Earnings Call Transcript - USNA Q2 2020

Operator, Operator

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

Patrique Richards, Executive Director of Investor Relations

Thank you and good morning. We appreciate you all joining us this morning to discuss our second quarter. 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; 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, 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

Good morning and thank you for joining us to review our second quarter. Over these past several months, we've proven to be nimble and adaptive and our results reflect these efforts. Our employees have adjusted quickly to working from home and are providing our customers with the same great customer experience and level of service they have come to expect. We also remain committed to executing on our many growth initiatives and continue to focus on the long-term growth of USANA. Not surprisingly, our associates are extremely resourceful. They are leveraging social media and other technology-based tools provided by USANA to reach more customers who are looking for high-quality health and wellness products such as ours. We also deployed several successful promotions during the quarter. These promotions helped generate additional momentum in customer growth that we expect to continue in the back half of the year. We also successfully hosted our first all-virtual Asia-Pacific Convention. Each year, we host several live events that are well attended. And a large part of the camaraderie and culture of USANA. While we are disappointed to break the tradition this year, we were pleased with the attendance of the event and have received positive feedback from attendees. While we look forward to resuming live events in the future, we are making the most of our virtual events in 2020 and leveraging the repurposed resources to reach an even larger audience. Before opening the call for questions, I'll comment briefly on our expectations and outlook for the back half of the year. While we recognize that we cannot anticipate all of the challenges that might arise as a result of the ongoing COVID-19 pandemic, we believe we've positioned ourselves well to continue adapting to an evolving operating environment. The health, wellness, and safety of our employees, associates, and customers around the world remain our top priorities and our operating plan will continue to reflect those priorities. Accordingly, many of our employees will continue to work from home and our manufacturing and shipping employees will continue to work under our new operating procedures for the foreseeable future. As noted in our earnings release, we are raising our full-year guidance to reflect the solid second quarter as well as the current momentum in the business. We plan on an increased cadence of promotions and incentives to support this momentum, particularly in the third quarter. We continue to manage our cost structure to align with sales performance and to ensure our financial flexibility to adapt to a changing environment. Additionally, we will continue investing in our long-term growth strategies. Overall, I am confident in the strength of USANA's underlying business and the growth strategies we have in place for the remainder of 2020 and beyond. With that, I will now ask the operator to please open the lines for questions.

Operator, Operator

Thank you. At this time, we will open the floor for questions. Our first question comes from Steph Wissink of Jefferies.

Steph Wissink, Analyst

Hi, thank you. Good morning, everyone. We have a few questions we'd like to unpack or themes we'd like to unpack with you. First, just starting with the comments on promotions and incentives, it sounds like you're going to be stepping those up, Q2 to Q3. So I'm wondering if you can just help us contextualize how much of a benefit you felt like you saw in Q2 from those effective promotions and incentives? And then what we should be thinking about in terms of the incrementality in Q3, both on the cost side and then your anticipation for accelerated momentum, as a result of those promotions?

Doug Hekking, CFO

Yes, Stephanie, this is Doug. Year-over-year, we experienced many similar factors during the second quarter of 2019 and 2020. In 2020, we had slightly better success with several of those product value propositions and pricing opportunities, along with the promotions we ran. Late in the second quarter, we launched a new promotion that gained significant traction, which will continue into Q3, and we are seeing optimistic results from it. Overall, this promotion likely contributed between $9 million and $10 million to the quarter. Looking ahead to the third quarter, the focus will be on adapting to the COVID environment, which impacted our timeline earlier in the year. As a result, many calendar items were pushed to the third quarter. You can expect to see a lot of those initiatives come to fruition then. The fourth quarter will have fewer promotions compared to Q3, and we expect a considerable boost from the promotions we've implemented in the third quarter. While we haven’t shared specifics about the third quarter yet, we anticipate a solid quarter.

Steph Wissink, Analyst

Okay. That's really helpful. So we should be thinking about this as a bit of a lift and shift versus you developing new promotions for the back half of the year, maybe some things that just got pushed out that would have been executed in the first half, the recoupment of some of those promotions in the second half or in Q3.

Doug Hekking, CFO

Yes, the promotion we started at the end of Q2 was something that really wasn't on the calendar that we had some appetite from our sales team to run. And so I think based upon the outline of that and how they are performing so far, that one is a little bit incremental relative to our initial plan and we're seeing some good results there so far.

Kevin Guest, CEO

And just another comment, this is Kevin. As we look at some of these promotions, our business is very much tied to us being connected to our customer base and these promotions help us stay connected and keep the momentum building and growing. So in this unique environment, we're used to gathering and getting together and having meetings. This provides a different venue, so to speak, to stay connected to those customers and those independent business owners in our sales force, and it's proven to be very successful.

Steph Wissink, Analyst

And Doug, where should we map those incremental promotions in the P&L, are those largely going to show up in gross margin or does it also factor into your associate incentive lines?

Doug Hekking, CFO

You'll see a little bit of both. And so, you can tell from the guidance we just released that we'll probably see a little bit of a discount in operating margin in the back half of the year, but you can see from the top-end sales, we're expecting a little bit of lift as well. So you'll see a little bit in both, you'll see some in incentives and also a bit of gross margin pressure, but nothing too distorted really across the front. It is a balanced offering.

Steph Wissink, Analyst

Okay. And then the second topic we want to just look at was China. We were anticipating some improvement there, but it seems like it's delayed a bit, so maybe you could just help us diagnostically look at that market relative to the success you've had in other parts of Asia. Can you talk a little bit about China and the China strategy for the back half?

Kevin Guest, CEO

Yes, COVID-19 in China is interesting in terms of how the market is returning to more normal operations. While there are still some limitations on meetings in China, all of our offices there are open. We are focusing on promotions and product offerings throughout the year, having already rolled out four or five this year with several more planned for the second half. In November, we typically hold our national meeting in China, but we have moved it to September this year and it will be an online event, which we expect to generate great momentum. Regarding the market, last year’s 100-day review has carried over into the current COVID environment and the economic outlook in China appears to have worsened somewhat. Consumers seem more cautious with their spending. However, we are still seeing growth in China, and we remain optimistic about the second half of the year based on current activities. In the Greater China region, growth in China was just under 2% in constant currency. The challenging situation in Hong Kong has impacted many companies, which has been a significant factor in the overall performance of the region.

Steph Wissink, Analyst

Okay, that's very helpful. And then the last one I just wanted to give you a chance to talk about the competitive environment. Because the growth you've seen in your business over the last several years has really been on the back of a fairly robust macroeconomic expansion cycle. I just wanted to have you think through or help us think through how the competitive environment might change in terms of price value as well as how you think about your value equation into maybe a bit more of a lower growth or no growth macro?

Doug Hekking, CFO

You know from our standpoint, we've been so focused on what we've been executing. We have not seen meaningful competitive pressure, but I think your context is right and that's something that's ever-present really in our thought process is that value proposition and how we approach the customers and making sure that they really perceive that value there. And so that will be just an ongoing part of our evaluation and our adjustments as we move forward, but I don't think there is an immediate pressing need to be overly responsive. I think it is just part of our basic process that we have in place.

Steph Wissink, Analyst

Great. That's all from us. Thank you very much.

Kevin Guest, CEO

Thanks, Stephanie.

Operator, Operator

Our next question comes from Doug Lane of Lane Research.

Doug Lane, Analyst

Yes, hi, good morning everybody. I wanted to talk or ask you if you could talk about your plans for convention this year with going to these virtual meetings and the annual convention in Salt Lake City is a big deal. So how are you approaching convention specifically? And how is that going to be reflected in spending in SG&A or have you for the third quarter?

Kevin Guest, CEO

We're taking a similar approach to our Asia-Pacific Convention for this year's convention. It will be a virtual event with product launches, special features, entertainment, and recognition segments. Participants will log on, with some VIP involvement and special training sessions available. The general public will also have access. Content-wise, it will resemble our previous conventions, including presentations from executive management and several leaders, along with trainers joining us. Most of the event will be live, with only a few pre-recorded segments. We expect to have significantly more attendees virtually compared to in-person events. We're seeing positive momentum with our format, which has been adjusted to offer shorter speeches and trainings, giving attendees access to meaningful modules that are user-friendly. National entertainment will perform during Q&A segments, and while the viewing experience will differ from being there in person, we anticipate a larger number of participants. We'll continue with our product launches and promotions as we have in the past, but everything will be virtual. Regarding SG&A spending, we are seeing cost savings from these virtual events, which we're reinvesting in our promotional activities. Overall, hosting a virtual convention is more cost-effective than bringing everyone to Salt Lake City.

Doug Lane, Analyst

No, that makes sense. But I know it's early days here, Kevin, the global conventions yet to be pulled off here, but you've been through the Asia-Pacific and just thinking forward here, assuming we re-enter a post-COVID world, does this really change the way you think about having these conventions going forward?

Kevin Guest, CEO

Certainly, we need to learn from this experience. I think my vision is that we will move into some sort of hybrid when we actually can meet in person, because I think there is power in meeting in person, but how can we leverage what we're learning through technology to those who can afford to travel around the world to come to an event. And so we will leverage that experience and opportunity and to how we do our events. I think it will be a hybrid. We will I think continue to utilize technology in a greater form from an events perspective, but I do expect us to return to our in-person convention as well. They might be a little more limited. We typically do national kickoff events in every market, in all of our markets, and we might go more virtual there and rely more heavily on technology from that perspective, where we do spend a lot of money and then focus more of the in-person on the global type events.

Doug Lane, Analyst

Okay, that's helpful. And then shifting gears back to China, because in the normal seasonality of your business, I would assume that the second quarter should be a bigger number in China than the first quarter because of the first quarter having Chinese New Year. And I know there's currency and there is Hong Kong and Taiwan involved here, but Doug, can you confirm whether or not the local currency sales, the absolute dollars in sales in China in the second quarter was comparable or higher or lower than it was in the first quarter?

Doug Hekking, CFO

Yes, I'm just pulling this up now for you, Doug.

Doug Lane, Analyst

I think what I'm getting at is that the second quarter should show stronger numbers in China compared to the first quarter due to the impact of Chinese New Year. I'm aware there are factors like currency fluctuations and the involvement of Hong Kong and Taiwan, but Doug, could you clarify whether the absolute dollar sales in local currency for China in the second quarter were comparable to, higher than, or lower than those in the first quarter?

Doug Hekking, CFO

China was down about 4% sequentially.

Doug Lane, Analyst

So that goes sort of counter to my thinking, which is on normal seasonality. So I wondered what changed in the first quarter that wouldn't result in a sequential improvement. Was it because you were particularly successful with your promotions in the first quarter or was there an actual change on the ground in the second quarter that resulted in the lower sequentially lower sales?

Doug Hekking, CFO

Yes, if you recall our narrative in the first quarter, we did have a promotion in China that was pretty successful in the first quarter. And so I think a lot of these quarters, when you look at discrete periods, you have to go back and factor that in. I think the primary difference is the promotional stuff. I think our organic run rate seems pretty consistent right now.

Doug Lane, Analyst

So yes, what I'm driving at is, you had to step down last year with 100-day review period, but we definitely saw stabilization heading into the back half of the year. So I just want to make sure that there's not something else going on there that's driving another step down, but it sounds like you would consider the stabilization characterization, if you will still applicable.

Doug Hekking, CFO

Yes. Yes, there is no new information or no new event to talk about in China at this point.

Doug Lane, Analyst

Okay, thank you.

Operator, Operator

Our next question comes from Ivan Feinseth of Tigress Financial Partners.

Ivan Feinseth, Analyst

Thank you. Congratulations on another great quarter. So when you mentioned the promotions within the quarter, can you give me some idea of what type of promotions these are? How they work? And how do you measure their impact?

Doug Hekking, CFO

Yes, Ivan, if you had spoken to us five years ago, many of our promotions were focused on incentives to acquire new customers. We've shifted significantly towards product promotion. Much of what we do with our share count is really about enhancing the value proposition of our product offerings, such as providing a product for free when you purchase certain items for a limited time. This constitutes the majority of our regular activities. In China, we have begun to see a more extensive product offering and an increased schedule for launching new products this year. We believe this will be beneficial, although it may take time to attract customers. Overall, we feel things are moving in the right direction.

Ivan Feinseth, Analyst

What was your most successful products or product categories this quarter? And how did you see the current pandemic environment helping that?

Doug Hekking, CFO

Yes, following the initial impact of COVID-19, we've noticed that products aimed at boosting immunity have continued to perform well, not quite at the peak levels we saw at first, but still above historical averages. In China, a new collagen product was launched and while it started off slowly, it is gaining traction and has been well received. We cannot discuss specific future product launches due to various implications, but there are some promising developments coming from China. Additionally, there are some upcoming product offerings that are also exciting.

Kevin Guest, CEO

Yes, like Doug said, we have a roadmap for 2020 the remainder of that in China and around the world. We have products that are going to be launched at the Americas and Europe convention in August, as well as we've talked about in the past that our Active Nutrition line is being worked on now for launches in 2021 and they'll go throughout the year in 2021 in all of our markets or most of the markets that have a food line or Active Nutrition as we're going to call them in the future. So we are really excited about that product launch strategy for the next couple of years.

Ivan Feinseth, Analyst

Did you experience any product shortages or run out of products that you could have sold more if you had more products, or was your supply chain robust enough that it supported demand for everything that was selling well throughout the quarter?

Kevin Guest, CEO

In this quarter, our supply chain hasn't been really an issue. When we first had the COVID-19, and what Doug talked about is we have some products that have an immunity association with them. We saw some really high numbers of that, and it was just a short amount of time where we had some stock-outs, but we've gotten that under control. And in general from a supply chain, we've been able to manage that extremely well with everything that's going on. Right now, with the last promotions that we've had, we have some strength in the supply chain, but that will be a short period of time as well.

Ivan Feinseth, Analyst

So was the collagen product demand, like for example, the pandemic has people using in excess of the amount of hand sanitizer, which causes a depletion in collagen. Do you think that was part of the cause of the demand, or what do you think the demand for the collagen products was driven by?

Kevin Guest, CEO

Yes, I think it's just the normal demand. When we launch a new product, we have a lot of our existing associates and preferred customers who want to try it. So we see a spike at the beginning and then it normalizes over time. I think with the collagen we saw that. Then we're seeing a really good run rate in general on that product because of the excitement levels.

Doug Hekking, CFO

And I think just the attributes of that product in general, Ivan, I think are the selling points of it. At least to my knowledge, I haven't heard anybody linking that to replace some collagen from hand sanitizers; it just been very well received.

Ivan Feinseth, Analyst

Okay. And can you give us some detail or just an overview of your Active Nutrition product line push, thought process? How you envision this coming out, rolling out, and the products that will be included?

Doug Hekking, CFO

Yes, I can give some color to that. I mean, when you look at it, we're looking at rolling it out at the beginning of the year in the first quarter in a few of our markets. And we're concentrating on the US, Canada, Mexico, and Australia, New Zealand probably being the first round of products and then that would roll out to the other markets. There's always some delays in our rollouts when it comes to registration of products, and we just have to deal with that to make it a smooth, make sure that we can give a large offering to those countries that have a little bit more of a regulatory environment or a tougher regulatory environment to get products in. Right now in food products, there are really two major products, you have powdered drinks, meal replacements, and then you have bars or food-type replacements. And then we have some support that goes along with it when it comes to the online support, the ability for recipes and everything else that goes along with a great foods and product line. We're going to look at more of that with Active Nutrition; it's going to be an expansion of the line. We're also going at this point in time going to keep the existing line for the foreseeable future just to make sure that the rollout goes extremely smooth. I think the biggest difference that we're going to have is more support around the line this time, and more programs, trying to build a community and all those things that we've seen with other companies that they've launched extremely strong food-type categories that support systems are very important. So that one of the areas that's going to be an enhancement; plus we'll have all new powder drinks, new formulas as well as more bars to support the line.

Kevin Guest, CEO

I want to emphasize that previously, when we depended on third parties for certain operations, we are now bringing everything in-house. This change allows us to be much more responsive and alleviates concerns about small batch sizes. We believe this is a significant advantage. As Jim mentioned, our offering is becoming more comprehensive. We're very enthusiastic about this development, and we see tremendous potential for growth and expansion in the future. Overall, it establishes a solid foundation as we prepare to enter this space with greater breadth than we have had before.

Ivan Feinseth, Analyst

Given the large number of athletes serving as brand ambassadors, how do you plan to integrate them into your marketing efforts for the Active Nutrition product line?

Kevin Guest, CEO

Yes, I think it will be a support to the product line with the athletes as well as other influencers that we have. We'll also use them as we can for, you'd look at, if you have these great athletes, you love to have them in a workout video or talking about recipes and all the things that affect their life from a very healthy offering and we'll do the same with this group. But I mean we literally, like you say, we have over 3,500 athletes around the world. So it's a huge opportunity for us to use specific ones in the program.

Ivan Feinseth, Analyst

Okay. Well, I look forward to the upcoming events and new products. Congratulations again on another great quarter.

Kevin Guest, CEO

Thanks.

Operator, Operator

And at this time, we have no further questions in queue. So I'd like to turn it back over to Mr. Pat Richards.

Patrique Richards, Executive Director of Investor Relations

Well, 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 801-954-7961.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.