USANA Health Sciences, Inc.

Please stand by, we're about to begin. 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. Andrew Masuda, Director of Investor Relations. Please go ahead, sir.

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 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 today by our CEO and Chairman of the Board, Kevin Guest, our President, Jim Brown, our Chief Financial Officer, Doug Hecking, 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.

Thank you, Andrew, and good morning, everyone. We appreciate you joining us to review our second quarter results. Pre-release and our final early release for the second quarter yesterday, 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 had a negative effect on the regional sales programs we offered during the quarter. Despite these 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 streamlined 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 this 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 lines for questions.

Thank you. If you'd like to ask a question on today's call, that is star 1 on your telephone keypad. And we'll go first to Stephanie Wisnik with Jefferies.

Hey, everyone. It's Chris Neiman. It's on for Steph. Thanks for taking the questions. The first one I have, could you maybe help us understand a little bit better the diverging performance between preferred customers, which really seem to be kind of holding up, versus associate accounts, which are turning down? Is there something maybe structural we should be thinking about, or what kind of color can you offer to kind of 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?

Yeah, Chris, this is Doug, and I'll let Kevin and Jim jump on and kind of give you kind of big picture narrative if I missed something here. But we, over the last several years, have 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 to tested a program that really was scheduled to end in March. We bumped it out a couple months, and that's why you see a little bit of sequential change in the Americas and Europe on PC from Q1 to Q2. But it really is from the strategies and what we've been focusing on and how we've been really approaching the business as far as building that preferred customer base and 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? 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 heavy belief 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 real high clip right now.

I just wanted to answer your question. You asked about the possibility of preferred customers becoming associates. Yes, they can. 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 the conversion rate from our preferred customers to associates.

Doug, I don't know if you... It's been low to date, but I think the ones that have made the move, I think really provide, you know, prove to be really successful associates because their understanding and belief in the product.

And I just want to add a little color on this. We, you know, being 30 years old, we have really done some data mining and some research and looked at, we really have a an excellent or had historically an excellent distributor experience, meaning someone who's 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, a 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. And 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. We really care about people utilizing our products every day. And so it's just an expansion of our overall strategy.

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

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 to the onboarding is retention and customer connection. And another key focus of our overall high-level strategy is connecting, especially in these COVID days we've not have the opportunity to connect as we normally would on a personal basis. And so this whole customer connection and interaction and touch points as they go throughout their journey is becoming more and more critical. And our onboarding process is just a heightened level of connection and interaction as our associates move through their journey of building a business.

Got it. And then you touched on COVID briefly there, which kind of segues into my next question. But as we look across your markets, you know, 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 kind of all the headlines related to restrictions. So 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.

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

Yeah, and just a little more color. Just speaking for myself, I tend to look through the lens of the United States as I think about how we're moving forward. But really, we are a global business. And if you take markets like the Philippines, where they're completely shut down, but most all of their business is dependent upon will call and working in an office environment versus here in the United States, 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. And we see that in Malaysia. and other markets in Asia where we're really strong. And so the person-to-person side of things is it has a bigger impact for us outside of the United States just because of how they inherently do business.

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 Maybe the softer top line number is primarily driven by the overall number of transactions. So maybe any color there.

Yeah, I think long term, I think the simple answer, we're not seeing anything that's 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. But as a whole, we've seen that trend pretty close within a relevant range and really not be that meaningfully different. Thank you. Yep, thank you.

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

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 you know, first quarter and fourth quarter, looking to the second half of the year?

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

And, Doug, this is Kevin. I just want to remind everyone, everyone, especially as we're coming out of unprecedented times, that we're really playing the long-term game here. And we've done some of these promotional activities to try and maintain and keep it an excitement level in a marketplace where we normally can't traditionally do our business as we would. But we feel like in the second half of the year and as we move more into a normal pace of business, that continuing to pursue those promotional activities isn't necessarily in the best interest of the long-term health of the company as we move forward. And so we're choosing this route for the long-term betterment of the company from a strategic perspective, as we've stated in our documents going forward. And so, again, we're kind of switching up our mode of business activity on purpose because of the changing environment as we look at the long-term health of the company.

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

I would say that China has been a market that's been impacted just because of the strict lockdowns. I think China has a better ability infrastructurally 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 density of population, availability of services and stuff. And to what Kevin said, they were so accustomed to doing business in an in-person environment. It's a really dramatic change for that market. And if we do get freed up there, I think that is added to that market as well.

Yeah, and just one thing, and Brent, you might want to talk to this. It's a credit to our team in China being creative and getting our products in a very, very locked down, 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. But in China, our on-the-ground team really, really performed. I don't know, Brent, if you want to just give some color to that situation to help Doug kind of understand the dynamics a little bit.

Sure. Yeah, in China, I think Doug mentioned already the infrastructure was 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. And just logistically, it's easier for us to distribute our products throughout the country than some of those other markets. But the lockdowns that we experienced throughout China in the second quarter and first quarter specifically really disrupted that ability to deliver that product. And so we had to get very creative through our distribution network to switch 3PLs, to switch shippers, final mile distributors in order to get that product to our customers. And our ability to adjust quickly on the fly the way that we did allowed us to continue to recognize revenue throughout the quarter.

Yeah, I would also add on that Brent's made some investments in the market in studios to allow us to manage content and reach that audience in kind of a higher velocity way and more responsive. Even before COVID kind of came into play for everybody around the world, China had really high percentage of their sales that were already happening in a non in-person environment. And so they were set up and people were accustomed to doing business like that. But yeah, there's a few key markets in Southeast Asia that, you know, we we've known had a couple of tough quarters here, but you know, I think we see the individuals there and we have confidence. And I think from a build standpoint, going forward back to your original question, Doug, yeah, I think there's an opportunity to go back and see that, you know, if we can go back and get a little bit more of a stable environment and start, you know, tracking in a good way and we're, we're really confident with the staff there.

And also, Doug, Walter, our chief operations officer who's here today, was just in the Philippines and might be able to give you kind of some color on what you experienced there, Walter, just being on the ground recently in the Philippines and what you're seeing there and what you're seeing for the future.

Well, in the Philippines, they've had, because of really lockdowns and because everybody's still wearing masks and you've still got to have Basically, you have to have vaccination passports to get into any building. And so people haven't been having a lot of in-person meetings. In fact, when I was there, they were some of the first in-person meetings that they were starting to have with our distributors, with teens out there. And the other part was the pickup center that we have. We have several pickup centers, and they've been empty. Our volume has gone down over the last – during the covet period it the volume in the pickup centers went down almost nothing where nobody was showing up and that's where they spent a lot of their time interacting and meeting with each other and so that's starting to open back up again but it's a cultural change that people have to go through they have to feel comfortable getting out they have to feel comfortable meeting in person again and those things are gradual changes that they're going through right now so i i think this you know just like you said doug i think you You mentioned that there should be some growth there, and I believe that that's going to happen in those markets. You're going to see more interaction, personal interaction, and in the near future, I think we're going to start seeing some better activity there.

Okay. That's good color. Thank you.

And once again, to ask a question, that is star 1 on your telephone keypad. We'll go next to Linda Bolton-Weiser with D.A. Davidson.

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.?

I think some of it for the quarter, a little bit of timing on the comparisons. We kind of transitioned out from one campaign that we were running in the first part that we see some real potential from from some structural opportunity there going forward. I think sequentially that was kind of the biggest narrative that we saw with the U.S. The U.S. did not run this sales program in the second quarter, and so they have a really tough comp year over year with that, and we just generally saw more success last year in the program that we ran.

Do you plan some promotional program in the second half?

On a local market basis, absolutely. We'll have things that engage our consumers and products and experience and some of the other stuff, but it's just not going to be the magnitude of what we've done historically. And I think that was Kevin's narrative really here, focusing on the long term and making sure that we're doing something that's additive on a sustainable basis. And we've learned quite a bit through doing some of these sales programs and we'll adjust accordingly, but you'll see local market activity for sure. you will probably not see something of magnitude for the company as a whole that's meaningful from a big thing. We do have our 30th year convention coming up, and there will be some activities and events and promotional campaigns surrounding that to build the excitement. But that's really kind of the biggest stuff we have in the back half year from a promotional standpoint that reaches across all markets.

And can you remind me, like, In like the U.S., like what percentage of your sales are kind of done like on a subscription basis where the customer is accepting product kind of every month? What percentage?

Yeah, mid to high 50%. You know, off the top of my head, I don't have the number in front of me, but I think we're probably high 50% of our sales are happening on the subscription business.

Okay. And then how recession resistant do you think your business will be if we do see, you know, this consumer weakening going on?

Yeah, I think we'll see. I mean, I think this is a new environment for all of us. You know, the story has been historically when you see a little bit of pressure on the economy, maybe you see a little bit more activity in our channel. I think this is just a totally different environment than what we've experienced, and we're actively reaching out. We're actively soliciting the opinions and feedback of customers, and we're taking these things, and we're reacting in a pretty short period of time. And so time will tell there. I think people are more health aware and more health conscious than they've ever been. And I think we have products that can go back and help them go back and take a little bit better charge of kind of their well-being going forward. So I think that's a big opportunity that we have. And we have to continue to go back and work to go back and communicate and really be front of mind for the consumers out there.

OK. I noticed it was good that your inventory did come down. It was both down year over year and down sequentially, which is good to see. Do you expect that decrease to continue in the second half? Like, well, do you think third quarter inventory will be down again sequentially?

I think we'll see a little bit of – and, Walter, you can jump in here. But I would expect to see it go down a little bit, not to the same – changes you saw from Q1 to Q2. I think we made a very intentional choice to make sure that we had inventory to go back and market and sell to our customers. And as we've seen demand trying to do this other stuff, same thing with our expense management. That team has been actively trying to go back and align those inventory levels with the performance that we have now and things that we have on the horizon.

Yeah, Doug, that was very intentional. What we did middle last year, we started building up inventory intentionally because we saw shipping and we saw covid related issues coming up worldwide so we built up more finished goods out in our markets we doubled the amount of raw materials we had because we were concerned about supply chain it actually saved us during that whole period and then we've slowly been building bringing back that back down we're going to keep bringing that down throughout the year a little bit unless we start seeing more disruptions in supply chain and then we're going to build back up again I would say it's worth having inventory.

The other aspect that we do from an operational standpoint is we have a real core competency at making our own products. I think that's been a huge benefit in this environment. It allows us to respond a little bit quicker with taking out one more player in that supply chain process. We've seen that as a definitive advantage as we've gone through this as well.

Our biggest challenge is still shipping. It's still transport across the ocean. If we make it in Salt Lake and it ships to Southeast Asia or somewhere else, that's still a challenge for us and that's the reason inventories are still generally a little bit high. That's been very intentional.

Okay. And I was just curious, do you have an operating cash flow number for the first half or the quarter?

Yeah, we did. Let me pull it up. We did about 15 million in operating cash flow in Q2. And I can pull you up year to date. I think what we're generally expecting for the year is something that, you know, that 100 to 105 million range.

Okay. Thank you. And then it did look to me like your SG&A expense was like a little lower than we had expected. And you kind of alluded to taking some actions to adjust the business to the conditions. Can you just talk about what cost reduction actions you're taking?

Yeah, I think in the immediate short term, most of what we've seen are things that vary from a variable perspective or things that are more performance-based that relate to our operational execution and just the environment, how we're generating operating margin. We still have work to do, and it usually takes several quarters. I think we're just being very intentional and prioritizing the business really to what Kevin said, what do we think is best for the long-term benefit and growth of the customers and individuals and families consuming our products, and that's what's going to get prioritized. But we do feel a need to go back and be more agile and have resources to kind of put to those things that are going to be a catalyst to really kind of executing on that vision and mission of the company.

Okay, that's it for me. Thank you very much.

Thank you, Linda.

And at this time, there are no further questions.

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.

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