Josh Foukas - Vice President of Legal and Investor Relations David Wentz - Co-Chief Executive Officer Kevin Guest - Co-Chief Executive Officer Paul Jones - Chief Financial Officer Douglas Hekking - Executive Vice President of Finance.

Tim Ramey - Pivotal Research Group Eric Gottlieb - D.A. Davidson & Co. Frank Camma - Sidoti & Company.

Good day, and welcome to the USANA Health Sciences third quarter conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Josh Foukas. Please go ahead, sir..

Good morning, everyone, and thanks for joining us this morning to review our third quarter results. Our call today is being broadcast live on the webcast and can be accessed directly from our website at www.usanahealthsciences.com. Shortly following the call, a replay will be available on our website.

As a reminder, during the course of this call, members of our management will make forward-looking statements regarding future events or the future financial performance of the company. Those statements involve risks and uncertainties that could cause our actual results to differ, perhaps materially from the results projected in such statements.

Example of these statements includes those relating to our 2016 strategies and financial outlook. We caution you that these statements should be considered in conjunction with our disclosures including the specific risk factors and financial data contained in our SEC filings.

I’m joined this morning by our Co-CEOs, Dave Wentz and Kevin Guest; Paul Jones, our Chief Financial Officer; and Doug Hekking, our Executive Vice President of Finance. Yesterday, after the market closed, we announced our third quarter results and posted our management commentary document to the company's website.

Before opening the call for questions, we'll first hear from Dave who will briefly review the quarter's highlight.

Dave?.

Good morning, everyone. It's great to be with you this morning. I'll keep my comments brief and then open the call up for questions. Now, while the third quarter was another solid quarter for USANA and included several important accomplishments, our top-line results came in below our expectations, due to softer than expected sales in China.

Let me address this first. As we have communicated throughout the year, our top priorities for 2016 are transitioning to our new state-of-the-art production facility in Beijing and enhancing our information technology infrastructure around the world.

Our growth in China has outpaced our manufacturing capacity and other infrastructure in that market, while our worldwide growth has required enhancements to our IT infrastructure as well. While these improvements take time to complete, they are absolutely essentials to USANA's long-term growth potential.

Our team determined at the outset of 2016 that it was not in the best interest of the company or its customers for the company to run significant growth initiatives, while focusing on the strategic objectives.

Doing so could have produced a host of issues for the company, including product backorders and customer service challenges in China and other market. So we have not offered any significant growth incentives in China or our other markets during 2016.

And the growth we have achieved has been entirely organic from continued momentum within the sales force. While we projected this momentum to continue throughout the year, we saw our momentum slow this quarter, predominately in China.

Despite this challenge, I am pleased to report that during the quarter, we received all of the necessary permits to begin production in our new China facility and we now anticipate that the facility will be fully operational by the end of the year.

With the facility coming online, we are making preparations to begin offering growth initiatives in China in early 2017. That said we still believe that we will be in a better position to fully drive growth in China and our other markets when the improvements to our IT infrastructure are complete.

Notwithstanding these growing pains, we made several significant accomplishments during the quarter. Obtaining the permits and product registrations I mentioned a moment ago is a meaningful accomplishment and is a result of a significant undertaking by our U.S. and China operations and regulatory team.

We also made solid progress during the quarter on adding talent to our global executive and employee team, which is also essential in light of our growth. We made several key hires in China in various areas including, sales, operations and government relation.

Our objective is to assemble a China team that has a talent and experience to generate future customer growth in that market. We also made several key hires to our team in the U.S. to help drive our strategic objectives around the world.

Next and perhaps most importantly, we accomplished one of the greatest innovations in the USANA's history with the launch of our InCelligence product platform, and our flagship, multivitamin, CellSentials. At our International Convention in August we launched both of these.

InCelligence is USANA’s proprietary technology that is designed to support your body’s natural ability to nourish, protect and renew itself. CellSentials is our new flagship multivitamin, and is part of our InCelligence platform.

These launches and our convention, in general, were a huge success with new records for sales and attendance at our convention. And our 2017 convention has already sold out. Now, in our release yesterday, we revised our 2016 outlook in light of the challenges I just mentioned and our anticipated growth rate for the remainder of the year.

Notwithstanding these challenges, I am confident in the strength of our underlying business in China and our other markets and believe that the strategy we are executing will better position USANA for long term growth.

Our balance sheet remains strong and we remain positioned to return value to shareholders and we look forward to delivering another record year for USANA. With that, I'll ask the operator to please open the lines for questions..

[Operator Instructions] We'll go ahead and take our first question from Tim Ramy with Pivotal Research Group..

Good morning, thanks. Just wanted to ask a bit more about the tax rate in pact? I believe you adopted this 2016-9 Standard early in the year and it didn’t have any major impacts then. This was a fairly major impact.

Why was it located in this quarter? And what do we think the impacts will be in future quarters?.

Tim, this is Doug Hekking. The reason you saw the impact in Q3 is that when we saw the equity exercises take place, and so it's from a model and from a guidance perspective that we gave out there, we typically haven't factored in or we're not planning on factoring in anything that hasn't happened, because there's two variables.

First of all is the employee exercising their equity award, and it's also kind of where the stock price is at that time. So the reason you really didn’t it that much in the first couple of quarters is we didn't have a great deal of exercise of equity by employees.

In the third quarter, you saw that pick up and so that was the reason you saw that thing. And going forward, like I said, we won't build anything in our guidance just because it's something that's outside our control, but we will recognize and explain in detail when it does occur..

Okay.

Is there such a thing as what we think the new normal tax rate will be? Is it 31.5% or 32% or you know X these large dislocations I guess?.

I would say, if you exclude the excess tax benefit impact on the income tax line, we're probably between that 34% and 34.5%, if you exclude those. But when we couple all those things together, yes, there really is no new rate that we can go back and provide, because the standard, by its very essence, introduces a lot more volatility to our earnings..

Okay. And I just wanted to ask a little bit more about the third quarter China performance. By the number, it was slower, but it didn’t look bad. And it looked like there was decent growth in associates and so on.

What was the signal to use that perhaps the -- to get to your sales guidance, I didn't have to whack my fourth quarter estimates, so it seems like it’s more of a fourth quarter impact than a third quarter impact.

What were you seeing that made you think that was the case?.

I think we were just expecting China to remain a little stronger, even though we haven't done much to help it this last year, but the numbers just dripped a little lower than expected. We're excited for our convention.

Next week, I guess, I'll be in China for another sold out event, which I think is 11,000 approximately, maybe 12,000 in the sold out arena in Guangzhou. So hopefully, we can get the people back and working and excited about the new facility and our ability to deliver on whatever they want to grow it to.

And so we're going to rally the troops next week and see what we can get going. But it’s a huge shift now. I mean, China has become a huge market, and to build back momentum is going to take some time because we have had our foot off the gas for a year, I guess.

And we're going to start putting in gas back on, but it will take a while for it to ramp back up. It's not going to be a light switch that we flip overnight..

Thank you. We'll take our next question from Eric Gottlieb with D.A. Davidson & Co..

Touching on the tax charges again, I believe you said that the adjustments would be 3% in either direction going forward. And here we are 16%.

Is this a one-time thing? I know it's hard to predict the future, but is 3% the norm still?.

Yes, I'm not sure where the 3% is coming from, Eric..

Okay..

But I think what we prefaced when we adopted the standard, what we said is this going to go back and increase volatility in that effective tax rate and have the potential to have meaningful swings like it did this third quarter, especially the result is just the exercise price being above both a strike price and net added fair value and that excess has typically been reported as a component of our stockholders' equity.

Now it gets pushed to that tax line item.

And like you said, it had a pretty substantial impact this quarter, but I'm not sure on the 3% where it's coming from, but we'll see some volatility there as we see exercises or if it's stagnant, see a lot of exercises and it depends on where people exercise that we'll see some difference in volatility on that tax line.

And I wish I could give you great clarity, but we don't have great clarity to provide..

Okay. Well, the 3% came I think from a conversation we had, but I will check my notes. I have a formal request. Given all the changes in taxes, I'm wondering if guidance could be -- for next year could be an EBITDA or pre-tax income or something that kind of takes that out and then move on..

I think that's -- we've always tried to back and give an operating margin target, so we'll continue to go back and do that, but I think your point is good one, I think that's what people should be attaching to..

Okay.

So how much of the IT investment is -- how much is the IT investment going to be when we are all said and done, and how much has already been spent?.

The IT investment is just an ongoing increase in our IT resources. It's not a purchase of a software or a big spend. It’s just it's in our current running rate. We'll continue to grow IT a little faster than other departments as technology becomes a bigger part of our business. But we're flowing at that rate. We've hired a number of great people.

We made a small purchase of some software, but it's all absorbed into our SG&A and we're going to continue to just make sure that we're not adding complexity on top of IT as they work to get the underlying system re-written and more efficient, faster, and more flexible, so that we can do more things in the future.

So you're seeing the IT spend currently..

Okay. Well, on that note, you said that you can't fully unlock China, even though we have this new plant, until you have the IT infrastructure in place. So maybe the overall project we don't have an idea on.

But when do you expect that with regards to China for that to be completed, or at least for that to be completed enough that we can unlock more value?.

There are some pieces that will be done around March of April next year. There are some pieces that will be done in August of the following year. There are some other pieces in May of '18. And there are some pieces at August of '18.

I mean, it's module by module, piece by piece, we're rewriting the code, because we customized it and changed it and add layers on top. And we need to go back, clean up the architecture, and not do the whole thing in one piece. It's just a systematized rewrite.

And that will be an ongoing thing for the future years of the company, where if there are five modules every five years, one of them will be re-written in a sequential process. And we weren't diligent enough these past years.

We just had it more complexity on top and now it’s time for us to make that investment in time, so more to speak than in dollars. We need to invest the time in getting it cleaned up before we add more complexity on top. So we're excited to have WeChat coming up soon in China. That will be an exciting thing for them.

And then just other pieces will continue to roll out. Some of them having more power to increase flexibility and make changes that we think will grow the company faster..

Great. I appreciate the color on that.

The incentive plans that you plan on launching in China, are they similar to the large programs you launched back in '15?.

No, no. The fourth quarter of '14, first quarter of '15, no, they wouldn't be that magnitude..

You said before, China's return of approval is 18 months -- takes 18 months to improve InCelligence, give or take, I mean that's not a set thing.

But to put it another way, how soon do you think InCelligence is going to be available in China? A range of time you had a guess?.

Product regulatory in China is three to five years. The more complex product, the longer it will take. So we're working on submitting updated formulas all the time and it takes a stepwise function. There maybe some other formulas in between the InCelligence formula getting there that will be upgrades and improvements along the way..

Right. And then China associate growth, you highlighted greater China. And then you also said in China, the country is up 22% from last year.

What was that sequentially?.

In just mainland China?.

Yes..

Let me grab that for you. The China was down about 2% sequentially -- mainland China was down about 2% sequentially..

And then positively as far as Southeast Asia, I saw growth in sales per associate, and obviously something I calculate, but roughly 9% after two years of declining.

What's driving momentum in that region?.

Yes, you have to go, but when we've gone back and we've looked at kind of the sales per associate, if you strip out the currency and you do it year-on-year, the numbers have been pretty consistent. Southeast Asia Pacific, you know, actually had a small pick up in currency during the quarter, and so that definitely played a role there.

We're really not seeing much of a change in pattern in the average spend per associate..

Okay. Fair enough. I will leave you off there, and I will ask some questions off-line. Thank you for the additional color..

Our next question comes from Frank Camma with Sidoti & Company..

Just following up on the InCelligence question here since it's not going to obviously be in China for a while. Looking back on it now, I mean obviously important product launch for you guys. Where did you expect this product to do its best? It looks like so far it hasn't had much of a -- obviously it is very early, but positive impact in the U.S.

market in particular, which I thought maybe in a market like that, it would, but another markets, perhaps it wouldn't.

Just you know if you can engage early thoughts on expectations versus where it's coming in at?.

Well, with this being a replacement of existing products, everyone just goes from the old product to the new product when it comes to our multivitamin, so there is not a big pickup with our existing customers. It's more of the new story and new reason to go back and talk to people and tell them about the advancement.

If maybe they didn’t decide to take the products at that time, maybe with this renewed story, they can get more of those people to join. So it's just a organic over time, giving something new to talk about, something new and innovative that other companies don't have to differentiate themselves and standout in the crowd.

And we're hoping that they will just increase their messaging and go back to some people maybe that didn't decide to buy in the past..

So what do you think your biggest challenge is right now in the U.S.? I mean, you've got the pretty good branding going on and awareness -- Dr. Oz.

Just wondering what do you think right now is holding you back specifically in the U.S.?.

Frank, this is Kevin. To answer your question, there are a few things that come to mind, as we look at the U.S. market and some areas where we're taking action.

One is just from a differentiation perspective, as we look at the United States the challenge is how do you not become a commodity that is equal to other products that are sold in other areas, so how do you differentiate yourself..

Right..

We're continuing to focus on the strategy of personalization and continuing to personalize our products from a differentiation perspective, thus InCelligence. And that's part of the whole InCelligence technology is personalization for individual sales.

And so as we look at that, that's an obstacle in the United States, because of the GNCs of the world and so forth and so on that compete with us in our space, and so we're continuing to work on personalization and follow that strategy through.

And the other side of that is just not the pills or products that they're taking, but it’s the technology side. Technology is also a big opportunity for us in the United States. We look at others in our space who have truly captured the ability to easily do business with the company, to attract a very strong customer base, so forth and so on.

Technology is another obstacle that we feel like we're on top of, and look forward to really opening up some areas in many markets, not just the United States as we increase in our technology side of things and doing business with USANA, which is also part of our personalization strategy as we differentiate USANA.

So those are a couple of obstacles we see in the U.S. Lastly, one thing that we're again very much focused on is new leadership development. And the new leaders that are out building and growing their USANA businesses with their customer base that loves our products.

And as we go to maturity phases, which we're in the United States, we are constantly developing ways to develop new leadership to share the USANA message. And Dr. Oz is part of that because, that’s a critical tool for them to say, boy, did you see the Dr. Oz show? Well, I represent USANA that you saw on the Dr.

Oz show, which has gain and is gaining more and more attraction..

It seems like a great technology and product. Do you get any feedback that maybe it is a little bit -- it's a complicated message though compared to traditional vitamin. I mean, it seems like the messaging might be a little more difficult.

Is that a fair statement or do you get any of that feedback?.

No, I think we're trying to use technology to simplify things, to give people personalized, customized product offerings without them having to read a 40 page product booklet to try and figure out what products are right for them.

With the right technology, we can let the experts let them know based on their lifestyle, based on their history, situation in life, what are the best products for them without them having to think about it.

With them, just getting a product recommendation and clicking order versus, which products do you want? Oh, I don't know, let me go learn about all of them and think about it and try and figure out the science here. That makes it far more complicated, the less that we had in the past.

We're going to use technology for mass personalization in a way that's scalable and allows people to give what's right exactly for them, not for men 40 to 70 or something [technical difficulty] individual to get value, so that the products they end up with each day are the ones they're going to change their health the most and have the biggest impact without them having to think about it at all, just by giving us information.

That data is, of course, extremely valuable as all companies know, when you know your customer better than anyone and you know what their wants, needs, dreams, concerns are, we can make sure we take care of them and have the best experience possible, which will keep them with for a lifetime if they are getting the best result they could possibly get..

And I assume you could also data mine that for maybe new products that would address --.

Absolutely. When we know that the people who don’t buy our products are interested in a particular health concern, we can move our R&D to fill that need and thus capture those people that we maybe losing.

And so we're very excited about the data mining that our company is able to do that many, many companies, I mean, retail is not able to do what we're able to do because we'll have so much information, in addition to all the social media and other things that people mine, we'll have them giving us information about what they eat, how much they exercise, what they are worried about each day and make sure that we take care of them better than anyone else can..

Okay. My final question is just on the inventory.

Can you talk about how much of that build-up -- I mean obviously you addressed the China issue, but how much of that build-up is really related to carrying the old food line? And also, if you could add any color on how the Smart Food line is doing so far?.

We have a few million dollars that are attributed to the new food line and incremental inventory that we think we'll start seeing decrease as we head into the 2017 year..

Okay..

But as far as the performance, Kevin, I don’t know if you want to touch on that, but I think what we've seen is pretty good adoption. I think people have been pretty pleased. The commentary that we're hearing about it, I think is pretty positive..

Yes, strategically our focus is the healthy-aware consumer, someone who is a little more educated as it relates to health and what they're putting in their body. And these new MySmart Foods that is a definite step in that direction in providing a healthier solution and a healthier product for the healthy-aware consumer.

Our bars that were released are doing extremely well. The shakes, whenever you're dealing with taste and switching over a product to taste, people sometimes would like to have what they're used to in the past, but we are seeing a great adoption rate globally, and in some markets record sales with the new MySmart Foods..

Great. Thanks, guys..

Thank you. And that does conclude our Q&A session for today. I will now hand it back over to our speakers for any additional or closing remarks..

Thanks everyone for your questions today and for your participation on the call. If you have any follow-up questions, please contact Investor Relations at USANA at telephone number 801-954-7823. Thank you..

And that does conclude today's program. We like to thank you for your participation. Have you a wonderful day and you may disconnect at any time..