Earnings Call Transcript - USNA Q1 2022

Operator, Operator

Good day and welcome to USANA Health Sciences' First 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

Good morning. We appreciate you joining us to review our first 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 our 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 the other executives. Yesterday, after the market closed, we announced our first quarter results and posted our management commentary document on the company's website. We'll now hear brief remarks from Kevin before opening up the call for questions.

Kevin Guest, CEO and Chairman of the Board

Thank you, Andrew, and good morning, everyone. We appreciate you joining us to review our first quarter results. USANA delivered solid first quarter results in the face of continued challenges across several key markets. Despite these challenges, both net sales and diluted EPS grew sequentially during the quarter. Our operating results for the first quarter varied across several key regions and markets. For example, the U.S. market generated year-over-year sales growth and performed modestly above our expectations. Conversely, some key markets in Southeast Asia-Pacific generated softer than expected results during and after the Lunar New Year holiday, despite our efforts to offset the seasonality through promotional offerings. Nonetheless, worldwide sales and operating results were in the range of internal expectations. During the quarter, we made progress on several of our 2022 strategic initiatives. We resumed the rollout of our active nutrition line across certain markets, and we continue to make enhancements to the overall customer experience through strategic digital investments. As we have all seen, the operating environment in China has become more challenging and unpredictable due to the escalation of COVID-19 and the accompanying lockdowns, restrictions, and other disruptions to individuals and businesses. Shanghai has experienced citywide lockdowns, and the Chinese government recently began implementing restrictions in parts of Beijing. At this point, we do not have transparency into whether these restrictions will continue to increase in the coming weeks in Beijing and other areas of China that are important to our business. Nevertheless, given the current circumstances, we anticipate some negative impact on our results in China, and we've lowered our fiscal 2022 outlook to reflect this uncertain environment. Regardless, we remain committed to supporting our associates, customers, and employees in this key market and will continue to adapt to these ever-changing conditions to generate momentum in the business. In closing, we remain confident that the successful execution of our global strategies will position USANA to deliver long-term sustainable growth in the future. With that, I'll now ask the operator to please open the lines for questions.

Operator, Operator

We'll go first to Chris Neamonitis at Jefferies.

Chris Neamonitis, Analyst

Wanted to ask about China and Asia Pacific. So maybe starting with China. Still sequential improvement despite the New Year and some of the more extreme restrictions, right? So can you talk about how maybe that market progressed in the quarter, maybe month by month? Are you seeing more digital uptake offsetting some of those external pressures? Or maybe just help us think about how you're able to support customers in that market?

Brent Neidig, Executive

Hey, this is Brent. We started a little sluggish in January, and we did see an uptake in February and March. I think that was primarily due to a lot of the initiatives that we rolled out in the latter half of the quarter. So it's very optimistic to see that especially given the challenging circumstances that are there throughout the country. We're very pleased with the effort that we made and for the results that we were able to deliver despite the challenging circumstances.

Chris Neamonitis, Analyst

And then on maybe on Asia Pacific, could you unpack for us the macro trends you're seeing specifically in Malaysia and the Philippines? I know you mentioned some COVID fatigue, but customer accounts seem to be hanging in there. So what are you hearing or seeing as it relates to productivity in those markets? And is there any sort of clearing event you would be able to point to as we move through the year?

Doug Hekking, CFO

Yeah, and I think you have two different stories really. I think the Philippines is coming off a really challenging year, and they've been working, I think similar to what we've seen in China, they've been working very diligently to go back and get the momentum turned to move in a good direction. I think we saw some flattening on a sequential basis and a little bit better performance sequentially. But we got some work to do there. In Malaysia, which has really been one of our top-performing markets. Year-on-year, you had a little bit of a dynamic with year-over-year comps on the timing of promotions, and kind of the cadence of promotions between the two quarters. And it really is the first time in Malaysia where we're starting to see this in a few markets – it's the first time that many folks were able to go out and see their families during the Lunar New Year, and we saw a little bit more of that than we had banked in. So we saw a little bit deeper dip during the Chinese New Year, and we saw from these promotional packs that we typically surrounded that period of time, maybe not resonating quite as strongly as they did last year. A host of factors, but that's a market that we are still incredibly optimistic about and expect to see some progress as the year goes on.

Chris Neamonitis, Analyst

Got it. And then just last one for me, just on input cost trends. I think last quarter you flagged about 5% to 7% of pressure on materials. But the new guidance implies maybe that's stepped-up since a couple of months ago. So is that how we should be thinking about it? And maybe if you could help us think about how that trend evolves through the year. Are you seeing any sort of relative stability in those baskets?

Doug Hekking, CFO

Well, because the last time we updated, there hasn't been that much time passed. I think we are still oriented in that same range that we have, but it's definitely something with our operations group, we are watching as we bring in the raw materials and finish it, and we'll go back and market and sell. So we'll definitely report on that as the year progresses. But right now, just because it's so recent to when we reported the year, there is not that much more to add there at this time.

Operator, Operator

We will go next to Doug Lane, Lane Research. Your line is open. Please go ahead.

Doug Lane, Analyst

Good morning, everybody. On the inflation front, have you enacted any price increases or what's your plan for price increases for the remainder of the year?

Doug Hekking, CFO

We have, and we have spent a great deal of time with each of the individual markets. We have met with the executive team and we have tried to take kind of a moderate approach and not be too forward-leaning on that. So towards the end of the quarter, mid to late first quarter, most of these price changes were enacted. They were relatively small in comparison to some of the inflationary pressures we are seeing, and given our gross margin, we felt that was the appropriate approach to take. So you're looking at somewhere in that 2% to 2.5% range on a weighted basis for some of that. But that definitely wasn't reflected for the full quarter.

Doug Lane, Analyst

And looking at your operating margin assumption, I think you took 50 basis points out of your range. And your cost of goods and your associate incentives have been pretty stable. Really the pressure has been the de-leveraging on the SG&A. Is most of that 50 basis point reduction just further de-leveraging on the SG&A because of your sales reduction, or do you anticipate a little bit more gross margin pressure than you have been seeing in the last couple of quarters?

Doug Hekking, CFO

I think we have definitely seen an elevated pressure on the cost of materials that we are producing. But a lot of what you are seeing in at least the first quarter relative expectation really was a little bit of de-leveraging on the sales line, and you could go back and clearly see that just on the year-on-year comparison. That's where the bulk of the operating margin was lost year-over-year due to the loss of leverage on the sales performance in Q1.

Doug Lane, Analyst

Okay. Yeah, definitely. And on your sales reduction, because again the sales number in the first quarter looks like it be what people were expecting. And so, that means, obviously the reduction is in the second, third, and fourth quarters. And you mentioned that, in the second half you still anticipate growth, but not as much as before. But is really the bulk of the revenue reduction going to hit the second quarter because of the lockdowns in China?

Doug Hekking, CFO

Yeah. I wouldn't say that. There is some timing of events. When you look at the second quarter of last year, we had this short-term program we ran in every market data in the second quarter last year, and we have spaced that program out this year across markets. China, one of our bigger markets, performed well in this. We are wrapping that up and having a significant part of that in the second quarter. It's been a little bit more challenging environment as the government has elevated how they've handled the COVID environment. It’s not an opportune time to run something of that magnitude, but it was already underway. I think you'll see a little bit of progress sequentially in the second quarter. And we're hoping to get a little bit more visibility, Doug, regarding what that situation is in China. What we saw this time wasn’t the same response from the government that we saw the first time when we initially went through COVID. We are adapting and responding to Brent’s plan. I think the team has done a great job, and we have new digital assets in the studio in-house that allow us to be pretty active in that environment. But the main reason you've seen some softening in our guidance is from some of the unknowns we're seeing in that environment.

Doug Lane, Analyst

And is it more impacting your ability to sell products or your ability to get products out to your customers?

Doug Hekking, CFO

Well, I think for a period of time, really towards the end of the first quarter, we had a small bump in deferred revenue, particularly trying to get products delivered to Shanghai because of some of the lockdowns and shutdowns there. We've been able to date to get products and manufacture products, but there has been some disruption in delivery relative to the positions that the government had. We've been trying to find compliant and productive ways to try to get products out. But we're definitely going back and staying in touch with the government as we do this to stay in good standing.

Doug Lane, Analyst

And just lastly, you mentioned on the previous call that you were planning to have an in-person event in China in the second half. Have you made a call on that yet, or are you still waiting to see on that?

Brent Neidig, Executive

Yes, Doug, just given the uncertainty, we decided to change the event that we had. We initially planned it for Nanjing in September, and we decided to go to a hybrid event. As Doug already mentioned, we have an in-house media studio, so we're going to leverage that asset and produce some high-quality content from the studio and plan on more small in-person gatherings throughout our branches and distributed workshops throughout the country. Given the current environment, I think it would be really unreasonable if we weren't able to actually pull an event off in-person at that magnitude.

Operator, Operator

We will now turn to Linda Bolton Weiser at D.A. Davidson.

Linda Bolton Weiser, Analyst

So I was just curious about the Americas and Europe region, which I think was down about 3% in constant currency. And yet the U.S., I think was up 5%. So I'm just kind of wondering, was the decline so big in the other parts of the region that offset the growth in the U.S., or can you just give a little more color on that region?

Doug Hekking, CFO

The primary catalyst there is we saw modest softening in Canada, which is a great market for us. But I think the bigger challenge we had is in our Mexico market, which has faced some competitive issues and is going through some difficulties. We’ve been actively supporting them, and I think we're optimistic. But yes, year-over-year, Mexico had a tougher performance quarter.

Linda Bolton Weiser, Analyst

And then I know when you had reported and talked about the fourth quarter results, you gave a little bit of sequential guidance for revenue. Thinking in the same way now, I mean, I'm seeing that revenue has to be down sequentially in the second quarter from the first quarter. Am I thinking of that correctly?

Doug Hekking, CFO

Yeah, well, we typically don't do a great deal of talking on a quarter-to-quarter basis, but we are expecting to see some incremental progress. I don't think it's going to be dramatic, but we do expect to take some steps forward in revenue performance in Q2.

Linda Bolton Weiser, Analyst

So you mean sequential revenue level in dollars?

Doug Hekking, CFO

Correct.

Linda Bolton Weiser, Analyst

Okay. And then I just saw that you added a small amount of debt to the balance sheet. Is that just related to your cash repatriation, or what was the reason for that?

Doug Hekking, CFO

Yeah, it's just timing. From time to time, we’ll go on the line as different things in our operations dictate. We did do a little bit of buyback activity in the first quarter, roughly $25 million. It really is a matter of timing, and some of that comes with capital or inventory buying or payment of annual bonuses. Sometimes there's a small residual layover, but that was really the nature of that.

Operator, Operator

And with no other questions holding, I'll turn the conference back for any additional or closing comments.

Andrew Masuda, Director of Investor Relations

Thank you for your questions and for your participation in today's conference call. If you have any remaining questions, please feel free to contact Investor Relations at 801-954-7210.

Operator, Operator

And ladies and gentlemen, that will conclude today's call. We thank you for your participation. You may disconnect at this time.