Earnings Call Transcript - USNA Q3 2020

Operator, Operator

Good day, everyone, 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 Mr. Patrique Richards, Executive Director of Investor Relations and Business Development. Please go ahead.

Patrique Richards, Executive Director of Investor Relations and Business Development

Good morning. We appreciate you joining us. 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 2020 as well as uncertainty related to the magnitude, scope, and duration of the impact of the COVID-19 pandemic on our business, 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 this morning by our CEO and Chairman of the Board, Kevin Guest; our President, Jim Brown; our Chief Financial Officer, Doug Hekking; as well as other executives. Yesterday after the market closed, we announced our third quarter results and posted our management commentary, results, and outlook document on the Company’s website. We’ll now hear brief remarks from Kevin before opening the call for questions.

Kevin Guest, CEO and Chairman of the Board

Good morning, and thank you for joining us to review our third quarter. We reported strong results for the third quarter with record earnings per share and sales approaching $300 million. These results were driven by, first, continued strong demand for our high-quality nutritional products, and second, successful incentive programs that were well received by our Associates. As a result, we also reported a record number of active customers for the quarter. We also successfully executed our all-virtual Americas and Europe Convention and China National Sales Meeting during the quarter. This virtual platform allowed us to reach a larger audience than our in-person only events while maintaining much of the camaraderie and culture of USANA. While we look forward to being able to gather in person again, we learned a lot from these events and expect to leverage what we have learned for future events. As noted in our earnings release, we are raising our full-year guidance to reflect our third quarter results and our expectations for the fourth quarter. All things considered, our 2020 results have been excellent during these unprecedented times, and I’m confident in the strength that we saw in this underlying business. We look forward to delivering further growth in 2021. With that, I will now ask the operator to please open the lines for questions.

Operator, Operator

Thank you. We will take our first question today from Doug Lane with Lane Research. Please go ahead with your question.

Doug Lane, Analyst

Hi, good morning, everybody. Kevin, this is the second straight quarter of really nice upside expectations, but it’s really with literally half of your business. Can you talk about China and when you start to see any sort of acceleration there? We’ve seen stabilization and maybe a little lift in the third quarter from the second quarter, but not really the kind of traction we saw in 2017 and 2018.

Kevin Guest, CEO and Chairman of the Board

Yes, Doug. I think we’re still coming out of the effects of our 100-day issue that we had at all supplemental companies that had nutritional supplements as part of their product mix. And we obviously know China experienced COVID like the rest of the world and virtually locked down the entire country. As we see things ramp up, the future growth related to China for me is still very positive. The upside for me was the growth that we saw in the rest of the markets outside of China, and we’re seeing a strong effect in our markets as we are experiencing these unprecedented times of COVID.

Doug Lane, Analyst

Do you think that – I mean…

Kevin Guest, CEO and Chairman of the Board

I think the other perspective I want to add is that, although the timing has taken a little longer than what we’d like to see, I believe our thoughts and perspective on China’s outlook is still very positive.

Doug Lane, Analyst

Yes.

Kevin Guest, CEO and Chairman of the Board

But we’re seeing a little bit lower kind of recovery and gaining momentum again, but we still have the same confidence we’ve had historically; it's just taking a little bit longer.

Doug Lane, Analyst

Yes, I mean just to drill down on that. Yes, we’ve seen just sort of in the general press commentary that that’s an improving macro environment and improving consumer spending environment. I would imagine some of the restrictions from the 100-day review period and the aftermath are being lifted. Is the stage set now for you to start to get back in there with more aggressive promotions and incentives to try to revitalize that sales force and try to build some traction internally versus waiting for external factors?

Kevin Guest, CEO and Chairman of the Board

Yes, I assure you that we’re not waiting. We have been very proactive and engaged there. What we see is that individuals have gone through some tough times; there’s a little bit higher savings rate and a little more caution towards kind of pursuing different things. But I think we’ve had very good discussions, and we hear enthusiasm from the sales team. We’ll continue to go back and lean on that. We’re starting to see a little bit more progress in some of the things that we’re offering up to the sales force and the consumer base.

Doug Lane, Analyst

Okay, fair enough. And then just shifting gears on the margins, which my expectations is just the components are a little bit different in that you had a little bit higher incentives for your associates, a little bit higher cost of goods, but then your SG&A was a lot lower. So I’m thinking that’s probably due to the shift this year, reaction to COVID, where you didn’t have your global convention and you substituted other kinds of marketing efforts. If you could just talk through how that played out in the third quarter, and how you see that going into next year?

Kevin Guest, CEO and Chairman of the Board

Yes, really high level. We do see the dynamics with the regions that we report on. We do see a little bit of an impact from the market sales mix that we have out there. Without a doubt, we ran some of these events, and we had some meaningful product sales. Many times those were down at a lower gross margin. We had some of that last year, not this year. So even in spite of that, with some of the promotions we’ve run, we’ve seen a little bit of pressure on gross margin. But what you’ve seen on incentives is primarily surrounding the incentive offerings and programs that we offered in the third quarter.

Doug Lane, Analyst

Okay. And just lastly, I know it’s early days and you’re talking very high level about 2021, but are you thinking about putting on another in-person convention next year, or is that still a wait and see?

Kevin Guest, CEO and Chairman of the Board

Yes, I think for some of the events that we had earlier in the year, I think we’re leaning towards virtual. For us to go back, reserve the venue, and coordinate everything, it’s not something we can decide with just a month or two left. We have to make some of these decisions well in advance. So I think, as of now, no, we don’t have anything kind of written in stone. I believe that for the first half of the year, we’ll have most of the events virtually and then we’ll wait and evaluate the environment.

Doug Lane, Analyst

Okay, thanks, everybody.

Operator, Operator

Thank you. And we’ll move onto our next question, and that is from Sebastian Barbero with Jefferies. Please go ahead with your question.

Sebastian Barbero, Analyst

Hi team, thanks for taking my question. I would like to go back to the China topic and wonder if you could comment on the latest update regarding in-person meetings. Are those fully authorized now? Are you still seeing some sort of restriction? And also, can you remind us — I just want to add one more. Can you remind us of the percentage of Greater China sales that come from Hong Kong?

Kevin Guest, CEO and Chairman of the Board

So regarding the meetings, we’re still seeing restrictions in the country, and that is having an effect. Of course, we’ve gone to virtual, and our associates in the field are doing a very good job of hosting those meetings virtually, but it’s still not the same. Honestly, we don’t know exactly when those meetings are going to be reopened. There are small meetings happening, but meetings of 50 or 100 people or larger are just not happening in China right now. About 5% of sales in the Greater China region comes from Hong Kong.

Sebastian Barbero, Analyst

Got it. Thank you. And I was wondering if you could quantify the benefit from promotions in the quarter?

Kevin Guest, CEO and Chairman of the Board

Yes. Overall, we typically would estimate the benefit from promotions in the $30 million to $35 million range on a year-over-year basis, which would be a high-level estimate. We definitely had fewer promotions this year, but they were more focused and of higher magnitude compared to last year. So net-net, that’s about what we estimate we delivered from those promotions relative to last year.

Sebastian Barbero, Analyst

Got it. And my last one goes to the fact that with record earnings in the quarter, we would have expected it to be active on the buybacks, especially now that the cash balance is nearing $300 million. How are you thinking about capital allocation? Any reason why you held back on repurchasing shares?

Kevin Guest, CEO and Chairman of the Board

Yes, and so capital allocation, the story has been fairly consistent for us. Our first priority is really growing the business organically. We’ve been far more active at looking at deal flow, exploring opportunities outside of what we typically do, whether it’s to accelerate growth, explore geographical expansion, or new product technology. We’re definitely looking at an elevated level of opportunities out there. As for share repurchase, it’s something that the Board and management alike are engaged in, looking for the right opportunity. We have certain criteria in place that we follow tightly, which prevents us from being aggressive with share repurchases during the quarter, but it’s certainly something we’re interested in if the right opportunity presents itself.

Sebastian Barbero, Analyst

Thank you.

Kevin Guest, CEO and Chairman of the Board

Thanks, Sebastian.

Operator, Operator

Thank you. Then we’ll move onto our next question, and that is from Ivan Feinseth with Tigress Financial Partners. Please go ahead with your question.

Ivan Feinseth, Analyst

Thank you. Congratulations on another great quarter.

Kevin Guest, CEO and Chairman of the Board

Thanks.

Ivan Feinseth, Analyst

So what were some of the standout product trends that continue to drive the good results?

Kevin Guest, CEO and Chairman of the Board

Yes. I think we still see relative to past years a lift in products that have been designed to support immune function. Not quite to the same extent as earlier in the year, but we still see some benefit there. China has been particularly active this year in terms of the cadence of rolling out different product offerings, I think more so than we have historically in Mainland China. We have some exciting things, including a collagen product that’s going to be very well received, and we have several of our other markets looking to see if they could incorporate these products. One of the nice benefits we get is that cross-marketing process where one market has products that another market doesn't, and we’re optimistic about that.

Ivan Feinseth, Analyst

And then what kind of feedback do you get from your distributors regarding their customers' interests and concerns for health supplements?

Kevin Guest, CEO and Chairman of the Board

Just like Doug said, there are products out there with immunity benefits that have generated considerable interest, and people are looking at them from a demand perspective. I think the questions we get from the field are primarily about when we will return to in-person meetings and grow our business as we have in the past. With COVID, it's a question on everyone's mind. We hope that by this time next year, we’ll be getting back to something more stable.

Doug Hekking, CFO

I would add that we’ve heard good feedback and positive morale among our sales force worldwide, particularly regarding these trial incentives we’ve been testing, which has been exciting for us.

Ivan Feinseth, Analyst

What about the virtual meetings? Are you using any specific platform that USANA sponsors, or do people choose from the platforms currently available? Do you think that given the impact and money saved from not having in-person events, you could invest in a platform that becomes an extension of the company that your distributors use to engage their customer base and for marketing efforts?

Kevin Guest, CEO and Chairman of the Board

It’s possible for us to invest in something like that. The reality is our associates gravitate to what works in their markets like Zoom and Webex—there are a few, and it’s market-specific. From a corporate side, it’s been working well for us, so we haven’t needed to look for other investments at this point. We’ve heard good feedback about the virtual conventions, and overall, we’re learning new things with each event that type of productive reach a broader audience than we typically see with in-person events. While our in-person events tend to have lower growth in product sales, in the grander scheme of things, it’s not a significant risk.

Doug Hekking, CFO

An interesting dynamic we've seen throughout these last few conventions is the participation of non-USANA customers or distributors who are eager to learn about the company, which traditionally wouldn’t have attended due to travel requirements. The accessibility of these events has added to our customer count. For instance, with our Americas and Europe event, we noticed a huge number of participants from China, which is fantastic. Overall, we aim to be as globally successful as possible, utilizing popular technology.

Ivan Feinseth, Analyst

And where are you in the rollout process for your Active Nutrition line?

Kevin Guest, CEO and Chairman of the Board

Yes, we’re still looking to launch that early next year, with a global rollout planned. It will be market-specific due to regulatory requirements that must be addressed beforehand. So we’re excited about it, and while the environment has slowed the process a bit, we expect to move forward soon.

Ivan Feinseth, Analyst

Can you give us a broad idea of some specifics for the line based on feedback or early market research? Additionally, how do you envision integrating this launch with your large group of athletes that you have as part of your marketing team?

Kevin Guest, CEO and Chairman of the Board

From a product perspective, they align closely with our core mission of health-focused supplementation, providing healthy alternatives we see in the marketplace, particularly in Active Nutrition. Our athletes will certainly be part of the story; they’ve been involved in product testing, and we’ve even utilized them in marketing our current products. We see them as a competitive edge given the volume of high-performance and Olympic athletes in our network. The target audience will mainly focus on females aged 25 to 35, and all components of the launch will align with our existing nutritional offerings for a holistic approach.

Ivan Feinseth, Analyst

I have some specific product and supplement questions, but I would appreciate the opportunity to speak later offline to go into more detail.

Kevin Guest, CEO and Chairman of the Board

Sounds good, Ivan.

Ivan Feinseth, Analyst

Okay, thanks. Congratulations.

Kevin Guest, CEO and Chairman of the Board

Thanks.

Operator, Operator

Thank you. There are no further questions at this time. I will turn the conference back over to Mr. Patrique Richards.

Patrique Richards, Executive Director of Investor Relations and Business Development

Thank you, and thank you for your questions and participation on today’s conference call. If you have any remaining questions, please feel free to contact Investor Relations at 801-954-7961.

Operator, Operator

Thank you. This concludes today’s call. Thank you for your participation. You may now disconnect.