Earnings Call Transcript - USNA Q2 2022

Operator, Operator

Good day and welcome to USANA Health Sciences' Second Quarter Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Andrew Masuda, Director of Investor Relations. Please go ahead, sir.

Andrew Masuda, Director of Investor Relations

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 be making 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 2022, 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 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 second quarter results and posted our management commentary document on the company's website. We'll now hear brief remarks from Kevin before opening the call for questions.

Kevin Guest, CEO

Thank you, Andrew, and good morning, everyone. We appreciate you joining us to review our second quarter results. Our operating performance during the second quarter was negatively impacted by COVID-related lockdowns, restrictions, and other disruptions in several key markets. These disruptions also added a negative effect on the regional sales program we offered during the quarter. Despite the short-term disruptions to our business, we remain confident in our business strategy and our prospects for future customer and sales growth. Although we continue to prioritize the alignment of spending with sales performance in the near-term, the health of our balance sheet and our generation of free cash flow will allow us to continue making the necessary investments to position USANA for future growth. During the quarter, we made progress on our strategy in several areas including the introduction and launch of enhancements to our associate onboarding program, which streamlines the onboarding process to provide associates with additional tools to set up and operate their business. We believe this will help support and increase our associate base over the long-term. Additionally, our digital strategy remains a primary focus for our team moving forward. We look forward to celebrating our 30th anniversary at our upcoming Global Convention in Salt Lake City in a few weeks. This will be a hybrid event with an expected in-person attendance of approximately 4,000 associates and tens of thousands participating virtually. We also have selected events and modest promotional activities planned in conjunction with the celebration to help generate excitement surrounding this event. In closing, we remain confident in the strategies we are pursuing for the long-term health of our business and in our overall long-term growth potential in our markets globally. With that, I'll now ask the operator to please open the line for questions.

Operator, Operator

Thank you. And we'll go first to Stephanie Wissink with Jefferies.

Chris Neamonitis, Analyst

Hey everyone, it's Chris Neamonitis on for Steph. Thanks for taking the questions. The first one I have. Can you help us understand a little bit better the diverging performance between preferred customers, which really seem to be holding up versus associates' counts, which are trending down? Is there something structural we should be thinking about, or what kind of colors can you offer to reconcile those two pieces? And then can you remind us again, is there conversion potential from preferred customers to associates? And if so, what does that typically look like?

Doug Hekking, CFO

Yes. Chris, this is Doug, and I'll let Kevin and Jim jump in to provide a big picture narrative if I miss something here. But we've over the last several years really leaned into making preferred customers a priority. We've had several structural things that we've done. We've been testing programs in the Americas and Europe region, in particular. We tested a program that really was scheduled to end in March; we bumped it out a couple of months, and that's why you see a little bit of sequential change in Americas and Europe on preferred customers from Q1 to Q2. It really is from the strategies and what we've been focusing on and how we've been approaching the business as far as building that preferred customer base in the mix of customers. The second part is, is there an opportunity for transition or movement from becoming an associate if you're a preferred customer? Yes, that opportunity is available. It doesn't happen as much as you think. But I think some of our best associates are those that are really passionate and heavily believe in the product, and a lot of that starts with the consumption of the product. So I think that does happen; it's just not a really high rate right now.

Chris Neamonitis, Analyst

Got it.

Kevin Guest, CEO

I just wanted to answer your question, oh, I'm sorry.

Chris Neamonitis, Analyst

Go ahead.

Kevin Guest, CEO

I just wanted to answer your question. You asked about the possibility of preferred customers becoming associates. Yes, they can elect if they want to become an associate and sell the products, and we actually hope that would be a great transition because they will have had an experience with the products and will be able to sell them more effectively. I don't have off the top of my head that conversion rate from our preferred customers to associates.

Doug Hekking, CFO

It's been low to date, but I think the ones that have made the move, I think really prove to be successful associates because of their understanding and belief in the product.

Kevin Guest, CEO

And I just want to add a little color on this. Being 30 years old, we have really done some data mining and research and looked at it. We really have had an excellent distributor experience, meaning someone who is selling and building a business and earning income as they share our product experience. Our focus has been recently over the last probably 18 months, at least, on customer experience and how do we interact and deal with customers because we feel that one of our main competitors is the experience they expect to receive when they come and interact with our company. If that experience isn't seamless, they'll go somewhere else. That's why our digital strategy is so critical to the growth of the company because it has to be a seamless experience for someone who simply just wants to take our products. So you can see that the increase in our customer counts is part of the success of that overall strategy as we grow the business. At the end of the day, we really care about people utilizing our products every day, and so it's just an expansion of our overall strategy.

Chris Neamonitis, Analyst

Got it. That's super helpful color. And maybe just as a follow-up to all that. Could you give us any color on the trends you're seeing, especially in the context of your enhanced onboarding program? Any trends on new associates coming into the business?

Kevin Guest, CEO

Well, this is Kevin again. It's too early to tell at this point. We just barely are releasing the first versions of our onboarding program, but one of the key objectives of the onboarding is retention and customer connection. Another key focus of our overall high-level strategy is connecting. Especially during these COVID days, we've not had the opportunity to connect as we normally would on a personal basis. This whole customer connection and interaction, and touch points throughout their journey has become more critical. Our onboarding process is just a heightened level of connection and interaction as our associates move through their journey of building a business.

Chris Neamonitis, Analyst

Got it. And you touched on COVID briefly there, which segues into my next question. As we look across your markets, obviously you have these COVID-related disruptions softening the top-line, but I'm surprised that performance in Greater China actually improved sequentially, especially given all the headlines related to restrictions. Why does a market like China perform better on a sequential basis than others, which I would assume would be less restrictive, but perhaps I'm wrong?

Doug Hekking, CFO

Well, I think you're exactly right. It is more restrictive in China than what we see in the other markets. The catalyst for why you saw sequential improvements is that for the last three years we've run this sales program that we've been testing, evaluating, and tweaking. China moved up their plans from running that later in the year to the second quarter. That's why you saw an improvement from Q1 to Q2. We noted in our comments and our release that we're generally disappointed across most of our markets with how that program performed. However, we're committed to going back and making structural changes that create sustainable growth traction instead of just trying to get something that pops short-term. Some of those changes that we've made are there, but I think the environmental factors with COVID, the drag on the economy, and consumers having to make tough choices create a challenging environment. China continues to go in and out of lockdowns, perhaps on a lesser scale than what they've experienced in the not-too-distant past. Some of the investments Brent Neidig, who oversees our market there, and his team have made are really going to pay dividends going forward, especially related to what Kevin said about our digital strategy.

Kevin Guest, CEO

Yes. And just a little more color, a lot from speaking for myself I tend to look through the lens of the United States as I think about how we're moving forward. Really, we are a global business, and if you take markets like the Philippines where they're completely shut down, but most of their business is dependent upon 'will-call' and working in an office environment versus here in the United States where we get things shipped. When COVID restrictions are in place, that has a huge negative impact just on people receiving products, doing business, and interacting. We see that in Malaysia and other markets in Asia where we're really strong. The person-to-person side of things has a bigger impact for us outside of the United States just because of how they inherently do business.

Chris Neamonitis, Analyst

Got it. That's great. And then last question before I hand it off. Maybe just on the purchases that are being made. Are you noticing anything different in terms of average basket size, or should we be thinking about the softer top-line number primarily driven by the overall number of transactions? Any color there?

Kevin Guest, CEO

Yes. I think long-term, the simple answer is we're not seeing anything that is definitive enough. I mean, we're a little bit off on the average spend this quarter. I think some of that can be tethered to the promotional activity and what happens during those cycles. Overall, we've seen that trend pretty close within a relevant range and really not be that meaningfully different.

Operator, Operator

We'll go next to Doug Lane with Lane Research.

Doug Lane, Analyst

Yes. Hi, good morning, everybody. Staying on, we're looking at the second half here. If I understand what went on in the second quarter, the bump in China sequentially, particularly with the preferred customers, was a little bit more promotionally related. So we should probably see that settle back to where it was in the first quarter and fourth quarter looking to the second half of the year.

Doug Hekking, CFO

Yes. And we would expect that just from the nature of how we count the active customers. We'd expect to see a little bit softening in the customer numbers, but I think we have a lot of important things going on in that market. So relative to how that calculation takes place, yes, that's accurate, Doug.

Kevin Guest, CEO

And Doug, this is Kevin. I just want to remind everyone, especially as we're coming out of unprecedented times, that we're really playing the long-term game here. We've done some of these promotional activities to try to maintain excitement in a marketplace where we normally can't traditionally do our business. In the second half of the year, and as we move more into a normal pace of business, pursuing those promotional activities isn't necessarily in the best interest of the long-term health of the company as we move forward. So we're choosing this route for the long-term betterment of the company from a strategic perspective.

Doug Lane, Analyst

Okay. I mean that makes sense. And yes, I mean, I get what you're doing there. Sticking with thinking through the impact of the macro environment today, particularly with COVID, I maybe like others expected a lot worse results in China and maybe not as bad results in Southeast Asia and Pacific, which continues to be quite weak. Am I reading this right? That actually the impact from COVID is more disruptive to your Southeast Asia and Pacific business than it really was to China at the end of the day, meaning if we ever do come out of this pandemic, that the bigger bounce will be in Southeast Asia-Pacific versus China.

Doug Hekking, CFO

I would say that China has been a market that's been impacted just because of the strict lockdowns. China has a better ability infrastructure to go back and handle some of the stuff going on. The Philippines, which has been an incredible market for us, has had a tough time with the density of population and availability of services. To what Kevin said, they were so accustomed to doing business in an in-person environment; it's a dramatic change for that market. If we do get freed up there, I think that could lead to positive results for that market as well.

Kevin Guest, CEO

Yes. And just one thing—Brent, you might want to talk about this. It's a credit to our team in China being creative in getting our products in a very, very lockdown difficult environment and finding different ways to get our products out to our people—which we didn't even have that opportunity in some markets. In China, our on-the-ground team really performed. I don't know, Brent, if you want to give some color to that situation to help Doug understand the dynamics a little bit.

Brent Neidig, Executive

Sure. Yes. In China, as Doug mentioned, the infrastructure is slightly different than what we see in the Philippines or Southeast Asia. There's been a higher preference of people being willing to switch to a virtual environment. Logistically, it's easier for us to distribute our products throughout the country than some of those other markets. However, the lockdown that we experienced throughout China in the second quarter and first quarter specifically really disrupted our ability to deliver that product. We had to get very creative through our distribution network to switch 3PLs, shippers, and final mile distributors to deliver that product to our customers. Our ability to adjust quickly allowed us to continue to recognize revenue throughout the quarter.

Doug Hekking, CFO

Yes. I would also add that Brent made some investments in the market in studios to allow us to manage content and reach that audience in a higher velocity way, and more responsively, even before COVID came into play for everybody around the world. China had a really high percentage of their sales that were already happening in a non-in-person environment. They were set up and accustomed to doing business like that. Yes, there are a few key markets in Southeast Asia that have had a couple of tough quarters, but we've seen confidence in the individuals there.

Kevin Guest, CEO

And also Doug, Walter, our Chief Operations Officer, who's here today was just in the Philippines and might be able to give you some insight on what he experienced there, what he's seeing for the future.

Walter Noot, COO

In the Philippines, they've had lockdowns, and because everybody's still wearing masks and requiring vaccination passports to enter any building, people haven't had many in-person meetings. In fact, the meetings I attended were among the first in-person meetings that they were starting to have with our distributors and teams. The pickup centers have been empty, our volume has declined, and during COVID periods, the pickup centers went down to almost nothing, where nobody was showing up. That's where they spend a lot of their time interacting and meeting with each other. Opening back up is gradual; people have to feel comfortable getting out and meeting in person again. I think this market will experience growth and more interaction soon.

Operator, Operator

We’ll now hear from Linda Bolton Weiser with D.A. Davidson.

Linda Bolton Weiser, Analyst

Hi, so the U.S. market was a little bit weaker than I guess I had modeled. Can you give us a little bit of color about what's going on in the U.S.?

Doug Hekking, CFO

I think some of it for the quarter is a little bit of timing on the comparisons. We kind of transitioned out from one campaign that we were running, and we see some real potential from a structural standpoint going forward. I think sequentially, that was kind of the biggest narrative we saw with the U.S. The U.S. did not run this sales program in the second quarter, which resulted in a tough comp year-over-year.

Linda Bolton Weiser, Analyst

Do you plan some promotional program in the second half?

Doug Hekking, CFO

On a local market basis, absolutely we will have things that engage our consumers and products and experiences. It just won't be the magnitude of what we've done historically. That was Kevin's narrative about focusing on the long-term and ensuring we're doing something that's additive on a sustainable basis. We learned quite a bit through doing some of these sales programs and will adjust accordingly. You'll see local market activity for sure. However, you will probably not see something of meaningful magnitude for the company as a whole. We do have our 30th anniversary celebration coming up, and there'll be activities and promotional campaigns surrounding that to build excitement.

Linda Bolton Weiser, Analyst

In the U.S., what percentage of your sales are done on a subscription basis where the customer is accepting product every month? What percentage?

Doug Hekking, CFO

Yes. Mid to high 50%. Off the top of my head, I don't have the number in front of me, but it's probably high 50% of our sales happening on a subscription basis.

Linda Bolton Weiser, Analyst

How recession resistant do you think your business will be if we see consumer weakening?

Doug Hekking, CFO

Yes. I think we'll see. This is a new environment for all of us. Historically, when there's a little pressure on the economy, we may see a little more activity in our channel. This is a totally different environment than we've experienced but we're actively reaching out to solicit opinions from end customers. We're reacting quickly. Time will tell. I think people are more health aware and health conscious than ever before. We have products that can help them take better charge of their well-being going forward. I think that's a big opportunity that we have, and we need to continue to communicate effectively.

Linda Bolton Weiser, Analyst

It was good that your inventory did come down, both year-over-year and sequentially. Do you expect that decrease to continue in the second half? Will third quarter inventory be down again sequentially?

Doug Hekking, CFO

I think we'll see a slight decrease, but not to the same extent you saw from Q1 to Q2. We made a very intentional choice to ensure we had inventory to market and sell to our customers. We've been actively trying to align inventory levels with our performance and the future outlook.

Walter Noot, COO

Yes. That was very intentional. We started building up inventory last year because we saw shipping and COVID-related issues emerging worldwide. So we built up more finished goods and doubled the amount of raw materials because we were concerned about supply chain. It saved us during that whole period. We're gradually bringing that down throughout the year unless we start seeing more disruptions in the supply chain, in which case we will build it back up again.

Doug Hekking, CFO

Yes. The other aspect from an operational standpoint is we have a real core competency in making our own products. This has been a huge advantage in this environment, allowing us to respond a bit quicker while taking out one more player in the supply chain. Our biggest challenge remains shipping and transport across the ocean, so if we make it in Salt Lake and it ships to Southeast Asia or somewhere else, that's still a challenge.

Linda Bolton Weiser, Analyst

Do you have an operating cash flow number for the first half or the quarter?

Doug Hekking, CFO

Yes, we did. We did about $15 million in operating cash flow in Q2. I think what we're generally expecting for the year is something in the $100 million to $105 million range.

Linda Bolton Weiser, Analyst

Thank you. It looked like your SG&A expense was a little lower than expected. Can you just talk about what cost reduction actions you're taking?

Doug Hekking, CFO

Yes. In the short-term, most of what we've seen are variable expenses or things more performance-based that relate to our operational execution and how we're generating operating margin. We have work to do and it usually takes several quarters. We prioritize the business based on what we think is best for the long-term growth of customers and individuals consuming our products. We feel we need to be more agile and project resources toward those things that will catalyze our mission.

Operator, Operator

And at this time, there are no further questions.

Kevin Guest, CEO

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

This does conclude today's conference. We thank you for your participation.