Earnings Call Transcript - USNA Q3 2022

Operator, Operator

Hello, and welcome to USANA Health Sciences Third Quarter Earnings Call. My name is Sarah, and I will be your coordinator for today's event. Please note, this conference is being recorded and for the duration of the call your lines will be on listen-only. However, you will have the opportunity to ask questions. I will now hand you over to your host, Andrew Masuda, to begin today's conference. Thank you.

Andrew Masuda, Host

Thank you and good morning, everyone. We appreciate you joining us to review our third 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 outlook for fiscal year 2022 as well as uncertainty related to the magnitude, scope and duration of the impact of the COVID-19 pandemic to 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 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 Kevin before opening the call for questions.

Kevin Guest, CEO

Thank you, Andrew, and good morning, everyone. We appreciate you joining us. We reported yesterday that our third quarter operating results were challenging due to an anticipated operating environment. COVID-related disruptions and increasing inflationary pressure on consumers were the primary factors that negatively affected our sales momentum and active customer counts in many of our markets. As we look ahead, we anticipate continued COVID-related inflationary and economic challenges in many of our markets, which is reflected in our adjusted fiscal 2022 outlook. Despite the challenging environment, USANA remains a very healthy business. We generated US$29 million of operating cash flow in the third quarter. We held a successful 30th anniversary convention in Salt Lake City and made meaningful progress to enhance our customer online shopping experience. We have the means, ability, and determination to put USANA back on a growth trajectory towards the full monty. We are taking action to implement several short-term initiatives to generate momentum in our business. These initiatives include new and modified incentives in various markets and regions, an increase in targeted and relevant communications between our management team and associate leaders, and accelerating our return to in-person meetings and events in markets where possible. We must always remember that we are in the people business, and the opportunity to build connectivity with our customers, after several years of disruption, will be invaluable to creating engagement and excitement in our business. Although we are committed to addressing the short-term challenges we are currently facing, the long-term health and growth of USANA remains our primary focus. And I remain confident that the successful execution of our strategic initiatives will position USANA to return to sustainable long-term growth. With that, I'll now ask the operator to please open the lines for questions.

Operator, Operator

The first question comes from the line of Linda Bolton-Weiser from D.A. Davidson. Please go ahead.

Linda Bolton-Weiser, Analyst

Yes, hi. How are you?

Kevin Guest, CEO

We're doing great, and thank you.

Linda Bolton-Weiser, Analyst

First of all, I guess, actually Mainland China, the performance was actually a little better than what we had projected, and it was like the other parts of China – I'm sorry, the other parts of Asia that were kind of very weak versus our projection. Can you kind of just touch on and give us a little more color on the other parts of Asia, Southeast Asia, et cetera, and what's going on there?

Doug Hekking, CFO

Yes, Linda, this is Doug. We had a few things going on. I think probably the largest thing is, in specific, our Southeast Asia region has relied much more on in-person type activity than what we've seen in the other markets. And so this prolonged environment with COVID and the economic and inflationary pressures impacted that region. We also had comps really sequentially from what we did in the second quarter. We had a pretty large promotion we ran in the second quarter that we did not do in the third. And we had some bleed on kind of momentum in the third quarter last year that we didn't have this year from the promotion they ran in the second quarter. That's probably the leading things that we've seen in the Southeast Asia market. Some of the challenges were really highlighted by Malaysia and Philippines, which are both great markets, but it's definitely been a challenging environment. We're starting to see some stabilization in those regions as well.

Linda Bolton-Weiser, Analyst

Okay. And just as a follow-on, just to go back to China, again it wasn't as bad as kind of what we had projected. I know it's hard to foresee, but do you actually think in China that the constant currency sales growth can be up possibly in the fourth quarter or still down, you think, in China?

Doug Hekking, CFO

Yes – and Kevin, you jump in here. I think we're still fighting a pretty tough battle. The environment in China right now is – and I think you've seen in the number of some of the peer companies out there, it's been very tough, and I think we fared fairly well. We know China is a much bigger part of our sales portfolio than what we see with our peer companies. But the zero COVID policy and just the limitations with our ability to go back and do in-person activities, we can do them, but it's limited. Sometimes based on what's happening locally, we have to abandon some of the plans that we have. We're definitely adapting and we're seeing a lot of new things and investments we're making in the China market that will give us some longer-term traction. But short-term, I think you'll continue to see us battling and fighting, but I think you'll see probably similar numbers in the short term.

Linda Bolton-Weiser, Analyst

Okay. And then just can you comment on what you're seeing on the cost side, the various input costs? Are things sort of getting a little bit better or stabilizing? Or kind of what are you seeing on that side?

Kevin Guest, CEO

Yes. When you look at it, I would characterize it as stabilizing at this point in time. We haven't seen costs come down and I'm talking about raw materials, definitely in Salt Lake City, where we produce the majority of our products. We do produce in China as well. But some of the challenges that we have with logistics are getting better, but the cost of that is still relatively high. Our expectation is that it will remain high probably through the midway of 2023. In China itself, the costs haven't been as high as they have been for the U.S. So that's a good thing as well. But we really haven't seen anything come down at this point in time, and we're really not expecting it to.

Doug Hekking, CFO

Yes. Linda, maybe another element to go back and just consider. I think the group has done a good job in the environment. But exchange rates right now, we produce out of the U.S. for every market with the exception of Mainland China. When you do that, you see the strength of the dollar create some gross margin compression as well, and we also see that in our SG&A line from an operating leverage perspective.

Linda Bolton-Weiser, Analyst

Okay. Thanks. And then sorry if I didn't see it in the financials, but what was the inventory at the end of the quarter? And was it down again sequentially?

Doug Hekking, CFO

Yes, it was. We're at $73 million total. We had a reclassification that we're making in the third quarter to put part of that in the long-term, but that includes both the short-term and long-term inventory, and it continues to be managed. We were obviously pretty aggressive at Jim's direction to go back and ensure we're not disrupting the customer experience and making sure we had inventory to sell. For a while there, it was pretty uncertain. So we made some strategic plays to go back and build up inventory. We're now starting to locate more inventory in markets as a buffer. We're currently at the point where we're starting to right-size that to our current run rate and revenue.

Linda Bolton-Weiser, Analyst

Okay, and then just one final one for me. I know it's really hard to gauge this, but I think that investors are seeking some visibility on when you might return to organic or constant currency sales growth. Because you are posting declines against double-digit declines, so it's a little bit hard even when comparisons are easy, it's hard to gauge when you might start growing. Do you think second quarter 2023 or do you think not until the second half of 2023 might we see that constant currency growth?

Doug Hekking, CFO

Yes. Linda, we're right in our planning cycle right now. I think we are seeing some stabilization, particularly in customer counts. But I would expect that we'll comment on that in a little bit more detail at the February call. We're still kind of sorting that out and getting information from the markets and pressure testing as we go. I think I'd probably defer until February; we'll give you some visibility at that point.

Linda Bolton-Weiser, Analyst

Okay, thank you so much.

Doug Hekking, CFO

Thank you.

Operator, Operator

We currently have no questions coming through. There are no further questions. I will now hand you back to your host.

Andrew Masuda, Host

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 for joining today's call. You may now disconnect your lines. Host, please stay on the line.