 

 

 

 

 

 

Gross profit

 

62,516

 

71,635

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Associate incentives

 

31,911

 

37,454

 

Selling, general and administrative

 

15,168

 

17,991

 

Research and development

 

689

 

830

 

 

 

 

 

 

 

Total operating expenses

 

47,768

 

56,275

 

 

 

 

 

 

 

Earnings from operations

 

14,748

 

15,360

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest income

 

93

 

169

 

Interest expense

 

(3

)

(10

)

Other, net

 

(157

)

177

 

 

 

 

 

 

 

Other income (expense), net

 

(67

)

336

 

 

 

 

 

 

 

Earnings before income taxes

 

14,681

 

15,696

 

 

 

 

 

 

 

Income taxes

 

5,138

 

5,352

 

 

 

 

 

 

 

Net earnings

 

$

9,543

 

$

10,344

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

Basic

 

$

0.50

 

$

0.57

 

Diluted

 

$

0.48

 

$

0.55

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

 

 

 

 

Basic

 

18,948

 

18,149

 

Diluted

 

19,821

 

18,777

 

 

The accompanying notes are an integral part of these statements.

4




USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except per share data)

(unaudited)

 

 

 

Six Months Ended

 

 

 

July 2,

 

July 1,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Net sales

 

$

158,593

 

$

183,562

 

 

 

 

 

 

 

Cost of sales

 

37,509

 

43,614

 

 

 

 

 

 

 

Gross profit

 

121,084

 

139,948

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Associate incentives

 

61,461

 

72,882

 

Selling, general and administrative

 

30,017

 

35,617

 

Research and development

 

1,288

 

1,562

 

 

 

 

 

 

 

Total operating expenses

 

92,766

 

110,061

 

 

 

 

 

 

 

Earnings from operations

 

28,318

 

29,887

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

Interest income

 

197

 

311

 

Interest expense

 

(3

)

(10

)

Other, net

 

(96

)

330

 

 

 

 

 

 

 

Other income, net

 

98

 

631

 

 

 

 

 

 

 

Earnings before income taxes

 

28,416

 

30,518

 

 

 

 

 

 

 

Income taxes

 

9,945

 

10,614

 

 

 

 

 

 

 

Net earnings

 

$

18,471

 

$

19,904

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

Basic

 

$

0.97

 

$

1.09

 

Diluted

 

$

0.93

 

$

1.05

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

 

 

 

 

Basic

 

19,008

 

18,304

 

Diluted

 

19,896

 

19,002

 

 

The accompanying notes are an integral part of these statements.

5




USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

Six Months Ended July 2, 2005 and July 1, 2006

(in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

Shares

 

Value

 

Capital

 

Earnings

 

Income (Loss)

 

Total

 

For the Six Months Ended July 2, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2005

 

18,953

 

$

19

 

$

11,853

 

$

34,496

 

$

1,475

 

$

47,843

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

 

 

 

18,471

 

 

18,471

 

Foreign currency translation adjustment, net

 

 

 

 

 

(740

)

(740

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

17,731

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock retired

 

(353

)

 

(3,948

)

(11,053

)

 

(15,001

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued under equity-based award plan, including tax benefit of $2,679

 

216

 

 

4,230

 

 

 

4,230

 

Balance at July 2, 2005

 

18,816

 

$

19

 

$

12,135

 

$

41,914

 

$

735

 

$

54,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended July 1, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2005

 

18,343

 

$

18

 

$

9,161

 

$

35,720

 

$

839

 

$

45,738

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

 

 

 

19,904

 

 

19,904

 

Foreign currency translation adjustment, net

 

 

 

 

 

(49

)

(49

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

19,855

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock retired

 

(801

)

 

(5,733

)

(24,413

)

 

(30,146

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity-based compensation expense

 

 

 

2,152

 

 

 

2,152

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock issued under equity-based award plan, including tax benefit of $1,033

 

181

 

 

1,840

 

 

 

1,840

 

Balance at July 1, 2006

 

17,723

 

$

18

 

$

7,420

 

$

31,211

 

$

790

 

$

39,439

 

 

The accompanying notes are an integral part of these statements.

6




USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

Six Months Ended

 

 

 

July 2,
2005

 

July 1,
2006

 

Increase (decrease) in cash and cash equivalents

 

 

 

 

 

Cash flows from operating activities

 

 

 

 

 

Net earnings

 

$

18,471

 

$

19,904

 

Adjustments to reconcile net earnings to net cash provided by operating activities

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

2,824

 

2,924

 

Loss on sale of property and equipment

 

5

 

8

 

Equity-based compensation expense

 

 

2,152

 

Excess tax benefit from equity-based payment arrangements

 

 

(832

)

Deferred income taxes

 

56

 

(721

)

Allowance for inventory valuation

 

43

 

1,690

 

Changes in operating assets and liabilities:

 

 

 

 

 

Inventories

 

(4,545

)

340

 

Prepaid expenses and other assets

 

(734

)

(411

)

Accounts payable

 

(261

)

1,379

 

Other current liabilities

 

6,105

 

3,805

 

Total adjustments

 

3,493

 

10,334

 

Net cash provided by operating activities

 

21,964

 

30,238

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from the sale of property and equipment

 

4

 

 

Purchases of property and equipment

 

(2,688

)

(3,104

)

Net cash used in investing activities

 

(2,684

)

(3,104

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Proceeds from exercise of equity-based awards

 

1,551

 

807

 

Excess tax benefit from equity-based payment arrangements

 

 

832

 

Redemption of common stock

 

(15,001

)

(30,146

)

Net cash used in financing activities

 

(13,450

)

(28,507

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

(469

)

(33

)

Net increase (decrease) in cash and cash equivalents

 

5,361

 

(1,406

)

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

15,067

 

10,579

 

Cash and cash equivalents, end of period

 

$

20,428

 

$

9,173

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

3

 

$

8

 

Income taxes

 

5,944

 

10,491

 

 

The accompanying notes are an integral part of these statements.

7




USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Basis of Presentation

The unaudited interim consolidated financial information of USANA Health Sciences, Inc. and Subsidiaries (the “Company” or “USANA”) has been prepared in accordance with Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.  In the opinion of management, the accompanying interim consolidated financial information contains all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position as of July 1, 2006, and results of operations for the quarters and six months ended July 2, 2005 and July 1, 2006.  These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.  The results of operations for the quarter and six months ended July 1, 2006 may not be indicative of the results that may be expected for the fiscal year ending December 30, 2006.

Recently Issued Accounting Standards

In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income tax positions. FIN 48 defines the threshold for recognizing tax return positions in the financial statements as “more likely than not” that the position is sustainable, based on its technical merits. FIN 48 also provides guidance on the measurement, classification and disclosure of tax return positions in the financial statements. FIN 48 is effective for the first reporting period beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to the beginning balance of retained earnings in the period of adoption. The Company is currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.

NOTE A—EQUITY-BASED COMPENSATION

Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” using the modified version of prospective application.  Under this method, compensation expense includes the estimated fair value of equity awards vested during the reported periods.  Expense for equity awards vested is determined based on grant date fair value previously calculated for pro forma disclosures under SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—An Amendment of FASB Statement No. 123.”  Equity-based compensation expense recognized for the quarter and six months ended July 1, 2006 was comprised as follows:

 

 

Quarter
Ended July 1,
2006

 

Six Months
Ended July 1,
2006

 

Cost of sales

 

$

143

 

$

270

 

Selling, general and administrative

 

930

 

1,637

 

Research and development

 

132

 

245

 

 

 

$

1,205

 

$

2,152

 

 

8




 

The impact of equity-based compensation expense on net earnings and earnings per share for the quarter and six months ended July 1, 2006, can be found in the pro forma table in this footnote.  The Company currently estimates that equity-based compensation expense will reduce basic and diluted earnings per share in 2006 by $0.18.  The following table shows remaining unrecognized compensation expense on a pre-tax basis related to all types of nonvested equity awards outstanding as of July 1, 2006.  This table does not include an estimate for future grants that may be issued.

Remainder of 2006

 

$

2,578

 

2007

 

5,095

 

2008

 

4,718

 

2009

 

2,840

 

2010

 

2,203

 

Thereafter

 

412

 

 

 

$

17,846

 

 

The cost above is expected to be recognized over a weighted-average period of 2.4 years.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits resulting from equity-based compensation as cash flows from operating activities in the condensed consolidated statements of cash flows.  SFAS No. 123(R) requires cash flows resulting from tax deductions in excess of the grant-date fair value of equity awards to be included in cash flows from financing activities.  The excess tax benefits of $832 related to equity-based compensation included in cash flows from financing activities in the first six months of 2006 would have been included in cash flows from operating activities if the Company had not adopted SFAS No. 123(R).

As permitted by SFAS No. 148, prior to the adoption of SFAS No. 123(R) the Company accounted for equity award expense under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” under which no compensation was recognized in the Company’s financial statements for the quarter and six months ended July 2, 2005.  In connection with the modified prospective method, disclosures made for periods prior to the adoption of SFAS No. 123(R) do not reflect restated amounts.

9




The following table presents equity-based compensation expense included in our financial statements for the quarter and six months ended July 1, 2006, and also illustrates the pro forma effects on net earnings and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, to equity-based compensation for the quarter and six months ended July 2, 2005:

 

 

 

 

Quarter Ended

 

Six Months Ended

 

 

 

 

 

July 2, 2005

 

July 1, 2006

 

July 2, 2005

 

July 1, 2006

 

Net earnings

 

As reported

 

$

9,543

 

$

10,344

 

$

18,471

 

$

19,904

 

 

 

 

 

 

 

 

 

 

 

 

 

Add: Compensation cost included in reported net income

 

 

 

 

819

 

 

1,504

 

 

 

 

 

 

 

 

 

 

 

 

 

Deduct: Total compensation expense under the fair value method for all awards

 

 

 

(466

)

(819

)

(914

)

(1,504

)

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

Pro forma

 

$

9,077

 

$

10,344

 

$

17,557

 

$

19,904

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share—basic

 

As reported

 

$

0.50

 

$

0.57

 

$

0.97

 

$

1.09

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pro forma

 

$

0.48

 

$

0.57

 

$

0.92

 

$

1.09

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share—diluted

 

As reported

 

$

0.48

 

$

0.55

 

$

0.93

 

$

1.05

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pro forma

 

$

0.46

 

$

0.55

 

$

0.88

 

$

1.05

 

The Company’s 2006 Equity Incentive Award Plan (2006 Plan), which was approved by the shareholders at the Annual Shareholders’ Meeting held on April 19, 2006, allows for the grant of various equity awards including stock options, stock-settled stock appreciation rights, deferred stock units, and other types of equity-based awards to the Company’s officers, key employees, and non-employee directors.  Prior to the approval of the 2006 Plan, the Company maintained the 2002 Stock Option Plan (2002 Plan), which was limited to the granting of incentive and non-qualified stock options.  Between January 1, 2006, and April 19, 2006, the Company issued 175 stock options under the 2002 Plan.  Options granted under the 2002 Plan generally vest 20% each year on the anniversary of the grant date and expire five to ten years from the date of grant.  The 2006 Plan replaces the 2002 Plan for all future grants, and no new awards will be granted under the 2002 Plan.  The 2006 Plan authorized 5,000 shares of common stock for issuance, of which 4,704 shares were available for future issuance as of July 1, 2006.  Of the 296 shares granted under the 2006 Plan, 290 were stock-settled stock appreciation rights, 3 were stock options, and 3 were deferred stock units.  The Company’s Compensation Committee has initially determined that awards to be granted to officers and key employees under the 2006 Plan will generally vest 20% each year on the anniversary of the grant date and expire five to five and one-half years from the date of grant.  Awards of stock options and stock-settled stock appreciation rights to be granted to non-employee directors will generally vest 25% each quarter commencing on the last day of the fiscal quarter in which the awards are granted, and will expire five years from the date of grant.  Awards of deferred stock units are full-value shares at the date of grant, vesting in connection with service period, and do not have expiration dates.

The Company continues to use the Black-Scholes option pricing model to estimate fair value of equity awards, which requires the input of highly subjective assumptions, including the expected stock price volatility.  Prior to the implementation of SFAS No. 123(R), expected volatility represented the historical share prices of the Company’s common stock over the expected life of the award and the risk-free interest rate was based on the U.S. Treasury yield curve on the date of grant with respect to the expected life of the award.  Expected life was based on the contractual term of the award.

Preceding the adoption of SFAS No. 123(R), the Company engaged a third-party valuation expert to analyze assumptions used by the Company and to determine changes necessary for a more accurate reflection of the estimated fair value of equity

10




 

awards granted by the Company.  Based on this analysis the Company decided that, effective January 1, 2006, expected volatility will be calculated by averaging the historical volatility of the Company and a peer group index.  The risk-free interest rate will continue to be based on the U.S. Treasury yield curve on the date of grant with respect to the expected life of the award.  Also, effective January 1, 2006, due to the “plain vanilla” characteristics of the Company’s stock options, the simplified method, as permitted by the guidance provided in Staff Accounting Bulletin No. 107, will be used to determine expected life while permitted.  We estimate that the equity-based compensation expense included in earnings before income taxes for the six months ended July 1, 2006 was decreased by approximately $128 due to the above mentioned change in assumptions used to estimate fair value of awards granted during the six months ended July 1, 2006.

The following table includes weighted-average assumptions used to calculate the fair value of awards granted during the periods indicated, as well as the weighted-average fair value of awards granted.  Deferred stock units are full-value shares at the date of grant and have been excluded from the table below.

 

 

Quarter Ended

 

Six Months Ended

 

 

 

July 2,
2005

 

July 1
2006

 

July 2
2005

 

July 1
2006

 

Expected volatility

 

72.00

%

57.04

%

72.00

%

57.04

%

Risk-free interest rate

 

3.87

%

4.98

%

3.87

%

4.79

%

Expected life

 

5.25 yrs.

 

4.125 yrs.

 

5.25 yrs.

 

4.125 yrs.

 

Expected dividend yield

 

0.00

%

0.00

%

0.00

%

0.00

%

Weighted-average fair value of awards granted

 

$

26.84

 

$

18.59

 

$

26.84

 

$

18.80

 

The weighted-average fair value and grant price of the 3 deferred stock units granted during the quarter and six months ended July 1, 2006 was $37.60.

A summary of the Company’s stock option and stock-settled stock appreciation right activity for the six months ended July 1, 2006 is as follows:

 

 

Shares

 

Weighted-
average
Exercise 
Price*

 

Weighted-average
Remaining 
Contractual Term

 

Aggregate
Intrinsic
Value**

 

Outstanding at December 31, 2005

 

1,773

 

$

17.43

 

6.97

 

$

37,121

 

Granted

 

468

 

$

38.14

 

 

$

 

Exercised

 

(181

)

$

4.47

 

 

$

 

Canceled or expired

 

 

$

 

 

$

 

Outstanding at July 1, 2006

 

2,060

 

$

23.26

 

6.05

 

$

31,186

 

Exercisable at July 1, 2006

 

589

 

$

26.16

 

7.69

 

$

7,472

 


*                    All awards are granted at the market value on the date of grant, which is established by averaging the closing price of the Company’s common stock over the five trading days preceding the date of grant.

**             Aggregate intrinsic value is defined as the difference between the current market value and the exercise price of awards that were in-the-money, and is estimated using the closing price of the Company’s common stock on the last trading day of periods ended as of the dates indicated.

Total intrinsic value of awards exercised, which includes stock options and stock-settled stock appreciation rights, during the six month periods ending July 2, 2005 and July 1, 2006, was $7,284 and $6,348, respectively.

11




 

A summary of the Company’s deferred stock unit activity for the six months ended July 1, 2006 is as follows:

 

Shares

 

Weighted-
average Fair 
Value

 

Nonvested at December 31, 2005

 

 

$

 

Granted

 

3

 

$

37.60

 

Vested

 

(1

)

$

37.60

 

Canceled or expired

 

 

$

 

Nonvested at July 1, 2006

 

2

 

$

37.60

 

 

The total fair value of awards vested during the six month periods ending July 2, 2005 and July 1, 2006, which includes stock options, stock-settled stock appreciation rights, and deferred stock units, was $2,383 and $2,561, respectively.

NOTE B—INVENTORIES

Inventories consist of the following:

 

December 31,
2005

 

July 1,
2006

 

Raw materials

 

$

11,878

 

$

10,676

 

Work in progress

 

3,533

 

2,734

 

Finished goods

 

9,482

 

10,040

 

 

 

24,893

 

23,450

 

 

 

 

 

 

 

Less allowance for inventory valuation

 

2,670

 

2,992

 

 

 

$

22,223

 

$

20,458

 

NOTE C—PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets consist of the following:

 

December 31,
2005

 

July 1,
2006

 

Prepaid expenses

 

$

2,038

 

$

1,337

 

Miscellaneous receivables, net

 

3,537

 

3,499

 

Other current assets

 

449

 

1,212

 

 

 

$

6,024

 

$

6,048

 

 

12




NOTE D—PROPERTY AND EQUIPMENT

Cost of property and equipment and their estimated useful lives is as follows:

 

 

Years

 

December 31,
2005

 

July 1,
2006

 

Building

 

40

 

$

10,377

 

$

10,347

 

Laboratory and production equipment

 

5-7

 

9,706

 

10,231

 

Sound and video library

 

5

 

600

 

600

 

Computer equipment and software

 

3-5

 

23,083

 

23,549

 

Furniture and fixtures

 

3-5

 

2,654

 

2,669

 

Automobiles

 

3-5

 

248

 

221

 

Leasehold improvements

 

3-5

 

2,709

 

2,742

 

Land improvements

 

15

 

931

 

931

 

 

 

 

 

50,308

 

51,290

 

 

 

 

 

 

 

 

 

Less accumulated depreciation and amortization

 

 

 

29,605

 

31,814

 

 

 

 

 

20,703

 

19,476

 

 

 

 

 

 

 

 

 

Land

 

 

 

2,064

 

2,066

 

 

 

 

 

 

 

 

 

Deposits and projects in process

 

 

 

535

 

2,235

 

 

 

 

 

$

23,302

 

$

23,777

 

 

NOTE E—GOODWILL

Goodwill represents the excess of the purchase price paid for acquired entities over the fair market value of the net assets acquired.  As of July 1, 2006, goodwill totaled $5,690, comprising $4,267 that was associated with the July 1, 2003 acquisition of Wasatch Product Development, Inc. (WPD) and $1,423 that was associated with the February 1, 2004 acquisition of FMG.  No events have occurred subsequent to either acquisition that have resulted in an impairment of the original goodwill amounts initially recorded from the transactions.  In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill must be tested at least annually and if the carrying amount of goodwill exceeds its fair value, an impairment loss must be recognized in an amount equal to that excess.

There were no changes in the carrying amount of goodwill for the acquired subsidiaries for the six months ended July 1, 2006:

 

WPD

 

FMG

 

Consolidated
Total

 

Balance at December 31, 2005

 

$

4,267

 

$

1,423

 

$

5,690

 

Goodwill acquired

 

 

 

 

Impairment adjustments

 

 

 

 

Balance at July 1, 2006

 

$

4,267

 

$

1,423

 

$

5,690

 

 

13




NOTE F—OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

 

December 31,
2005

 

July 1,
2006

 

Associate incentives

 

$

3,528

 

$

4,592

 

Accrued employee compensation

 

6,257

 

4,435

 

Income taxes

 

2,429

 

2,446

 

Sales taxes

 

2,354

 

2,093

 

Associate promotions

 

616

 

1,937

 

Unearned revenue

 

1,903

 

3,307

 

Provision for returns and allowances

 

943

 

883

 

All other

 

3,571

 

4,786

 

 

 

$

21,601

 

$

24,479

 

 

NOTE G—COMMON STOCK AND EARNINGS PER SHARE

Basic earnings per share are based on the weighted average number of shares outstanding for each period.  Weighted-average shares issued and weighted-average shares redeemed during the periods indicated have been included in the calculation of weighted-average shares outstanding for basic earnings per share.  Diluted earnings per common share are based on shares outstanding (computed under basic EPS) and potentially dilutive shares.  Shares included in diluted earnings per share calculations include stock options granted that are in the money but have not yet been exercised.

 

For the Quarter Ended

 

 

 

   July 2,   
2005

 

   July 2,   
2006

 

Earnings available to common shareholders

 

$

9,543

 

$

10,344

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

 

 

 

Common shares outstanding entire period

 

18,953

 

18,343

 

Weighted average common shares:

 

 

 

 

 

Issued during period

 

211

 

173

 

Canceled during period

 

(216

)

(367

)

Weighted average common shares outstanding during period

 

18,948

 

18,149

 

Earnings per common share—basic

 

$

0.50

 

$

0.57

 

 

 

 

 

 

 

Diluted EPS

 

 

 

 

 

Shares

 

 

 

 

 

Weighted average shares outstanding during period—basic

 

18,948

 

18,149

 

Dilutive effect of stock options

 

873

 

628

 

Weighted average shares outstanding during period—diluted

 

19,821

 

18,777

 

Earnings per common share—diluted

 

$

0.48

 

$

0.55

 

 

14




 

Options to purchase 571 shares of stock were not included in the computation of EPS for the quarter ended July 1, 2006 due to their exercise price being greater than the average market price of the shares. 

 

For the Six Months Ended

 

 

 

   July 2,   
2005

 

   July 1   
2006

 

Earnings available to common shareholders

 

$

18,471

 

$

19,904

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

 

 

 

Common shares outstanding entire period

 

18,953

 

18,343

 

Weighted average common shares:

 

 

 

 

 

Issued during period

 

163

 

144

 

Canceled during period

 

(108

)

(183

)

Weighted average common shares outstanding during period

 

19,008

 

18,304

 

Earnings per common share—basic

 

$

0.97

 

$

1.09

 

 

 

 

 

 

 

Diluted EPS

 

 

 

 

 

Shares

 

 

 

 

 

Weighted average shares outstanding during period—basic

 

19,008

 

18,304

 

Dilutive effect of equity-based awards

 

888

 

698

 

Weighted average shares outstanding during period—diluted

 

19,896

 

19,002

 

Earnings per common share—diluted

 

$

0.93

 

$

1.05

 

 

Options to purchase 319 shares of stock were not included in the computation of EPS for the six months ended July 1, 2006 due to their exercise price being greater than the average market price of the shares.

During the six months ended July 2, 2005, and July 1, 2006, the Company expended $15,001, and $30,146 to purchase 353 and 801 shares, respectively, under the Company’s share repurchase plan.  The purchase of shares under this plan reduces the number of shares issued and outstanding.

NOTE H—SEGMENT INFORMATION

The Company’s operations are distinguished by regions served and method of distribution employed.  Two reportable business segments are recognized by the Company: Direct Selling and Contract Manufacturing.  These operating segments are evaluated regularly by management in determining the allocation of resources and in assessing the performance of the Company.  Management evaluates performance based on net sales and the amount of operating income or loss.  Segment profit or loss is based on profit or loss from operations before income taxes.  All intercompany transactions, intercompany profit, currency gains and losses, interest income and expense, and income taxes are excluded in the Company’s determination of segment profit or loss.

Direct Selling

The Company’s Direct Selling segment develops, manufactures, and distributes nutritional, weight management, and personal care products, and is the primary segment in which the Company operates.  Products are distributed through a network marketing system using independent distributors referred to as “Associates.”  Products are also sold directly to “Preferred Customers,” who purchase products for personal use and are not permitted to resell or distribute the products.

15




 

Selected financial information for the Direct Selling segment is reported for two geographic regions: North America and Pacific Rim.  North America includes the United States, Canada, and Mexico.  All other entities outside of North America are located within the Pacific Rim region, which includes Australia-New Zealand, Hong Kong, Japan, Taiwan, South Korea, and Singapore.

The profitability of each reported region within the Direct Selling segment is representative of what is controllable within that region by local management and is not necessarily indicative of actual profit or loss generated by a fully burdened region.  However, the presentation of the data is consistent with how management evaluates each region and the respective markets within that region.

Contract Manufacturing

Operating activities for the Contract Manufacturing segment primarily exist for the production of the Company’s Sensé™ line of skin and personal care products.  In addition to the production of the Sensé product line, contract manufacturing services are provided to a limited number of external customers.  This segment includes operations located in Draper, Utah and at a facility in Tianjin, China, which the Company acquired in October 2005.  Manufacturing and packaging activities for the Company’s Sensé products began at the Draper, Utah facility during the fourth quarter of 2003.  In the second quarters of 2005 and 2006, we had one and two external customers, respectively, that accounted for more than ten percent of segment sales.

Financial information summarized by operating segment and geographic region for the quarters ended July 2, 2005 and July 1, 2006 is listed below:

 

Net Sales from
External 
Customers

 

Inter-segment
Revenues

 

Earnings 
before Income
Taxes

 

Quarter ended July 2, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

52,264

 

$

15,316

 

$

7,444

 

Pacific Rim

 

27,548

 

1,382

 

7,068

 

 

 

 

 

 

 

 

 

Segment Total

 

79,812

 

16,698

 

14,512

 

 

 

 

 

 

 

 

 

Contract Manufacturing

 

2,203

 

1,796

 

221

 

 

 

 

 

 

 

 

 

Reportable Segments Total

 

82,015

 

18,494

 

14,733

 

 

 

 

 

 

 

 

 

Unallocated and Other *

 

 

(18,494

)

(52

)

 

 

 

 

 

 

 

 

Consolidated Total

 

$

82,015

 

$

 

$

14,681

 

 

16




 

 

Net Sales from
External
Customers

 

Inter-segment
Revenues

 

Earnings 
before Income
Taxes

 

Quarter ended July 1, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

62,201

 

$

16,651

 

$

7,917

 

Pacific Rim

 

28,876

 

1,402

 

8,484

 

 

 

 

 

 

 

 

 

Segment Total

 

91,077

 

18,053

 

16,401

 

 

 

 

 

 

 

 

 

Contract Manufacturing

 

2,834

 

1,236

 

(97

)

 

 

 

 

 

 

 

 

Reportable Segments Total

 

93,911

 

19,289

 

16,304

 

 

 

 

 

 

 

 

 

Unallocated and Other *

 

 

(19,289

)

(608

)

 

 

 

 

 

 

 

 

Consolidated Total

 

$

93,911

 

$

 

$

15,696

 

 

Financial information summarized by operating segment and geographic region for the six months ended July 2, 2005 and July 1, 2006 is listed below:

 

 

 

Net Sales from 
External 
Customers

 

Inter-segment 
Revenues

 

Earnings before
Income Taxes

 

Long-lived 
Assets

 

Total 
Assets

 

Six months ended July 2, 2005:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

101,522

 

$

33,251

 

$

14,419

 

$

22,426

 

$

68,688

 

Pacific Rim

 

52,939

 

2,659

 

12,714

 

2,909

 

18,778

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment Total

 

154,461

 

35,910

 

27,133

 

25,335

 

87,466

 

 

 

 

 

 

 

 

 

 

 

 

 

Contract Manufacturing

 

4,132

 

3,871

 

772

 

6,361

 

12,720

 

 

 

 

 

 

 

 

 

 

 

 

 

Reportable Segments Total

 

158,593

 

39,781

 

27,905

 

31,696

 

100,186

 

 

 

 

 

 

 

 

 

 

 

 

 

Unallocated and Other *

 

 

(39,781

)

511

 

39

 

(18,368

)

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Total

 

$

158,593

 

$

 

$

28,416

 

$

31,735

 

$

81,818

 

 

17




 

 

 

Net Sales from 
External 
Customers

 

Inter-segment 
Revenues

 

Earnings before
Income Taxes

 

Long-lived 
Assets

 

Total 
Assets

 

Six months ended July 1, 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

122,335

 

$

32,666

 

$

16,260

 

$

21,864

 

$

41,190

 

Pacific Rim

 

55,495

 

2,643

 

14,405

 

2,681

 

13,780

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment Total

 

177,830

 

35,309

 

30,665

 

24,545

 

54,970

 

 

 

 

 

 

 

 

 

 

 

 

 

Contract Manufacturing

 

5,732

 

2,325

 

(181

)

7,531

 

12,892

 

 

 

 

 

 

 

 

 

 

 

 

 

Reportable Segments Total

 

183,562

 

37,634

 

30,484

 

32,076

 

67,862

 

 

 

 

 

 

 

 

 

 

 

 

 

Unallocated and Other *

 

 

(37,634

)

34

 

3

 

2,428

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Total

 

$

183,562

 

$

 

$

30,518

 

$

32,079

 

$

70,290

 


*                    “Unallocated and Other” includes certain corporate items and eliminations that are not allocated to the operating segments.

NOTE I—SUBSEQUENT EVENTS

On July 26, 2006, we announced that our Board of Directors authorized an additional dollar amount for the repurchase of our outstanding shares of $40,000, increasing the total authorized amount to $50,654.

18




Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of USANA’s financial condition and results of operations should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes contained in this quarterly report.

General

USANA Health Sciences, Inc. develops and manufactures high-quality nutritional, weight management, and personal care products.  We market our products on the basis of high levels of bioavailability, safety, and quality.  We distribute our products through a network marketing system using independent distributors whom we refer to as “Associates.”  As of July 1, 2006, we had 142,000 active Associates worldwide.  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 July 1, 2006, we had 75,000 active Preferred Customers worldwide.  The majority of sales in the Direct Selling segment come from Associates.  For the six months ended July 1, 2006, sales to Associates accounted for approximately 86% of net sales for the Direct Selling segment.  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.

The fiscal year end of USANA is the Saturday closest to December 31 of each year.  Fiscal year 2005 ended on December 31, 2005, and fiscal year 2006 will end on December 30, 2006.

As discussed more fully in Note H — Segment Information to the consolidated financial statements, 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 primarily consists of manufacturing and packaging the Company’s Sensé™ product line of skin and personal care products, but also includes contract manufacturing services provided to a limited number of third-party customers.

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.  Additionally, we offer combination packs, which generally contain a variety of products from each product line.

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 especially important, USANA offers: UsanimalsÔ, a 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 available in a convenient pillow pack format, HealthPak 100Ô.

The 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, Active CalciumÔ Chewable, PhytoEstrinÔ, Palmetto PlusÔ, Ginkgo-PSÔ, Garlic ECÔ, Visionexâ, OptOmegaâ, and Hepasil DTX™.

The Macro Optimizers include healthy, low-glycemic convenience foods and other related products.  NutrimealÔ, Fibergyâ, and SoyaMaxÔ drink mixes, and Nutrition and Fibergy Bars™ are included in this product category.  This product line also includes our RESET™ Weight Management Program designed to assist in a long-term change in diet, and the accompanying

19




 

RESET™ kit.  The RESET kit is conveniently packaged in a self-contained box with the USANA products needed to complete a five-day regimen, designed to assist in losing weight and providing a start to a long-term change in diet.

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.  These products are produced with our patent-pending, self-preserving technology.  This technology uses a unique blend of botanicals, antioxidants, and active ingredients to keep products fresh, without adding traditional chemical preservatives.  Products in this line include Perfecting Essence, Gentle Daily Cleanser, Hydrating Toner, Daytime Protective Emulsion, Eye Nourisher, Night Renewal, Serum Intensive, Rice Bran Polisher, Revitalizing Shampoo, Nourishing Conditioner, Firming Body Nourisher, Energizing Shower Gel, and Intensive Hand Therapy.

All Other

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 businesses and selling our products.  These resource materials or sales tools include product brochures and business forms that are designed by us and printed by outside publishers.  We periodically contract with authors and publishers to produce or provide books, tapes, and other items that deal with health topics and personal motivation, which we then sell to Associates.  We also write and develop our own materials for CDs and DVDs, which are produced by our wholly-owned subsidiary FMG Productions.  New Associates are required to purchase a starter kit, which contains USANA training materials that assist Associates in starting and growing their businesses.  Associates do not earn commissions on the sale of starter kits or sales tools.

The following table summarizes the approximate percentage of total product revenue for the Direct Selling segment contributed by major product line for the six months ended as of the dates indicated:

 

 

Sales By Product Line

 

 

 

Six Months Ended

 

 

 

July 2,

 

July 1,

 

 

 

2005

 

2006

 

Product Line

 

 

 

 

 

 

 

USANAâ Nutritionals

 

 

 

 

 

Essentials *

 

37

%

38

%

Optimizers

 

35

%

33

%

Macro Optimizers

 

9

%

14

%

Sensé — beautiful scienceâ

 

15

%

12

%

All Other

 

4

%

3

%


* 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 six months ended as of the dates indicated.

 

 

Six Months Ended

 

 

 

July 2,

 

July 1,

 

 

 

2005

 

2006

 

USANAâ Essentials

 

22

%

22

%

HealthPak 100 ™

 

12

%

14

%

Proflavanolâ

 

10

%

9

%

 

20




 

Forward-Looking Statements and Certain Risks

The statements contained in this report that are not purely historical are considered to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act.  These statements represent our expectations, hopes, beliefs, anticipations, commitments, intentions, and strategies regarding the future.  They may be identified by the use of words or phrases such as “believes,” “expects,” “anticipates,” “should,” “plans,” “estimates,” and “potential,” among others.  Forward-looking statements include, but are not limited to, statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations regarding our financial performance, revenue, and expense levels in the future and the sufficiency of our existing assets to fund future operations and capital spending needs.  Readers are cautioned that actual results could differ materially from the anticipated results or other expectations that are expressed in these forward-looking statements for the reasons detailed in our most recent Annual Report on Form 10-K at pages 20 through 30.  The fact that some of the risk factors may be the same or similar to our past reports filed with the Securities and Exchange Commission means only that the risks are present in multiple periods.  We believe that many of the risks detailed here and in our other SEC filings are part of doing business in the industry in which we operate and compete and will likely be present in all periods reported.  The fact that certain risks are endemic to the industry does not lessen their significance.  The forward-looking statements contained in this report are made as of the date of this report and we assume no obligation to update them or to update the reasons why actual results could differ from those projected in such forward-looking statements.  Among others, risks and uncertainties that may affect our business, financial condition, performance, development, and results of operations include:

·                  Our ability to attract and maintain a sufficient number of Associates;

·                  High turnover of Associates;

·                  Our dependence upon a network marketing system to distribute our products;

·                  Activities of our independent Associates;

·                  Our planned expansion into international markets, including delays in commencement of sales in any new market, delays in compliance with local marketing or other regulatory requirements, or changes in target markets;

·                  Rigorous government scrutiny of network marketing practices;

·                  Potential political events that may negatively affect economic conditions;

·                  Potential natural disasters that may negatively affect economic conditions;

·                  Potential effects of adverse publicity regarding nutritional supplements or the network marketing industry;

·                  Reliance on key management personnel, including our Founder, Chairman of the Board of Directors, and Chief Executive Officer Myron W. Wentz, Ph.D.;

·                  Extensive government regulation of the Company’s products, manufacturing, and network marketing system;

·                  Potential inability to sustain or manage growth, including the failure to continue to develop new products;

·                  An increase in the amount of Associate incentives paid;

·                  Our reliance on the use of information technology;

·                  The adverse effect of the loss of a high-level sponsoring Associate, together with a group of leading Associates, in that person’s downline;

·                  The loss of market share of our products or the Associates to competitors;

21




 

·                  Potential adverse effects of taxation and transfer pricing regulations;

·                  The fluctuation in the value of foreign currencies against the US dollar;

·                  Our reliance on outside suppliers for raw materials;

·                  Shortages of raw materials that we use in certain of our products;

·                  Significant price increases of our key raw materials;

·                  Product liability claims and other risks associated with our manufacturing activity;

·                  Intellectual property risks;

·                  Liability claims associated with our “Athlete Guarantee” program; and

·                  Disruptions to shipping channels that are used to distribute our products to international warehouses.

Results of Operations

Implementation of SFAS No. 123(R)

Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123(R), which require equity-based compensation expense to be recognized in financial statements.  The Company used the modified version of prospective application to adopt these provisions.  Under this method, compensation expense includes the estimated fair value of equity awards vested during the reported period.  Our financial statements for 2006 interim periods are the first to reflect equity-based compensation expense.  Equity-based compensation expense recognized for the quarter, and six months ended July 1, 2006 was comprised as follows:

 

Quarter

 

Six Months

 

 

 

Ended July 1,

 

Ended July 1,

 

 

 

2006

 

2006

 

 

 

 

 

 

 

Cost of sales

 

$

143

 

$

270

 

Selling, general and administrative

 

930

 

1,637

 

Research and development

 

132

 

245

 

 

 

$

1,205

 

$

2,152

 

 

Net of tax, earnings for the quarter and six months ended July 1, 2006 were reduced by $819 thousand, and $1,504 thousand, respectively.  Earnings per basic and diluted share were reduced $0.04, and $0.07, respectively, from what earnings would have been exclusive of equity-based compensation.  The Company currently estimates that equity-based compensation expense will reduce basic and diluted earnings per share in 2006 by $0.18.  The following table shows remaining unrecognized compensation expense on a pre-tax basis related to all types of nonvested equity awards outstanding as of July 1, 2006.  This table does not include an estimate for future grants that may be issued.

Remainder of 2006

 

$

2,578

 

2007

 

5,095

 

2008

 

4,718

 

2009

 

2,840

 

2010

 

2,203

 

Thereafter

 

412

 

 

 

$

17,846

 

 

The expense above is expected to be recognized over a weighted-average period of 2.4 years.

 

22




 

More information on the Company’s equity-based compensation plans and the accounting for equity-based compensation expense can be found in note A—Equity-based Compensation to the consolidated financial statements.

Quarters Ended July 2, 2005 and July 1, 2006

Net Sales.  Net sales increased 14.5% to $93.9 million for the quarter ended July 1, 2006, an increase of $11.9 million from $82.0 million for the comparable quarter in 2005.  During the current quarter, net sales in the Direct Selling segment increased by $11.3 million, and net sales in the Contract Manufacturing segment increased by $0.6 million, when compared with the same period in 2005.

The following table summarizes the changes in net sales by segment and country for the fiscal quarters ended July 2, 2005 and July 1, 2006.

 

 

 

 

Sales By Segment and Region

 

 

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

Quarter Ended

 

Change from

 

Percent

 

Segment / Region

 

 

 

July 2, 2005

 

July 1, 2006

 

Prior Year

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Direct Selling

 

 

 

 

 

 

 

 

 

 

 

 

 

North America

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

33,067

 

40.3

%

$

39,818