USNA - NYSE

Good day, everyone, and welcome to USANA Health Sciences Second Quarter Earnings Call. Today's call is being recorded. And now at this time, I'd like to turn the call over to Andrew Masuda. Please go ahead.

Thank you, and good morning, everyone. We appreciate you joining us to review our second quarter results. Today's conference call is being broadcast live via webcast and can be accessed directly from our website at ir.usana.com. Shortly following the call, a replay will be available on our website. As a reminder, during the course of this conference call, management will make forward-looking statements regarding future events or the future financial performance of our company. Those statements involve risks and uncertainties that could cause actual results to differ perhaps materially from the results projected in such forward-looking statements. Examples of these statements include those regarding our strategies and outlook for fiscal year 2023 as well as uncertainty related to the economic and operating environment around the world, our operations and financial results. We caution you that these statements should be considered in conjunction with disclosures, including specific risk factors and financial data contained in our most recent filings with the SEC. I'm joined by our President and CEO, Jim Brown; our Chief Financial Officer, Doug Hekking, our Executive Chairman, Kevin Guest; as well as other executives. Yesterday, after the market closed, we announced our second quarter results and posted our management commentary document on the company's website. We'll now hear brief remarks from Jim before opening the call for questions.

Thank you, Andrew, and good morning, everyone. We appreciate you joining us. We're pleased to report second quarter operating results that were better than our expectations. During the quarter, we saw further stabilization in our active customer counts, stronger-than-anticipated net sales in Mainland China and continued progress on several of our long-term strategic initiatives. As we mentioned in our first quarter call, first quarter net sales included approximately $12 million related to purchasing in Mainland China for our immunity products following the lifting of COVID restrictions, and approximately $13 million related to buy up ahead of announced price increases in several markets. Both of these first quarter events created a tough sequential quarter comparison for the second quarter. We also had a challenging year-over-year comparison due to a large global promotion in the second quarter of 2022, which did not reoccur in 2023. Given the challenging comparable periods, we were pleased with the performance of the business during the quarter. Before opening the call up for questions, I'd like to spend a few minutes reviewing some of the progress we made during the quarter. If you recall at the beginning of the year, we made the strategic decision to move away from the large global incentives that we offer throughout different quarters in each of the previous 3 years. While these promotions resulted in a strong sales activity during the quarter in which the promotion was offered, we realized that it was difficult to retain these customers at desired levels in subsequent periods. And it ultimately creates variability and fatigue with many of our leaders. Our 2023 strategic -- strategy entails offering smaller market-specific incentives at various times throughout the year to generate sustainable sales and active customer growth. As I commented a few minutes ago, this change in approach has created difficult year-over-year comparisons in the first half of 2023. Although we remain in a fluid operating environment that is being influenced by inflationary pressures, we are generally pleased with the net sales and active customer counts and recognize that there is far more work to do to generate growth. Moving on, our team in China did an excellent job of executing the strategy in this key market during the second quarter. Local currency sales in the market grew 10% sequentially and exceeded our expectations, driven by strong demand from a small market specific promotion offered during the quarter. We are pleased with our performance in this market, particularly given the macroeconomic environment. The country continues to reopen, allowing us to hold more in-person meetings and reengage with our customers in a single largest market. We are, however, continuing to see an impact on consumer spending from a broader inflationary pressures, which are affecting customer purchasing decisions. Nevertheless, our team remains optimistic that we'll continue to see improvements in the market as China continues to operate more freely and we'll execute our strategies in this market that still presents enormous opportunity for growth. In May, we announced our plan to expand into India and officially launch operations in late 2023. This new market expansion is several years in the making and wouldn't be possible without the diligent work and effort that our team has spent preparing for the launch. India is an exciting and compelling market opportunity. And we believe that our world-class health and wellness products and our business model are ideally suited for this market. That said, I have the utmost confidence in our local leadership team, and I would like to stress that our approach to expanding and growing this market will be intentional and will focus on long-term sustainable growth. We anticipate sales contribution to be modest on the onset and look forward to providing future updates on this market once we officially launch operations. In closing, our year-to-date performance and our current visibility into the remainder of the year is allowing us to raise the low end of our fiscal 2023 guidance range. We remain confident in our abilities to execute our strategies, which we believe will position USANA deliver sustainable long-term growth. With that, I'll now ask April, our operator to please open the lines for questions.

[Operator Instructions] And we'll first hear from Linda Bolton-Weiser of D.A. Davidson.

So I had just a question about the North Asia region, I guess, Korea, it looked like to me that the performance got sort of worse, sequentially. But then again, I know there's some noise because of the pull forward of things in the first quarter. Do you feel that -- can you just maybe talk about Korea and how that market is doing? Is it getting sort of better or worse in your opinion?

Yes. Linda, this is Doug. I'll comment, and I'll let Jim jump in and add any comments on top of it. So I think some of the sequential progress or a sequential headwind that you saw with Korea was primarily related to the run-up due to the price increase and kind of buying advance to that. But Korea has been an incredibly strong market for us for the last number of years, and we have seen that flattening out a little bit. The team is working hard. They're engaged. They're really working on customer engagement, but we have seen that market flattening out a little bit relative to what we've seen as far as year-over-year growth. Jim, anything to add on top of that?

Yes. Just to add, we had our Asia Pacific convention, and it was in Korea during the quarter. Even though we have seen, like Doug talked about, a little flattening out where we see excitement in the field. We had the biggest group was the Korean group and that was thousands of people. And you just had excitement and commitment from that group of associates.

Okay. And the gross margin in the quarter was actually very good. It beat our expectation and it showed some good improvement both -- I think it was both sequentially and year-over-year, if I'm remembering, do you envision that level kind of carrying forward? And is it the pricing that help so much. But kind of that level that we saw in the second quarter, how does that pan out kind going forward?

Yes. I mean as we talked about, we have some kind of unique nuances in the first half of the year to just make sure we put things in context. One is what Jim talked about in his opening remarks in the first quarter. In the second quarter, as we mentioned, some of our publicly provided material, we had a promotion in China that we are expecting maybe to generate $10 million from during the period, and we probably were upwards of $15 million, $16 million in incremental sales generated from that promotion in China. And you see a little bit of lifting from our internal expectations because it outperformed a little bit. It's been on the calendar. But some of those things in China, and Brent Neidig, who oversees the market has a lot of incredible strategies and efforts going on to build really long-term sustainable growth in the market. But we don't have the same cadence of promotional activity or one-off events in the back half of the year. And so that's just a little bit of context and gives a little bit of color on what we provided.

So you're saying that the gross margin was helped by that incremental revenue and that is that high gross margin revenue?

No. I think we see a little bit of a switch when we have a greater proportion of revenue coming from China and kind of the mix of the line items in their income statement. They typically have a modestly better gross margin, a little bit higher incentive rate. Overall, the margins are strong, but it's a little bit of a different structure in China than what we see in other markets.

So I'm not sure I'm understanding. So the China promotion that was better than expected occurred in the second quarter and that high gross margin business. So that helps the gross margin. Is that what you're trying to say?

Yes, that's what I'm saying.

Okay. So then maybe going forward, we should be a little a little lower in our expectation maybe for gross margin.

Yes. Yes. I think you saw something is probably a little bit better than what we'd expect in the back half of the year. And I think just the mix by market is the primary catalyst there.

Okay. I got you. And then I was just examining your cash flow a little bit. And your operating cash flow, I mean, it was down year-over-year, I think, there's such line in the cash flow statement called other liabilities or something like that. That seems to be the culprit in affecting your cash flow. What is that line item? And is there something we should be concerned about? Or why is that such a negative element of the cash flow statement?

I mean, typically, in the front half of the year when you're looking at that kind of 6-month stuff and doing the other stuff, you see a lot of stuff that had been accrued throughout '22 that gets settled up in '23. For example, some of the employee bonuses, some different tax payments that would be in that other liabilities, some of those types of things that you typically get flushed out. And when you look year-on-year, it just kind of depends on how those things influence it. But obviously, the operating margin has been a little bit softer than what we've seen historically just because of a little bit of top line pressure, but I think we're committed to continue investing. And so we're still generating robust cash flow and solid cash flow. But I think comparison is going to somewhat mirror over some reasonable period of time our operating margins as well.

Okay. And then just 1 more question on the cash flow. You had a lot of cash on your balance sheet, and you've kind of paused share repurchase. Is that cash kind of stranded overseas? And do you need to repay before you take it? I'm just wondering why you feel like you can't access that cash on your balance sheet to do share repurchase. Is it inaccessible for some reason?

No, there's obviously at some point in time because we're running international business, not all of it's readily available here, but we could always go back and draw on our credit facilities that we wanted to. So that really isn't kind of put in the short term. I think every quarter, we visit with the board and we talk about capital allocation, what some of the different purposes are we're considering and kind of just where we're at and kind of the priorities of the business. And that's the primary factor in that. We've -- as we've talked about, we've looked at more kind of outside business opportunities probably at a greater level than we ever had in the company's history. As we get into some discussions going, those are things that we have in mind as we look at it in addition to other priorities we have as a company. But -- no, I think the way it's managed. There's a little bit of a timing issue with some of the markets. But no, that doesn't hander us, and we really haven't given too much clarity exactly what we're going to do on the share repurchase.

Okay. And then switching back to China. I mean your comments sounded pretty positive, and you pointed out the sequential improvement there like I know you don't want to get into specific guidance, but I'm thinking that maybe China in local currency revenue could be flat or up in the third quarter for you, flat or up year-over-year. Is -- am I thinking correctly? Am I way kind of off on that?

Yes. We've been thinking more sequentially on how we've talked about it. Year-on-year, I'm trying to go back in process in my mind a little bit, Linda. We obviously had the promotion we just talked about in the second quarter, and we're not going to comp sequentially in a favorable manner or not because we're not running something similar in the third quarter. Year-on-year, I'd have to -- I'll go back and look, I don't have that right in front of me now. But I'm confident, as we hear Brent and leadership team in China and some of the conversations they've had and some of the traction, I think they're getting a lot of these things, but some of these things are more structural and long-term oriented that we think are going to be very additive is just not going to have the effect, as you would with a very short-term promotion.

Do you find that the China customers are oriented toward immunity and health and wellness because of the COVID aftermath?

Yes. Brent is in the room here. Maybe I'll let him -- he's probably definitely more inside the China consumer than I do.

We saw a very strong buy up of our immune products in the fourth quarter and in the first quarter of this year when the zero-COVID policy lifted. And after that, we started to see more of a tapering of sales from those products. So I think it's kind of returning back to a normal level of what we would expect to see. But long term, absolutely, the Chinese consumer is very health conscious, health focus and immune focus. So I think that those products will continue to be strong sellers for us into the future.

Okay. And just let me just -- if I could please just ask 1 other question on the SG&A expense. It was a little higher than we expected in the quarter. I guess it was something like $68 million or so, if I'm remembering, is that because of the conventions and meetings that you had? And kind of going forward, is that the amount I should think about? Or is it maybe going to tick down a little bit in the like the third and fourth quarter on a quarterly basis?

Yes. You're correct, Linda. I mean that's something just because of the whole environment surrounding COVID, we haven't had a great deal of those in-person engagements. It's definitely a priority from the sales structure. So we had a good chunk of change in SG&A expense and that was the driver of having modest increases in SG&A year-on-year. And right now, even though we have some plans in the third quarter, for example, in our Americas and Europe, it's not the same magnitude of dollars that you would have seen there. So you probably should not see it at that absolute rate. And then circling back around real quick one. I look at the year-over-year, I think we would see some progress year-on-year with China. That would be the expectation, even after kind of taking out kind of the sequential change with not having the same promotion.

Next, we hear from Anthony Lebiedzinski of Sidoti.

So nice to see a sequential sales improvement in China. I know that was driven partly because of a local market promotion there. Just wondering if you could comment anything as far as you can share with us as far as how your trends have been so far in July?

Yes. I mean, I think it's the same thing as you come off promotions. I think we're still with kind of the activity we've had trying to see kind of what that level set area is that's in kind of an unintended or not having a sales event or something right surrounding it. So I think we're seeing it absent the promotion, clicking on a good cadence. I think we're pleased with it. I think we obviously want to do better, and it's something we're pushing towards. But as Jim talked about in his comments, I think we've seen more of a stabilized customer base. And really what we need to do to get that inflection point and start getting that momentum and that traction start building going forward. And that's obviously the intent of our long-term strategies and some of the things we augment on a short-term basis as well. But like I said, I think we're generally pleased, but we understand we have work to do as well.

Understood. And in your management commentary, you talked about new incentive opportunities for your sales force. So are you referring to your affiliate program in North America? Or is that something else? Maybe you could just expand on that, please?

Yes. That's primarily the reference, but we're looking in several markets. And I think it would be good for maybe Jim to comment on this from a strategic standpoint. But things that we think are going to really be relevant to be additive to what we're doing and engage the customer base at a higher level.

Yes. I mean when you look at a couple of comments, right? We talked -- SG&A was just mentioned a few minutes ago, but 1 of the things that we did in the first and second quarter at a much higher rate was travel and go to -- and have in-person meetings, the big conventions as well as smaller meetings within each of the countries out there to reconnect with the field. And then you're going to see, like we talked about the affiliate program as a new way to make money in North America, and we're going to look at those opportunities to expand that in 2024 to the markets that are interested in it. And then we're open to making small tweaks to our business model by market. And we talked about it as well. We're not going to have the large promotions like we did last year, but we do have a lot -- our planned specific local market promotions throughout the second half of the year.

Understood. Okay. And then you also talked about expanded digital commerce capabilities. So if you could maybe just also share with us maybe some examples of what you're planning to do? And which markets do you think have the most opportunity to benefit from that initiative?

Yes. I mean when we talk about our digital footprint, what we're mainly trying to do is make our business easier for our associates, affiliates and just anyone who wants to order products and consume products. There are some hotspots. We are working a lot in China. You got the WeChat platform that basically is how commerce is done in China. So we're working to make sure that we stay relevant in that market. We're pushing stuff out in the Americas, a lot of it to do with the affiliate program to make sure that the digital assets are enough to have that be successful. And then we look at it from market to market. Some of our bigger markets are always wanting some digital platform or something new, and we have to, as a company, sit back and see which ones will make an impact. But that mobile-first for our IT systems is kind of where we're at throughout all 25 markets.

I would say also, Anthony, as we've talked about a lot of the shareable content that makes it easier for our sales force to do stuff really across the board and engage the customers. And yes, really the main catalyst here is finding ways to interact at an enhanced and more relevant kind of level to go back and kind of get more and more traction going forward. And I think feedback we've had has been positive, which you got to get more users of some of that technology, and there's definitely more work to be done on the horizon.

Got it. Okay. And then -- so given the timing of when you're entering India later this year, so obviously, you do have some upfront costs there. Have you guys talked about how much of a drag you think this will be on EPS this year?

Yes. From an operating margin standpoint, you're probably in that $2.5 million to $3 million range is kind of what we're expecting as far as kind of a net expense just from what's happening. And the opening or nonopening and timing of that really doesn't factor in there. It was really trying to go back and get the best talent we can and get everything done in an appropriate way. And there's just there's kind of a period expense aspect to that, that we think is a worthwhile investment.

Yes. We started hiring the management team almost this time last year. But -- in the second half of the year, we really did. So we're just going to have some of those costs in the year that we won't see revenue coming around until, again, later in the -- later in 2023.

Got it. Okay. And lastly, just to follow up on Linda's question about the cash position. Obviously a very strong balance sheet that you guys have. Maybe if you could just rank if you could just kind of go over your priorities for your capital allocation between the different usages of that cash. And I know you talked about acquisition opportunities. Maybe if you can also touch on as far as what you're looking for to do as far as acquisitions? If you could share any details about your strategy, that would be very helpful.

Yes. I'll give you the kind of the high-level way that we go back and approach. And Walter, who heads up our business development things is in the room, I'll let him maybe talk a little bit about some of the aspects. But first priority is really investing in things that are going to stimulate and grow the organic business. As we go back and have things that we think we're going to get traction and build either short term or long term, those are some areas of investment that we think we have. And then also, second would really be looking at things that aren't confined to our business, some of these inorganic type of opportunities that Walter will touch on a little bit. And then following that, when we don't have some immediate use in evaluating the environment, what we've done historically is really seek to go back and return that value through a share repurchase program. And those are kind of big picture, the levels we have. We're debt-free. So debt repayment really isn't on the capital allocation. But that's high level. And then maybe I'll have Walter give a little bit of color on the biz dev and some of the focal areas.

Yes. I mean, we invested -- if you look at last year, we invested in a company called Built Bar -- I'm sorry, Rise Bar, as an example. And Rise is a small company. We let them run independently. We -- we have really good synergies because we can make their products. So we're making their products which reduces their COGS, but we're letting them run independent. And we're looking at brands that have different sales channels. So if they sell DTC, Amazon, they sell retail. Those are great opportunities for us. And so we are out in the market looking for businesses, looking for companies that we think have a good return. And I think the opportunities are out there. We've got a lot on the table right now.

And I think the sweet spot is typically a company is a little bit smaller size where we think we can go back and provide a great service or vice versa. And really kind of building some core competencies that maybe aren't currently in our sweet spot seems to be a pretty big area of focus for us.

Our next question comes from Susan Anderson of Canaccord Genuity.

I guess just really quick. I think you mentioned that you saw consumer spending starting to feel a little bit pinched because of inflation. I guess, were you talking specifically in the U.S. or was that globally?

Yes. I think across the board, we took a little -- even though it wasn't dramatic relative to what we see in the marketplace. We definitely took a little bit more step forward this year, a little bit higher price adjustment than what we've seen. We've definitely been soft handed in that last couple of years and being very mindful of the impact on consumers out there with kind of these different pressures on them. And I don't know of a company out there that adjust prices that are received with open arms. So we're navigating that. We've been very open to communication. But I think consumers in many markets are starting to feel the pinch a little bit.

Okay. Great. And then I guess maybe I just wanted to ask about India. I know it's early and you're still kind of putting together plans there. But I don't know if there's any [indiscernible] gone into other markets, how quickly sales could ramp up or how you expect it to perform relative to those other markets?

Yes. I mean our expectation is not going to have a -- we have it in our comments, it's not going to have a big impact on revenue for 2023, and we're more excited about what will happen in 2024. We've seen as a company, we announced this at our AP convention in the second quarter. We saw excitement from the field. We had meetings to talk about India and hundreds of people showed up. So to start the market, we would love some outside leadership to come in and help start it as well as leaders within the market to get it going. But again, '23 impact will be minimal in '24 from my expectations. It's a huge opportunity like China as an opportunity, but we expect it just to modestly contribute next year.

[Operator Instructions] And it appears there are no further questions at this time. I'll turn the call back over to our presenters for any additional or closing comments.

Thanks, April, and thank you, everyone, for your questions and for your participation on today's conference call. If you have any remaining questions, please feel free to contact Investor Relations at (801) 954-7210.