Earnings Call Transcript - USNA Q3 2024

Operator, Operator

Good day, and welcome to today's Usana Health Sciences Third Quarter Earnings Conference Call. Throughout today's recorded presentation, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. Now, I'd like to hand the call over to Andrew Masuda. Please go ahead, sir.

Andrew Masuda, Vice President of Investor Relations

Thank you, Sergei, and good morning, everyone. We appreciate you joining us to review our third quarter 2024 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 2024, 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 Chief Commercial Officer, Brent Neidig; as well as other executives. Yesterday, after the market closed, we announced our third 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.

Jim Brown, CEO

Thank you, Andrew, and good morning, everyone. Third quarter net sales fell modestly short of our internal expectations as the operating environment in many of our key markets remained challenging. Notably, our China market experienced a more challenging environment in the third quarter than what we experienced during the first six months of the year. Although we increased active customer counts by 7% year-over-year in this important market, our net sales declined by 4% due to a decrease in average spend. We anticipate a continued challenging operating environment through the remainder of the year. We are planning to increase promotional activity in the fourth quarter to support and build momentum in our business. Our updated fiscal 2024 guidance incorporates these elements. We continue to focus on and execute the strategic initiatives previously communicated. Although these initiatives have not yet meaningfully manifested themselves in our operating results, we believe they are instrumental to laying the foundation for future growth and are confident that they will drive long-term customer and revenue growth. Let me share with you a few items. First, we continue to prioritize engaging with our associate sales leaders, who are vital to bringing in new customers to the Usana family. During the third quarter, we hosted a successful American-Europe Convention in Las Vegas, and this was one of the best conventions we've had in terms of feedback from our associates. Training, development, and recognition were key focus areas at this event, with an emphasis on actionable initiatives to help our sales leaders grow their business. Feedback has been positive and leaders are actively adopting these new initiatives. Second, thanks to the collaborative efforts of our sales, marketing, and research and development teams, we launched our first set of products under our new commercial team structure, Celavive Resurfacing Serum, and a Whey Protein Isolate. Both products were launched in the US and Canada and will be available in other markets over the next couple of quarters. These product launches illustrate the early stages of our product innovation strategy, which includes increasing the cadence of new and upgraded high-quality, relevant, and premium products. Additionally, I am encouraged by the increased agility that allowed us to bring these products to market. We have an exciting pipeline of additional products across our product categories currently in development with plans to be introduced throughout next year. I'll close by saying that I am utmost confident in our team to execute our strategy to return Usana to longer-term growth. With that, I'll now ask the operator to please open the lines for questions.

Operator, Operator

Our first question comes from Anthony Lebiedzinski from Fidelity Sidoti. Please go ahead.

Anthony Lebiedzinski, Analyst

Good morning, and thank you for your questions. Firstly, you mentioned the positive feedback from the Las Vegas Convention. You highlighted a few points, but could you provide more details on the feedback you're receiving? Additionally, how quickly can you implement some of those suggestions, and when can we expect to see tangible benefits from them?

Brent Neidig, CRO

Thanks, Anthony. This is Brent. I'll take that question. As you know, momentum in this business is very important. And the momentum derives from trust between the company and our sales leaders. I think that's one of the most important things that we did in this convention, and that an initiative we've tried to go forward with in 2024 is rebuilding that trust with our sales leaders. The positive feedback that we received is that they feel the company is on the right direction. They feel that we have taken their feedback and input into account when we create new products. The tools and the systems that we presented at the convention were also in line with what it is that they were hoping for. Through that feedback mechanism, we've heard that they are extremely excited for the future. And like I said, it takes time for momentum to grow, but we expect this is the first part of that momentum phase. Over the course of Q4 and into Q1 of next year, we expect that to continue to grow.

Anthony Lebiedzinski, Analyst

Thank you for that, Brent. Okay. And then in terms of the faster new product development process that you guys talked about, I guess, what would be the main reason for that you've been able to do this? And I mean, do you think you'll need to hire perhaps more people to help ensure this continues?

Brent Neidig, CRO

I don't think more people are needed. The thing that we primarily did internally is we restructured the way that product development process works. We've created cross-functional teams that sit together, and they're able to solve problems more quickly than they used to. There's tighter collaboration now between our research and development team and the product team. We're taking feedback more quickly from our markets, and we're just able to implement that much more rapidly than we ever have before. As Jim mentioned in his opening comments, we've got a very robust product pipeline prepared for 2025, and that's really a result of all of this improvement that's been made within this product development process.

Douglas Hekking, CFO

Yeah. And Anthony, this is Doug. What Brent is saying is right on point. I think the other thing is both from Brent's leadership and Jim's leadership, if we see a need to go back and invest more in those areas, it's something we're committed to do. Right now, we think we're resourced and looking to gain some efficiency from this new structure of the commercial team, but I think we're pretty optimistic, but definitely willing to invest in things that we think generate a return.

Anthony Lebiedzinski, Analyst

Understood. Regarding the follow-up on the pipeline of new products, can you provide more details about the timing? Will there be more SKUs than you typically offer in the past? Also, will these new products be available in all markets, or are you only planning to introduce them in selected markets? Could you elaborate on this?

Brent Neidig, CRO

Sure. We are focusing on new product development while ensuring our existing product lineup remains appealing and competitive. Our primary effort will initially go into making significant upgrades to our current products, which will roll out gradually, starting with some changes in Q1 and gaining momentum in Q2 and Q3. We typically launch new products in the United States first due to the regulatory environment and the processes involved in bringing a product to market. However, we plan to expand the rollout globally as the quarters progress. China has its own product development process, so its timeline may vary from other markets, but we aim to roll out products globally when needed.

Jim Brown, CEO

And this is Jim. Just a little bit more. We will see the SKU count increase a little bit at the beginning. But with the product teams, they're looking at the whole product lifecycle. So over time, we'll be evaluating some of the SKUs that aren't performing as well and probably discontinuing some. I would say the engagement that Brent's done with the field leaders, and his team across the globe has more regional and local opportunities for different product offerings as well. And so that's something that's taken into consideration.

Anthony Lebiedzinski, Analyst

That makes sense. Okay. And then before I pass it on to others, I have one last question. Part of your lower SG&A was due to reduced advertising expenses. Do you think that this reduction in advertising had any impact on your third-quarter sales? Also, how should we consider advertising for the fourth quarter and beyond?

Jim Brown, CEO

Yeah. I think the primary catalyst here is just moving away from certain activities that just weren't demonstrating much of a return. I think we're constantly looking to repurpose things to stimulate whether that's in the form of promotions, incentives, or ad spend. We'll continue to look at those things. What you saw particularly is that we're moving away from a few activities that just have not proven to be that effective.

Anthony Lebiedzinski, Analyst

That makes a lot of sense. All right. Well, thank you very much and best of luck.

Jim Brown, CEO

Thanks, Anthony.

Operator, Operator

And our next question comes from Linda Bolton Weiser from Davidson. Please go ahead.

Linda Bolton Weiser, Analyst

Yes, hi. So I was wondering, as you pick up the promotional activity, does that affect more the associate incentive expense line, or does that affect the gross margin more, or maybe both?

Jim Brown, CEO

Yeah. And Brett can chime in here too, but we run different types of promotions and incentives. Some are designed specifically more towards short-term value initiatives to drive behavior, getting people exposed to the products. Others are more towards rewarding people on sales to generate it by new customers they introduce. So you see a little bit of both. I would say, in the short term, we'll probably have more of trying to go back and really continue to follow-up on the engagement we have with the field and support new sales generated to new customers, which will be probably a heavier piece of that. I think you'll see some increase in payouts; at least that's what we've modeled.

Linda Bolton Weiser, Analyst

Okay. And then the revised guidance for the year in terms of the EPS for the fourth quarter that's implied, I mean, I had to reduce my estimate quite a bit, and more so it seemed like on the margins. What would be the particular things impacting margins in the fourth quarter? Is that just that increased promotional spending, or is there something else going on in the cost structure? Maybe you can explain that about the margin expectations for the fourth quarter?

Jim Brown, CEO

Yeah, I'll give you a little bit of color. With our third quarter results, EPS was actually higher than what we anticipated. There are some things that we just didn't get in motion during the third quarter and we would have expected a little lower margin profile in Q3 and EPS. But it's what you said and kind of what we just talked about. I would expect a higher spend on the incentive line as we step into this and support the field and continue to work on creating some high levels of engagement.

Linda Bolton Weiser, Analyst

Okay. And then just on your new products, the whey protein, is that specifically designed for customers that are taking GLP-1 drugs? I'm just curious about that.

Brent Neidig, CRO

Hey, Linda, it's Brent. That isn't the main intention for that particular product. It could be used in that capacity just because many people that are on GLP-1 drugs don't get a sufficient protein profile in their diet. But it's in general just a very premium whey protein isolate. It's very clean and there's a large market for that out there, especially amongst our existing distributor base. So that's primarily the reason why we brought that to market.

Linda Bolton Weiser, Analyst

I'm curious about the beauty serum product. Is it correct to say it's a beauty product? I'm wondering why you chose to introduce this over a new product in nutritional supplements, which is traditionally your area of strength and scale. What made you decide on these two products that are in somewhat different categories?

Brent Neidig, CRO

Well, one product that did actually come to market at our Americas and Europe Convention is called Rest Complete, and that is in the nutritionals category, and that's specifically a sleep product. We didn't call that out per se, but that is a product that did come to market. You're exactly right. We've got three categories. Nutritionals is by far and away our largest and most popular category. When you look at 2025, the brunt of our product introductions and upgrades are going to be focused on the nutritionals category to ensure that we continue to maintain our premium position in that space. But we also have many new products in store for our Celavive line, which is our skin care line. This just happened to be one of the products that was ready at the time to bring to market.

Linda Bolton Weiser, Analyst

Okay. And then I'm curious about your capital allocation thoughts. I know you discuss it frequently with the Board, but your free cash flow has come down, but it's still fairly strong. It's at least $50 million a year. Is your intent to just kind of let your cash balance build up? What's the trigger? I guess, what do you need to see in order to maybe go back to share repurchase or something like that?

Douglas Hekking, CFO

Yes, Linda, you mentioned it. In the first half hour of the Board meeting, we discussed this issue, which comes up every quarter. The Board, guided by Jim, is reviewing all the various initiatives we have underway, ensuring we aren't overly focused on short-term gains. We're planning for the future to determine the best use of our cash. The message from the Board and Jim is clear: we need to find ways to utilize that cash to generate returns. Our top priority remains investing in our organic business. We are actively exploring various business development opportunities as our second priority. When we don't see immediate opportunities, we consider options for excess cash distribution, and what we've implemented is share repurchase. These are the areas we are concentrating on.

Linda Bolton Weiser, Analyst

Okay. And then my last question just has to do with China. You said, I guess, in the press release or something that you didn't think the stimulus activities there would really affect your business all that much. But I don't know. I mean, the Chinese government is doing these things because they want to try to stimulate consumer activity and the economy. So I mean, are you just saying you feel like it's hopeless? Or there's such a secular issue in China, a structural issue. If government stimulus won't help, then what will, I guess? And how are you planning for that in the future as it being your largest market?

Brent Neidig, CRO

Yeah. This is Brent here. I think it's extremely optimistic that we're seeing the government take a stimulus approach or stimulus measures to incentivize economic development and growth within China. That's something that we certainly want to see and that's something that our distributors and customers in China want to see as well. I think what was mentioned in the opening remarks is that we believe the current stimulus that's been done, it's primarily been directed towards shoring up the stock market, shoring up provincial and local branches, banks, and governments. So that particular stimulus that came out, we don't see a direct impact on consumers' willingness to spend in the short term. But in my comments to Anthony previously, when I talk about momentum, the anecdotes that we've been hearing from our customers and from our team over in China is that this is a positive sign and that it starts to change the psyche of the people over in China, knowing that the government is there to help shore up and support their economic efforts. So we're optimistic that, that will continue. And as it does, we believe that, that will change the sentiment of our consumers in China, and we should see that average spend per customer continue to go up from where it's currently at. Our customer acquisition throughout the year so far has been greater than in 2023. Our active customer count has increased as well. So those are all very positive indicators. We just now believe that as soon as that economic faith starts to pick up, then spend should match the customer count, and that will be a positive thing for us.

Jim Brown, CEO

Yes. I would say that consumers are responding slightly. We frequently communicate with the team there, and we receive their feedback which helps us understand their perspective better. The Chinese consumer differs somewhat from those in the U.S., and their behaviors reflect that. What Brent mentioned is accurate; there is a positive response to the government's actions. However, currently, those actions are not directly impacting individual consumer spending, though they have the potential to do so. Based on our communications, the Chinese government seems determined to continue supporting the economy and growth in China, which gives us optimism. However, the initial measures we've seen so far haven't acted as a catalyst for our business.

Linda Bolton Weiser, Analyst

Okay. Well, thanks for that and good luck with everything.

Jim Brown, CEO

Thanks, Linda.

Operator, Operator

It appears there are currently no further questions at this time. With this, I'd like to hand the call back over to Andrew Masuda for any additional or closing remarks. Over to you, sir.

Andrew Masuda, Vice President of Investor Relations

Thank you 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.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.