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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended January 1, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ____________
Commission file number: 0-21116
______________________
USANA, INC.
(Exact name of registrant as specified in its charter)
Utah 87-0500306
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3838 West Parkway Blvd., Salt Lake City, Utah 84120
(Address of principal executive offices, Zip Code)
(801) 954-7100
(Registrant's telephone number, including area code)
______________________
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
______________________
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of March 21, 2000 was approximately $30,140,376.
The number of shares outstanding of the registrant's common stock as of
March 21, 2000 was 9,890,437.
Documents incorporated by reference. The Company incorporates information
required by Part III (Items 10, 11, 12 and 13) of this report by reference to
the Company's definitive proxy statement to be filed pursuant to Regulation 14A.
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USANA, INC.
FORM 10-K
For the Fiscal Year Ended January 1, 2000
INDEX
Page
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Part I
Item 1 Business ............................................................................................... 3
Item 2 Properties ............................................................................................. 15
Item 3 Legal Proceedings ...................................................................................... 16
Item 4 Submission of Matters to a Vote of Security Holders .................................................... 17
Part II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters .................................. 17
Item 6 Selected Financial Data ............................................................................... 18
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 19
Item 7a Quantitative and Qualitative Disclosures About Market Risk ............................................. 30
Item 8 Financial Statements and Supplementary Data ............................................................ 37
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .................................................................................. 37
Part III
Item 10 Directors and Executive Officers of the Registrant ..................................................... 37
Item 11 Executive Compensation ................................................................................. 37
Item 12 Security Ownership of Certain Beneficial Owners and Management ......................................... 38
Item 13 Certain Relationships and Related Transactions ......................................................... 38
Part IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K ....................................... 38
Signatures
2
PART I
Item 1. Business
General
USANA, Inc. ("USANA" or the "Company") develops and manufactures high-
quality nutritional, personal care and weight management products. The Company
distributes its products through a network marketing system and refers to its
distributors as "Associates." As of January 1, 2000, the Company had
approximately 113,000 current Associates in the United States, Canada,
Australia, New Zealand, Hong Kong, and the United Kingdom (hereinafter includes
the Netherlands). The Company defines a current Associate as an Associate that
has purchased product from the Company at any time during the most recent
twelve-month period. USANA also sells products directly to Preferred Customers,
who do not act as distributors of the products. At January 1, 2000, the Company
had approximately 46,000 Preferred Customers.
Founded in 1992 by Myron W. Wentz, Ph.D., USANA is committed to continuous
product innovation and sound scientific research. The Company's three primary
product lines consist of nutritional, personal care and weight management
products. Nutritional products accounted for approximately 83% of net sales in
1999. The top-selling products, USANA Essentials and Proflavanol, represented
approximately 42% and 16%, respectively, of net sales in 1999. USANA's personal
care line includes skin, hair and body, and dental care products. Weight
management products include a dietary supplement tablet, food bars, meal
entrees, instructional videos and other products developed to provide a
comprehensive approach to weight management, proper diet and exercise, nutrition
and healthy living. High levels of bioavailability, safety and quality
characterize all of the Company's products.
The Company's products are distributed primarily through a network
marketing system. The Company believes that network marketing is an effective
way to distribute its products because network marketing allows person-to-person
product education, which is not readily available through traditional
distribution channels. Network marketing appeals to a broad cross-section of
people, particularly those seeking to supplement family income, start a home-
based business or pursue entrepreneurial opportunities other than conventional
full-time employment. The Company considers its rewarding compensation program
and weekly Associate incentive payments to be attractive components of its
network marketing system.
The Company introduced its Preferred Customer program in 1997 for customers
who want to purchase USANA products for personal use, but do not wish to become
Associates. The Preferred Customer program has become an important part of
USANA's business. During 1999, Preferred Customer purchases accounted for
approximately 11% of net sales.
North America is the primary market for the Company's products. Sales in
the United States and Canada collectively represented approximately 75% of net
sales in 1999. In February 1998, the Company began operations in Australia-New
Zealand, its first market outside North America. Sales in the Australia-New
Zealand market represented approximately 20% of net sales in 1999. The Company
also commenced operations in the United Kingdom market in December 1998. To
manage the combination of low sales and relatively high operating costs in the
United Kingdom, the Company made a decision to service the United Kingdom
beginning in February 2000 from its headquarters in Salt Lake City, Utah. The
Company also opened Hong Kong, its first market in Asia, in November 1999.
The Company's growth strategy is to introduce new products, attract and
retain Associates and Preferred Customers, enter new markets and pursue
strategic acquisitions. The Company believes it can successfully implement this
growth strategy by continuing to capitalize on its operating strengths:
. Science-based products,
. Strong research and development program,
. In-house manufacturing capabilities,
. Attractive Associate compensation plan and benefits, and
. Experienced management team.
3
During 1999, the Company introduced several new products including Body Rox
(Essentials for Teens), Usanimals (Essentials for Kids), Garlic EC, BiOmega-3,
E-Prime, Iron 28, ActiCal, PhytoEstrin, Palmetto Plus, Ginkgo-PS, St. John's
Wort, SoyaMax, and a new L*E*A*N Team Formula.
Financial Information by Business Segment
The Company is principally engaged in a single line of business, the
development, manufacture and distribution of nutritional, personal care and
weight management products. The Company's reportable business segments are
distinguished by geography and include the United States, Canada, Australia-New
Zealand, Hong Kong, and the United Kingdom. Segment information of the Company
for each of the last three fiscal years is included in Note L of the Financial
Statements.
Industry Overview
The nutritional supplements industry includes many small- and medium-sized
companies that manufacture and distribute products generally intended to enhance
the body's performance and well being. Nutritional supplements include vitamins,
minerals, dietary supplements, herbs, botanicals and compounds derived
therefrom.
In their Healthy Living Industry Report dated February 28, 2000, Adams,
Harkness & Hill stated that their research suggests the overall market for
natural products is approximately $19 billion and growing at a 15% to 20% annual
rate.
The Company believes that growth in the nutritional supplement market is
driven by several factors including:
. The general public's heightened awareness and understanding of the
connection between diet and health,
. The aging population, particularly the baby-boomer generation, which
is more likely to consume nutritional supplements,
. Product introductions in response to new scientific research,
. The worldwide trend toward preventive health care, and
. The adoption of the Dietary Supplement Health and Education Act of
1994 ("DSHEA") in the United States.
Nutritional supplements are sold through mass market retailers, including
mass merchandisers, drug stores, supermarkets and discount stores, health food
stores and direct sales organizations, including network marketing organizations
and catalog companies. Direct selling, of which network marketing is a
significant segment, has increased in popularity as a distribution channel due
primarily to advances in technology and communications resulting in improved
product distribution and faster dissemination of information. The distribution
of products through network marketing has grown significantly in recent years.
The Direct Sellers Association ("DSA") reported that worldwide sales through the
network marketing channel were estimated to be $83 billion in 1998 and had over
33 million distributors. According to the "Survey of Attitudes Toward Direct
Selling," commissioned by the DSA and conducted and prepared by Wirthlin
Worldwide, three product categories experiencing the greatest gains in the
direct selling industry since 1976 are food, nutrition and wellness products.
As both a developer and manufacturer of nutritional supplements with a
network marketing distribution system, the Company believes it is well
positioned to capitalize on the demand for nutritional supplement products and
growth trends in direct sales.
Operating Strengths and Growth Strategy
The Company's objective is to be a leading developer, manufacturer and
distributor of science-based nutritional products. The Company believes that it
will be able to continue to grow by capitalizing on the following operating
strengths:
Science-based Products. The Company has developed a line of high-quality
nutritional products based upon a combination of published research, in vitro
testing, in-house clinical studies and sponsored research. The Company believes
that
4
the identification and delivery of essential vitamins, minerals and other
supplements will help individuals achieve and maintain lifelong health.
Strong Research and Development. The Company's research and development
effort is directed by Dr. Wentz and is supported by a team of 23 scientists and
researchers, including eight scientists holding Ph.D. degrees. In its research
and development laboratory, the Company's scientists:
. Investigate in vitro activity of new natural extracts,
. Identify and research combinations of nutrients that may be candidates
for new products,
. Study the metabolic activity of existing and newly identified
nutritional supplements, and
. Enhance existing products as new discoveries in nutrition are made and
as required to enter international markets.
The Company also performs retrospective analyses of anecdotal information
provided by consumers of its products. In addition, the Company is currently the
sponsor of three double-blind, placebo-controlled clinical studies intended to
further investigate the efficacy of its products.
In-house Manufacturing. USANA believes that its ability to manufacture a
significant portion of its products is a competitive advantage and contributes
to its ability to provide high-quality products for several reasons:
. The Company is able to control the quality of raw materials and the
purity and potency of its finished products,
. The Company can monitor the manufacturing process to reduce the risk
of product contamination,
. By testing products at several stages in the manufacturing process,
the Company can ensure accurate product labeling, and
. The Company believes it can better control the underlying costs
associated with manufacturing nutritional supplements.
Attractive Associate Compensation Plan and Benefits. The Company is
committed to providing a highly competitive compensation plan to attract and
retain Associates, who constitute the sales force of the Company. The Company
believes its Associate compensation plan is one of the most financially
rewarding in the direct selling industry. Associate incentives were 44.1% of net
sales in 1999. The Company pays Associate incentives on a weekly basis and
offers its Associates an opportunity to participate in a plan to purchase the
Company's common stock through commission check deductions. The Company also
provides extensive support services to its Associates by telephone, fax and the
Internet. The Company sponsors events throughout the year, which offer
information about the Company's products and network marketing system. These
meetings are designed to assist Associates in business development and to
provide a forum for interaction with successful Associates and the Company's
scientists.
Experienced Management Team. The Company's management team includes
individuals with expertise in various scientific and managerial disciplines,
including nutrition, product research and development, marketing, direct sales,
information technology, finance, operations and manufacturing. The current
executive management team has been in place for more than three years and has
been responsible for strengthening the Company's internal controls, financial
condition and infrastructure to support growth and international expansion.
Growth Strategy
The Company intends to pursue its growth objectives by implementing the
following growth strategy:
Introduce New Products. The Company utilizes its research and development
capabilities to introduce innovative products and to continuously enhance
existing products. During 1999, the Company introduced several new products,
including 12 nutritional supplements and a new L*E*A*N Team Formula. The Company
also introduced Selenium and the L*E*A*N
5
Team program into its Australia-New Zealand market and Procosamine in its United
Kingdom market. The Company introduces new products throughout the year,
primarily at Company-sponsored Associate events.
Attract and Retain Associates and Preferred Customers. As of January 1,
2000, the Company had approximately 113,000 current Associates and 46,000
Preferred Customers compared to approximately 116,000 current Associates and
26,000 Preferred Customers one year ago. In February 2000, the Company
introduced a value initiative that decreased prices on its products by an
average of approximately 24%. With the introduction of the value initiative, the
Company believes that it will be more successful in its efforts to attract and
retain both Associates and Preferred Customers by offering high quality products
and comprehensive customer support services at the lowest prices in the
Company's history.
Enter New Markets. The Company believes that, in addition to the North
American market, significant growth opportunities exist in international
markets. In November 1999, the Company opened operations in Hong Kong. The
Company's decision to enter new markets in the future will be based on its
assessment of several factors, including market size, anticipated demand for the
Company's products, receptivity to direct sales and ease of entry, including
possible regulatory restrictions on the products or marketing system of the
Company. The Company has begun to register certain products with regulatory and
government agencies in order to position it for further international expansion.
The Company seeks to seamlessly integrate its Associate compensation plan in
each of its markets to allow Associates to receive commissions for global
product sales, rather than merely local product sales. This seamless downline
structure is designed to allow an Associate to build a global network by
creating downlines across national borders. Associates are not required to
establish new downlines or requalify for higher levels of compensation in newly
opened markets. The Company believes this seamless compensation plan
significantly enhances its ability to expand internationally and intends, where
permitted, to integrate future markets into the plan.
Pursue Strategic Acquisitions. The Company believes that attractive
acquisition opportunities may arise in the future. The Company intends to pursue
strategic acquisition opportunities that would expand its product lines, enhance
its manufacturing and technical expertise, allow vertical integration or
otherwise complement its business or further its strategic goals.
Products
Product names used in this report are, in certain cases, trademarks and are
also the property of the Company, including Poly C(R), CoQuinone(R),
Proflavanol(R), Melatonin KL(R), OptOmega(R), Nutrimeal(TM), Fibergy(R),
L*E*A*N(TM), VitalZomes(R), Procosamine(TM), Procosa(TM), Forever L*E*A*N(R),
Lifemasters(R), USANA TRUE HEALTH(TM), BiOmega-3(TM), Garlic EC(TM), E-
Prime(TM), Iron 28(TM), ActiCal(TM), PhytoEstrin(TM), Palmetto Plus(TM), Ginkgo-
PS(TM), St. John's Wort(TM), Cranberry Drink(TM), Body Rox(TM) (Essentials for
Teens), Usanimals(TM) (Essentials for Kids), and SoyaMax(TM).
The Company's primary product lines consist of nutritional, personal care
and weight management products. In each of the last three years, the nutritional
product line constituted 80% or more of the Company's net sales. The Company's
principal product lines are briefly described below:
Nutritional Products. This product line includes antioxidants, minerals,
vitamins, other nutritional supplements, meal replacement drinks, fiber drinks,
and food bars. USANA's nutritional supplement products are designed to provide
optimal absorption, bioavailability and efficacy. The top-selling products of
the Company are the USANA Essentials (comprised of Mega Antioxidant and Chelated
Mineral) and Proflavanol, which represented approximately 42% and 16%,
respectively, of net sales in 1999. Other products in this line include Body Rox
(Essentials for Teens), Poly C, Procosamine, CoQuinone, Melatonin KL, OptOmega,
BiOmega-3, Garlic EC, E-Prime, Iron 28, ActiCal, PhytoEstrin, Palmetto Plus,
Ginkgo-PS, St. John's Wort, Nutrimeal, Fibergy, Cranberry Drink, Usanimals
(Essentials for Kids), and SoyaMax.
Personal Care Products. The personal care product line includes skin, hair
and body, and dental care products. The skin care products are designed to
provide a total skin protection system. Natural oils and emollients,
antioxidants and botanical extracts are key ingredients in USANA's skin care
line, consisting of the Antioxidant Skin Care System, Vital Zomes Serum
Replenisher, Revitalizing Hydrating Treatment and USANA Sunscreen. The Company
has designed hair and body products that generally incorporate pure, natural
substances instead of cheaper, synthetic substances. These products include
shampoo, conditioner, hand and body lotion, shower gel, and the Dental Care
System. The key product in the Dental Care System is the all-natural toothpaste,
which contains a unique combination of natural ingredients that have been shown
to be effective in reducing bacterial plaque adhesion to tooth enamel. The other
products in the Dental Care System are mouthwash, fluoride gel, a toothbrush,
dental floss and a tongue scraper.
6
Weight Management Products. The Company has developed its L*E*A*N Team
program to provide a comprehensive approach to weight management, proper diet
and nutrition, and healthy living. The program's underlying principles,
Lifestyle, Education, Activity and Nutrition, literally spell out the L*E*A*N
philosophy. Developed with the assistance of health, nutrition and fitness
experts, the USANA L*E*A*N program seeks to use the latest developments in
nutritional science, psychology and exercise physiology to promote lifelong
health, fitness and well being. The complete USANA L*E*A*N program is packaged
in a custom gym bag and includes:
. A program guide,
. A physical activity guide and instructional videos,
. A motivational audio cassette series,
. A recipe book,
. Calipers to measure body fat,
. L*E*A*N Nutrimeal,
. The New USANA L*E*A*N Formula, a dietary supplement tablet that contains
botanical extracts to augment the body's natural weight-loss processes with
a new ingredient called Advantra Z,
. Food bars,
. Meal entrees, and
. Aerobic workout videos.
In addition to its three principal product lines, the Company has developed
and makes available to Associates a number of materials to assist them in
building their business and selling the Company's products. These resource
materials or sales aids, which may be purchased from the Company, include
product brochures and business forms designed by the Company and printed by
outside publishers. From time to time the Company contracts with authors and
publishers to provide books, tapes and other items dealing with health and
personal motivation. The Company also writes and develops materials for audio
and videotapes, which are produced by third parties. Affinity and identity are
also furthered through the sale of logo merchandise such as clothing, caps, mugs
and other products. Associates do not earn commissions on sales aids, Associate
kits or logo merchandise.
Research and Development
The Company is committed to continuous product innovation and improvement
through sound scientific research. The mission of the Company's research and
development team is to develop superior products that support life-long health.
Products are developed and enhanced using a combination of published research,
in vitro testing, in-house clinical studies and sponsored research. The Company
periodically consults with a panel of physicians who advise the Company on
product development. The Company invested $1.2 million in 1997 and $1.4 million
in both 1998 and 1999, in research and development activities. The Company
intends to continue to use its resources in the research and development of new
products and reformulation of existing products.
The Company maintains a research and development program based upon
established scientific research methodologies. The modern research facilities
located at its Salt Lake City headquarters are equipped to handle analytical
testing of new raw ingredients, raw material extraction research, in vitro
testing, cell culture procedures and human bioavailability studies. Clinical
evaluations are designed and sponsored by the Company. Anecdotal information
from customers is reviewed and retrospective analyses are performed on this
data. Contract clinical studies are conducted on selected existing products for
which the retrospective analysis has demonstrated a positive effect, and also on
new products to investigate efficacy. Currently, the Company is sponsoring three
double-blind, placebo-controlled clinical studies.
7
Manufacturing and Quality Assurance
At its Salt Lake City, Utah, manufacturing facility, the Company
manufactured products that accounted for approximately 74% of net sales in 1999.
The Company's production process includes the following steps:
. Identifying and evaluating suppliers of raw materials,
. Acquiring premium-quality raw materials,
. Weighing or otherwise measuring the raw materials,
. Mixing raw materials into batches,
. Forming the mixtures into tablets,
. Coating and sorting the tablets, and
. Bottling and labeling the finished products.
Most of these processes are performed using automatic and semi-automatic
equipment. The Company conducts sample testing of raw materials and finished
products for purity, potency and composition conforming to the Company's
specifications. Constructed in 1996, USANA's production facility is registered
with the Food and Drug Agency ("FDA") and the Canadian Health Protection Branch
("HPB") and is certified by the Australian Therapeutic Goods Administration
("TGA"). Although the Company need only comply with food-level Good
Manufacturing Practice regulations ("GMP's") of the FDA, it believes that it is
in compliance with that agency's more demanding drug-level GMP's. The
certification by the TGA applies to that agency's drug-level GMP's.
The Company also contracts with third-party manufacturers and vendors for
the production of some of its products, including most of the products in its
personal care and weight management product lines and certain of its nutritional
products. These third-party vendors and manufacturers produce and, in most
cases, package the Company's products according to formulations developed by or
in conjunction with USANA's product development team.
USANA conducts quality assurance in its two laboratories located in Salt
Lake City, Utah. The microbiology laboratory serves as the primary quality
control facility, where quality assurance personnel test for biological
contamination in raw materials and finished goods. In the analytical chemistry
laboratory, USANA scientists test for chemical contamination and accurate active
ingredient levels of raw materials and finished products and conduct stability
tests on finished products. The Company performs chemical assays on vitamins and
mineral constituents under United States Pharmacopoeia and other validated
methods in its analytical chemistry laboratories.
Most of the raw ingredients used in the manufacture of the Company's
products are available from a number of suppliers. The Company has not generally
experienced difficulty in obtaining necessary quantities of raw ingredients.
When supplies of certain raw materials have tightened, the Company has been able
to find alternative sources of raw materials when needed and believes it will be
able to do so in the future.
The Company's manufacturing facility currently produces an average of 33
million tablets a month, using approximately 66% of its manufacturing capacity
(assuming two eight-hour shifts per day, five days per week). The Company's
packaging equipment fills an average of 350,000 bottles a month, using
approximately 80% of its packaging capacity (again assuming two eight-hour
shifts per day, five days per week). Currently the Company is operating two
shifts per day in packaging and manufacturing. This facility also fills tubes
with the Company's skin care products. The Company expects that growth in new
and existing markets will require additional manufacturing, packaging and
warehouse capacity in the next 12 months. There can be no assurance that such
growth will occur. However, if it does, then the Company will be required to use
cash from operations or obtain financing from available bank lines of credit or
the sale of its equity securities to expand its facilities.
8
Distribution and Marketing
USANA distributes its products primarily through a network marketing
system. The Company also sells directly to its Preferred Customers. Network
marketing is a form of person-to-person direct selling through a network of
vertically organized distributors who purchase products at wholesale prices from
the manufacturer and then make retail sales to consumers. The emergence of
readily available means of mass communication such as personal computers,
facsimiles, low-cost long distance telephone services, satellite conferencing
and the Internet have contributed to the rapid growth of direct selling,
including network marketing. Network marketing is gaining in popularity as a
viable alternative to traditional retail and mail order marketing. The concept
of network marketing is based on the strength of personal recommendations that
frequently come from friends, neighbors, relatives and close acquaintances. The
Company believes that network marketing is an effective way to distribute its
products because it allows person-to-person product education, which is not as
readily available through traditional distribution channels.
Customers who desire to sell the Company's products may become Associates
by being sponsored into the program by another Associate, thereby becoming part
of the sponsoring Associate's downline. The Company believes many of its
Associates are attracted to USANA because of the quality of its products and its
rewarding compensation plan. New Associates must enter into a written contract,
which obligates them to adhere to USANA's policies and procedures. Associates
are also required to purchase an Associate kit that includes a detailed manual
of the policies and procedures. The cost of this kit is $50, which approximates
the Company's costs of producing and distributing the kit. Associates must also
pay an annual renewal fee to the Company of $20.
Associates order products directly from the Company, subject to certain
limitations and restrictions. For example, an Associate may not purchase more
products during any four-week period than the Associate can reasonably expect to
sell and personally consume during that same period. An Associates business
continues until terminated by the Company or voluntarily canceled by the
Associate. Initial training of Associates about the Company, its products, the
Associate compensation plan, and how to effectively engage in network marketing
is provided primarily by an Associate's sponsor and others in their upline
organization. In addition, the Company develops and sells a variety of training
materials and sales aids, as well as a detailed policies and procedures manual
and description of the Company's Associate compensation plan. The Company
sponsors and conducts regional, national and international Associate events and
intensive leadership training seminars. Attendance at these sessions is
voluntary, and the Company undertakes no generalized effort to provide
individualized training to Associates. Associates may not sell competitive
products to other USANA Associates or solicit USANA Associates to participate in
other network marketing opportunities. The Company also restricts advertising
and making representations or claims concerning its products or compensation
plan.
The Associate compensation plan provides several opportunities for
Associates to earn compensation, provided they are willing to consistently work
at building, training and retaining their downline organizations to maintain
sales of the Company's products to consumers. The Company believes its Associate
compensation plan is distinctive for its equitable Associate payouts, which are
designed to create appropriate incentives for sales of USANA products. Each
Associate must purchase and sell product in order to earn commissions and
bonuses. Associates cannot simply recruit others for the purpose of developing a
downline and then earn income passively. Associates can earn compensation in
three ways:
. Purchasing products at special distributor prices from the Company and
selling them to consumers at higher retail prices,
. Generating sales volume points in their downlines, and
. Participating in a leadership bonus pool paid to Associates who meet
certain performance requirements.
The Company seeks to seamlessly integrate its Associate compensation plan
across all markets in which its products are sold, in order to allow Associates
to receive commissions for global, rather than merely local, product sales. This
seamless downline structure is designed to allow an Associate to build a global
network by creating downlines across national borders. Associates are not
required to establish new downlines or requalify for higher levels of
compensation in newly opened markets. The Company believes this seamless
compensation plan significantly enhances its ability to expand internationally
and the Company intends, where permitted, to integrate any new markets into this
plan.
The Company also offers a Preferred Customer program designed for consumers
who desire to purchase the Company's products for their personal use, but who
choose not to become Associates. The Company believes this program gives it
access to
9
a market that would otherwise be missed by targeting customers who enjoy USANA
products, but prefer a mail order type relationship with the Company. Preferred
Customers may not engage in retail sales of products purchased through the
program, although they may enroll as Associates at any time if they desire.
Preferred Customers are not eligible to earn commissions unless they become
Associates.
The Company's product return policy allows retail customers to return the
unused portion of any product to the Associate and receive a full cash refund.
Any Associate who provides a refund to a customer is reimbursed by the Company
with product or credit in his or her account upon providing proper documentation
and the remainder of the returned product.
Return of unused and resalable products initiated by a customer will be
refunded at 100% of the purchase price to the customer, less a 10% restocking
fee for up to one year from the date of purchase. Product that was damaged
during shipment to the customer is also 100% refundable. Product returns valued
at $100 or more, other than product that was damaged at the time of receipt by
an Associate, may result in termination of the distributorship. Returns as a
percentage of net sales were 1.3% in 1997, 1.5% in 1998 and 1.7% in 1999.
Substantially all of the Company's sales are made to Preferred Customers
and through independent Associates. No single Associate accounted for 5% or more
of net sales in any of the last three years. Associates are independent
contractors and are not agents, employees, or legal representatives of USANA.
Employees and affiliates of the Company cannot be Associates, although there is
no prohibition on their family members from becoming Associates as long as they
do not reside in the same household. Associates may sell products only in
markets where the Company has approved the sale of its products.
The Company systematically reviews reports of alleged Associate
misbehavior. If the Company determines that an Associate has violated any of the
Associate policies or procedures, it may take a number of disciplinary actions.
For example, the Company may terminate the Associate's rights completely or
impose sanctions such as warnings, fines, probation, withdraw or deny awards,
suspend privileges, withhold commissions until specific conditions are
satisfied, or take other appropriate injunctions at the Company's discretion. An
in-house compliance officer and a commission auditor also routinely review
Associate activities. Infractions of the policies and procedures are reported to
a compliance committee that determines what disciplinary action may be warranted
in each case.
Information Technology
The Company believes its ability to efficiently manage its distribution,
compensation, manufacturing, inventory control and communications functions
through the use of sophisticated and dependable information processing systems
is critical to its success. The Company's information technology systems are
designed and selected in order to facilitate order entry and customer billing,
maintain Associate records, accurately track purchases and Associate incentive
payments, manage accounting, finance and manufacturing operations, and provide
customer service and technical support. The Company's information systems are
maintained by in-house staff and outside consultants.
Regulatory Matters
Product Regulation. Manufacturing, packaging, labeling, advertising,
promotion, distribution, and sale of the Company's products are subject to
regulation by numerous governmental agencies in the United States and other
countries. In the United States, the FDA regulates the Company's products under
the Food, Drug, and Cosmetic Act ("FDC Act") and regulations promulgated
thereunder. The Company's products are also subject to regulation by, among
others, the Consumer Product Safety Commission, the US Department of
Agriculture, and the Environmental Protection Agency ("EPA"). Advertising of the
Company's products is subject to regulation by the Federal Trade Commission
("FTC") under the Federal Trade Commission Act ("FTC Act"). The manufacturing,
labeling, and advertising of products are also regulated by various governmental
agencies in each foreign country in which the Company distributes its products.
The majority of the Company's products are regulated as dietary supplements
under the FDC Act. Dietary supplements are regulated as foods under the
Nutrition Labeling and Education Act of 1990 ("NLEA"). The NLEA establishes
requirements for ingredient and nutritional labeling and labeling claims for
foods. Dietary supplements are also regulated under DSHEA. The Company believes
DSHEA is favorable to the dietary supplement industry. Although the Company
believes its product claims comply with the law, the Company may need to revise
its labeling.
In addition, a dietary supplement that contains a new dietary ingredient
(defined as an ingredient not on the market before October 15, 1994) must have a
history of use or other evidence of safety establishing that it is reasonably
expected to be safe. The manufacturer must notify the FDA at least 75 days
before marketing products containing new dietary ingredients and
10
provide the FDA with the information upon which the manufacturer based its
conclusion that the product has a reasonable expectation of safety.
The FDA issued final dietary supplement labeling regulations in 1997 that
required a new format for product labels and necessitated revising dietary
supplement product labels by March 23, 1999. All companies in the dietary
supplement industry were required to comply with these new regulations. The
Company updated its product labels in 1997 in response to these new regulations.
The FDA also announced that it is considering the adoption of new GMP's specific
to dietary supplements. Such GMP's, if promulgated, may be significantly more
rigorous than currently applicable GMP's and contain quality assurance
requirements similar to the FDA's GMP's for drug products. The Company believes
it currently manufactures its dietary supplement products according to the
standards of the drug-level GMP's. However, the Company may be required to
expend additional capital and resources on manufacturing controls in the future
in order to comply with the law.
Other products marketed by the Company include cosmetics, over-the-counter
("OTC") drugs, and medical devices. In general, the Company's cosmetic products
currently are not subject to premarket approval by the FDA. However, cosmetics
are subject to regulation by the FDA under the FDC Act's adulteration and
misbranding provisions. Cosmetics also are subject to specific labeling
regulations, including warning statements if the safety of a cosmetic is not
adequately substantiated or if the product may be hazardous, as well as
ingredient statements and other packaging requirements under the Fair Packaging
and Labeling Act. Cosmetics that meet the definition of a drug (e.g., are
intended to treat or prevent disease or affect the structure or function of the
body), such as the Company's sunscreens and anti-cavity dental treatment gel,
are regulated as drugs. OTC drug products may be marketed if they conform to the
requirements of any OTC monograph that is applicable to a drug. Drug products
not conforming to monograph requirements for OTC drug products require an
approved New Drug Application ("NDA") before marketing. The agency has not yet
promulgated final monographs for some of the Company's products, such as
sunscreens. If the agency finds that a product or ingredient of one of the
Company's OTC drug products is not generally recognized as safe and effective or
does not include it in a final monograph applicable to one of the Company's OTC
drug products, the Company will have to reformulate or cease marketing the
product until it is the subject of an approved NDA or until such time, if ever,
that the monograph is amended to include the Company's product. For example, the
Company's hand and body lotion contains an ingredient, colloidal silver, that is
the subject of a proposed rule finding that currently it is not generally
recognized as safe and effective for external or internal use. If the rule
becomes final, the Company will have to stop marketing the product as currently
formulated. Whether or not an OTC drug product conforms to a monograph or is
subject to an approved NDA, such a drug must comply with other requirements
under the FDC Act including GMP's, labeling, and the FDC Act's misbranding and
adulteration provisions.
Most of the Company's medical device products, as currently designed and
marketed, do not require premarket approval or clearance by the FDA. The Medical
Device Amendments of 1976 to the FDC Act established three regulatory classes
for medical devices depending on the degree of control necessary to provide a
reasonable assurance of safety and effectiveness. Generally, Class I devices
present the least risk to health and Class III devices present the greatest risk
to health and the most complex or novel technologies. Some Class I and most
Class II devices currently require premarket notification and clearance by the
FDA before marketing under section 510(k) of the FDC Act. Devices for which the
FDA has not promulgated a classification regulation also require premarket
notification and clearance. Class III devices require premarket approval before
commercial distribution, because the FDA either has promulgated a regulation
requiring a premarket application for a pre-amendments type of device, or a
post-amendments device was not found substantially equivalent to a legally
marketed device. The Company's toothbrush and floss are currently regulated as
Class I devices and do not require premarket notification or clearance by the
agency. The Company's tongue scraper device is as yet unclassified by the FDA
and, therefore, the manufacturer received FDA clearance following premarket
notification under section 510(k) before marketing. Modifications to the
Company's marketed devices will require a premarket notification and clearance
under section 510(k) before the changed device can be marketed, if the change or
modification could significantly affect safety or effectiveness. All of the
Company's devices, unless specifically exempted by regulation, are subject to
the FDC Act's general controls, which include, among other things, registration
and listing, adherence to Quality System Regulation requirements for
manufacturing, Medical Device Reporting, and the potential for voluntary and
mandatory recalls.
The Company's advertising of its products is subject to regulation by the
FTC under the FTC Act. Section 5 of the FTC Act prohibits unfair methods of
competition and unfair or deceptive acts or practices in or affecting commerce.
Section 12 of the FTC Act provides that the dissemination or the causing to be
disseminated of any false advertisement pertaining to drugs or foods, which
would include dietary supplements, is an unfair or deceptive act or practice.
Under the FTC's Substantiation Doctrine, an advertiser is required to have a
"reasonable basis" for all objective product claims before the claims are made.
Failure to adequately substantiate claims may be considered either deceptive or
unfair practices. Pursuant to this FTC requirement, the Company is required to
have adequate substantiation for all material advertising claims made for its
products.
11
In recent years the FTC has initiated numerous investigations of and
actions against dietary supplement, weight management, and cosmetic products and
companies. The FTC has recently issued a guidance document to assist these
companies in understanding and complying with the substantiation requirement.
The Company is organizing the documentation to support its advertising and
promotional practices in compliance with the guidelines.
The FTC may enforce compliance with the law in a variety of ways, both
administratively and judicially. Means available to the FTC include compulsory
process, cease and desist orders, and injunctions. FTC enforcement can result in
orders requiring, among other things, limits on advertising, corrective
advertising, consumer redress, divestiture of assets, rescission of contracts,
and such other relief as deemed necessary. Violation of such orders could result
in substantial financial or other penalties. Any such action by the FTC could
materially adversely affect the Company's ability to successfully market its
products.
In markets outside the United States, prior to commencing operations or
marketing its products, the Company may be required to obtain approvals,
licenses, or certifications from a country's ministry of health or comparable
agency. Approvals or licensing may be conditioned on reformulation of the
Company's products for the market or may be unavailable with respect to certain
products or product ingredients. The Company must also comply with local product
labeling and packaging regulations that vary from country to country.
The Company cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can it determine what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on its business in the future. They could include, however,
requirements for the reformulation of certain products to meet new standards,
the recall or discontinuation of certain products that cannot be reformulated,
additional record keeping, expanded documentation of the properties of certain
products, expanded or different labeling, and additional scientific
substantiation. Any or all such requirements could have a material adverse
effect on the Company's business, financial condition and results of operations.
Network Marketing Regulation. Other laws and regulations affecting the
Company have been enacted to prevent the use of deceptive or fraudulent
practices that have sometimes been inappropriately associated with legitimate
direct selling and network marketing activities. These include anti-pyramiding,
securities, lottery, referral selling, anti-fraud and business opportunity
statutes, regulations and court cases. Illegal schemes, typically referred to as
"pyramid," "chain distribution," or "endless chain" schemes, compensate
participants primarily for the introduction or enrollment of additional
participants into the scheme. Often, these schemes are characterized by large
up-front entry or sign-up fees, over-priced products of low value, little or no
emphasis on the sale or use of products, high-pressure recruiting tactics and
claims of huge and quick financial rewards with little or no effort. Generally
these laws are directed at ensuring that product sales ultimately are made to
consumers and that advancement within such sales organizations is based on sales
of the enterprise's products, rather than investments in such organizations or
other non-retail sales related criteria. Where required by law, the Company
obtains regulatory approval of its network marketing system, or, where approval
is not required or available, the favorable opinion of local counsel as to
regulatory compliance.
The Company occasionally receives requests to supply information regarding
its network marketing plan to certain regulatory agencies. Although the Company
has from time to time modified its network marketing system to comply with
interpretations of various regulatory authorities, it believes that its network
marketing program presently is in compliance with laws and regulations relating
to direct selling activities. Nevertheless, the Company remains subject to the
risk that, in one or more of its present or future markets, its marketing system
or the conduct of certain of its Associates could be found not to be in
compliance with applicable laws and regulations. Failure by the Company or its
Associates to comply with these laws and regulations could have an adverse
material effect on the Company in a particular market or in general. Any or all
of such factors could adversely affect the way the Company does business and
could affect the Company's ability to attract potential Associates or enter new
markets. In the United States, the FTC has been active in its enforcement
efforts against both pyramid schemes and legitimate network marketing
organizations with certain legally problematic components, having instituted
several enforcement actions resulting in signed settlement agreements and
payment of large fines. Although the Company has not been the target of an FTC
investigation, there can be no assurance that the FTC will not investigate the
Company in the future.
The Company cannot predict the nature of any future law, regulation,
interpretation or application, nor can it predict what effect additional
governmental legislation or regulations, judicial decisions, or administrative
orders, when and if promulgated, would have on its business in the future. It is
possible that such future developments may require revisions to the Company's
network marketing program. Any or all of such requirements could have a material
adverse effect on the Company's business, results of operations and financial
condition.
12
Competition
The business of developing and distributing nutritional, personal care and
weight management products such as those offered by the Company is highly
competitive. Numerous manufacturers, distributors and retailers compete for
consumers and, in the case of other network marketing companies, for Associates.
The Company competes directly with other entities that manufacture, market and
distribute products in each of its product lines. The Company competes with
these entities by emphasizing the underlying science, value and high quality of
its products as well as the convenience and financial benefits afforded by its
network marketing system. However, many of the Company's competitors are
substantially larger than the Company and have greater financial resources and
broader name recognition. The Company's markets are highly sensitive to the
introduction of new products that may rapidly capture a significant share of
such markets.
The nutritional supplement market in which the Company's leading products
compete is characterized by:
. Large selections of essentially similar products that are difficult to
differentiate,
. Retail consumer emphasis on value pricing,
. Constantly changing formulations based on evolving scientific
research,
. Low entry barriers resulting from low brand loyalty, rapid change,
widely available manufacturing, low regulatory requirements and ready
access to large distribution channels, and
. A lack of uniform standards regarding product ingredient sources,
potency, purity, absorption rate and form.
Similar factors are also characteristic of products comprising the
Company's other product lines. There can be no assurance that the Company will
be able to effectively compete in this intensely competitive environment. In
addition, nutritional, personal care and weight management products can be
purchased in a wide variety of channels of distribution, including retail
stores. The Company's product offerings in each product category are relatively
few compared to the wide variety of products offered by many of its competitors
and are often premium priced. As a result, the Company's ability to remain
competitive depends in part upon the successful introduction of new products and
enhancements of existing products.
The Company is also subject to significant competition from other network
marketing organizations for the time, attention and commitment of new and
current Associates. The Company's ability to remain competitive depends, in
significant part, on the Company's success in recruiting and retaining
Associates. The Company believes that it offers a rewarding Associate
compensation plan and attractive Associate benefits and services. To the extent
practicable, the Company's Associate compensation plan is designed to be
seamless, permitting international expansion without requalification or re-entry
requirements. Payments of Associate incentives are made weekly, reducing the
time an Associate must wait between purchase and sale of products and payment of
commissions. There can be no assurance that the Company's programs for
recruiting and retaining Associates will be successful. The Company competes for
the time, attention and commitment of its independent distributor force. The
pool of individuals interested in the business opportunities presented by direct
selling tends to be limited in each market and is reduced to the extent other
network marketing companies successfully recruit these individuals into their
businesses. Although management believes the Company offers an attractive
opportunity for Associates, there can be no assurance that other network
marketing companies will not be able to recruit the Company's existing
Associates or deplete the pool of potential Associates in a given market.
The Company believes that the leading network marketing company in the
world, based on total sales, is Amway Corporation and its affiliates, and that
Avon Products, Inc. is the leading direct seller of beauty and related products
worldwide. Leading competitors in the nutritional products and nutritional
direct selling markets include Herbalife International, Inc., Nature's Sunshine
Products, Inc., Rexall Sundown, Inc. and its direct selling division Rexall
Showcase International, Inc., Twinlab Corporation, Shaklee Corporation and Nu
Skin International, Inc. The Company believes there are other manufacturers of
competing product lines that may or will launch direct selling enterprises,
which will compete with the Company in certain of its product lines and for
distributors. There can be no assurance that the Company will be able to
successfully meet the challenges posed by such increased competition.
Intellectual Property
13
Trademarks. The Company uses registered trademarks in its business,
particularly relating to its corporate and product names. The Company owns 11
trademarks registered with the United States Patent and Trademark Office. The
Company has also filed applications to register six additional trademarks.
Federal registration of a trademark enables the registered owner of the mark to
bar the unauthorized use of the registered mark in connection with a similar
product in the same channels of trade by any third party anywhere in the United
States, regardless of whether the registered owner has ever used the trademark
in the area where the unauthorized use occurs. The Company also has filed
applications and owns trademark registrations, and intends to register
additional trademarks, in foreign countries where the Company's products are or
may be sold in the future. Protection afforded registered trademarks in some
jurisdictions may not be as extensive as the protection available in the United
States.
The Company also claims certain product names, unregistered trademarks and
service marks under common law. Common law trademark rights do not provide the
Company with the same level of protection afforded by registration of a
trademark. In addition, common law trademark rights are limited to the
geographic area in which the trademark is actually used. The Company believes
its trademarks, whether registered or claimed under common law, constitute
valuable assets of the Company, adding to recognition of the Company and the
marketing of its products. The Company therefore believes these proprietary
rights have been and will continue to be important in enabling the Company to
compete in its industry.
Trade Secrets. The Company has certain trade secrets that it seeks to
protect, in part, through confidentiality agreements with employees and other
parties. Certain of the Company's employees involved in research and development
activities have not entered into such agreements. Even where these agreements
exist, there can be no assurance that these agreements will not be breached,
that the Company would have adequate remedies for any breach or that the
Company's trade secrets will not otherwise become known to or independently
developed by competitors.
Patents. The Company does not own any patents and has no patent
applications pending or plans to seek patent protection of any of its products.
The Company believes that patent protection is not generally available for
nutritional supplements, the Company's core products. To the extent patents may
be obtained for nutritional products, the scope of such patents may not be
sufficiently broad to provide meaningful protection against infringement.
Labeling regulations require the Company to disclose product ingredients and
formulations, which makes enforcement of patents in the nutritional supplements
industry difficult. The Company does not believe that the lack of patents in any
way will adversely affect the Company's ability to compete in the nutritional
supplement, personal care or weight management industries.
The Company intends to protect its legal rights concerning its intellectual
property by all appropriate legal action. The Company may become involved from
time to time in litigation to determine the enforceability, scope and validity
of any of the foregoing proprietary rights. Any such litigation could result in
substantial cost to the Company and divert the efforts of its management and
technical personnel.
Backlog
The Company typically ships products within 72 hours after the receipt of
the order. As of January 1, 2000, there was no significant backlog.
Working Capital Practices
The Company maintains significant amounts of inventory in stock in order to
provide a high level of service to its Associates and Preferred Customers.
Substantial inventories are required to serve the needs of USANA's dual role as
manufacturer and distributor.
Environment
The Company presently is not aware of any instance in which it has
contravened federal, state or local provisions enacted for or relating to
protection of the environment or in which it otherwise may be subject under such
laws to liability for environmental conditions that could materially affect the
Company's operations.
14
Employees
As of March 21, 2000, the Company had approximately 435 employees (as
measured by full time equivalency), as follows: 343 in the United States, 51 in
Australia-New Zealand, 18 in Canada, and 23 in Hong Kong. Of the Company's
employees, 166 are involved in customer service and order entry, 107 in
manufacturing and shipping, 135 in selling and administration and 27 in research
and development and quality control. The Company's employees are not represented
by a collective bargaining agreement and the Company has experienced no work
stoppages as a result of labor disputes. The Company believes its relationship
with its employees is good.
Item 2. Properties
The Company's headquarters are located in Salt Lake City, Utah in a 104,000
square foot building on approximately one-half of a 16-acre parcel owned by the
Company. Of the 104,000 square feet presently occupied by the Company,
approximately 28,000 square feet are used for manufacturing, packaging and
distribution; 26,000 square feet are devoted to warehouse space; and the
remaining 50,000 square feet are occupied by executive and administrative
personnel, Associate services, research and development, and three laboratories.
The Company believes that its headquarters and the available property at this
site will prove to be adequate for anticipated growth. Administrative space in
the building is almost fully utilized and production capacity is currently
running at approximately 66% and 80% in the Company's manufacturing and
packaging facilities, respectively.
15
The following table summarizes the Company's facilities as of January 1,
2000. Total monthly lease commitments for these properties average approximately
$40,000.
Approximate Square Expiration
Location Leased/Function Feet Owned Date
----------- ---------------- ------ ---------- ----
Salt Lake City,
Utah USA............. Corporate headquarters/manufacturing/warehouse 104,000 Owned --
Tooele, Utah,
USA.................. Call center 11,200 Leased April 30, 2000
Ontario,
Canada............... Warehouse/distribution center/office 18,000 Leased March 31, 2003
Sydney,
Australia............ Central office/call center/warehouse/distribution 20,000 Leased October 30, 2002
Auckland,
New Zealand.......... Warehouse/distribution center/office 4,000 Leased March 1, 2001
Milton Keynes,
England.............. Central office/call center/distribution center 23,500 Owned --
Causeway Bay,
Hong Kong............ Central office/call center 6,900 Leased May 31, 2002
The Company is in the process of selling its facility in the United
Kingdom. As of March 21, 2000, no offers have been accepted by the Company on
this facility. The Company maintains general commercial and casualty insurance
on its properties, which it deems to be adequate for its present needs.
Item 3. Legal Proceedings
The Company is party to certain litigation in the United States Federal
District Court for the District of Connecticut, which is also affected by two
related actions as follows:
The U.S. Lawsuit. On March 6, 1996, International Nutrition Company ("INC")
filed a patent infringement action (the "U.S. Lawsuit") against a number of
defendants, including USANA, alleging infringement of U.S. patent number
4,698,360 (the "'360 patent"). The complaint, filed in the United States
District Court for the District of Connecticut ("District Court"), alleges that
USANA's Proflavanol product infringes the '360 patent. The complaint seeks
preliminary and permanent injunctions against the manufacture, sale and use of
Proflavanol, as well as damages in unspecified amounts, costs and attorneys'
fees. If INC were to prevail in its claim for injunctive relief, USANA would be
prohibited from using, selling, offering to sell, manufacturing or importing any
infringing product. If liability were established, damages in the case could
range from a reasonable royalty to lost profits, and if willfulness is
established, could also include treble damages, as well as attorneys' fees.
Having conducted a thorough investigation of the '360 patent and the allegations
made in the complaint, USANA believes that its manufacture and sale of
Proflavanol do not infringe any valid claim of the '360 patent.
Reexamination Proceeding. On April 17, 1996, an unidentified party filed a
request (the "Reexamination Proceeding") with the United States Patent and
Trademark Office ("PTO") to reexamine the validity of the '360 patent. The
request for reexamination was granted and the PTO conducted the Reexamination
Proceeding. The U.S. Lawsuit was stayed pending the outcome of the Reexamination
Proceeding. On August 22, 1997, the PTO granted a Certificate of Reexamination
for the '360 patent, confirming the validity of each of the claims of the patent
over the prior art cited as part of the Reexamination Proceeding.
The French Lawsuit. INC claims an ownership interest in the '360 patent by
assignment from Societe Civile d'Investigation Pharmacologique d'Acquitane
("SCIPA"), who took a one-half interest in the patent from the inventor, Jack
Masquielier. The other half of the '360 patent was conveyed by Mr. Masquelier to
a company known as Horphag Research Ltd. ("Horphag"). In October 1995, Horphag
sued SCIPA, INC and others in Bordeaux, France (the "French Lawsuit"). In its
action, Horphag alleged that SCIPA's transfer of its one-half interest in the
'360 patent to INC violated Horphag's right of preemption under French law and
the provisions of the agreement by which Horphag and SCIPA acquired their
ownership interests in the '360 patent. Horphag's complaint in the French
Lawsuit requested that the French court order that the assignment from SCIPA to
16
INC be declared null and void, and that the court issue an order declaring that
INC has no ownership interest in the '360 patent. USANA purchases its raw
ingredients for Proflavanol from Indena, a licensee of Horphag.
On March 21, 1997, the District Court ordered that the action not proceed
until resolution of the French Lawsuit. On March 25, 1997, the trial court in
Bordeaux issued a decision declaring that under French law, INC has no interest
in the '360 patent, because of the principle of preemption. Specifically, the
French trial court held that SCIPA, through whom INC claims ownership rights in
the '360 patent, had an obligation to offer its one-half interest in the patent
to Horphag before selling it to INC. Because SCIPA did not offer its interest to
Horphag, the French trial court nullified the assignment from SCIPA to INC,
finding that SCIPA has again become a joint owner of the '360 patent. INC
appealed the decision of the trial court.
On May 28, 1998, the Court of Appeals in Bordeaux affirmed the decision of
the trial court that INC has no ownership interest in the '360 patent.
Specifically, the decision holds that INC does not now hold and never has held
any ownership rights in the '360 patent. The appellate court also found that
recent attempts by Mr. Masquelier to assign an interest in the '360 patent to
INC were null and void because he had no ownership interest in the '360 patent
and therefore could not assign such an interest to INC. The French appellate
decision also rejected INC's argument that it purchased an interest in the '360
patent in good faith, without knowledge of Horphag's one-half interest.
On July 10, 1998, USANA filed a motion to dismiss the INC complaint in the
U.S. Lawsuit, alleging that based on the decisions of the French courts INC has
no standing to sue. Alternatively, USANA alleged that, under U.S. law, even if
INC were a co-owner of the '360 patent, it owns at most a one-half interest and
cannot bring suit to enforce the patent unless the other co-owner voluntarily
agrees to join in such suit as a plaintiff. The other owner of the '360 patent,
Horphag, has not voluntarily joined the U.S. Lawsuit as a plaintiff and, in
fact, is a defendant in that proceeding. Therefore, USANA believed the
litigation must be dismissed.
The District Court ultimately ordered that the motions to dismiss be re-
filed as motions for summary judgment, together with statements of uncontested
facts.
On March 18, 2000, the District Court granted the motions (including the
motion filed by USANA) for summary judgment and ruled that INC's claims for
patent infringement dismissed.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
The Company's common stock trades on the Nasdaq Stock Market under the
symbol "USNA." The following table contains the reported high and low sale
prices for the Company's common stock as reported on the Nasdaq Stock Market for
the periods indicated:
High Low
1998
First Quarter ............................... $ 14.50 $ 8.88
Second Quarter ............................... 17.25 12.75
Third Quarter ............................... 24.13 8.00
Fourth Quarter ............................... 14.75 9.31
1999
First Quarter ............................... $ 18.00 $ 5.88
Second Quarter ............................... 11.25 6.75
Third Quarter ............................... 9.00 6.25
Fourth Quarter ............................... 8.75 3.81
17
On March 21, 2000, the high and low sales price of the Company's common
stock were $6.00 and $5.75, respectively.
Shareholders
As of March 21, 2000, there were approximately 473 holders of record of the
Company's common stock and an estimated 5,400 beneficial owners, including
shares of common stock held in street name.
Dividends
The Company has never declared or paid cash dividends on its common stock.
The Company currently intends to retain future earnings to fund the development
and growth of its business and does not anticipate paying any cash dividends in
the foreseeable future. Future cash dividends, if any, will be determined by the
Board of Directors and will be based on the Company's earnings, capital,
financial condition and other factors deemed relevant by the Board of Directors.
The Company's credit facility contains restrictions on the Company's ability to
declare cash dividends on its capital stock or redeem or retire such stock
without the lender's written consent.
Item 6. Selected Financial Data
The selected consolidated financial data set forth below with respect to
the Company's consolidated statements of earnings and consolidated balance
sheets for each of the last five fiscal years are derived from the consolidated
financial statements of the Company. The data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the audited consolidated financial statements and related notes
thereto.
Year Ended
-------------------------------------------------
Dec. 31, Dec. 28, Dec. 27, Jan. 2, Jan. 1,(1)
1995 1996 1997 1999 2000
------- ------- ------- ------- --------
(in thousands, except per share data)
Consolidated Statement of Earnings Data:
Net sales............................................................. $24,541 $56,700 $85,205 $121,558 $129,386
Cost of sales......................................................... 5,703 11,596 17,852 25,279 25,452
------- ------- ------- -------- --------
Gross profit....................................................... 18,838 45,104 67,353 96,279 103,934
Operating expenses:
Associate incentives.................................................. 10,800 25,890 39,536 54,408 57,044
Selling, general and administrative................................... 4,246 10,515 16,040 25,284 31,499
Restructuring and impairment.......................................... -- -- -- -- 4,400
Research and development.............................................. 256 798 1,245 1,362 1,377
------- ------- ------- -------- --------
Total operating expenses........................................... 15,302 37,203 56,821 81,054 94,320
------- ------- ------- -------- --------
Earnings from operations................................................ 3,536 7,901 10,532 15,225 9,614
Other income (expense), net............................................. 191 247 166 178 (48)
------- ------- ------- -------- --------
Earnings before income taxes............................................ 3,727 8,148 10,698 15,403 9,566
Income taxes............................................................ 1,422 3,113 4,116 5,906 3,665
------- ------- ------- -------- --------
Net earnings............................................................ $ 2,305 $ 5,035 $ 6,582 $ 9,497 $ 5,901
======= ======= ======= ======== ========
Earnings per share--diluted............................................. $ 0.20 $ 0.38 $ 0.49 $ 0.68 $ 0.47
======= ======= ======= ======== ========
Weighted average shares outstanding--diluted............................ 11,589 13,326 13,319 13,929 12,473
======= ======= ======= ======== ========
18
As of
--------------------------------------------------
Dec. 31, Dec. 28, Dec. 27, Jan. 2, Jan.1,(1)
1995 1996 1997 1999 2000
------- ------- ------- -------- --------
(in thousands, except per share data)
Consolidated Balance Sheet Data:
Cash and cash equivalents.......................... $ 2,976 $ 1,130 $ 2,608 $ 2,617 $ 1,411
Working capital.................................... 1,795 458 4,569 7,899 (1,281)
Current assets..................................... 5,361 9,040 11,273 16,615 15,048
Total assets....................................... 10,174 21,079 26,369 39,426 36,773
Long-term debt, less current maturities............ 4 -- -- -- 7,500
Stockholders' equity............................... 6,555 12,368 19,258 30,086 12,919
Other Data:
Current Associates (2)............................. 34,000 59,000 84,000 116,000 113,000
Preferred Customers (3)............................ -- -- 9,000 26,000 46,000
- --------------------------------------------------------------------------------
(1) The 1999 fiscal year and the 1997 fiscal year were 52-week years. Fiscal
year 1998 was a 53-week year. Fiscal year 1996 began on January 1, 1996 and
ended on December 28, 1996. The year 1995 was a calendar year.
(2) The Company defines a current Associate as an Associate who has purchased
product from the Company at any time during the most recent twelve-month
period. The Company adopted this definition in September 1997. The number of
current Associates for prior periods is an estimate.
(3) The Company introduced its Preferred Customer program in the third quarter
of 1997. Preferred Customers purchase products from the Company at wholesale
prices for personal use, but do not distribute the products.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this report.
Overview
USANA develops and manufactures high-quality nutritional, personal care and
weight management products. The Company distributes its products through a
network marketing system. As of January 1, 2000, the Company had approximately
113,000 current Associates in the United States, Canada, Australia, New Zealand,
Hong Kong and the United Kingdom. The Company initiated operations in the United
Kingdom and Hong Kong markets in December 1998 and November 1999, respectively.
The Company's three primary product lines consist of nutritional, personal
care and weight management products. Nutritional products accounted for
approximately 83% of the Company's net sales in 1999. The Company's top selling
products, USANA Essentials and Proflavanol, represented approximately 42% and
16%, respectively, of net sales in 1999. No other products accounted for more
than 10% of net sales during the year. USANA's personal care line includes skin,
hair and body, and dental care products. The Company's weight management line
includes a dietary supplement in tablet form, food bars, meal entrees,
instructional videos and other products developed to provide a comprehensive
approach to weight management, proper diet, nutrition and healthy living. During
1999, the Company introduced several new products, Body Rox (Essentials for
Teens), Usanimals (Essentials for Kids), Garlic EC, BiOmega-3, E-Prime, Iron 28,
ActiCal, PhytoEstrin, Palmetto Plus, Ginkgo-PS, St. John's Wort, SoyaMax, and a
new L*E*A*N Team Formula. In addition to its primary product lines, the Company
also sells Associate kits and sales aids which accounted for approximately 2.5%
of the Company's net sales in 1999.
19
Net sales are primarily dependent upon the efforts of a network of
independent Associates who purchase products and sales materials. The Company
also offers a Preferred Customer program specifically designed for customers who
desire to purchase USANA's products for personal consumption, but who choose not
to become Associates. As of January 1, 2000, the Company had approximately
46,000 Preferred Customers. The Company recognizes revenue when products are
shipped and title passes to Associates and Preferred Customers. In 1999, sales
in the Company's five primary markets, the United States, Canada, Australia-New
Zealand, Hong Kong and the United Kingdom, were 52.4%, 23.0%, 20.3%, 2.2% and
2.1%, respectively, of net sales of the Company. As the Company expands into
additional international markets, it expects international operations to account
for an increasing percentage of net sales.
Cost of sales primarily consists of expenses related to raw materials,
labor, quality assurance and overhead directly associated with the procurement
and production of products and sales materials as well as duties and taxes
associated with product exports. In 1999, products manufactured by the Company
accounted for approximately 74% of its net sales. As international sales
increase as a percentage of net sales, the Company expects that its overall cost
of sales could increase slightly, reflecting additional duties, freight and
other expenses associated with international expansion.
Associate incentives are the Company's most significant expense and
represented 44.1% of net sales in 1999. Associate incentives include commissions
and leadership bonuses, and are paid weekly based on sales volume points. Most
products are assigned a sales volume point value independent of the product's
price. Associates earn commissions based on sales volume points generated in
their downline. Generally, Associate kits, sales aids and logo merchandise, such
as items of clothing and luggage, have no sales volume point value and therefore
the Company pays no commissions on the sale of these items.
The Company closely monitors the amount of Associate incentives paid as a
percentage of net sales and may from time to time adjust its Associate
compensation plan to prevent Associate incentives from having a significant
adverse effect on earnings, while continuing to maintain an appropriate
incentive for its Associates. For example, in the third quarter of 1997, the
Company introduced a repricing strategy across its product lines that created a
spread between the price an Associate pays for the product and the sales volume
point value associated with the product. This new price strategy had the effect
of reducing the amount of total Associate incentives paid as a percentage of net
sales. At the same time, the Company changed its leadership bonus program,
increasing the payout from 2.0% to 3.0% of total sales volume points.
Selling, general and administrative expenses include wages and benefits,
depreciation and amortization, rents and utilities, Associate events, promotion
and advertising, and professional fees along with other marketing and
administrative expenses. Wages and benefits represent the largest component of
selling, general and administrative expenses. The Company expects to add human
resources and associated infrastructure as operations expand. The President,
Chief Executive Officer and Chairman of the Board of Directors of the Company,
Dr. Wentz, does not receive a salary, and the Company does not anticipate that
Dr. Wentz will take a salary for the foreseeable future. However, if Dr. Wentz
were to take a salary, selling, general and administrative expenses would
increase. Depreciation and amortization expense has increased as a result of
substantial investments in computer and telecommunications equipment and systems
to support international expansion. The Company anticipates that additional
capital investments will be required in future periods to promote and support
growth in sales and the increasing size of the Associate and Preferred Customer
base.
Research and development expenses include costs incurred in developing new
products, supporting and enhancing existing products and reformulating products
for introduction in international markets. The Company capitalizes product
development costs after market feasibility is established. These costs are
amortized as cost of sales over an average of 12 months, beginning with the
month the products become available for sale.
The Company operates on a 52-53 week year, ending on the Saturday closest
to December 31.
20
Results Of Operations
The following table summarizes operating results as a percentage of net
sales, respectively, for the periods indicated:
Year Ended
-----------------------------------
Dec. 27, Jan. 2, Jan. 1,
1997 1999 2000
--------- ------- -------
Net sales ...................................................... 100.0% 100.0% 100.0%
Cost of sales .................................................. 21.0 20.8 19.7
----- ----- -----
Gross profit ................................................ 79.0 79.2 80.3
Operating expenses:
Associate incentives ........................................ 46.4 44.8 44.1
Selling, general and administrative ......................... 18.8 20.8 24.3
Restructuring and impairment ................................ -- -- 3.4
Research and development .................................... 1.5 1.1 1.1
----- ----- -----
Earnings from operations ....................................... 12.3 12.5 7.4
Other income ................................................... 0.2 0.2 0.0
----- ----- -----
Earnings before income taxes ................................... 12.5 12.7 7.4
Income taxes ................................................... 4.8 4.9 2.8
----- ----- -----
Net earnings ................................................... 7.7% 7.8% 4.6%
===== ===== =====
Years Ended January 1, 2000 and January 2, 1999
Net Sales. Net sales increased 6.4% to $129.4 million in 1999, an increase
of $7.8 million from $121.6 million in 1998. The increase in net sales is
primarily a result of introducing two new markets - the United Kingdom in
December 1998 and Hong Kong in November 1999. Sales growth can also be
attributed to a 77% increase in the Company's Preferred Customer base. As of
January 1, 2000, the Company had approximately 46,000 Preferred Customers
compared to approximately 26,000 Preferred Customers at January 2, 1999.
Approximately 90% of the increase in Preferred Customers took place in the North
American and Australia-New Zealand markets. As of January 1, 2000, the Company
had approximately 113,000 current Associates compared to 116,000 current
Associates at January 2, 1999.
The following tables illustrate the growth (decline) in sales and customers
by market for the years ended January 2, 1999 and January 1, 2000:
SALES BY MARKET
(in thousands)
Year Ended
----------------------------------------------
Growth
(Decline)over %
Market January 2, 1999 January 1, 2000 Prior Year Growth
- ------ ---------------------- ------------------- ----------------- --------
United States............. $ 69,822 57.5% $ 67,742 52.4% $(2,080) (3.0%)
Canada.................... 32,739 26.9 29,765 23.0 (2,974) (9.1%)
Australia-New Zealand..... 18,659 15.3 26,260 20.3 7,601 40.7%
United Kingdom............ 338 0.3 2,690 2.1 2,352 695.9%
Hong Kong................. - - 2,929 2.2 2,929 -
-------- ----- -------- ----- -------
Consolidated.............. $121,558 100.0% $129,386 100.0% $ 7,828 6.4%
======== ===== ======== ===== =======
21
CURRENT ASSOCIATES BY MARKET
Growth
As of As of (Decline) over %
Market January 2, 1999 January 1, 2000 Prior Year Growth
- ------ ---------------------- ---------------------- --------------- ----------
United States.................. 59,000 50.9% 51,000 45.1% (8,000) (13.6%)
Canada......................... 32,000 27.5 26,000 23.0 (6,000) (18.8%)
Australia-New Zealand.......... 24,000 20.7 27,000 23.9 3,000 12.5%
United Kingdom................. 1,000 0.9 3,000 2.7 2,000 200.0%
Hong Kong...................... - - 6,000 5.3 6,000 -
--------- --------- --------- --------- ---------
Consolidated................... 116,000 100.0% 113,000 100.0% (3,000) (2.6%)
========= ========= ========= ========= =========
PREFERRED CUSTOMERS BY MARKET
As of As of Growth over %
Market January 2, 1999 January 1, 2000 Prior Year Growth
- ------ ---------------------- ---------------------- --------------- ----------
United States.............. 16,000 61.5% 25,000 54.3% 9,000 56.3%
Canada..................... 8,000 30.8 11,000 23.9 3,000 37.5%
Australia-New Zealand...... 2,000 7.7 8,000 17.4 6,000 300.0%
United Kingdom............. - - 1,000 2.2 1,000 -
Hong Kong.................. - - 1,000 2.2 1,000 -
--------- --------- --------- --------- ---------
Consolidated............... 26,000 100.0% 46,000 100.0% 20,000 76.9%
========= ========= ========= ========= =========
TOTAL CUSTOMERS BY MARKET
Growth
As of As of (Decline) over %
Market January 2, 1999 January 1, 2000 Prior Year Growth
- ------ ---------------------- ---------------------- --------------- ----------
United States.................. 75,000 52.8% 76,000 47.8% 1,000 1.3%
Canada......................... 40,000 28.2 37,000 23.3 (3,000) (7.5%)
Australia-New Zealand.......... 26,000 18.3 35,000 22.0 9,000 34.6%
United Kingdom................. 1,000 0.7 4,000 2.5 3,000 300.0%
Hong Kong...................... - - 7,000 4.4 7,000 -
--------- --------- --------- --------- ---------
Consolidated................... 142,000 100.0% 159,000 100.0% 17,000 12.0%
========= ========= ========= ========= =========
Cost of Sales. Cost of sales increased 0.7% to $25.5 million in 1999, an
increase of $173,000 from $25.3 million in 1998. As a percentage of net sales,
cost of sales decreased to 19.7% in 1999 from 20.8% in 1998. The decrease in
cost of sales as a percentage of net sales can be attributed to:
. A change in sales mix to fewer Associate kits, sales aids and logo
merchandise, which are sold at a reduced gross profit margin compared
to other USANA products, and
. Increased production and procurement efficiencies.
22
Associate Incentives. Associate incentives increased 4.8% to $57.0 million
in 1999, an increase of $2.6 million from $54.4 million in 1998. As a
percentage of net sales, Associate incentives decreased to 44.1% in 1999 from
44.8% in 1998. The decrease in Associate incentives relative to net sales can
be attributed to:
. Continued efforts at managing pricing of the Company's products, which
has created a spread between the wholesale price of the products and
the related sales volume points,
. The introduction of the new level in the Associate compensation plan
in early 1999, and
. Inefficiencies in the Associate network in the United Kingdom and Hong
Kong.
The new level, or position, in the Associate compensation plan represents
the earliest level in the Company's network marketing system eligible to receive
incentives. The Company believes this new level will assist in Associate
retention efforts by paying these Associates earlier on reduced downline
requirements; however, this level does pay at a lower rate than other levels in
the Company's network marketing system.
Selling, general and administrative. Selling, general and administrative
expenses increased 24.6% to $31.5 million in 1999, an increase of $6.2 million
from $25.3 million in 1998. As a percent of net sales, selling, general and
administrative expenses increased to 24.3% in 1999 from 20.8% in 1998. The
increase in selling, general and administrative expenses can be attributed to:
. Higher relative costs associated with operations in the United
Kingdom,
. Increased spending on sales and marketing efforts,
. Increased costs including, but not limited to, employee compensation
as a result of building the Company's infrastructure to meet strategic
objectives, and
. Increased depreciation and amortization expense as a result of
substantial investments in current and prior periods in computer and
telecommunications equipment to support growth and international
expansion.
Restructuring. The Company recorded a restructuring charge and reserve
totaling $2.7 million ($1.7 million or $0.13 per share, after tax) in the third
quarter of 1999. The restructuring charge includes the impact of a substantial
reduction in United Kingdom operations, liquidation of associated assets in the
United Kingdom and reduction of staff outside of the United Kingdom. Charges
incorporated into the Company's restructuring initiative include $900,000 for
non-voluntary employee termination benefits, $1.4 million for the liquidation of
associated assets used in United Kingdom operations and $400,000 for other exit
costs.
The Company expects that all activities associated with the Company's
restructuring initiative will be completed by the end of the third quarter of
2000. As of January 1, 2000, approximately $448,000 was charged against the
restructuring reserve.
Impairment. In accordance with Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," the Company wrote off the remaining book value of its former
custom network marketing system (legacy system) totaling $1.7 million ($1.0
million, or $0.09 per share, after tax) in the third quarter of 1999. This
charge was the result of the Company's decision to move to a new custom network
marketing computer system ("System"). Conversion from the legacy system to the
new System has been taking place since the time the impairment was recognized.
The future benefits of the legacy system to the Company are minimal and
immaterial and could have been removed from operations at the time the
impairment was recognized.
Research and Development. Research and development expenses remained flat
at $1.4 million for 1999 and 1998. As a percentage of net sales, research and
development remained flat at 1.1% for 1999 and 1998. Although current research
and development spending is flat, the Company continues to keep abreast of the
latest research in nutrition and degenerative diseases and is committed to
developing new products, reformulating existing products and maintaining its
involvement in numerous clinical studies.
23
Net Earnings. Net earnings decreased 37.9% to $5.9 million in 1999, a
decrease of $3.6 million from $9.5 million in 1998. The $4.4 million
restructuring and impairment charge ($2.7 million, or $0.22 per share, after
tax) was the primary contributor to the substantial decrease in net earnings in
1999 when compared to 1998. Additionally, the substantial increase in selling,
general and administrative contributed to decreased net earnings in 1999.
Diluted earnings per share decreased to $0.47 for 1999, a decrease of $0.21 from
$0.68 in 1998.
Years Ended January 2, 1999 and December 27, 1997
Net Sales. Net sales increased 42.7% to $121.6 million in 1998, an increase
of $36.4 million from $85.2 million in 1997. Approximately 90% of the growth in
net sales for this period was attributable to increases in total unit sales. The
increase in unit sales is primarily the result of a 38.1% increase in the
Company's Associate base and continued growth in its Preferred Customer program,
which was introduced in the third quarter of 1997. As of January 2, 1999, the
Company had approximately 116,000 current Associates compared to approximately
84,000 current Associates at December 27, 1997. Approximately 75% of the growth
in the Associate base can be associated with the opening of the Australia-New
Zealand market in February 1998. As of January 2, 1999, the Company had
approximately 26,000 Preferred Customers. Successful regional conventions, new
product introductions and the product price increase in the third quarter of
1997 also contributed to sales growth in 1998.
The following tables illustrate the growth (decline) in sales and customers
by market for the years ended December 27, 1997 and January 2, 1999:
SALES BY MARKET
(in thousands)
Year Ended
----------------------------------------------
Growth over %
Market December 27, 1997 January 2, 1999 Prior Year Growth
- ------ ---------------------- ------------------- ----------------- --------
United States............. $58,975 69.2% $ 69,822 57.5% $10,847 18.4%
Canada.................... 26,230 30.8 32,739 26.9 6,509 24.8%
Australia-New Zealand..... - - 18,659 15.3 18,659 -
United Kingdom............ - - 338 0.3 338 -
--------- --------- ---------- ------- ----------
Consolidated.............. $85,205 100.0% $121,558 100.0% $36,353 42.7%
========= ========= ========== ======= ==========
CURRENT ASSOCIATES BY MARKET
As of As of Growth over %
Market December 27, 1997 January 2, 1999 Prior Year Growth
- ------ ----------------------- ---------------------- ------------- ------------
United States............. 56,000 66.7% 59,000 50.9% 3,000 5.4%
Canada.................... 28,000 33.3 32,000 27.5 4,000 14.3%
Australia-New Zealand..... - - 24,000 20.7 24,000 -
United Kingdom............ - - 1,000 0.9 1,000 -
--------- --------- ---------- ---------- ----------
Consolidated.............. 84,000 100.0% 116,000 100.0% 32,000 38.1%
========= ========= ========== ========== ==========
24
PREFERRED CUSTOMERS BY MARKET
As of As of Growth over %
Market December 27, 1997 January 2, 1999 Prior Year Growth
- ------ ----------------- --------------- ------------ ------
United States.................. 6,000 66.7% 16,000 61.5% 10,000 166.7%
Canada......................... 3,000 33.3 8,000 30.8 5,000 166.7%
Australia-New Zealand.......... - - 2,000 7.7 2,000 -
United Kingdom................. - - - - - -
------ ------ ------- ------ ------------
Consolidated................... 9,000 100.0% 26,000 100.0% 17,000 188.9%
====== ====== ======= ====== ============
TOTAL CUSTOMERS BY MARKET
As of As of Growth over %
Market December 27, 1997 January 2, 1999 Prior Year Growth
- ------ ----------------- --------------- ------------ ------
United States.................. 62,000 66.7% 75,000 52.8% 13,000 21.0%
Canada......................... 31,000 33.3 40,000 28.2 9,000 29.0%
Australia-New Zealand.......... - - 26,000 18.3 26,000 -
United Kingdom................. - - 1,000 0.7 1,000 -
------ ------ ------- ------ ------------
Consolidated................... 93,000 100.0% 142,000 100.0% 49,000 52.7%
====== ====== ======= ====== ============
Cost of Sales. Cost of sales increased 41.6% to $25.3 million in 1998, an
increase of $7.4 million from $17.9 million in 1997. As a percentage of net
sales, cost of sales decreased slightly to 20.8% in 1998 from 21.0% in 1997. The
decrease in cost of sales as a percentage of net sales can be attributed
primarily to the price increase introduced in the third quarter of 1997 and
volume-based efficiencies in production and procurement activities. These
factors were partially offset by additional costs such as freight and duties
associated with exporting products to Australia-New Zealand and the United
Kingdom, and a change in the sales mix to include a higher percentage of
Associate kits, which have a significantly lower gross profit margin. When a new
market is opened, the Company initially experiences a higher demand for
Associate kits in that market.
Associate Incentives. Associate incentives increased 37.6% to $54.4 million
in 1998, an increase of $14.9 million from $39.5 million in 1997. As a
percentage of net sales, Associate incentives decreased to 44.8% in 1998 from
46.4% in 1997. The decrease in Associate incentives as a percentage of net sales
can be attributed primarily to the implementation of the Company's repricing
strategy and a change in the sales mix that resulted from increased demand for
Associate kits in the Australia-New Zealand market. The decrease in Associate
incentives as a percentage of net sales was partially offset by an increase in
the Company's leadership bonus program from 2.0% to 3.0% of the sales volume
points generated.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 57.6% to $25.3 million in 1998, an increase of
$9.3 million from $16.0 million in 1997. As a percentage of net sales, selling,
general and administrative expenses increased to 20.8% in 1998 from 18.8% in
1997. The increase in selling, general and administrative expenses can be
attributed to several factors:
. Higher variable expenses such as increases in customer service
staffing levels and discount fees on credit cards in association with
growth in sales and the increased number of Associates and Preferred
Customers,
. Increased depreciation and amortization expense of approximately 1% as
a percentage of net sales as a result of substantial investments in
current and prior periods in computer and telecommunications equipment
to support growth and international expansion,
. Increased costs including, but not limited to, employee compensation
as a result of building the Company's infrastructure to meet strategic
objectives, and
25
. Higher relative costs associated with international expansion,
primarily related to commencing operations in Australia-New Zealand
and the United Kingdom.
Research and Development Expenses. Research and development expenses
increased 9.4% to $1.4 million in 1998, an increase of $0.2 million from $1.2
million in 1997. The modest increases in research and development expenses in
1998 were primarily the result of new product development, ongoing clinical
studies and the reformulation of existing products.
Net Earnings. Net earnings increased 44.3% to $9.5 million in 1998, an
increase of $2.9 million from $6.6 million in 1997. The increase in net earnings
is primarily the result of higher sales. Net earnings reflect the combined
effect of decreased cost of sales, decreased Associate incentives, and increased
selling, general and administrative expenses relative to net sales, which
resulted in a 7.8% profit margin in 1998 compared to 7.7% in 1997. Diluted
earnings per share increased 38.8% to $0.68 in 1998, an increase of $0.19 from
$0.49 in 1997.
Quarterly Financial Information and Seasonality
The table below sets forth unaudited quarterly operating results for each
of the Company's last eight fiscal quarters as well as certain of the data
expressed as a percentage of net sales for the periods indicated. This
information has been prepared by the Company on a basis consistent with the
Company's Consolidated Financial Statements and includes all adjustments,
consisting only of normal recurring adjustments, that management considers
necessary for a fair presentation of the data. The Company's quarterly results
are not necessarily indicative of future results of operations. This information
should be read in conjunction with the Consolidated Financial Statements of the
Company and Notes thereto included elsewhere in this report.
The Company believes that the impact of seasonality on its results of
operations is not material, although historically growth has been slower in the
fourth quarter of each year. This could change as new markets are opened and
become a more significant part of the Company's business. In addition, the
significant growth experienced by the Company since its inception has made it
difficult to accurately determine seasonal trends.
Quarter Ended
-------------
Mar. 28, June 27, Sep. 26, Jan. 2,(1) April 3, July 3, Oct. 2, Jan. 1,
1998 1998 1998 1999 1999 1999 1999 2000
---- ---- ---- ---- ---- ---- ---- ----
(in thousands, except per share data)
Consolidated Statements of Earnings
Data:
Net sales.................................... $26,164 $30,913 $32,123 $32,358 $31,323 $32,478 $32,359 $33,226
Cost of sales................................ 5,486 6,408 6,725 6,660 6,383 6,340 6,316 6,413
------- ------- ------- ------- ------- ------- ------- -------
Gross profit....................... 20,678 24,505 25,398 25,698 24,940 26,138 26,043 26,813
Operating expenses:
Associate incentives.................. 11,762 13,930 14,312 14,404 13,909 14,437 14,286 14,412
Selling, general and administrative... 5,433 6,318 6,705 6,828 7,244 7,741 8,405 8,109
Restructuring and impairment.......... -- -- -- -- -- -- 4,400 --
Research and development.............. 354 373 405 230 356 329 343 349
------- ------- ------- ------- ------- ------- ------- -------
Total operating expenses........... 17,549 20,621 21,422 21,462 21,509 22,507 27,434 22,870
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) from operations.............. 3,129 3,884 3,976 4,236 3,431 3,631 (1,391) 3,943
Other income (expense), net.................. 46 21 113 (2) 34 (10) 197 (269)
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) before income taxes.......... 3,175 3,905 4,089 4,234 3,465 3,621 (1,194) 3,674
Income taxes (benefit)....................... 1,239 1,501 1,559 1,607 1,337 1,377 (444) 1,395
------- ------- ------- ------- ------- ------- ------- -------
Net earnings (loss).......................... $ 1,936 $ 2,404 $ 2,530 $ 2,627 $ 2,128 $ 2,244 $ (750) $ 2,279
======= ======= ======= ======= ======= ======= ======= =======
Earnings (loss) per share--diluted........... $ 0.14 $ 0.17 $ 0.18 $ 0.19 $ 0.16 $ 0.17 $ (0.06) $ 0.22
======= ======= ======= ======= ======= ======= ======= =======
Weighted average shares outstanding--
Diluted............................... 13,771 14,064 14,190 13,901 13,557 13,252 12,473 10,368
======= ======= ======= ======= ======= ======= ======= =======
26
Quarter Ended
-------------
Mar. 28, June 27, Sep. 26, Jan. 2,(1) April 3, July 3, Oct. 2, Jan. 1,
1998 1998 1998 1999 1999 1999 1999 2000
---- ---- ---- ---- ---- ---- ---- ----
As a Percentage of Net Sales:
Net sales.................................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................................ 21.0 20.7 20.9 20.6 20.4 19.5 19.5 19.3
----- ----- ----- ----- ----- ----- ----- -----
Gross profit............................. 79.0 79.3 79.1 79.4 79.6 80.5 80.5 80.7
Operating expenses:
Associate incentives....................... 45.0 45.1 44.6 44.5 44.4 44.5 44.1 43.4
Selling, general and administrative........ 20.8 20.4 20.9 21.1 23.1 23.8 26.0 24.4
Restructuring and impairment............... -- -- -- -- -- -- 13.6 --
Research and development................... 1.4 1.2 1.3 0.7 1.1 1.0 1.1 1.1
----- ----- ----- ----- ----- ----- ----- -----
Total operating expenses................. 67.2 66.7 66.8 66.3 68.7 69.3 84.8 68.8
----- ----- ----- ----- ----- ----- ----- -----
Earnings (loss) from operations.............. 11.8 12.6 12.3 13.1 11.0 11.2 (4.3) 11.9
Other income (expense), net.................. 0.2 0.1 0.4 0.0 0.1 0.0 0.6 (0.8)
----- ----- ----- ----- ----- ----- ----- -----
Earnings (loss) before income taxes.......... 12.0 12.7 12.7 13.1 11.1 11.1 (3.7) 11.1
Income taxes (benefit)....................... 4.7 4.9 4.8 5.0 4.3 4.2 (1.4) 4.2
----- ----- ----- ----- ----- ----- ----- -----
Net earnings (loss).......................... 7.3% 7.8% 7.9% 8.1% 6.8% 6.9% (2.3)% 6.9%
===== ===== ===== ===== ===== ===== ===== =====
_______________________________________________________________________________
(1) The quarter ended January 2, 1999 was a 14 week quarter. All other quarters
in the table represent 13 week quarters.
The Company may experience variations on a quarterly basis in its results
of operations, in response to, among other things:
. The timing of Company-sponsored Associate events,
. New product introductions,
. The opening of new markets,
. The timing of holidays, especially in the fourth quarter, which may
reduce the amount of time Associates spend selling the Company's
products or recruiting new Associates,
. The adverse effect of Associates' or the Company's failure, or
allegations of their failure, to comply with applicable governmental
regulations,
. The negative impact of changes in or interpretations of regulations
that may limit or restrict the sale of certain of the Company's
products,
. The operation of its network marketing system,
. Fluctuations in currency exchange rates,
. The recruiting and retention of Associates,
. The integration and operation of new information technology systems,
. The inability of the Company to introduce new products or the
introduction of new products by the Company's competitors,
. Availability of raw materials,
. General conditions in the nutritional supplement, personal care and
weight management industries or the network marketing industry and
. Consumer perceptions of the Company's products and operations.
27
Because the Company's products are ingested by consumers or applied to
their bodies, the Company is highly dependent upon consumers' perception of the
safety, quality and efficacy of its products. As a result, substantial negative
publicity, whether founded or unfounded, concerning one or more of the Company's
products or other products similar to the Company's products could adversely
affect the Company's business, financial condition and results of operations.
As a result of these and other factors the Company's quarterly revenues,
expenses and results of operations could vary significantly in the future, and
period-to-period comparisons should not be relied upon as indications of future
performance. There can be no assurance that the Company will be able to increase
its revenues in future periods or be able to sustain its level of revenue or its
rate of revenue growth on a quarterly or annual basis. Furthermore, no
assurances can be given that the Company's revenue growth rate in new markets
where operations have not commenced will follow this pattern. Due to the
foregoing factors, the Company's future results of operations could be below the
expectations of public market analysts and investors. In such event, the market
price of the common stock of the Company would likely be materially adversely
affected.
Liquidity and Capital Resources
The Company has financed its growth primarily with cash flows from
operations. In 1999, the Company generated net cash from operations of $15.0
million compared to $10.6 million in 1998. Cash and cash equivalents decreased
to $1.4 million at January 1, 2000 from $2.6 million at January 2, 1999. Checks
written in excess of cash in bank totaled $1.4 million at January 1, 2000.
On January 1, 2000, the Company had negative net working capital of $1.3
million compared to positive net working capital of $7.9 million at January 2,
1999. The change in net working capital in 1999 was primarily the result of
redeeming common stock and advancing funds to a related party, which totaled
$23.6 million during the year. This use of working capital for long-term
purposes is expected to provide earnings per share benefits in future periods.
Furthermore, the Company has substantial, unused availability under its line of
credit.
The Company does not extend credit to its customers, but requires payment
prior to shipping, which eliminates significant receivables.
The Company invested $4.9 million in property and equipment in 1999
compared to $11.3 million in 1998. Inventory decreased to $9.9 million at
January 1, 2000 compared to $10.5 at January 2, 1999.
On September 21, 1999, the Company completed the repurchase of 2.65 million
shares of its common stock from Gull Holdings, Ltd. ("Gull"). An earlier
purchase of 300,000 shares was made on May 24, 1999, under an agreement entered
into on April 28, 1999. The series of related transactions reduced the
ownership of Gull from 58.2% to 45.7%, of the issued and outstanding capital
stock of the Company as of January 1, 2000. These transactions reduced the
issued and outstanding shares of the company by 22.6%. Gull is an Isle of Man
company owned and controlled by Myron W. Wentz, Ph.D., the founder, Chairman,
President and CEO of the Company. The transactions were privately negotiated,
reviewed by the Audit Committee of the Board of Directors and approved by the
independent directors of the Company. The aggregate purchase price of the 2.95
million shares was $24 million and was financed by existing cash balances and
borrowings of approximately $18 million under a new credit agreement with Bank
of America in the form of a $10 million term loan and a $15 million revolving
line of credit. The Company expects to retire debt related to this transaction
before the end of fiscal year 2001.
During 1999, the Company entered into agreements with Bank of America that
made available $25 million in secured credit facilities ("Credit Facilities").
A $10 million five-year term loan and a $15 million three-year revolving line of
credit comprise these facilities. At January 1, 2000, the Company had $13.6
million available under the line of credit, which expires September 1, 2002.
The interest rate is computed at the bank's prime rate or the London Interbank
Offered Rate (LIBOR) base rate adjusted by features specified in the Credit
Facilities. The Company may choose to borrow at the bank's publicly announced
Reference Rate plus a margin per annum as specified in the Credit Facilities or,
at the option of the Company, loans within the approved commitment may be
available in minimum amounts of $100,000 or more for specific periods ranging
from one to six months, at LIBOR plus a margin as specified in the Credit
Facilities. Receivables, inventories and equipment secure the Credit
Facilities. The Credit Facilities contain restrictive covenants requiring the
Company to maintain certain financial ratios. The Company was in compliance
with these covenants on January 1, 2000. As of January 1, 2000, $9.5 million
was outstanding on the five-year term loan and $1.4 million was outstanding on
the line of credit.
A significant percentage of the Company's net sales are generated from the
sale of products outside the United States. The Company intends to continue to
expand its foreign operations. The foreign operations of the Company expose it
to risks associated with changes in social, political and economic conditions
inherent in foreign operations, including changes in the laws
28
and policies that govern foreign investment in countries where it has operations
as well as, to a lesser extent, changes in U.S. laws and regulations relating to
foreign trade and investment. In addition, the Company's results of operations
and the value of its foreign assets are affected by fluctuations in foreign
currency exchange rates, which may favorably or adversely affect reported
earnings and, accordingly, the comparability of period-to-period results of
operations. Changes in currency exchange rates may affect the relative prices at
which the Company and foreign competitors sell their products in the same
market. Sales outside the United States represented 12.3%, 21.1%, 30.8%, 42.5%
and 47.6% of the Company's net sales in 1995, 1996, 1997, 1998, and 1999,
respectively. The Company enters into forward and option contracts to hedge
certain commitments denominated in foreign currency, including intercompany cash
transfers. Transaction hedging activities seek to protect operating results and
cash flows from the potentially adverse effects of currency exchange
fluctuations.
The Company believes that its current cash balances, the available line of
credit and cash provided by operations will be sufficient to cover its needs in
the ordinary course of business for the next 12 months. In the event the Company
experiences an adverse operating environment or unusual capital expenditure
requirements, additional financing may be required. However, no assurance can be
given that additional financing, if required, would be available on favorable
terms. The Company may also require or seek additional financing, including
through the sale of its equity securities to finance future expansion into new
markets, finance capital acquisitions associated with the growth of the Company
and for other reasons. Any financing which involves the sale of equity
securities or instruments convertible into such securities could result in
immediate and possibly significant dilution to existing shareholders.
Year 2000 Issues
During 1999, the Company's systems that were not Year 2000 compliant were
brought into compliance. Amounts spent on bringing non-compliant systems into
compliance totaled less than $100,000. Subsequent to December 31, 1999, the
Company has not experienced any significant Year 2000 problems.
Notwithstanding the foregoing, there can be no assurance the Company will
not experience operational difficulties as a result of ongoing Year 2000 issues,
either arising out of internal operations or caused by third-party service
providers, which individually or collectively could have an adverse impact on
business operations and require the Company to incur unanticipated expenses to
remedy any problems.
Inflation
The Company does not believe that inflation has had a material impact on
its historical operations or profitability.
Outlook
Management believes net sales will increase medium- to long-term as a
result of a value initiative that the Company introduced in February 2000. The
value initiative incorporated the following changes:
. Reduced prices, on average, by 24%
. Reduced the price of the Company's top selling product, the
Essentials, by 35%
. Offered a 10% discount for all customers who are active on the
Company's autoship program, and
. Decreased the ratio of sales volume points to the wholesale price of
the products.
Although it may take some time to generate enough volume to compensate for
the new lower prices, management believes the better value, in the form of lower
prices, and moving customers to its autoship program, will benefit both the
Company and its customers as follows:
. The Company is expected to benefit by improving customer loyalty and
retention.
29
. Preferred Customers will benefit by taking advantage of the Company's
quality products at the new lower prices.
. Management believes that Associates will have an easier time
recruiting Preferred Customers and other Associates at the new lower
prices. Additionally, the expected improvements in loyalty and
retention should assist the Associates with their business opportunity
under the Company's Associate compensation plan.
Associate incentives as a percentage of net sales are expected to decline
as a result of the decrease in the ratio of sales volume points to wholesale
prices. Cost of sales is expected to rise as a percentage of sales proportional
to the decline in Associate incentives as a result of the new lower prices.
Selling, general and administrative expenses are expected to increase
substantially in the short-term in order to promote and support the Company's
new value initiative. As unit volume increases, management believes that
selling, general and administrative expenses should decrease as a percentage of
sales.
Research and development costs are expected to be in line with historical
levels.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The Company conducts its business in several countries and intends to
continue to expand its foreign operations. The net sales are affected by
fluctuations in interest rates, currency exchange rates and other uncertainties
inherent in doing business and selling product in more than one currency. In
addition, the operations of the Company are exposed to significant risks
associated with changes in social, political and economic conditions inherent in
foreign operations, including changes in the laws and policies that govern
foreign investment in countries where it has operations as well as, to a lesser
extent, changes in U.S. laws and regulations relating to foreign trade and
investment.
Fluctuations in foreign currency exchange rates may favorably or adversely
affect the Company's reported earnings and, accordingly, the comparability of
its period-to-period results of operations. Changes in currency exchange rates
may affect the relative prices at which the Company sells its products. When the
value of the U.S. dollar is high in comparison with other currencies in which
sales are made, this will have a negative impact on net sales. Additionally, if
the dollar weakens against currencies in which the Company incurs or is required
to pay expenses, this will have a negative impact on net sales.
To protect against these risks, the Company enters into forward and option
contracts to hedge certain commitments denominated in foreign currency,
including intercompany cash transfers. Transaction hedging activities seek to
protect operating results and cash flows from the potentially adverse effects of
currency exchange fluctuations. The Company believes that its cash management
and investment policies have minimized these risks. However, there can be no
assurance that these practices will be successful in eliminating all or
substantially all of the risks encountered by the Company in connection with its
foreign currency transactions.
Forward-Looking Statements and Certain Risks Affecting the Company
The statements contained in this Report that are not purely historical are
"forward-looking statements" within the meaning of Section 21E of the Securities
Exchange Act. These statements regard the Company's expectations, hopes,
beliefs, commitments, intentions and strategies regarding the future. They may
be identified by the use of words or phrases such as "believes," "expects,"
"anticipates," "should," "plans," "estimates," and "potential," among others.
Forward-looking statements include, but are not limited to, statements contained
in Management's Discussion and Analysis of Financial Condition and Results of
Operations regarding the Company's financial performance, revenue and expense
levels in the future and the sufficiency of its existing assets to fund future
operations and capital spending needs. Actual results could differ materially
from the anticipated results or other expectations expressed in such forward-
looking statements or for the reasons discussed below. The fact that some of the
risk factors may be the same or similar to the Company's past reports filed with
the Securities and Exchange Commission means only that the risks are present in
multiple periods. The Company believes that many of the risks detailed here are
part of doing business in the industry in which the Company operates and
competes and will likely be present in all periods reported. The fact that
certain risks are endemic to the industry does not lessen their significance.
The forward-looking statements contained in this report are made as of the date
of this report and the Company assumes no obligation to update them
30
or to update the reasons why actual results could differ from those projected in
such forward-looking statements. Among others, risks and uncertainties that may
affect the business, financial condition, performance, development, and results
of operations of the Company include the following:
The Company relies on non-employee, independent Associates to purchase,
market and sell its products. The Company's Associates are independent
contractors who purchase products directly from the Company for their own use or
for resale. Associates typically work at the distribution of the Company's
products on a part-time basis and may and likely will engage in other business
activities, some of which may compete with the Company. The Company has a large
number of Associates and a relatively small corporate staff to implement its
marketing programs and provide motivational support to its Associates. The
Company undertakes no effort to provide individual training to its Associates.
Associates may voluntarily terminate their agreements with the Company at any
time. There is typically significant turnover in distributors from year to year.
Because of this high turnover, the Company must continually recruit new
Associates. The Company's net sales are directly dependent upon the efforts of
these non-employee, independent distributors and future growth in sales volume
will depend in large part upon the Company's success in increasing the number of
new Associates and improving productivity of its Associates. Consequently, the
loss of a key Associate or group of Associates, large turnovers or decreases in
the size of the Associate force, seasonal or other decreases in purchase volume,
sales volume reduction and the costs associated with training new Associates and
other related expenses may adversely affect the Company's business, financial
condition and results of operations. Moreover, the Company's ability to continue
to attract and retain Associates can be affected by a number of factors, some of
which are beyond the control of the Company, including:
. General business and economic conditions,
. Public perceptions about network marketing programs,
. High-visibility investigations or legal proceeding against network
marketing companies by federal or state authorities or private
citizens, and
. Public perceptions about the value and efficacy of nutritional,
personal care or weight management products generally.
There can be no assurance that the Company will be able to continue to
attract and retain Associates in numbers sufficient to sustain the Company's
future growth or to maintain present growth levels, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company does not directly control the independent acts of its
Associates. The Company's Associates are required to sign and adhere to the
Company's Associate Application and Agreement, which obligates them to abide by
USANA policies and procedures. Although these policies and procedures prohibit
Associates from making certain claims regarding the Company's products or income
potential from the distribution of those products, Associates may from time to
time create promotional materials or otherwise provide information that does not
accurately describe the Company's marketing program. They also may make
statements regarding potential earnings, product claims or other matters in
violation of the Company's policies or applicable laws and regulations
concerning these matters. Such violations may result in legal action by
regulatory agencies. Future legal actions against Associates or others
associated with the Company could lead to increased regulatory scrutiny of the
Company and its network marketing system. The Company takes what it believes to
be commercially reasonable steps to monitor Associate activities to guard
against misrepresentation and other illegal or unethical conduct by Associates
and to assure that the terms of its compensation plan are observed. There can be
no assurance, however, that the Company's efforts in this regard will be
sufficient to accomplish this objective. Publicity resulting from such Associate
activities can also make it more difficult for the Company to attract and retain
Associates and may have an adverse effect on the Company's business, financial
condition and results of operations.
Network marketing is subject to intense government scrutiny and regulation.
Network marketing systems such as the Company's are frequently subject to laws
and regulations directed at ensuring that product sales are made to consumers of
the products and that compensation, recognition and advancement within the
marketing organization are based on the sale of products rather than investment
in the sponsoring company. In the United States, these laws and regulations
include the federal and state securities laws, the regulation of the offer and
sale of franchises and business opportunities, regulations and statutes
administered by the FTC and various state anti-pyramid and business opportunity
laws that target direct selling businesses that promise quick rewards for little
or no effort, require high entry costs, use high pressure recruiting methods or
do not involve legitimate products. Similar laws govern the Company's activities
in foreign countries where it presently has operations or may
31
have operations in the future. The Company is subject to the risk that, in one
or more of its present or future markets, its marketing system could be found
not to comply with these laws and regulations or may be prohibited. Failure by
the Company to comply with these laws and regulations or such a prohibition
could have a material adverse effect on the Company's business, financial
condition and results of operations. Further the Company may simply be
prohibited from distributing its products through a network-marketing channel in
some foreign countries.
The Company's business is subject to the effects of adverse publicity and
negative public perception. The Company's ability to attract and retain
Associates and to sustain and enhance sales through its Associates can be
affected by adverse publicity or negative public perception regarding the
Company or its competitors. This negative public perception may include
publicity regarding the legality of network marketing, the quality or efficacy
of nutritional supplement products or ingredients in general or the Company's
products or ingredients specifically, and regulatory investigations of the
Company or its competitors or other network marketing companies and their
products, or Associate actions. There can be no assurance that the Company will
not be subject to adverse publicity or negative public perception in the future
or that such adverse publicity will not have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company relies heavily on its key management personnel. The Company
depends on the services of its founder, Dr. Wentz, who serves as President,
Chief Executive Officer and Chairman of the Board, and its other executive
officers. Dr. Wentz is a highly visible spokesman for the Company and its
products, and the Company believes its success depends in large part on the
continued visibility and reputation of Dr. Wentz, which helps distinguish the
Company from its competitors. Dr. Wentz is not a permanent resident of the
United States and will likely spend no more than four months per year in the
United States, however he intends to devote a majority of his time to the
Company's business and expects to travel outside the United States to direct and
promote the Company's international expansion. The loss or limitation of Dr.
Wentz's services as the lead spokesman for the Company and its products, as a
key developer of those products or as an executive officer of the Company could
have a material adverse effect upon the Company's business, financial condition
and results of operations.
The Company's executive officers other than Dr. Wentz are primarily
responsible for the Company's day-to-day operations, and the Company believes
its success depends in part on its ability to retain its executive officers and
to continue to attract additional qualified individuals to its management team.
The Company does not maintain a key man life insurance policy on Dr. Wentz or
any of its other officers, nor does it have an employment agreement with any of
its officers other than Gilbert A. Fuller, Senior Vice President and Chief
Financial Officer, which expires in May 2000. The loss or limitation of the
services of any of the Company's executive officers or the inability of the
Company to attract additional qualified management personnel could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The ownership of a significant amount of the Company's common stock gives
Dr. Wentz effective control of the Company. Gull Holdings, Ltd., which is
solely owned and controlled by Dr. Wentz, owned approximately 46% of the
Company's outstanding common stock at January 1, 2000. This ownership percentage
may increase as the Company completes a public share repurchase program during
the current fiscal year. Consequently, Dr. Wentz has effective control of the
Company, including the ability to elect a majority of the Board of Directors of
the Company. Similarly, Dr. Wentz is in a position to effectively control
decisions to adopt, amend or repeal the Company's Articles of Incorporation and
Bylaws and prevent a takeover of the Company by one or more third parties, or
sell or otherwise transfer his stock to a third party, which could deprive the
Company's stockholders of a premium that might otherwise be realized by them in
connection with an acquisition of the Company.
The products and manufacturing activities of the Company are subject to
extensive government regulation. The manufacture, packaging, labeling,
advertising, promotion, distribution and sale of the Company's products are
subject to regulation by numerous national and local governmental agencies in
the United States and other countries. In the United States, the FDA regulates
the Company's products under the FDC Act and regulations promulgated thereunder.
The Company's products also are subject to regulation by, among others, the
Consumer Product Safety Commission, the United States Department of Agriculture
and the EPA. Advertising and other forms of promotion and methods of marketing
of the Company's products under the FTC Act are regulated by the FTC. Various
state and local agencies as well as those of each foreign country in which the
Company distributes products also regulate the manufacture, labeling and
advertising of the Company's products.
Failure of the Company to comply with applicable FDA regulatory
requirements may result in, among other things, injunctions, product
withdrawals, recalls, product seizures, fines, and criminal prosecutions. Any
such action by the FDA could materially adversely affect the Company's ability
to successfully market its products. In addition, if the FTC has reason to
believe the law is being violated (e.g., the Company does not possess adequate
substantiation for product claims), it can initiate an enforcement action. The
FTC has a variety of processes and remedies available to it for enforcement,
both administratively and judicially, including compulsory process authority,
cease and desist orders and injunctions. FTC enforcement could result in
32
orders requiring, among other things, limits on advertising, consumer redress,
divestiture of assets, rescission of contracts, and such other relief as may be
deemed necessary. Violation of such orders could result in substantial financial
or other penalties. Any such action by the FTC could materially adversely affect
the Company's ability to successfully market its products.
In markets outside the United States, prior to commencing operations or
marketing its products, the Company may be required to obtain approvals,
licenses or certifications from a country's ministry of health or comparable
agency. For example, the Company's manufacturing facility has been registered
with the FDA and the Canadian HPB and is certified by Australia's TGA. Approvals
or licensing may be conditioned on reformulation of the Company's products or
may be unavailable with respect to certain products or product ingredients. The
Company must also comply with product labeling and packaging regulations that
vary from country to country. These activities are also subject to regulation by
various agencies or the countries in which the Company's products are sold.
The Company cannot predict the nature of any future laws, regulations,
interpretations, or applications, nor can it determine what effect additional
governmental regulations or administrative orders, when and if promulgated,
would have on its business in the future. They could include, however,
requirements for the reformulation of certain products to meet new standards,
the recall or discontinuance of certain products, additional record keeping,
expanded documentation of the properties of certain products, expanded or
different labeling, and additional scientific substantiation. Any or all such
requirements could have a material adverse effect on the Company.
The Company's business expansion into foreign markets is subject to risks.
The Company commenced operations in Australia and New Zealand in February 1998,
in the United Kingdom in December 1998 and in Hong Kong in November 1999. The
Company believes that its ability to achieve future growth is dependent in part
on its ability to continue its international expansion efforts. However, there
can be no assurance that the Company will be able to grow in its existing
international markets, enter new international markets on a timely basis or that
new markets will be profitable. The Company must overcome significant regulatory
and legal barriers before it can begin marketing in any foreign market. Also,
before marketing commences it is difficult to assess the extent to which the
Company's products and sales techniques will be accepted or successful in any
given country. In addition to significant regulatory barriers, the Company may
also encounter problems conducting operations in new markets with different
cultures and legal systems from those encountered elsewhere. The Company may be
required to reformulate certain of its products before commencing sales in a
given country. Once the Company has entered a market, it must adhere to the
regulatory and legal requirements of that market. No assurance can be given that
the Company will be able to successfully reformulate its products in any of the
Company's current or potential international markets to meet local regulatory
requirements or attract local customers. The failure to do so would have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that the Company will be able
to obtain and retain necessary permits and approvals or that it will have
sufficient capital to finance its expansion efforts in a timely manner. In many
market areas, network marketing companies other than the Company already have
significant market penetration, the effect of which could be to desensitize the
local Associate population to a new opportunity such as the Company, or to make
it more difficult for the Company to recruit qualified Associates. There can be
no assurance that, even if the Company is able to commence operations in foreign
countries, there will be a sufficiently large population of persons inclined to
participate in a network marketing system such as the Company's. The Company
believes its future success will depend in part on its ability to seamlessly
integrate its Associate compensation plan across all markets in which the
Company's products are sold. There can be no assurance that the Company will be
able to further develop and maintain a seamless compensation program.
The increase in Associate incentives expense reduces profitability. Since
its inception, the Company generally has experienced increases, as a percentage
of net sales, in the amount of incentives, including commissions and leadership
bonuses, paid to its Associates. From time to time the Company has changed its
Associate compensation plan to better manage these incentives. For example,
during the third quarter of 1997, the Company introduced a broad repricing
strategy across its product lines, creating a spread between the price the
Associate pays for the product and the sales volume point value associated with
the product. At the same time, the Company changed its leadership bonus program,
increasing the payout from 2.0% to 3.0% of total sales volume points. In
February 2000, the Company introduced a broad repricing initiative reducing the
average price of its products by approximately 24%. Management closely monitors
the amount of Associate incentives paid as a percentage of net sales and may
adjust its Associate compensation plan to prevent Associate incentives from
having a significant adverse effect on earnings. There can be no assurance that
these changes or future changes to the Associate compensation plan or product
pricing will be successful in maintaining the level of Associate incentives
expense as a percentage of net sales. Furthermore, these changes may make it
difficult to recruit and retain qualified and motivated Associates.
The Company relies on and is subject to risks associated with information
technology systems. The Company's success is dependent on the accuracy,
reliability and proper use of sophisticated and dependable information
processing systems and management information technology. The Company's
information technology systems are designed and selected in order to
33
facilitate order entry and customer billing, maintain Associate and Preferred
Customer records, accurately track purchases and incentive payments, manage
accounting, finance and manufacturing operations, generate reports and provide
customer service and technical support. Any interruption in these systems could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company recognizes the need to regularly upgrade
its management information systems to most effectively manage its operations and
Associate data base.
The Company relies on the successful efforts of certain Associates. The
Company's Associate compensation plan is designed to permit Associates to
sponsor new Associates, creating multiple "business centers," or levels in the
marketing structure. Sponsored Associates are referred to as "downline"
Associates within the sponsoring Associate's "downline network." If these
downline Associates in turn sponsor new Associates, additional business centers
are created, with the new downline Associates becoming part of the original
sponsor's downline network. As a result of this network marketing system,
Associates develop business relationships with other Associates. The Company
believes its revenue is generated by thousands of Associates. However, the loss
of a high-level sponsoring Associate, together with a group of leading
Associates in that person's downline, or the loss of a significant number of
Associates for any reason, would have a material adverse effect on the Company's
business, financial condition and results of operations.
The business of the Company is subject to the risks associated with intense
competition from larger, wealthier and more established competitors. The Company
faces intense competition in the business of distributing and marketing
nutritional supplements, vitamins and minerals, personal care products, weight
management items, and other nutritional products. Numerous manufacturers,
distributors and retailers compete actively for consumers and, in the case of
other network marketing companies, for Associates. The Company competes directly
with other entities that manufacture, market and distribute products in each of
its product lines. The Company competes by emphasizing the underlying science,
value and high quality of its products as well as the convenience and financial
benefits afforded by its network marketing system. However, many of the
Company's competitors are substantially larger than the Company and have greater
financial resources and broader name recognition. The Company's markets are
highly sensitive to the introduction of new products that may rapidly capture a
significant share of such markets. The nutritional supplement market in which
the Company's leading products compete is characterized by:
. A large selection of essentially similar products that are difficult
to differentiate,
. Retail consumer emphasis on value pricing,
. Constantly changing formulations based on evolving scientific
research,
. Low entry barriers resulting from low brand loyalty, rapid change,
widely available manufacturing outsourcing, low regulatory
requirements, and ready access to large distribution channels, and
. A lack of uniform standards regarding product ingredient source,
potency, purity, absorption rate and form.
Similar factors are also characteristic of products comprising the
Company's other product lines. There can be no assurance that the Company will
be able to compete in this intensely competitive environment. In addition,
nutrition, personal care and weight management products can be purchased in a
wide variety of channels of distribution including retail stores. The Company's
product offerings in each product category are also relatively small compared to
the wide variety of products offered by many other companies. As a result, the
Company's ability to remain competitive depends in part upon the successful
introduction of new products.
The Company is also subject to significant competition from other network
marketing organizations for the time, attention and commitment of new and
existing Associates. The Company's ability to remain competitive depends, in
significant part, on the Company's success in recruiting and retaining
Associates. There can be no assurance that the Company's programs for recruiting
and retaining Associates will be successful. The pool of individuals interested
in the business opportunities presented by direct selling tends to be limited in
each market, and it is reduced to the extent other network marketing companies
successfully recruit these individuals into their businesses. Although
management believes the Company offers an attractive opportunity for Associates,
there can be no assurance that other network marketing companies will not be
able to recruit the Company's existing Associates or deplete the pool of
potential Associates in a given market.
The Company believes that the leading network marketing company in terms of
global sales is Amway Corporation and its affiliates and that Avon Products is
the leading direct seller of beauty and related products worldwide. Leading
competitors in the nutritional products and nutritional direct selling markets
include Herbalife International, Inc., Nature's Sunshine Products,
34
Inc., Rexall Sundown, Inc. and its direct selling division Rexall Showcase
International, Inc., Twinlab Corporation, Shaklee Corporation and NuSkin
International, Inc. The Company believes there are other manufacturers of
competing product lines that may or will launch direct selling enterprises,
which will compete with the Company in certain of its product lines and for
Associates. There can be no assurance that the Company will be able to
successfully meet the challenges posed by this increased competition.
The Company's foreign expansion subjects it to the increased expense and
risks associated with foreign duties and import restrictions. At present, most
of the Company's products are manufactured in the United States and are exported
to the countries in which they ultimately are sold. The countries in which the
Company operates may impose various legal restrictions on imports. In most
cases, permits or licenses are required to import particular types of goods,
including products of the type sold by the Company. Duties of varying amounts
are imposed based on the values or quantities of the goods imported. In certain
countries and jurisdictions, nutritional and other products are subject to
significant import duties. Certain products that the Company exports from the
United States, notably products in the personal care line are subject to foreign
health and safety regulations. Certain nutritional products may also be subject
to governmental regulations regarding food and drugs, which regulations may
limit the Company's ability to sell some of its products in some countries and
jurisdictions. To date, the Company has not experienced any difficulty in
obtaining or maintaining import licenses, but there can be no assurance that it
will be able to maintain these licenses or obtain the necessary licenses to
enter new markets. In addition, new regulations may be adopted or any of the
existing regulations could be changed at any time in a manner that could have a
material adverse effect on the Company's business, financial condition and
results of operations. Duties on imports could be changed in a manner that would
be materially adverse to the Company's sales and its competitive position
compared to locally produced goods. In addition, import restrictions in certain
countries and jurisdictions may prevent the importation of U.S.-manufactured
products altogether.
Foreign operations are affected by taxation and transfer pricing
considerations. The Company's principal domicile is the United States, where it
is incorporated. Sales in the United States, Canada, Australia-New Zealand, the
United Kingdom and Hong Kong represented 52.4%, 23.0%, 20.3%, 2.1% and 2.2% of
total sales in 1999, respectively. The Company is subject to income taxes at an
effective rate of 39%, 45%, 36%, 33%, 31% and 16% in the United States, Canada,
New Zealand, Australia, the United Kingdom and Hong Kong, respectively. Under
tax treaties, the Company is eligible to receive foreign tax credits in the
United States for taxes actually paid abroad. As the Company's operations expand
outside the United States, taxes paid to foreign taxing authorities may exceed
amounts of the credits available to the Company, resulting in the Company's
paying a higher overall effective tax rate on its worldwide operations. The
Company has adopted transfer pricing agreements with its subsidiaries to
regulate intercompany transfers, which agreements are subject to transfer
pricing laws that regulate the flow of funds between the subsidiaries and the
Company for product purchases, management services and contractual obligations
such as the payment of Associate incentives. If the United States Internal
Revenue Service or the taxing authorities of any other jurisdiction were to
successfully challenge these agreements or require changes in the Company's
transfer pricing practices, the Company could become subject to higher taxes and
its earnings would be adversely affected. The Company believes that it operates
in compliance with all applicable foreign exchange control and transfer pricing
laws. However, there can be no assurance that the Company will continue to be
found to be operating in compliance with foreign exchange control and transfer
pricing laws, or that such laws will not be modified, which, as a result, may
require changes in the Company's operating procedures.
Foreign operations are affected by exchange rate fluctuations. Sales
outside the United States represented 12.3%, 21.1%, 30.8%, 42.5% and 47.6% of
the Company's net sales in 1995, 1996, 1997, 1998, and 1999, respectively. The
Company intends to continue to expand its foreign operations, exposing the
Company to risks of changes in social, political and economic conditions in
foreign countries, including changes in the laws and policies that govern
foreign investment in countries where it has operations. Since a significant
portion of the Company's sales are in foreign countries, exchange rate
fluctuations may have a significant effect on the Company's sales and gross
margins. Further, if exchange rates fluctuate dramatically, it may become
uneconomical for the Company to establish or continue activities in certain
countries. For instance, changes in currency exchange rates may affect the
relative prices at which the Company and foreign competitors sell their products
in the same market. As the Company's business expands outside the United States,
an increasing share of its net sales and cost of sales will be transacted in
currencies other than the U.S. dollar. Accounting practices require that the
Company's non-U.S. sales and selling, general and administrative expenses be
converted to U.S. dollars for reporting purposes. Consequently, the reported net
earnings of the Company in future periods may be significantly affected by
fluctuations in currency exchange rates, with earnings generally increasing with
a weaker U.S. dollar and decreasing with a strengthening U.S. dollar. Product
purchases from the Company by its foreign subsidiaries are transacted in U.S.
dollars. As operations expand in countries where foreign currency transactions
may be made, the Company's operating results will be increasingly subject to the
risks of exchange rate fluctuations and the Company may not be able to
accurately estimate the impact of such changes on its future business, product
pricing, results of operations or financial condition. In addition, the value of
the U.S. dollar in-relation to other currencies may also adversely affect the
Company's sales to customers outside the United States. The Company enters into
forward foreign exchange contracts to hedge
35
certain commitments denominated in foreign currency, including intercompany cash
transfers. The Company generally does not use derivative instruments to manage
currency fluctuations. There can be no assurance that such hedging transactions
will protect operating results and cash flows from potentially adverse effects
of currency exchange fluctuations. Such adverse effects would also adversely
affect the Company's business, financial condition and results of operations.
The Company depends on outside suppliers for raw materials. The Company
acquires all of its raw materials for the manufacture of its products from
third-party suppliers. Normally, materials used in manufacturing the Company's
products are purchased on account or by purchase order. The Company has very few
long-term agreements for the supply of such materials. There is a risk that any
of the Company's suppliers or manufacturers could discontinue selling their
products to the Company. Although the Company believes that it could establish
alternate sources for most of its products, any delay in locating and
establishing relationships with other sources could result in product shortages
and back orders for the products, with a resulting loss of net sales. For
example, since the fourth quarter of fiscal year 1996 and continuing
intermittently during 1997 and 1998, the Company experienced difficulty in
obtaining sufficient quantities of natural Vitamin E powder, an ingredient
required for the manufacture of several of its products. As a consequence, the
Company was required to alter its products and to substitute different products
from another source. In addition, the Company relies on third-party
manufacturers for several of its products, including its food bars and drink
mixes. The Company has in the past discontinued or temporarily stopped sales of
certain products manufactured by third parties while those products were on back
order. There can be no assurance that suppliers will provide the raw materials
needed by the Company in the quantities requested or at a price the Company is
willing to pay. Because the Company does not control the actual production of
these raw materials, it is also subject to delays caused by interruption in
production of materials based on conditions not within its control, including
weather, crop conditions, transportation interruptions, strikes by supplier
employees and natural disasters or other catastrophic events. The inability of
the Company to obtain adequate supplies of raw materials for its products at
favorable prices, or at all, could have a material adverse effect on the
Company's business, financial condition and results of operations.
Nutritional supplement products may be supported by only limited
availability of conclusive clinical studies. The Company's products include
nutritional supplements that are made from vitamins, minerals, herbs and other
substances for which there is a long history of human consumption. Some of the
Company's products contain innovative ingredients or combinations of
ingredients. Although the Company believes all of its products to be safe when
taken as directed, there is little long-term experience with human consumption
of certain of these product ingredients or combinations of ingredients in
concentrated form. The Company conducts research tests the formulation and
production of its products, but the Company has performed or sponsored only
limited clinical studies. Furthermore, because the Company is highly dependent
on consumers' perception of the efficacy, safety and quality of its products, as
well as similar products distributed by other companies, the Company could be
adversely affected in the event such products should prove or be asserted to be
ineffective or harmful to consumers or in the event of adverse publicity
associated with illness or other adverse effects resulting from consumers' use
or misuse of the Company's products or similar products.
Manufacturers such as the Company may be subject to product liability
claims. As a manufacturer and distributor of products for human consumption and
topical application, the Company could become exposed to product liability
claims and litigation to prosecute such claims. Additionally, the manufacture
and sale of such products involves the risk of injury to consumers as a result
of tampering by unauthorized third parties or product contamination. To date,
the Company has not been party to any product liability litigation, although
certain individuals have asserted that they have suffered adverse consequences
as a result of using the Company's nutritional products. These matters
historically have been settled to the satisfaction of the Company and have not
to date resulted in material payments by the Company. The Company is aware of no
instance in which any of its products are or have been defective in any way that
could give rise to material losses or expenditures related to product liability
claims. Although the Company maintains product liability insurance which it
believes to be adequate for its needs, there can be no assurance that the
Company will not be subject to claims in the future or that its insurance
coverage will be adequate or that it will be able to maintain adequate insurance
coverage.
The Company's business is subject to particular intellectual property
risks. The Company owns no patents, has filed no patent applications and does
not intend in the immediate future to file a patent application covering any of
the formulations of its nutritional or other products. The labeling regulations
governing the Company's nutritional supplements require that the ingredients of
such products be precisely and accurately indicated on product containers.
Accordingly, patent protection for nutritional supplements often is impractical,
if not impossible, given the large number of manufacturers who produce
nutritional supplements having many active ingredients in common. Additionally,
the nutritional supplement industry is characterized by rapid change and
frequent reformulations of products as the body of scientific research and
literature refines current understanding of the application and efficacy of
certain substances and interactions among various substances. In this respect,
the Company maintains an active research and development program that is devoted
to developing better, purer and more effective
36
formulations of its nutritional or other products. The labeling regulations
governing the Company's nutritional supplements require that the ingredients of
such products be precisely and accurately indicated on product containers.
Accordingly, patent protection for nutritional supplements often is impractical,
if not impossible, given the large number of manufacturers who produce
nutritional supplements having many active ingredients in common. Additionally,
the nutritional supplement industry is characterized by rapid change and
frequent reformulations of products as the body of scientific research and
literature refines current understanding of the application and efficacy of
certain substances and interactions among various substances. In this respect,
the Company maintains an active research and development program that is devoted
to developing better, purer and more effective formulations of its nutritional
products. The Company protects its investment in research, as well as the
techniques it uses to improve the purity and effectiveness of its products by
relying on trade secret laws, although it has not to date entered into
confidentiality agreements with certain of its employees involved in research
and development activities. Additionally, the Company endeavors to seek, to the
fullest extent permitted by applicable law, trademark and trade dress protection
for its products, which protection has been sought in the United States, Canada
and many of the other countries in which the Company is either presently
operating or plans to commence operations in the near future. The Company's
research and development efforts may at some future time result in patentable
products, in which case patents would be sought; however, no assurance can be
given that patents would be obtained. Notwithstanding the Company's efforts as
described above, there can be no assurance that such efforts to protect its
trade secrets and trademarks will be successful. Nor can there be any assurance
that third parties will not assert claims against the Company for infringement
of the proprietary rights of others. If an infringement claim is asserted, the
Company may be required to obtain a license of such rights, pay royalties on a
retrospective or prospective basis or terminate its manufacturing and marketing
of its products alleged to have infringed. Litigation with respect to such
matters could result in substantial costs and diversion of management and other
resources and could have a material adverse effect on the Company's business,
financial condition and operating results. There can be no assurance, however,
that third-party claims will not in the future adversely affect the Company's
business, financial condition and results of operations.
The Company's manufacturing activity is subject to certain risks. The
Company's results of operations are dependent upon the continued operation of
its manufacturing facility in Salt Lake City, Utah. The operation of a
nutritional supplement manufacturing facility involves many risks, including
power failures, the breakdown, failure or substandard performance of equipment,
the improper installation or operation of equipment, natural or other disasters
and the need to comply with the requirements or directives of government
agencies, including the FDA. There can be no assurance that the occurrence of
these or any other operational problems at the Company's facility would not have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company is subject to a variety of environmental laws
relating to the storage, discharge, handling, emission, generation, manufacture,
use and disposal of chemicals, solid and hazardous waste and other toxic and
hazardous materials. The Company's manufacturing operations presently do not
result in the generation of material amounts of hazardous or toxic substances.
Nevertheless, complying with new or more stringent laws or regulations, or more
vigorous enforcement of current or future policies of regulatory agencies, could
require substantial expenditures by the Company and could have a material
adverse effect on its business, financial condition and results of operations.
Environmental laws and regulations require the Company to maintain and comply
with a number of permits, authorizations and approvals and to maintain and
update training programs and safety data regarding materials used in its
processes. Violations of those requirements could result in financial penalties
and other enforcement actions, and could require the Company to halt one or more
portions of its operations until a violation is cured. The combined costs of
curing incidents of non-compliance, resolving enforcement actions that might be
initiated by government authorities or satisfying business requirements
following any period affected by the need to take such actions could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Item 8. Financial Statements and Supplementary Data
The Financial Statements and Supplementary Data of the Company required
by this Item are set forth at the pages indicated at Item 14.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information for this Item is incorporated by reference to the
Company's definitive proxy statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended.
Item 11. Executive Compensation
Incorporated by reference to the Company's definitive proxy statement
to be filed pursuant to Regulation 14A.
37
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference to the Company's definitive proxy statement
to be filed pursuant to Regulation 14A.
Item 13. Certain Relationships and Related Transactions
Incorporated by reference to the Company's definitive proxy statement
to be filed pursuant to Regulation 14A.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this Form:
1. Financial Statements
Report of Independent Auditors..................................... F-1
Consolidated Balance Sheets........................................ F-2
Consolidated Statements of Earnings................................ F-3
Consolidated Statements of Stockholders' Equity.................... F-4
Consolidated Statements of Cash Flows.............................. F-5
Notes to the Consolidated Financial Statements..................... F-7
2. Supplementary Data
Quarterly Financial Data (unaudited) (included in the Notes to the
Consolidated Financial Statements)
3. Financial Statement Schedules.
[Those that are required are included in the Consolidated Financial
Statements or Notes thereto.]
4. Exhibits.
38
Form 10-K
For Year Ended January 1, 2000
Exhibit Index
Exhibit
Number Description
- ------- -----------
3.1 Articles of Incorporation [Incorporated by reference to the Company's
Registration Statement on Form 10, File No. 0-21116, effective April
16, 1993]
3.2 Bylaws [Incorporated by reference to the Company's Registration
Statement on Form 10, File No. 0-21116, effective April 16, 1993]
4.1 Specimen Stock Certificate for Common Stock, no par value
[Incorporated by reference to the Company's Registration Statement on
Form 10, File No. 0-21116, effective April 16, 1993]
10.1 Business Loan Agreement by and between Bank of America National Trust
and Savings Association, d/b/a Seafirst Bank ("Seafirst Bank") and the
Company [Incorporated by reference to the Company's Report on Form 10-
Q for the period ended June 27, 1998]
10.2 Loan Modification Agreement by and between Seafirst Bank and the
Company [Incorporated by reference to the Company's Report on Form 10-
Q for the period ended June 27, 1998]
10.3 Employment Agreement dated June 1, 1997 by and between the Company and
Gilbert A. Fuller [Incorporated by reference to the Company's Report
on Form 10-Q for the period ended June 27, 1998]
10.4 Amended and Restated Long-Term Stock Investment and Incentive Plan
[Incorporated by reference to the Company's Report on Form 10-Q for
the period ended June 27, 1998]
10.5 Promissory Note and Redemption Agreement dated April 28, 1999
[Incorporated by reference to the Company's Report on Form 10-Q for
the period ended April 3, 1999]
10.6 Stock Pledge Agreement dated April 28, 1999 [Incorporated by reference
to the Company's Report on Form 10-Q for the period ended April 3,
1999]
10.7 Redemption Agreement dated July 30, 1999 [Incorporated by reference to
the Company's Report on Form 8-K, filed September 24, 1999]
10.8 Term Note dated September 20, 1999 [Incorporated by reference to the
Company's Report on Form 8-K, filed September 24, 1999]
10.9 Revolving Note dated September 20, 1999 [Incorporated by reference to
the Company's Report on Form 8-K, filed September 24, 1999]
10.10 Credit Agreement dated September 20, 1999 [Incorporated by reference
to the Company's Report on Form 8-K, filed September 24, 1999]
11.1 Computation of Net Income per Share (included in Notes to Consolidated
Financial Statements)
21 Subsidiaries of the Company
39
27.1 Financial Data Schedule
99.1 Press Release dated September 21, 1999. [Incorporated by reference to
the Company's Report on Form 8-K, filed September 24, 1999]
(a) Reports on Form 8-K.
The Company filed a Form 8-K on September 24, 1999 to report the
redemption of 2.65 million shares from a company owned and controlled by
its founder, Chairman, President and CEO, Myron Wentz.
40
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on this 29th day of March, 2000:
USANA, INC.
By: /s/ Myron W. Wentz
---------------------------------------------
Myron W. Wentz, PhD,
President and Chairman
Date: March 29, 2000
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:
Signature Title Date
--------- ----- ----
/s/ Myron W. Wentz Chairman, President (Principal March 29, 2000
- -------------------------------------
Myron W. Wentz, PhD Executive Officer)
/s/ Ronald S. Poelman Director March 29, 2000
- ---------------------------------------
Ronald S. Poelman
/s/ Robert Anciaux Director March 29, 2000
- ---------------------------------------
Robert Anciaux
/s/ Ned M. Weinshenker Director March 29, 2000
- ---------------------------------------
Ned M. Weinshenker, PhD
/s/ David A. Wentz Director March 29, 2000
- ---------------------------------------
David A. Wentz
/s/ Gilbert A. Fuller Senior Vice President And Chief March 29, 2000
- ---------------------------------------
Gilbert A. Fuller Financial Officer (Principal
Financial Officer and Principal
Accounting Officer)
41
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
USANA, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of USANA, Inc. and
Subsidiaries (the Company) as of January 2, 1999 and January 1, 2000 and the
related consolidated statements of earnings, stockholders' equity and cash flows
for each of the three years in the period ended January 1, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of USANA, Inc. and
Subsidiaries as of January 2, 1999 and January 1, 2000 and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended January 1, 2000, in conformity with generally
accepted accounting principles.
/s/ Grant Thornton LLP
Salt Lake City, Utah
February 1, 2000
USANA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
January 2, January 1,
1999 2000
----------------- ---------------
ASSETS
Current Assets
Cash and cash equivalents $ 2,617 $ 1,411
Receivables, net (Notes D and E) 294 534
Income taxes receivable - 302
Current maturities of notes receivable (Note D) 16 5
Inventories, net (Notes B and E) 10,543 9,855
Prepaid expenses 1,912 1,536
Deferred income taxes (Note H) 1,233 1,405
-------------- --------------
Total current assets 16,615 15,048
Property and Equipment, net (Notes C, E and G) 22,751 21,528
Notes Receivable, less current maturities (Note D) 5 -
Other Assets 55 197
-------------- --------------
$ 39,426 $ 36,773
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Checks written in excess of cash in bank $ - $ 1,416
Current maturities of long-term debt (Note E) - 2,000
Accounts payable 4,211 4,060
Other current liabilities (Note F) 4,505 5,201
Line of credit (Note E) - 1,400
Restructuring provision (Note G) - 2,252
-------------- --------------
Total current liabilities 8,716 16,329
Deferred Income Taxes (Note H) 624 25
Long-term Debt, less current maturities (Note E) - 7,500
Commitments and Contingencies (Note J) - -
Stockholders' Equity (Notes I, K, N and O)
Common stock, no par value; authorized 50,000 shares;
issued and outstanding 13,047 shares at January 2,
1999 and 10,169 shares at January 1, 2000 9,131 2,877
Retained earnings 21,668 10,078
Note receivable - related party (531) -
Accumulated other comprehensive loss (182) (36)
------------- ------------
Total stockholders' equity 30,086 12,919
------------- ------------
$ 39,426 $ 36,773
============= =============
The accompanying notes are an integral part of this statement.
F-2
USANA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands, except per share data)
Year ended
--------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
--------------- --------------- --------------
Net sales $ 85,205 $ 121,558 $ 129,386
Cost of sales 17,852 25,279 25,452
--------------- --------------- --------------
Gross profit 67,353 96,279 103,934
Operating expenses
Associate incentives (Note I) 39,536 54,408 57,044
Selling, general and administrative 16,040 25,284 31,499
Restructuring and impairment (Note G) - - 4,400
Research and development 1,245 1,362 1,377
--------------- --------------- --------------
Total operating expenses 56,821 81,054 94,320
--------------- --------------- --------------
Earnings from operations 10,532 15,225 9,614
--------------- --------------- --------------
Other income (expense)
Interest income 157 259 240
Interest expense (16) (8) (316)
Other, net 25 (73) 28
--------------- --------------- --------------
Total other income (expense) 166 178 (48)
--------------- --------------- --------------
Earnings before income taxes 10,698 15,403 9,566
Income taxes (Note H) 4,116 5,906 3,665
--------------- --------------- --------------
Net earnings $ 6,582 $ 9,497 $ 5,901
=============== =============== ==============
Earnings per common share (Note N)
Basic $ 0.52 $ 0.73 $ 0.49
Diluted $ 0.49 $ 0.68 $ 0.47
Weighted average common and dilutive common equivalent shares
outstanding
Basic 12,741 12,937 12,158
Diluted 13,319 13,929 12,473
The accompanying notes are an integral part of this statement.
F-3
USANA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 27, 1997, January 2, 1999 and January 1, 2000
(in thousands)
Accumulated
other
Common stock Retained comprehensive
Shares Amount earnings income (loss) Other Total
---------- ----------- ----------- --------------- ------------- ------------
Balance at December 28, 1996 12,702 $ 6,769 $ 5,589 $ 10 $ - $ 12,368
Comprehensive income
Net earnings for the year - - 6,582 - - 6,582
Foreign currency translation adjustment - - - (90) - (90)
------------
Comprehensive income 6,492
Common stock issued under stock option
plan, including tax benefit of $232 110 398 - - - 398
---------- ---------- ----------- --------------- ------------- ------------
Balance at December 27, 1997 12,812 7,167 12,171 (80) - 19,258
Comprehensive income
Net earnings for the year - - 9,497 - - 9,497
Foreign currency translation adjustment - - - (102) - (102)
------------
Comprehensive income 9,395
Advances to related party - - - (531) (531)
Common stock issued under stock option
plan, including tax benefit of $816 235 1,964 - - - 1,964
---------- ---------- ----------- --------------- ------------- ------------
Balance at January 2, 1999 13,047 9,131 21,668 (182) (531) 30,086
Comprehensive income
Net earnings for the year - - 5,901 - - 5,901
Foreign currency translation adjustment - - - 146 - 146
------------
Comprehensive income 6,047
Common stock retired and advances to
related party (Note I) (2,950) (6,596) (17,491) - 531 (23,556)
Common stock issued under stock option
plan, including tax benefit of $132 72 342 - - - 342
---------- ---------- ----------- --------------- ------------- ------------
Balance at January 1, 2000 10,169 $ 2,877 $ 10,078 $ (36) $ - $ 12,919
========== ========== =========== =============== ============= ============
The accompanying notes are an integral part of this statement.
F-4
USANA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year ended
------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
--------------- --------------- ------------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities
Net earnings $ 6,582 $ 9,497 $ 5,901
Adjustments to reconcile net earnings to net cash provided
by operating activities
Depreciation and amortization 2,216 3,377 4,489
Loss on sale of property and equipment - 30 15
Provision for losses on receivables 139 307 76
Provision for inventory obsolescence 220 792 685
Deferred income taxes (217) (160) (771)
Loss on restructuring and impairment - - 4,400
Changes in assets and liabilities
Receivables (182) (494) (362)
Income taxes receivable 405 - (283)
Inventories (336) (4,988) 33
Prepaid expenses and other assets (1,617) (596) 500
Accounts payable (1,497) 1,014 (172)
Other current liabilities 1,351 1,869 896
Restructuring provision - - (448)
-------------- ----------- -----------
Total adjustments 482 1,151 9,058
-------------- ----------- -----------
Net cash provided by
operating activities 7,064 10,648 14,959
-------------- ----------- -----------
Cash flows from investing activities
Receipts on notes receivable 27 30 16
Increase in notes receivable - (5) -
Increase in notes receivable - related party - (531) -
Purchase of property and equipment (5,299) (11,273) (4,927)
Proceeds from sale of property and equipment 1,110 86 25
-------------- ----------- -----------
Net cash used in
investing activities (4,162) (11,693) (4,886)
-------------- ----------- -----------
(Continued)
F-5
USANA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands)
Year ended
-----------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
---------------- -------------- ------------
Cash flows from financing activities
Checks written in excess of cash in bank - - 1,416
Net proceeds from sale of common stock 166 1,148 210
Common stock retired and advances to related party - - (23,556)
Proceeds from the issuance of long-term debt - - 10,000
Increase in line of credit (1,500) - 1,400
Principal payments of long-term debt - - (500)
-------------- ----------- -----------
Net cash (used in) provided by
financing activities (1,334) 1,148 (11,030)
Effect of exchange rate changes on cash (90) (94) (249)
-------------- ----------- -----------
Net increase (decrease) in cash and cash 1,478 9 (1,206)
equivalents
Cash and cash equivalents at beginning of year 1,130 2,608 2,617
-------------- ----------- -----------
Cash and cash equivalents at end of year $ 2,608 $ 2,617 $ 1,411
============== =========== ===========
Supplemental disclosures of cash flow information
- -------------------------------------------------
Cash paid during the year for
Interest $ 16 $ 8 $ 287
Income taxes 3,889 5,506 4,545
Non-cash investing and financing activities
- -------------------------------------------
During 1999, the Company repurchased shares of common stock from a
related party for $23,556 and settlement of a $531 note owed to the
Company from the related party.
F-6
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies consistently applied in the preparation of
the accompanying consolidated financial statements follow.
1. Financial statement presentation
--------------------------------
The accounting and reporting policies of USANA, Inc. and Subsidiaries (the
Company) conform with generally accepted accounting principles and general
practices in the manufacturing industry.
2. Principles of consolidation
---------------------------
The consolidated financial statements include the accounts and operations
of USANA, Inc. and its wholly-owned subsidiaries in Canada, Australia, New
Zealand, the United Kingdom and Hong Kong. All significant intercompany
accounts and transactions have been eliminated in consolidation.
3. Business activity
-----------------
The Company develops and manufactures nutritional, personal care and weight
management products which are sold through a network marketing system
throughout the United States, Canada, Australia, New Zealand, and the
United Kingdom (hereinafter includes the Netherlands). Direct selling in
Hong Kong began in 1999.
4. Fiscal year
-----------
The Company operates on a 52-53 week year, ending on the Saturday closest
to December 31. Fiscal years 1999 and 1997 were 52-week years. Fiscal 1998
was a 53-week year.
5. Cash and cash equivalents
-------------------------
The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents.
6. Internal software development costs
-----------------------------------
Software development costs for internally used software are capitalized
beginning when adequate funds are committed and technological feasibility
for the project is established up to the time the product is ready for use.
Amortization of capitalized costs begins when the software is ready for its
intended use and after substantially all tests to determine whether the
software is operational have been completed. Internally developed software
is amortized over 3-5 years.
7. Inventories
-----------
Inventories are stated at the lower of cost or market using the first-in,
first-out method.
8. Depreciation and amortization
-----------------------------
Depreciation is provided in amounts sufficient to relate the cost of
depreciable assets to operations over the estimated service lives.
Leasehold improvements are amortized over the shorter of the life of the
respective lease or the service life of the improvements. The straight-line
method of depreciation and amortization is followed for financial reporting
purposes. Maintenance, repairs and renewals, which neither materially add
to the value of the property nor appreciably prolong its life, are charged
to expense as incurred. Gains or losses on dispositions of property and
equipment are included in earnings. The Company capitalizes assets with a
cost in excess of one thousand dollars.
F-7
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
9. Revenue recognition and deferred revenue
----------------------------------------
The Company receives payment for the sale of products at the time
Associates and Preferred Customers place orders. Sales are recorded when
the product is shipped and title passes to the customer. Payments received
for unshipped products are recorded as deferred revenue and are included in
other current liabilities.
10. Income taxes
------------
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred income tax assets and liabilities are
provided based on the difference between the financial statement and tax
bases of assets and liabilities as measured by the currently enacted tax
rates in effect for the years in which these differences are expected to
reverse. Deferred tax expense or benefit is the result of changes in
deferred tax assets and liabilities. An allowance against deferred tax
assets is recorded in whole or in part when it is more likely than not that
such tax benefits will not be realized.
11. Product return policy
---------------------
Returned product that is unused and resalable will be refunded up to one
year from the date of purchase at 100 percent of the sales price to the
customer less a 10 percent restocking fee. Returned product that was
damaged during shipment to the customer is 100 percent refundable. Return
of product other than that which was damaged at the time of receipt by an
Associate constitutes potential cancellation of the distributorship.
Product returns have not been significant.
12. Research and development
------------------------
Research and development costs have been charged to expense as incurred.
13. Earnings per share
------------------
Basic earnings per common share (EPS) are based on the weighted average
number of common shares outstanding during each period. Diluted earnings
per common share are based on shares outstanding (computed as under basic
EPS) and potentially dilutive common shares. Potential common shares
included in the diluted earnings per share calculation include in the money
stock options granted but not exercised.
14. Fair value of financial instruments
-----------------------------------
The carrying value of the Company's cash and cash equivalents, notes
receivable, accounts receivable, payables and line of credit approximate
carrying values due to the short-term maturity of the instruments.
15. Translation of foreign currencies
---------------------------------
The foreign subsidiaries' asset and liability accounts, which are
originally recorded in the appropriate local currency, are translated for
consolidated financial reporting purposes, into U.S. dollar amounts at
period-end exchange rates. Revenue and expense accounts are translated at
the weighted-average rates for the period. Foreign currency translation
adjustments are accumulated as a component of comprehensive income.
16. Common stock
------------
The Company follows the practice of recording amounts received upon the
exercise of options by crediting common stock. No charges are reflected in
the consolidated statements of earnings as a result of the grant or
exercise of stock options. The Company realizes an income tax benefit from
the exercise of certain stock options. This benefit results in a decrease
in current income taxes payable and an increase in the common stock amount.
Common stock and stock options have been adjusted to reflect a two-for-one
stock split effective August 3, 1998.
F-8
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
17. Segment information
-------------------
The Company's operations involve a single industry segment; the
development, manufacturing and distribution of nutritional, personal care
and weight management products. The Company operates in various geographic
segments. No Associate accounted for more than ten percent of net sales for
the years ended December 27, 1997, January 2, 1999 and January 1, 2000.
18. Recently issued accounting pronouncements not yet adopted
---------------------------------------------------------
SFAS 133, as modified by SFAS 137, "Accounting for Derivative Investments
and Hedging Activities - Deferral of the Effective Date of FASB Statement
133", requires entities to recognize all derivatives in their financial
statements as either assets or liabilities measured at fair value. SFAS 133
also specifies new methods for accounting for hedging transactions,
prescribes the items and transactions that may be hedged, and specifies
detailed criteria to be met to qualify for hedge accounting.
SFAS 133, as modified by SFAS 137, is effective for fiscal years beginning
after June 15, 2000. The Company does not believe that the adoption of SFAS
133 will have a material impact on its financials statements.
19. Use of estimates
----------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and the related notes. Actual results could differ from those
estimates.
20. Foreign currency contracts
--------------------------
Gains and losses on forward and option contracts that qualify as hedges are
deferred and recognized as an adjustment of the carrying amount of the
hedged asset, or liability, or identifiable foreign currency firm
commitment. Gains and losses on foreign currency exchange and option
contracts that do not qualify as hedges are recognized in income based on
the fair market value of the contracts.
21. Certain reclassifications
-------------------------
Certain nonmaterial reclassifications have been made to the 1997 and 1998
financial statements to conform to the 1999 presentation.
NOTE B - INVENTORIES
Inventories consist of the following:
January 2, January 1,
1999 2000
------------ -----------
Raw materials $ 3,043 $ 2,344
Work in progress 1,534 1,945
Finished goods 6,592 6,388
------------ -----------
11,169 10,677
Less allowance for inventory obsolescence
626 822
------------ -----------
$ 10,543 $ 9,855
============ ===========
F-9
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE B - INVENTORIES - CONTINUED
The history of allowance for inventory obsolescence is as follows:
Year ended
-----------------------------------------
December 27, January 2, January 1,
1997 1999 2000
------------- ----------- -----------
Balance at beginning of year $ - $ 220 $ 626
Provisions 220 792 685
Write-offs - (386) (489)
------------- ---------- ---------
Balance at end of year $ 220 $ 626 $ 822
============= =========== =========
NOTE C - PROPERTY AND EQUIPMENT
Cost of property and equipment and their estimated useful lives is as
follows:
January 2, January 1,
Years 1999 2000
------- ----------- ------------
Building 40 $ 7,414 $ 7,422
Laboratory and production equipment 5-7 2,697 2,926
Computer equipment and software 3-5 11,075 11,629
Furniture and fixtures 3-5 2,024 2,132
Automobiles 3-5 320 323
Leasehold improvements 3-5 461 769
Land improvements 15 542 542
----------- ------------
24,533 25,743
Less accumulated depreciation and amortization 5,681 9,158
----------- ------------
18,852 16,585
Land 2,548 2,548
Deposits and projects in process 1,351 2,395
----------- ------------
$ 22,751 $ 21,528
=========== ============
NOTE D - RECEIVABLES
Receivable consist of the following:
January 2, January 1,
1999 2000
-------------- -------------
Receivables $ 542 $ 764
Less allowance for doubtful accounts 248 230
-------------- -------------
$ 294 $ 534
============== =============
F-10
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE D - RECEIVABLES - CONTINUED
The history of the allowance for doubtful accounts is as follows:
Year ended
-----------------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
----------------- ----------------- --------------
Balance at beginning of year $ - $ 139 $ 248
Provisions 139 307 76
Write-offs - (198) (94)
----------------- ----------------- --------------
Balance at end of year $ 139 $ 248 $ 230
================= ================= ==============
Notes receivable consists of the following:
January 2, January 1,
1999 2000
------------- -------------
10% note receivable from a company, due over three years,
collateralized by equipment $ 16 $ -
Non-interest bearing note receivable from an employee of the
Company, unsecured, due in May 2000. 5 5
------------- -------------
21 5
Less current maturities 16 5
------------- -------------
$ 5 $ -
============= =============
NOTE E - LONG TERM DEBT AND LINE OF CREDIT
During 1999, the Company entered into agreements with a financial
institution to provide up to $25,000 in secured credit facilities ("Credit
Facilities") consisting of a $10,000 5-year term loan and a $15,000 3-year
revolving line of credit.
The term loan payable requires quarterly principal payments of $500 and
quarterly interest payments at the London Interbank Offered Rate (LIBOR)
plus 2.0% (6.0% at January 1, 2000). At January 1, 2000, interest rates on
the term loan payable were 7.995% for $500 and 7.9425% for $9,000 using
five and six-month LIBOR, respectively, as the base. The term loan matures
in September 2004.
Maturities of long-term debt are as follows:
Fiscal year ending
----------------------
2000 $ 2,000
2001 2,000
2002 2,000
2003 2,000
2004 1,500
Thereafter -
=======
$ 9,500
=======
F-11
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE E - LONG TERM DEBT AND LINE OF CREDIT - CONTINUED
At January 1, 2000, the Company had $13,600 available under the line of
credit, which expires September 1, 2002. The interest rate is computed at
the bank's prime rate or LIBOR adjusted by features specified in the Credit
Facilities. The Company may choose to borrow at the bank's publicly
announced Reference Rate plus a margin per annum as specified in the Credit
Facilities or, at the option of the Company, loans within the approved
commitment may be available in minimum amounts of $100 or more for specific
periods ranging from one to six months, at LIBOR plus a margin specified in
the Credit Facilities.
Receivables, inventories and equipment secure the Credit Facilities. The
Credit Facilities contain restrictive covenants requiring the Company to
maintain certain financial ratios. As of January 1, 2000, the Company was
in compliance with these covenants. As of January 1, 2000, $9,500 was due
on the 5-year term loan and $1,400 million was outstanding on the line of
credit.
NOTE F - OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
January 2, January 1,
1999 2000
-------------- --------------
Associate incentives $ 1,140 $ 1,201
Accrued compensation 964 772
Sales taxes 845 692
Income taxes 429 564
Accrued Associate promotions 130 478
Deferred revenue 34 35
All other 963 1,459
-------------- --------------
$ 4,505 $ 5,201
============== ==============
NOTE G - RESTRUCTURING AND IMPAIRMENT
Restructuring
-------------
The Company recorded a restructuring charge and reserve totaling $2,700
($1,700 after tax, or $0.13 per share) in the third quarter of 1999. The
restructuring charge includes the impact of a substantial reduction in
United Kingdom operations, liquidation of associated assets in the United
Kingdom and reduction of staff outside of the United Kingdom. Charges
incorporated into the Company's restructuring initiative includes $900 for
non-voluntary employee termination benefits, $1,400 for the liquidation of
associated assets used in United Kingdom operations and $400 for other exit
costs.
The Company expects that all activities associated with the Company's
restructuring initiative will be completed by the end of the third quarter
of 2000. As of January 1, 2000, approximately $448 was charged against the
restructuring reserve.
F-12
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE G - RESTRUCTURING AND IMPAIRMENT - CONTINUED
Impairment
----------
In accordance with Financial Accounting Standards No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of," the Company wrote off the remaining book value of its former
custom network marketing system (legacy system) totaling $1,700 ($1,000
after tax, or $0.09 per share) in the third quarter of 1999. This charge
was the result of the Company's decision to move to a new custom network
marketing computer system ("System"). Conversion from the legacy system to
the new System has been taking place since the time the impairment was
recognized. The future benefits of the legacy system to the Company are
minimal and immaterial and could have been removed from operation at the
time the impairment was recognized.
NOTE H - INCOME TAXES
Income tax expense (benefit) consists of the following:
Year ended
-----------------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
------------------ ------------------ ---------------
Current
Federal and State $ 3,866 $ 5,343 $ 3,680
Foreign 467 723 756
------------------ ------------------ ---------------
4,333 6,066 4,436
Deferred
Federal and State (217) (152) (935)
Foreign - (8) 164
------------------ ------------------ ---------------
$ 4,116 $ 5,906 $ 3,665
================= ================= ==============
The income tax provision reconciled to the tax computed at the federal
statutory rate of 34 percent for 1997 and 35 percent for 1998 and 1999 is
as follows:
Year ended
-----------------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
----------------- ----------------- --------------
Federal income taxes at statutory rate $ 3,637 $ 5,391 $ 3,347
State income taxes, net of federal
tax benefit 369 517 370
Difference between U.S. statutory rate and
foreign rate 110 141 (23)
All other - (143) (29)
----------------- ----------------- --------------
$ 4,116 $ 5,906 $ 3,665
================= ================= ==============
F-13
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE H - INCOME TAXES - CONTINUED
Deferred tax assets and liabilities consist of the following:
January 2, January 1,
1999 2000
----------------- -------------
Deferred tax assets
Inventory capitalization $ 290 $ 142
Intercompany sales 929 31
Accrued restructuring provision - 856
All other 14 376
----------------- -------------
$ 1,233 $ 1,405
================= =============
Deferred tax liabilities
Accumulated depreciation (358) (188)
Foreign tax credit carryforward - 600
All other (266) (437)
----------------- -------------
$ (624) $ (25)
================= =============
No valuation allowance was provided for the foreign tax credit carryforward
of $600 because management believes it is more likely than not that, based
on projected future cash flows, these amounts will be recovered prior to
expiration in five years.
NOTE I - RELATED PARTY TRANSACTIONS
During fiscal 1998, the Company purchased certain assets and incurred
certain expenses on behalf of an officer of the Company. In consideration
of these purchases the officer promised to pay to the Company, on demand,
the principal amount of $531 plus interest at 7.75 percent per annum.
During fiscal 1999, the Company repurchased 2,950 shares from the officer
for $24,087, less the $531 owed to the Company.
Several family members of an officer of the Company are Associates of the
Company. In the fiscal year ended January 1, 2000, Associate incentives
paid to these distributorships totaled $1,115. The officer of the Company
has no ownership in and does not receive compensation from these
distributorships. The individuals involved in these distributorships do not
receive preferential treatment over any Associate of the Company.
NOTE J - COMMITMENTS AND CONTINGENCIES
1. Operating leases
----------------
The Company currently conducts its Canadian, Australian, New Zealand and
Hong Kong operations in leased facilities. Each of the lease agreements are
noncancelable operating leases and expire through 2003. The minimum rental
commitments under operating leases at January 1, 2000 are as follows:
Fiscal year ending
------------------------
2000 $ 484
2001 492
2002 299
2003 17
2004 -
Thereafter -
--------
$ 1,292
========
NOTE J - COMMITMENTS AND CONTINGENCIES - CONTINUED
F-14
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
1. Operating leases (Continued)
---------------------------
The leases generally provide that property taxes, insurance, and
maintenance expenses are obligations of the Company. It is expected that in
the normal course of business, operating leases that expire will be renewed
or replaced by leases on other properties. The total rent expense for the
years ended December 27, 1997, January 2, 1999 and January 1, 2000 was
approximately $373, $657 and $545.
2. Contingencies
-------------
The Company is involved in various lawsuits and disputes arising in the
normal course of business. In the opinion of management, based upon advice
of counsel, the ultimate outcome of these lawsuits will not have a material
impact on the Company's financial position or results of operations.
3. Employee Benefit Plan
---------------------
The Company has an employee benefit plan under Section 401(k) of the
Internal Revenue Code. This plan covers employees who are at least 18 years
of age and have been employed by the Company longer than three months. The
Company makes matching contributions of $.50 on each $1.00 of contribution
up to six percent of the participating employees compensation. In addition,
the Company may make a discretionary contribution based on earnings. The
Company's matching contributions vest at 25 percent per year beginning with
the first year. Total contributions by the Company to the plan for the
years ended December 27, 1997, January 2, 1999 and January 1, 2000 were
$133, $172 and $281, respectively.
4. Foreign currency contracts
--------------------------
In order to reduce the impact of changes in foreign exchange rates on
consolidated results of operations and future foreign currency denominated
cash flows, the Company was a party to various forward exchange contracts
at January 1, 2000. These contracts help the Company manage currency
movements affecting existing foreign currency denominated assets,
liabilities and firm commitments.
At January 1, 2000, the Company had approximately $94 recorded in
unamortized option contracts. Total open foreign currency forward exchange
contracts at January 1, 2000, are described in the table below:
Contract Amount
----------------------------------------------
Weighted
Average
Foreign Maturities
currency U.S. (in months)
---------------- ----------- --------------
Canadian Dollar $ 3,275 $ 2,250 3.3
Australian Dollar $ 11,813 $ 7,818 6.4
NOTE K - STOCK OPTIONS
On June 23, 1998, the Company's Board of Directors approved the combination
of the 1995 Long-term Stock Investment and Incentive Plan and the 1995
Directors' Stock Option Plan without increasing the aggregate number of
shares available for issuance under the combined plans. The Amended and
Restated Long-Term Stock Investment and Incentive Plan (the Plan) reserved
4,000 shares under the Plan. Accordingly, the Board of Directors has
approved the granting of options under the Plan as follows:
F-15
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE K - STOCK OPTIONS - CONTINUED
As of January 1, 2000, Company directors, officers and key employees have
been granted options to acquire 3,032 shares of common stock that vest
periodically through June 2004. The options have been granted at prices
ranging from $1.53 to $15.48 per share, which were the market prices of the
Company's shares on the dates granted. During 1997, exercise prices on
certain options were changed to $7.83 per share. The options expire upon
the earlier of an expiration date fixed by the committee responsible for
administering the Plan or ten years from the date of grant.
The Company has adopted only the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). Therefore, the Company continues to account for
stock based compensation under Accounting Principles Board Opinion No. 25,
under which no compensation cost has been recognized. Had compensation
cost for the stock based compensation been determined consistent with SFAS
123, the Company's net earnings and earnings per share would have been
changed to the following pro forma amounts:
Year ended
-----------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
----------------- -------------- --------------
Net earnings As reported $ 6,582 $ 9,497 $ 5,901
================= ============== ==============
Pro forma $ 5,541 $ 8,224 $ 4,558
================= ============== ==============
Earnings per share - basic As reported $ 0.52 $ 0.73 $ 0.49
================= ============== ==============
Pro forma $ 0.43 $ 0.64 $ 0.37
================= ============== ==============
Earnings per share - diluted As reported $ 0.49 $ 0.68 $ 0.47
================= ============== ==============
Pro forma $ 0.42 $ 0.59 $ 0.37
================= ============== ==============
The fair value of these options was estimated at the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions; expected volatility of 62 percent for 1997, 60 percent for
1998 and 62 percent for 1999; average risk-free interest rate of 6.13
percent for 1997, 5.67 percent for 1998 and 5.50 percent for 1999; average
expected life is equal to the actual life for 1997, 1998 and 1999.
Dividends were assumed not to be paid during the period of calculation. The
weighted-average fair value of options granted was $8.41, $11.42 and $9.34
in 1997, 1998 and 1999, respectively.
Option pricing models require the input of highly subjective assumptions
including the expected stock price volatility. Also, the Company's employee
stock options have characteristics significantly different from those of
traded options including long-vesting schedules, and changes in the
subjective input assumptions can materially affect the fair value estimate.
Management believes the best assumptions available were used to value the
options and the resulting option values are reasonable.
F-16
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE K - STOCK OPTIONS - CONTINUED
Changes in the Company's stock options are as follows:
Weighted-
average
Shares Exercise price exercise price
-------------- --------------------- ------------------
Outstanding at December 29, 1996 2,057 $1.53 - 10.52 $ 6.66
Granted 190 7.83 - 8.75 8.41
Exercised (109) 1.53 1.53
Canceled or expired (160) 1.53 - 7.83 5.77
-------------- --------------------- ------------------
Outstanding at December 27, 1997 1,978 1.53 - 8.75 5.49
Granted 310 8.90 - 15.48 11.42
Exercised (235) 1.53 - 7.83 4.89
Canceled or expired (107) 7.83 7.83
-------------- --------------------- ------------------
Outstanding at January 2, 1999 1,946 1.53 - 15.48 6.74
Granted 125 7.83 - 10.62 9.34
Exercised (73) 1.53 - 7.83 2.87
Canceled or expired (14) 7.83 - 10.62 8.63
-------------- --------------------- ------------------
Outstanding at January 1, 2000 1,984 $1.53 - 15.48 $ 7.03
============== ===================== ==================
Exercisable at January 1, 2000 936 $1.53 - 15.48 $ 6.71
============== ===================== ==================
Additional information about stock options outstanding and exercisable at
January 1, 2000 is summarized as follows:
Options Outstanding Options Exercisable
------------------------------------------------------------- -------------------------------------
Range of Weighted-average
exercise Number remaining Weighted-average Number Weighted-average
prices outstanding contractual life exercise price exercisable exercise price
------------ ----------- ---------------- ---------------- ------------- ----------------------
$ 1.53 312 5.4 years $ 1.53 87 $ 1.53
4.85 - 5.97 357 5.9 years 4.98 268 4.94
7.83 - 8.90 1,044 6.2 years 8.08 534 7.94
9.94 - 12.75 191 7.9 years 10.66 31 10.71
13.70 - 15.48 80 8.5 years 15.25 16 15.25
----- ---
1,984 936
===== ===
F-17
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE L - SEGMENT INFORMATION
The Company's chief operating decision makers utilize information about
geographic operations in determining the allocation of resources and in
assessing the performance of the Company. Management considers the
geographic segments of the Company to be the only reportable operating
segments.
The accounting policies used to develop segment information correspond to
those described in the summary of significant accounting policies. Segment
profit or loss is based on profit or loss from operations before income
taxes and includes a management fee charged by the domestic operation to
each of the foreign entities. All other intersegment transactions are
eliminated from the following segment information. Interest revenues and
expenses, income taxes, and equity in the earnings of subsidiaries, while
significant, are not included in the Company's determination of segment
profit or loss in assessing the performance of a segment.
Revenues from external customers for each of the geographic segments is
attributed to the identified countries based on the Company's familiarity
with its customer base.
Financial information summarized by geographic segment for the years ended
December 27, 1997, January 2, 1999 and January 1, 2000 is listed below:
Revenues from
External Earnings before Long-lived
Customers Income Taxes Assets Total Assets
----------------- ----------------- ------------------ ------------------
Year ended December 27, 1997:
Domestic $ 58,975 $ 7,458 $14,789 $23,809
Canada 26,230 3,240 70 1,381
Australia - New Zealand - - 237 1,179
United Kingdom - - - -
Hong Kong - - - -
All Others - - - -
----------------- ----------------- ------------------ ------------------
Totals $ 85,205 $10,698 $15,096 $26,369
================= ================= ================== ==================
Year ended January 2, 1999:
Domestic $ 69,822 $ 7,981 $20,477 $29,744
Canada 32,739 6,156 246 3,014
Australia - New Zealand 18,659 1,423 1,077 3,850
United Kingdom 338 (144) 1,011 2,812
Hong Kong - (13) - -
All Others - - - 6
----------------- ----------------- ------------------ ------------------
Totals $121,558 $15,403 $22,811 $39,426
================= ================= ================== ==================
Year ended January 1, 2000:
Domestic $ 67,742 $ 3,320 $19,289 $28,052
Canada 29,765 4,816 269 1,606
Australia - New Zealand 26,260 3,582 884 2,838
United Kingdom 2,690 (2,649) 707 2,079
Hong Kong 2,929 538 576 2,186
All Others - (41) - 12
----------------- ----------------- ------------------ ------------------
Totals $129,386 $ 9,566 $21,725 $36,773
================= ================= ================== ==================
F-18
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE M - QUARTERLY FINANCIAL RESULTS (Unaudited)
Summarized quarterly financial information for fiscal years 1998 and 1999
is as follows:
First Second Third Fourth
------------ ------------ ------------- -------------
1998 quarter
------------
Net sales $ 26,164 $ 30,913 $ 32,123 $ 32,358
Gross profit $ 20,678 $ 24,505 $ 25,398 $ 25,698
Net earnings $ 1,936 $ 2,404 $ 2,530 $ 2,627
Earnings per share:
Basic $ 0.15 $ 0.19 $ 0.19 $ 0.20
Diluted $ 0.14 $ 0.17 $ 0.18 $ 0.19
First Second Third Fourth
------------ ------------ ------------- -------------
1999 quarter
------------
Net sales $ 31,323 $ 32,478 $ 32,359 $ 33,226
Gross profit $ 24,940 $ 26,138 $ 26,043 $ 26,813
Net earnings $ 2,128 $ 2,244 $ (750) $ 2,279
Earnings per share:
Basic $ 0.16 $ 0.17 $ (0.06) $ 0.22
Diluted $ 0.16 $ 0.17 $ (0.06) $ 0.22
NOTE N - EARNINGS PER SHARE
Year ended
--------------------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
----------------- ----------------- --------------
Earnings available to common shareholders $ 6,582 $ 9,497 $ 5,901
Basic EPS
- ------------------------------------------------------
Shares
Common shares outstanding entire period 12,702 12,812 13,047
Weighted average common shares:
Issued during period 39 125 36
Canceled during period - - (925)
----------------- ----------------- --------------
Weighted average common shares outstanding during
period 12,741 12,937 12,158
================= ================= ==============
Earnings per common share - basic $ 0.52 $ 0.73 $ 0.49
================= ================= ==============
F-19
USANA, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
NOTE N - EARNINGS PER SHARE - CONTINUED
Year ended
-----------------------------------------------
December 27, January 2, January 1,
1997 1999 2000
--------------- ---------- -----------
Diluted EPS
- ----------------------------------------------
Shares
Weighted average common shares outstanding during
period - basic 12,741 12,937 12,158
Dilutive effect of stock options 578 992 315
----------- ---------- ---------
Weighted average common shares outstanding during
period - diluted 13,319 13,929 12,473
=========== ========== =========
Earnings per common share - diluted $ 0.49 $ 0.68 $ 0.47
=========== ========== =========
NOTE O - SUBSEQUENT EVENTS
Subsequent to year-end, the Company announced that its board of directors
approved an open market share repurchase program that will include up to one
million shares of its outstanding common stock.
F-20