USANA HEALTH SCIENCES INC - Quarter Report: 2017 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2017

 

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: 001-35024

 

 

USANA HEALTH SCIENCES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)		Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  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 November 3, 2017 was 23,992,549

 

 

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USANA HEALTH SCIENCES, INC.

 

FORM 10-Q

 

For the Quarterly Period Ended September 30, 2017

 

INDEX

 

			Page
PART I. FINANCIAL INFORMATION
Item 1	Financial Statements (unaudited)
		Condensed Consolidated Balance Sheets	3
		Condensed Consolidated Statements of Comprehensive Income	4
		Condensed Consolidated Statements of Stockholders’ Equity	5
		Condensed Consolidated Statements of Cash Flows	6
		Notes to Condensed Consolidated Financial Statements	7-15
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16-25
Item 3	Quantitative and Qualitative Disclosures About Market Risk		25
Item 4	Controls and Procedures		25
PART II. OTHER INFORMATION
Item 1	Legal Proceedings		26
Item 1A	Risk Factors		26
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds		27
Item 3	Defaults Upon Senior Securities		27
Item 4	Mine Safety Disclosures		27
Item 5	Other Information		27
Item 6	Exhibits		27
Signatures			29

 

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PART I.  FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(in thousands, except par value)

(unaudited)

 

		As of			As of
		December 31,			September 30,
		2016			2017
ASSETS
Current assets
Cash and cash equivalents		$	175,774		$	191,745
Inventories		64,810			63,334
Prepaid expenses and other current assets		37,277			31,373
Total current assets		277,861			286,452
Property and equipment, net		101,267			102,146
Goodwill		16,715			17,167
Intangible assets, net		34,349			34,728
Deferred tax assets		18,292			28,577
Other assets		22,158			21,581
		$	470,642		$	490,651
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	9,040		$	9,290
Other current liabilities		129,451			112,137
Total current liabilities		138,491			121,427
Deferred tax liabilities		5,499			5,249
Other long-term liabilities		1,365			1,163
Stockholders’ equity
Common stock, $0.001 par value; Authorized — 50,000 shares, issued and outstanding 24,485 as of December 31, 2016 and 23,946 as of September 30, 2017		24			24
Additional paid-in capital		71,505			72,962
Retained earnings		265,405			293,921
Accumulated other comprehensive income (loss)		(11,647		)	(4,095		)
Total stockholders’ equity		325,287			362,812
		$	470,642		$	490,651

 

The accompanying notes are an integral part of these statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(in thousands, except per share data)

(unaudited)

 

		Quarter Ended						Nine Months Ended
		October 1,			September 30,			October 1,			September 30,
		2016			2017			2016			2017
Net sales		$	254,219		$	261,765		$	753,182		$	774,151
Cost of sales		44,979			47,135			133,869			133,691
Gross profit		209,240			214,630			619,313			640,460
Operating expenses:
Associate incentives		112,816			116,010			335,541			350,195
Selling, general and administrative		60,591			67,263			176,986			193,653
Total operating expenses		173,407			183,273			512,527			543,848
Earnings from operations		35,833			31,357			106,786			96,612
Other income (expense):
Interest income		338			571			1,099			1,644
Interest expense		(46		)	(10		)	(424		)	(31		)
Other, net		(24		)	129			(684		)	19
Other income (expense), net		268			690			(9		)	1,632
Earnings before income taxes		36,101			32,047			106,777			98,244
Income taxes		6,003			8,278			28,618			29,858
Net earnings		$	30,098		$	23,769		$	78,159		$	68,386
Earnings per common share
Basic		$	1.24		$	0.98		$	3.24		$	2.80
Diluted		$	1.20		$	0.97		$	3.12		$	2.75
Weighted average common shares outstanding
Basic		24,178			24,283			24,112			24,462
Diluted		25,050			24,588			25,050			24,871
Comprehensive income:
Net earnings		$	30,098		$	23,769		$	78,159		$	68,386
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment		(341		)	2,941			(2,643		)	10,153
Tax benefit (expense) related to foreign currency translation adjustment		(515		)	(625		)	1,655			(2,601		)
Other comprehensive income (loss), net of tax		(856		)	2,316			(988		)	7,552
Comprehensive income		$	29,242		$	26,085		$	77,171		$	75,938

 

The accompanying notes are an integral part of these statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Nine Months Ended September 30, 2017

 

(in thousands)

(unaudited)

 

													Accumulated
							Additional						Other
		Common Stock					Paid-in			Retained			Comprehensive
		Shares		Value			Capital			Earnings			Income (Loss)			Total
Balance at December 31, 2016		24,485		$	24		$	71,505		$	265,405		$	(11,647	)	$	325,287
Net earnings										68,386						68,386
Other comprehensive income (loss), net of tax													7,552			7,552
Equity-based compensation expense							11,711									11,711
Common stock repurchased and retired		(865	)	(1		)	(10,129		)	(39,870		)				(50,000		)
Common stock issued under equity award plans		326		1												1
Tax withholding for net-share settled equity awards							(125		)							(125		)
Balance at September 30, 2017		23,946		$	24		$	72,962		$	293,921		$	(4,095	)	$	362,812

 

The accompanying notes are an integral part of these statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(in thousands)

(unaudited)

 

		Nine Months Ended
		October 1,			September 30,
		2016			2017
Cash flows from operating activities
Net earnings		$	78,159		$	68,386
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities
Depreciation and amortization		9,930			11,797
(Gain) loss on sale of property and equipment		55			8
Equity-based compensation expense		13,963			11,711
Deferred income taxes		(2,249		)	(12,801		)
Changes in operating assets and liabilities:
Inventories		(7,922		)	4,556
Prepaid expenses and other assets		(12,179		)	6,352
Accounts payable		597			550
Other liabilities		1,386			(21,909		)
Net cash provided by (used in) operating activities		81,740			68,650
Cash flows from investing activities
Additions to notes receivable		(4		)	—
Receipts on notes receivable		605			259
Proceeds from sale of property and equipment		3			16
Purchases of property and equipment		(26,047		)	(9,168		)
Net cash provided by (used in) investing activities		(25,443		)	(8,893		)
Cash flows from financing activities
Repurchase of common stock		(64,610		)	(50,000		)
Borrowings on line of credit		73,700			3,500
Payments on line of credit		(72,500		)	(3,500		)
Payments related to tax withholding for net-share settled equity awards		—			(125		)
Deferred debt issuance costs		(250		)	—
Net cash provided by (used in) financing activities		(63,660		)	(50,125		)
Effect of exchange rate changes on cash and cash equivalents		(1,304		)	6,339
Net increase (decrease) in cash and cash equivalents		(8,667		)	15,971
Cash and cash equivalents, beginning of period		143,210			175,774
Cash and cash equivalents, end of period		$	134,543		$	191,745
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest		$	317		$	9
Income taxes		41,114			40,532
Cash received during the period for:
Income tax refund		—			4,700
Non-cash investing activities:
Credits on notes receivable		1,142			412
Accrued purchases of property and equipment		1,763			202

 

The accompanying notes are an integral part of these statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE A — ORGANIZATION, CONSOLIDATION, AND BASIS OF PRESENTATION

 

USANA Health Sciences, Inc. develops and manufactures high-quality nutritional and personal care products that are sold internationally through a global network marketing system, which is a form of direct selling. The Condensed Consolidated Financial Statements include the accounts and operations of USANA Health Sciences, Inc. and its wholly-owned subsidiaries (collectively, the “Company” or “USANA”) in two geographic regions: Asia Pacific, and Americas and Europe.  Asia Pacific is further divided into three sub-regions: Greater China, Southeast Asia Pacific, and North Asia. Greater China includes Hong Kong, Taiwan and China; Southeast Asia Pacific includes Australia, New Zealand, Singapore, Malaysia, the Philippines, Thailand, and Indonesia; North Asia includes Japan, and South Korea.  Americas and Europe includes the United States, Canada, Mexico, Colombia, the United Kingdom, France, Belgium, and the Netherlands.  All intercompany accounts and transactions have been eliminated in consolidation.

 

The condensed consolidated balance sheet as of December 31, 2016, derived from audited consolidated financial statements, and the unaudited interim consolidated financial information of the Company have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”).  Accordingly, certain information and footnote disclosures that are normally included in financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.  In the opinion of management, the accompanying interim condensed consolidated financial information contains all adjustments, consisting only of normal recurring adjustments that are necessary to state fairly the Company’s financial position as of September 30, 2017 and results of operations for the quarters and nine months ended October 1, 2016 and September 30, 2017.

 

The interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto that are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC.  The results of operations for the nine months ended September 30, 2017, are not necessarily indicative of the results that may be expected for the fiscal year ending December 30, 2017.

 

Recent Accounting Pronouncements

 

Adopted accounting pronouncements

 

In January 2017 the FASB issued an Accounting Standard Update (“ASU”) No. 2017-04, “Intangibles-Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment.”  ASU 2017-04 simplifies the accounting for goodwill impairment by eliminating the Step 2 requirement to calculate the implied fair value of goodwill.  Instead, under ASU 2017-04, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of each reporting unit with its carrying amount.  An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.  The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted.  The Company adopted ASU 2017-04 effective for the quarter ended September 30, 2017 in conjunction with its annual goodwill impairment test.  The adoption of this ASU did not have an impact on the Company’s consolidated financial statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE A — ORGANIZATION, CONSOLIDATION, AND BASIS OF PRESENTATION - CONTINUED

 

Issued accounting pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).”  ASU 2014-09 includes a five-step process by which entities will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which an entity expects to be entitled in exchange for those goods or services.  The standard also will require enhanced disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In July 2015, the FASB announced a decision to defer the effective date of this ASU. ASU 2014-09 is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted for annual and interim reporting periods beginning after December 15, 2016.  The amendments may be applied retrospectively to each prior period (full retrospective) or retrospectively with the cumulative effect recognized as of the date of initial application (modified retrospective).  The Company plans to adopt ASU 2014-09 in the first quarter of 2018 and apply the modified retrospective approach.

 

The Company continues to evaluate the impact of this ASU on the specific areas that apply to the Company and their potential impact to its processes, accounting, financial reporting, disclosures, and controls.  At this point, the Company has determined that the overall impact of adopting this ASU will not be material.  This ASU will primarily involve updating revenue related internal control documentation and expanding revenue disclosures in our periodic filings.  In addition to the documentation updates, the Company is considering a change in the timing for recognizing revenue on orders that have shipped but have not been delivered at period end. None of these changes are expected to have a material impact on the Company’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).”  ASU 2016-02 is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  Additionally, the ASU will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements.  The update requires lessees to apply a modified retrospective approach for recognition and disclosure, beginning with the earliest period presented.  The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted.  The Company is currently in the process of evaluating the impact of the ASU on the Company’s outstanding leases and expects that adoption will have an impact on the consolidated balance sheets related to recording right-of-use assets and corresponding lease liabilities.

 

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. The ASU requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The ASU is effective for annual and interim periods in fiscal years beginning after December 15, 2017.  The Company does not expect the adoption of ASU 2016-18 will have a material impact on its statement of cash flows.

 

In May 2017 the FASB issued ASU No. 2017-09, “Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting.”  ASU 2017-09 provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award.  ASU 2017-09 does not change the accounting for modifications but clarifies that modification accounting guidance should only be applied if there is a change to the value, vesting conditions, or award classification and would not be required if the changes are considered non-substantive.  The ASU is effective for all annual and interim periods in fiscal years beginning after December 15, 2017.  The Company does not expect the adoption of ASU 2017-09 will have a material impact on its consolidated financial statements.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE B — FAIR VALUE MEASURES

 

The Company measures at fair value certain of its financial and non-financial assets and liabilities by using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, essentially an exit price, based on the highest and best use of the asset or liability. The levels of the fair value hierarchy are:

 

·                  Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date.

·                  Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

·                  Level 3 inputs are unobservable and are used to measure fair value in situations where there is little, if any, market activity for the asset or liability at the measurement date.

 

As of the dates indicated, the following financial assets and liabilities were measured at fair value on a recurring basis using the type of inputs shown:

 

					Fair Value Measurements Using
					Inputs
		December 31, 2016			Level 1			Level 2			Level 3
Money market funds included in cash equivalents		$	27,917		$	27,917		$	—		$	—
Foreign currency contracts included in prepaid expenses and other current assets		4			—			4			—
		$	27,921		$	27,917		$	4		$	—

 

					Fair Value Measurements Using
					Inputs
		September 30, 2017			Level 1			Level 2			Level 3
Money market funds included in cash equivalents		$	74,584		$	74,584		$	—		$	—
Foreign currency contracts included in other current liabilities		(37		)	—			(37		)	—
		$	74,547		$	74,584		$	(37	)	$	—

 

There were no transfers of financial assets or liabilities between levels of the fair value hierarchy for the periods indicated.

 

The majority of the Company’s non-financial assets, which include goodwill, intangible assets, and property and equipment, are not required to be carried at fair value on a recurring basis. However, if certain triggering events occur (or tested at least annually for goodwill and indefinite-lived intangibles) such that a non-financial asset is required to be evaluated for impairment, an impairment charge is recorded to reduce the carrying value to the fair value, if the carrying value exceeds the fair value. At December 31, 2016 and September 30, 2017, there were no non-financial assets measured at fair value on a non-recurring basis.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE B — FAIR VALUE MEASURES - CONTINUED

 

The Company’s financial instruments include cash equivalents, accounts receivable, restricted cash, notes receivable, and accounts payable. The recorded values of cash equivalents, accounts receivable, restricted cash, and accounts payable approximate their fair values, based on their short-term nature. Historically, the carrying value of the notes receivable approximated fair value because the variable interest rates in the notes reflected current market rates. As of September 30, 2017, an impairment was recorded on a note receivable (discussed in Note E) based on the estimated fair value of the underlying collateral as a practical expedient, which is considered to be a non-recurring fair value measurement using Level 2 inputs as significant observable inputs exist for similar assets.

 

NOTE C — INVENTORIES

 

Inventories consisted of the following:

 

		December 31,			September 30,
		2016			2017
Raw materials		$	26,186		$	22,353
Work in progress		9,455			8,876
Finished goods		29,169			32,105
		$	64,810		$	63,334

 

NOTE D — INTANGIBLE ASSETS

 

The Company performed its annual goodwill impairment test during the third quarter of 2017.  The Company performed a qualitative assessment of each reporting unit and determined that it was not more-likely-than-not that the fair value of any reporting unit was less than its carrying amount.  As a result, a quantitative goodwill impairment test was not required and no impairments of goodwill were recognized.

 

The Company performed its annual indefinite-lived intangible asset impairment test during the third quarter of 2017.  The Company performed a qualitative assessment of the indefinite-lived intangible asset and determined that is was not more-likely-than-not that the fair value of the indefinite-lived intangible asset was less than the carrying amount.  As a result, the quantitative impairment test was not required and no impairment was recognized.

 

NOTE E — OTHER ASSETS

 

Other assets consist primarily of land use rights related to a production facility in China and a secured loan to a former supplier of the Company’s nutrition bars.  The Company extended non-revolving credit to the former supplier of nutrition bars to allow it to acquire equipment that was necessary to manufacture the USANA nutrition bars, which is secured by the equipment.  This relationship was intended to provide improved supply chain stability for USANA and create a mutually beneficial relationship between the parties.    Interest accrues at an annual interest rate of LIBOR plus 400 basis points. The note has a maturity date of February 1, 2024 and was to be repaid by a combination of cash payments and credits for the manufacture of USANA’s nutrition bars.  There is no prepayment penalty.  The total contractual unpaid principal balance, including accrued unpaid interest on the note receivable from this supplier as of December 31, 2016, and September 30, 2017 was $6,867 and $6,742, respectively.

 

A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the scheduled payments in accordance with the contractual terms of the loan.  Factors considered in determining impairment include payment status, collateral value and the probability of collecting payments when due.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE E — OTHER ASSETS - CONTINUED

 

During the first half of 2017, the Company experienced challenges with the third-party supplier of the Company’s nutrition bars and subsequently determined to no longer use this supplier.  The Company has evaluated the recoverability of the note receivable from this supplier, considering financial data of the third-party supplier, and the estimated fair value of the collateralized equipment as of September 30, 2017.  Based on this analysis, the Company believes it is probable that the note receivable has been impaired.  Accordingly, an impairment of $1,622 was recorded as determined by the difference between the notes receivable balance and the estimated fair value of the collateralized equipment as a practical expedient.  The Company will continue to evaluate the recoverability of the note receivable in future periods.

 

This third-party supplier is considered to be a variable interest entity; however, the Company is not the primary beneficiary due to the inability to direct the activities that most significantly affect the third-party supplier’s economic performance. Additionally, the Company does not absorb a majority of the third-party supplier’s expected losses or returns. Consequentially, the financial information of the third-party supplier is not consolidated. The maximum exposure to loss as a result of the Company’s involvement with the third-party supplier is limited to the carrying value of the note receivable due from the third-party supplier.

 

NOTE F — LINE OF CREDIT

 

The Company has a $75,000 line of credit with Bank of America.  Interest is computed at the bank’s Prime Rate or LIBOR, adjusted by features specified in the Credit Agreement.  The collateral for this line of credit is the pledge of the capital stock of certain subsidiaries of the Company, set forth in a separate pledge agreement with the bank.  On February 19, 2016, the Company entered into an Amended and Restated Credit Agreement with Bank of America, which extends the term of the Credit Agreement to April 27, 2021 and increases the Company’s consolidated rolling four-quarter adjusted EBITDA covenant from $60,000 to equal to or greater than $100,000 and a ratio of consolidated funded debt to adjusted EBITDA of 2.0 to 1.0 at the end of each quarter.

 

The adjusted EBITDA under this agreement is modified for certain non-cash expenses.  Part of the credit agreement is that any existing bank guarantees are considered a reduction of the overall availability of credit and part of the covenant calculation.  This resulted in a $5,241, and $4,729 reduction in the available borrowing limit as of December 31, 2016 and September 30, 2017, respectively, due to existing normal course of business guarantees in certain markets.

 

There was no outstanding debt on this line of credit at December 31, 2016 or at September 30, 2017.  The Company will be required to pay any balance on this line of credit in full at the time of maturity in April 2021 unless the line of credit is replaced or terms are renegotiated.

 

NOTE G — CONTINGENCIES

 

The Company is involved in various lawsuits, claims and other legal matters from time to time that arise in the ordinary course of conducting business, including matters involving its products, intellectual property, supplier relationships, distributors, competitor relationships, employees and other matters.  The Company records a liability when a particular contingency is probable and estimable.  The Company faces contingencies that are reasonably possible to occur; however, they cannot currently be estimated.  While complete assurance cannot be given to the outcome of these proceedings, management does not currently believe that any of these matters, individually or in the aggregate, will have a material adverse effect on the Company’s financial condition, liquidity, or results of operations.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE G — CONTINGENCIES - CONTINUED

 

In August 2014, a purported shareholder derivative lawsuit was filed in the Third Judicial District Court of Salt Lake County, State of Utah (James Robert Rawcliffe v. Robert Anciaux, et al.,) against certain of the Company’s directors and officers. The derivative complaint, which also names USANA as a nominal defendant but is asserted on USANA’s behalf, contains claims of breach of fiduciary duty, waste of corporate assets and unjust enrichment against the defendant directors and officers in connection with certain equity awards granted by the Compensation Committee of the Company’s Board of Directors in February 2014. In October 2014, the Company filed a motion to dismiss the complaint and, in March 2015, the court granted that motion and dismissed the complaint without prejudice. In May 2015, the plaintiffs filed an appeal with the Utah Supreme Court. The Supreme Court remanded the case to the Utah Court of Appeals.  In December 2016, the Court of Appeals certified the case to the Utah Supreme Court, confirming the Company’s belief that this case addresses a new issue under Utah law.  Subsequent to September 30, 2017, in October 2017 the Utah Supreme Court affirmed the trial court’s motion to dismiss the complaint.

 

On February 7, 2017, the Company disclosed in a Current Report on Form 8-K filed with the SEC that it is conducting a voluntary internal investigation regarding its BabyCare operations in China.  In connection with this investigation, the Company expects to continue to incur costs in conducting the on-going review and investigation, in responding to requests for information in connection with any government investigations and in defending any potential civil or governmental proceedings that are instituted against it or any of its current or former officers or directors.  The Company has voluntarily contacted the SEC and the United States Department of Justice to advise both agencies that an internal investigation is underway and intends to provide additional information to both agencies as the investigation progresses.  Because the internal investigation is ongoing, the Company cannot predict the duration, scope, or result of the investigation.  One or more governmental actions could be instituted in respect of the matters that are the subject of the internal investigation, and such actions, if brought, may result in judgments, settlements, fines, penalties, injunctions, cease and desist orders, criminal penalties, or other relief.

 

On February 13, 2017, a putative shareholder class action complaint was filed in the United States District Court for the District of Utah, with the plaintiff, Chi Wah, alleging that the Company failed to disclose that (i) the Company’s BabyCare subsidiary had engaged in improper reimbursement practices in China, (ii) these practices constituted violations of the Foreign Corrupt Practices Act (“FCPA”), (iii) as such, the Company’s China revenues were in part the product of unlawful conduct and unlikely to be sustainable, and (iv) the foregoing conduct, when it became known, was likely to subject the Company to significant regulatory scrutiny.  The lawsuit names as defendants the Company; its former Co-Chief Executive Officer, David A. Wentz; and its Chief Leadership Development Officer, Paul A. Jones (formerly the Chief Financial Officer).  On behalf of the plaintiff, and a putative class of purchasers of USANA stock between March 14, 2014 and February 7, 2017, the plaintiff asserts claims for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder.  The plaintiff seeks, among other things, an award of damages, interest, reasonable attorney’s fees, expert fees, and other costs.  The Company believes that the action is without merit, and intends to vigorously defend against all claims asserted.  In September 2017, the Company filed a motion to dismiss the complaint.

 

Chinese regulators regularly make inquiries about the business activities of direct sellers in China and have done so with the Company’s operating subsidiary in China, BabyCare, Ltd.  There have been instances where inquiries or complaints about BabyCare’s business have resulted in the payment of fines by BabyCare.  For instance, during the first quarter of 2017, an inquiry from a provincial-level regulator was received and promptly resolved by BabyCare.  A fine was issued in a BabyCare Associate’s name and paid by BabyCare in connection with resolving this matter.  The fine was not quantitatively material.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE H — COMMON STOCK AND EARNINGS PER SHARE

 

Basic earnings per share are based on the weighted-average number of shares outstanding for each period. Shares that have been repurchased and retired during the periods specified below have been included in the calculation of the number of weighted-average shares that are outstanding for the calculation of basic earnings per share based on the time they were outstanding in any period. Diluted earnings per common share are based on shares that are outstanding (computed under basic EPS) and on potentially dilutive shares. Shares that are included in the diluted earnings per share calculations under the treasury stock method include equity awards that are in-the-money but have not yet been exercised.

 

The following is a reconciliation of the numerator and denominator used to calculate basic earnings per share and diluted earnings per share for the periods indicated:

 

		Quarter Ended						Nine Months Ended
		October 1,			September 30,			October 1,			September 30,
		2016			2017			2016			2017
Net earnings available to common shareholders		$	30,098		$	23,769		$	78,159		$	68,386
Weighted average common shares outstanding - basic		24,178			24,283			24,112			24,462
Dilutive effect of in-the-money equity awards		872			305			938			409
Weighted average common shares outstanding - diluted		25,050			24,588			25,050			24,871
Earnings per common share from net earnings - basic		$	1.24		$	0.98		$	3.24		$	2.80
Earnings per common share from net earnings - diluted		$	1.20		$	0.97		$	3.12		$	2.75

 

Equity awards for the following shares were not included in the computation of diluted EPS due to the fact that their effect would be anti-dilutive:

 

		Quarter Ended				Nine Months Ended
		October 1,		September 30,		October 1,		September 30,
		2016		2017		2016		2017
		2,309		2,035		2,236		2,091

 

During the quarter ended September 30, 2017, the Company repurchased and retired 865 shares, for $50,000 under the Company’s share repurchase plan.

 

During the nine months ended October 1, 2016, and September 30, 2017, the Company repurchased and retired 1,106 shares, and 865 shares for $64,610 and $50,000, respectively under the Company’s share repurchase plan.  The excess of the repurchase price over par value is allocated between additional paid-in capital and retained earnings on a pro-rata basis.  The purchase of shares under this plan reduces the number of shares outstanding in the above calculations.

 

As of September 30, 2017, the remaining approved repurchase amount under the stock repurchase plan was $50,000.  There currently is no expiration date on the remaining approved repurchase amount and no requirement for future share repurchases.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE I — SEGMENT INFORMATION

 

USANA operates as a direct selling company that develops, manufactures, and distributes high-quality nutritional and personal care products that are sold through a global network marketing system of independent distributors (“Associates”).  As such, management aggregates its operating segments into one reportable segment as management believes that the Company’s segments exhibit similar long-term financial performance and have similar economic characteristics.  Performance for a region or market is evaluated based on sales.  No single Associate accounted for 10% or more of net sales for the periods presented.  The table below summarizes the approximate percentage of total product revenue that has been contributed by the Company’s nutritional and personal care products for the periods indicated.

 

		Quarter Ended				Nine Months Ended
		October 1,		September 30,		October 1,		September 30,
		2016		2017		2016		2017
USANA® Nutritionals		85	%	83	%	83	%	84	%
USANA Foods		8	%	9	%	10	%	9	%
Sensé — beautiful science®		6	%	6	%	6	%	6	%

 

Selected financial information for the Company is presented for two geographic regions: Asia Pacific, with three sub-regions under Asia Pacific, and Americas and Europe.  Individual markets are categorized into these regions as follows:

 

·                  Asia Pacific —

 

·                  Greater China — Hong Kong, Taiwan and China(1)

·                  Southeast Asia Pacific — Australia, New Zealand, Singapore, Malaysia, the Philippines, Thailand, and Indonesia

·                  North Asia — Japan and South Korea

 

·                 Americas and Europe — United States, Canada, Mexico, Colombia, the United Kingdom, France, Belgium, and the Netherlands.

 

(1) The Company’s business in China is that of BabyCare, its wholly-owned subsidiary.

 

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USANA HEALTH SCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(in thousands, except per share data)

(unaudited)

 

NOTE I — SEGMENT INFORMATION - CONTINUED

 

Selected Financial Information

 

Financial information by geographic region is presented for the periods indicated below:

 

		Quarter Ended						Nine Months Ended
		October 1,			September 30,			October 1,			September 30,
		2016			2017			2016			2017
Net Sales to External Customers
Asia Pacific
Greater China		$	124,470		$	131,273		$	373,308		$	399,713
Southeast Asia Pacific		54,351			52,310			154,335			151,381
North Asia		11,555			15,708			33,376			42,612
Asia Pacific Total		190,376			199,291			561,019			593,706
Americas and Europe		63,843			62,474			192,163			180,445
Consolidated Total		$	254,219		$	261,765		$	753,182		$	774,151

 

The following table provides further information on markets representing ten percent or more of consolidated net sales and long-lived assets, respectively:

 

		Quarter Ended						Nine Months Ended
		October 1,			September 30,			October 1,			September 30,
		2016			2017			2016			2017
Net sales:
China		$	108,355		$	116,174		$	324,689		$	352,462
United States		$	34,352		$	34,183		$	101,245		$	93,219

 

		As of
		December 31,			September 30,
		2016			2017
Long-lived assets:
China		$	91,909		$	94,938
United States		$	63,654		$	61,384

 

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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 is presented in six

 

sections:

 

·                  Overview

·                  Customers

·                  Current Focus and Recent Developments

·                  Results of Operations

·                  Liquidity and Capital Resources

·                  Forward-Looking Statements and Certain Risks

 

This discussion and analysis should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and Notes thereto that are contained in this quarterly report, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2016, and our other filings, including Current Reports on Form 8-K, that have been filed with the SEC through the date of this report.

 

Overview

 

We develop and manufacture high-quality, science-based nutritional and personal care products that are distributed internationally through a network marketing system, which is a form of direct selling.  We have chosen this distribution method as we believe it is more conducive to meeting our vision as a company, which is improving the overall health and nutrition of individuals and families around the world.  Our customer base comprises two types of customers: “Associates” and “Preferred Customers” referred to together as “active Customers.”  Associates share in our company vision by acting as independent distributors of our products in addition to purchasing our products for their personal use.  Preferred Customers purchase our products strictly for their personal use and are not permitted to resell or to distribute the products.  As of September 30, 2017, we had approximately 563,000 active Customers worldwide.  For purposes of this report, we only count as active Customers those Associates and Preferred Customers who have purchased from us at any time during the most recent three-month period.

 

We have ongoing operations in the following markets, which are grouped and presented as follows:

 

·                  Asia Pacific

 

·                  Greater China — Hong Kong, Taiwan, and China(1)

 

·                  Southeast Asia Pacific — Australia, New Zealand, Singapore, Malaysia, the Philippines, Thailand, and Indonesia

 

·                  North Asia — Japan and South Korea

 

·                  Americas and Europe — United States, Canada, Mexico, Colombia, the United Kingdom, France, Belgium, and the Netherlands

 

(1)         Our business in China is that of BabyCare, our wholly-owned subsidiary.

 

Our primary product lines consist of USANAâ Nutritionals, USANA Foods, and Sensé — beautiful scienceâ (Sensé), which is our line of personal care products.  The USANA Nutritionals product line is further categorized into two separate classifications: Essentials and Optimizers.  The following tables summarize the approximate percentage of total product revenue that has been contributed by our major product lines and our top-selling products for the current and prior-year periods as indicated:

 

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		Nine Months Ended
		October 1, 2016		September 30, 2017
Product Line
USANA® Nutritionals
Essentials/CellSentials		20	%	19	%
Optimizers		63	%	65	%
USANA Foods		10	%	9	%
Sensé — beautiful science®		6	%	6	%
All Other		1	%	1	%
Key Product
USANA® Essentials		14	%	13	%
Proflavanol®		13	%	12	%
BiOmega-3™		13	%	14	%

 

We believe that our ability to attract and retain Associates and Preferred Customers to sell and consume our products is positively influenced by a number of factors, some of which include: the general public’s heightened awareness and understanding of the connection between diet and long-term health, and the growing desire for a secondary source of income and small business ownership.

 

We believe that our high-quality products and our financially rewarding Associate Compensation Plan are the key components to attracting and retaining Associates.  We periodically make changes to our Compensation Plan in an effort to ensure that our plan is among the most rewarding in the industry, to encourage behavior that we believe leads to a successful business for our Associates, and to ensure that our plan provides us with leverage to grow sales and earnings.

 

To further support our Associates in building their businesses, we sponsor meetings and events throughout the year, which offer information about our products and our network marketing system.  These meetings are designed to assist Associates in their business development and to provide a forum for interaction with our Associate leaders and members of our management team.  We also provide low cost sales tools, including online sales, business management, and training tools, which we believe are an integral part of building and maintaining a successful home-based business for our Associates.  Although we provide training and sales tools, we ultimately rely on our Associates to sell our products, attract new active Customers to purchase our products, and educate and train new Associates.

 

Because we have operations in multiple markets, with sales and expenses being generated and incurred in multiple currencies, our reported U.S. dollar sales and earnings can be significantly affected by fluctuations in currency exchange rates.  In general, our operating results are affected positively by a weakening of the U.S. dollar and negatively by a strengthening of the U.S. dollar.  During the nine months ended September 30, 2017, net sales outside of the United States represented 88.0% of consolidated net sales.  In our net sales discussions that follow, we approximate the impact of currency fluctuations on net sales by translating current year sales at the average exchange rates in effect during the comparable periods of the prior year.

 

Customers

 

Because we sell our products exclusively to a customer base of independent Associates and Preferred Customers, to increase net sales we must increase either the number or the productivity of our active Customers.  Increasing the productivity of our active Customers has not been our primary focus.  Rather, we seek to increase the number of active Customers who use and sell our products.  We believe this focus is more consistent with our vision of improving the overall health and nutrition of individuals and families around the world.  Sales to Associates account for the majority of our product sales, representing approximately 91% of product sales during the nine months ended September 30, 2017; the remainder of our sales are to Preferred Customers.  Increases or decreases in product sales are typically the result of variations in the volume of product sold relating to fluctuations in the number of

 

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