USANA Health Sciences, Inc.

Good day, everyone, and welcome to USANA Health Sciences' second quarter earnings call. Today's call is being recorded, and now at this time, I'd like to turn the call over to Andrew Masuda. Please go ahead.

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 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 2023 as well as uncertainty related to the economic and operating environment around the world, our 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 President and CEO, Jim Brown, our Chief Financial Officer, Doug Hecking, our Executive Chairman, Kevin Guest, 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 Jim before opening the call for questions.

Thank you, Andrew, and good morning, everyone. We appreciate you joining us. We're pleased to report second quarter operating results that were better than our expectations. During the quarter, we saw further stabilization in our active customer counts, stronger than anticipated net sales in mainland China, and continued progress on several of our long-term strategic initiatives. As we mentioned in our first quarter call, first quarter net sales included approximately 12 million related to purchasing in mainland China for our immunity products following the lifting of COVID restrictions, and approximately 13 million related to buy-off ahead of announced price increases in several markets. Both of these first quarter events created a tough sequential quarter comparison for the second quarter. We also had a challenging year-over-year comparison due to a large global promotion in the second quarter of 2022, which did not reoccur in 2023. Given the challenging comparable periods, we were pleased with the performance of the business during the quarter. Before opening the call up for questions, I'd like to spend a few minutes reviewing some of the progress we made during the quarter. If you recall, at the beginning of the year, we made the strategic decision to move away from the large global incentives that we offered throughout different quarters in each of the previous three years. While these promotions resulted in a strong sales activity during the quarter in which the promotion was offered, we realized that it was difficult to retain these customers at desired levels in subsequent periods, and it ultimately created variability and fatigue with many of our leaders. Our 2023 strategic excuse me, strategy entails offering smaller market-specific incentives at various times throughout the year to generate sustainable sales and active customer growth. As I commented a few minutes ago, this change in approach has created difficult year-over-year comparisons in the first half of 2023. Although we remain in a fluid operating environment that is being influenced by inflationary pressures, we are generally pleased with the net sales and active customer counts and recognize that there is far more work to do to generate growth. Moving on, our team in China did an excellent job of executing the strategy in this key market during the second quarter. Local currency sales in the market grew 10% sequentially and exceeded our expectations, driven by strong demand from a small market-specific promotion offered during the quarter. We are pleased with our performance in this market, particularly given the macroeconomic environment. The country continues to reopen, allowing us to hold more in-person meetings and reengage with our customers in a single largest market. We are, however, continuing to see an impact on consumer spending from a broader inflationary pressures, which are affecting customer purchasing decisions. Nevertheless, our team remains optimistic that we'll continue to see improvements in the market as China continues to operate more freely, and we'll execute our strategies in this market that still presents enormous opportunity for growth. In May, we announced our plan to expand into India and officially launch operations in late 2023. This new market expansion is several years in the making and wouldn't be possible without the diligent work and effort that our team has spent preparing for the launch. India is an exciting and compelling market opportunity and we believe that our world-class health and wellness products and our business model are ideally suited for this market. That said, I have the utmost confidence in our local leadership team and would like to stress that our approach to expanding and growing this market will be intentional and will focus on long-term sustainable growth. We anticipate sales contribution to be modest on the onset and look forward to providing future updates on this market once we officially launch operations. In closing, our year-to-date performance and our current visibility into the remainder of the year is allowing us to raise the low end of our fiscal 2023 guidance range. We remain confident in our abilities to execute our strategies, which we believe will position USANA to deliver sustainable long-term growth. With that, I'll now ask April, our operator, to please open the lines for questions.

Thank you. If you would like to ask a question, simply press the star key, followed by the digit 1 on your telephone keypad. Also, if you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, press star 1 at this time. We'll pause for just a moment. And we'll first hear from Linda Boltenweiser of DA Davidson.

Yes, hello, hi. So I had just a question about the North Asia region, I guess, you know, I guess Korea. It looked like to me that the performance got sort of worse sequentially. But then again, I know there's some noise because of the pull forward of things in the first quarter. Do you view that – can you just maybe talk about Korea and how that market is doing? Is it getting sort of better or worse, in your opinion?

Yeah. Linda, this is Doug. I'll comment and I'll let Jim jump in and add any comments on top of it. Okay. I think some of the sequential progress or sequential headwind that you saw with Korea was primarily related to the run-up due to the price increase and kind of buying in advance of that. But Korea has been an incredibly strong market for us for the last number of years, and we have seen that flattening out a little bit. The team is working hard. They're engaged. They're really working on customer engagement, but we have seen that market flattening out a little bit relative to what we've seen as far as year-over-year growth. Jim, anything to add on top of that?

Yeah, just to add, you know, we had our Asia-Pacific Convention, and it was in Korea during the quarter. Even though we have seen, like Doug talked about, a little flattening out where we see excitement in the field. We had the biggest group was the Korean group, and that was thousands of people. And you just had excitement and commitment from that group of associates.

Okay. And, you know, the growth margin in the quarter was actually very good. You know, it beat our expectation, and it showed some good improvement. I think it was both sequentially and year over year, if I'm remembering. Do you envision that level kind of carrying forward? And is it the pricing that helped so much? But kind of that level that we saw in the second quarter, how does that – pan out kind of going forward?

Yeah, I mean, as we talked about, we have some kind of unique nuances in the first half a year to just make sure we put things in context. One is what Jim talked about in his open remarks in the first quarter. In the second quarter, as we mentioned, some of our publicly provided material, we had a promotion in China that we were expecting maybe to generate, you know, $10 million from during the period, and we probably were upwards of $15, $16 million in incremental sales generated from that promotion in China. And you see a little bit of lift even from our internal expectations because it outperformed a little bit. It's been on the calendar. But, you know, some of those things in China, and, you know, Brent Neideck, who oversees the market, has a lot of incredible strategies and efforts going on to build really long-term sustainable growth in the market. But we don't have the same cadence of promotional activity or one-off events in the back half of the year. And so that's just a little bit of context and gives a little bit of color on what we provided.

So you're saying that the gross margin was helped by that incremental revenue and that is that high gross margin revenue?

No, I think we see a little bit of a switch when we have a greater proportion of revenue coming from China and kind of the mix of the line items in their income statement. They typically have a modestly better gross margin, a little bit higher incentive rate. You know, overall, the margins are strong, but it's a little bit of a different structure in China than what we see in other markets.

So I'm not sure I'm understanding. So the China promotion that was better than expected occurred in the second quarter, and that's high-growth margin business, so that helps the growth margin. Is that what you're trying to say?

Yes, that's what I'm saying.

Oh, okay. So then maybe going forward we should be a little more – a little lower in our expectation maybe for growth margin, right?

Yes. Yeah, I think you saw something that's probably a little bit better than what we'd expect in the back half of the year, and I think just that mixed by market is the primary catalyst there.

Okay. I got you. And then, you know, I was just examining your cash flow a little bit, and you're operating cash flow. I mean, it was down year over year, I think. There's this line in the cash flow statement called other liabilities or something like that. That seems to be the culprit in affecting your cash flow. What is that line item, and is there something we should be concerned about, or why is that such a negative element of the cash flow statement?

I mean, typically in the front half of the year when you're looking at that kind of six-month stub and doing the other stuff, you see a lot of stuff that's been accrued throughout 22 that get settled up in 23. For example, some employee bonuses, some different tax payments that would be in that other liability, some of those types of things that you typically get flushed out. And, you know, when you look year on year, it just kind of depends on how those things influenced it. But, you know, obviously the operating margin has been a little bit softer than what we've seen historically just because a little bit of top line pressure. But, you know, I think we're committed to continue investing. And so, We're still generating robust cash flow and solid cash flow, but I think comparison is going to somewhat mirror over some reasonable period of time our operating margins as well.

Okay. And then just one more question on the cash flow. You had a lot of cash on your balance sheet, and you've kind of paused share repurchase. Is that cash kind of stranded overseas, and Do you need to repatriate that cash? I'm just wondering why you feel like you can't access that cash on your balance sheet to do share repurchase. Is it inaccessible for some reason?

There's obviously at some point in time, because we're running an international business, not all of it's readily available here, but we could always go back and draw on our credit facilities if we wanted to. So that really isn't kind of pertinent in the short term. I think every quarter we visit with the board and we talk about capital allocation, what some of the different purposes are we're considering and and kind of just where we're at and kind of the priorities of the business. And that's the primary factor in that we've, as we've talked about, we've looked at more kind of outside business opportunities, probably at a greater level than we ever have in the company's history. As we get into some discussions going, those are things that we have in mind as we look at it, in addition to other priorities we have as a company. But... No, I think the way it's managed, there's a little bit of a timing issue with some of the markets, but no, that doesn't hinder us, and we really haven't given too much clarity exactly what we're going to do on the share repurchase.

Okay. And then switching back to China, I mean, your comments sounded pretty positive, and you pointed out the sequential improvement there. Did I know you don't want to get into specific guidance, but I'm thinking that maybe China and local currency revenue could be flat or up in the third quarter for you, flat or up year over year. Am I thinking correctly or am I way kind of off on that?

Yeah, we've been thinking more sequentially on how we've talked about it. Year on year, I'm trying to go back and process in my mind a little bit, Linda. We obviously had the promotion we just talked about in the second quarter, and we're not going to comp sequentially in a in a favorable manner or not because we're not running something similar in the third quarter. Year on year, I'll go back and look. I don't have that right in front of me now. But, you know, I'm confident as we hear Brent and leadership team in China and some of the conversation they've had and some of the traction, I think they're getting a lot of these things. But some of these things are more structural and long-term oriented that we think are going to be very additive. It's just not going to have the effect as you would with a very short-term promotion.

Do you find that the China customers are oriented toward immunity and health and wellness because of the COVID aftermath?

Brent's in the room here. Maybe I'll let him. He's probably definitely more inside the China consumer than I do.

Hi, Linda. Hi. We saw a very strong buy-up of our immune products in the fourth quarter and in the first quarter of this year when the zero COVID policy lifted. And after that, we started to see more of a tapering of sales from those products. So I think it's kind of returning back to a normal level of what we would expect to see. But long term, absolutely, the Chinese consumer is very health conscious, health focused, and immune focused. So I think that those products will continue to be strong sellers for us into the future.

Okay. And just, let me just, if I could please just ask one other question on the SG&A expense. It was a little higher than we expected in the quarter. I guess it was something like 68 million or so, if I'm remembering. Is that because of the conventions and meetings that you had? And kind of going forward, is that the amount I should think about? Or is it maybe going to tick down a little bit in the, like the third and fourth quarter on a quarterly basis?

Yeah, you're correct, Linda. I mean, that's something just because of the whole environment surrounding COVID, we haven't had a great deal of those in-person engagements. There's definitely a priority from the sales structure. So we had a good chunk of change in SG&A expense, and that was the driver of having modest increases in SG&A year on year. And right now, even though we have some plans in the third quarter, for example, in our Americas and Europe, it's not the same magnitude of dollars that you would have seen there. So you probably should not see it at that absolute rate. And then circling back around real quick, when I look at year-over-year, I think we would see some progress year-on-year with China. That would be the expectation, even after kind of taking out, you know, kind of the sequential change with not having the same promotion.

Okay. Okay, I guess that's all for me. Thank you so much. I appreciate it.

Thanks, Linda.

Next, we'll hear from Anthony Lebedzinski of Sidoti.

Good morning and thank you for taking the questions. So nice to see a sequential sales improvement in China. I know that was driven partly because of a local market promotion there. Just wondering if you could comment on anything as far as you can share with us as far as how your trends have been so far in July.

Yeah, I mean, I think it's the same thing as you come off promotions. I think we're still with kind of the activity we've had trying to see kind of what that level set area is that's in kind of an unincented or not having a sales event or something right surrounding it. So I think we're seeing it, you know, absent the promotion, you know, clicking on a good cadence. I think we're pleased with it. I think we obviously want to do better and it's something we're pushing towards, but... You know, as Jim talked about in his comments, I think we've seen more of a stabilized customer base. And really what we need to do to get that inflection point is start getting that momentum and that traction start building going forward. And that's obviously the intent of our long-term strategies and some of the things we augment on a short-term basis as well. But like I said, I think we're generally pleased, but we understand we have work to do as well.

Understood. And in your management commentary, you talked about new incentive opportunities for your sales force. So are you referring to your affiliate program in North America, or is that something else? Maybe you could just expand on that, please.

Yeah, that's primarily the reference. But we're looking in several markets, and I think it would be good for maybe Jim to comment on this from a strategic standpoint, of things we think are going to really be relevant, be additive to what we're doing, and engage the customer base at a higher level.

Yeah, I mean, when you look at, you know, a couple comments, right? SG&A was just mentioned a few minutes ago, but one of the things that we did in the first and second quarter at a much higher rate was travel and go and have in-person meetings, the big conventions as well as smaller meetings within each of the countries out there to reconnect with the field. And then you're going to see, like we talked about, the affiliate program is a new way to make money. in North America, and we're going to look at those opportunities to expand that in 2024 to the markets that are interested in it. And then we're open to making, you know, small tweaks to our business model by market. And, you know, we talked about it as well. We're not going to have the large promotions like we did last year, but we do have a lot or plan specific local market promotions throughout the second half of the year.

Understood. Okay, thank you for that. And then you also talked about expanded digital commerce capabilities. So if you could maybe just also share with us maybe some examples of what you're planning to do and which markets do you think have the most opportunity to benefit from that initiative?

Yeah, I mean, when we talk about our digital footprint, what we're mainly trying to do is make our business easier for our associates, affiliates, and just anyone who wants to order products and consume products. There are some hot spots. We're working a lot in China. You've got the WeChat platform that basically is how commerce is done in China. So we're working to make sure that we stay relevant in that market. We're pushing stuff out in the Americas, a lot of it to do with the affiliate program to make sure that the digital assets are enough to have that be successful. And then we look at it from market to market. Some of our bigger markets are always wanting some digital platform or something new. And we have to, as a company, sit back and see which ones will make an impact. But, you know, that mobile first for our IT systems is kind of where we're at throughout all 25 markets.

I would say also, Anthony, as we've talked about, a lot of the shareable content that makes it easier for Salesforce to do stuff really across the board and engage the customers. And that's really the main catalyst here is finding ways to interact at a at an enhanced and more relevant kind of level to go back and kind of get more and more traction going forward. And I think, you know, feedback we've had has been positive, but you've got to get more users of some of that technology, and there's definitely more work to be done on the horizon.

Got it. Okay. And then, so, you know, given the timing of when you're entering India later this year, so obviously you do have some upfront costs there. Have you guys talked about how much of a drag you think this will be on EPS this year?

Yeah, from an operating margin standpoint, you're probably in that $2.5 to $3 million range is kind of what we're expecting as far as kind of a net expense, you know, just from what's happening. And the opening or non-opening and timing of that really doesn't factor in there. It was really trying to go back and get the best talent we can and get everything done in an appropriate way. And there's just a kind of a period expense aspect to that that we think is a worthwhile investment.

Yeah, we started hiring the management team almost this time last year, but in the second half of the year we really did. So we're just going to have some of those costs in the year that we won't see, you know, revenue coming around until, again, later in 2023. Got it.

Okay. And lastly, you know, just to follow up on Linda's question about the cash positions, obviously a very strong balance sheet that you guys have. Maybe if you could just rank, if you could just kind of go over your priorities for your capital allocation, you know, between, you know, the different usages of that cash. And I know you talked about acquisition opportunities. Maybe if you can also touch on as far as, you know, what you're looking to do as far as acquisitions, if you could share any details about your strategy, that would be very helpful.

Yeah, I'll give you the kind of the high-level way that we go back and approach it. And Walter, who heads up our business development things in the room, I'll let him maybe talk a little bit about some of the aspects. But first priority is really investing in things that are going to stimulate and grow the organic business. You know, as we go back and have things that we think we're going to get traction and build either short-term or long-term, those are some areas of investment that we think we have. And then also second would really be looking at things that aren't confined to our business some of these inorganic type of opportunities that Walter were touching on a little bit. And then following that, when we don't have some immediate use in evaluating the environment, what we've done historically is really seek to go back and return that value through a share repurchase program. And, you know, those are kind of big picture, the levels we have. We're debt-free, so debt repayment really isn't on that capital allocation. But that's high level. And then maybe I'll have Walter give a little bit of color on the biz dev and some of the focal areas.

Yeah, I mean, we invested, if you look at last year, we invested in a company called Built Bar, or I'm sorry, Rise Bar, as an example. And Rise is a small company. We let them run independently. We have really good synergies because we can make their products. So we're making their products, which reduces their cogs. But we're letting them run independent. And we're looking at brands that have different sales channels. So if they sell DTC, Amazon... They sell retail. Those are great opportunities for us. And so we are out in the market looking for businesses, looking for companies that we think have a good return. And I think the opportunities are out there. We've got a lot on the table right now.

And I think the sweet spot is typically companies a little bit smaller size where we think we can go back and provide a great service or vice versa and really kind of building some core competencies that maybe aren't currently in our sweet spot seems to be a pretty big area of focus for us.

Understood. Okay. Well, thank you, and best of luck going forward.

Thanks, Adam.

Our next question comes from Susan Anderson of Canaccord Genuity.

Hi. Thanks for taking my question. I guess just really quick, I think you mentioned that you saw consumer spending starting to feel a little bit pinched because of inflation. I guess were you talking specifically in the U.S., or was that globally?

Yeah, I think across the board, we took a little, even though it wasn't dramatic relative to what we see in the marketplace, we definitely took a little bit more step forward this year, a little bit higher price adjustment than what we've seen. We've definitely been soft-handed in that last couple years and being very mindful of the impact on consumers out there with kind of these different pressures on them, and I don't know of a company out there that adjusts prices that are received with open arms, so we're navigating that. We've been very open to communication, but You know, I think consumers in many markets are starting to feel the pinch a little bit.

Okay, great. And then I guess maybe I just wanted to ask about India. I know it's early and, you know, you're still kind of putting together plans there. But I don't know if there's any – gone into other markets, you know, how quickly sales could ramp up or how you expect it to perform relative to those other markets.

Yeah, I mean, our expectation is not going to have a – we have in our comments it's not going to have a big impact on revenue for 2023, and we're more excited about what will happen in 2024. We've seen as a company, we announced this at our AP convention in the second quarter. We saw excitement from the field. We had meetings to talk about India, and hundreds of people showed up. So to start the market, we would love some outside leadership to come in and help, you know, start it, as well as leaders within the market to, you know, get it going, but again, 23 impact will be minimal, and 24, from my expectations, it's a huge opportunity, like China is an opportunity, but we expect it just to modestly contribute next year.

Okay, great. And then I guess just lastly on potential acquisition, you talked about you've been looking at a number of different distribution channels and brands. I guess I'm curious, is there a particular segment that you're more focused on, such as wellness over beauty? And then I'm also curious just kind of what type of valuations you're seeing out there lately if anything's come down. Thanks.

So, yeah, I would say definitely wellness over beauty. Beauty, we've seen some companies that we've been somewhat interested in, but mostly it's in wellness, sports nutrition, hydration, products like that. A lot of times products that don't really overlap us much So they're probably a little bit different in segment and the way they are built. When you look at valuations, we're looking anywhere. I mean, if they're going down, you know that. So it's been favorable for us anywhere from six to 12 X on EBITDA, depending on the size of the company and the performance of the company. And then you just never know where they're at and how they're doing. But sometimes people have really high expectations kind of based on what they've seen last year. And we've had to either, minimize those expectations or just stop talking to them because, you know, people are, I think they're still kind of, they still have that appetite of what happened in 21 and maybe even in 22. Yeah.

Okay, great. Thanks so much for all the detail. Good luck the rest of the year.

Thanks, Susan.

As a reminder, it's star one. If you would like to ask a question or make a comment, we'll pause for a moment. Again, it's star one to ask a question or make a comment. And it appears there are no further questions at this time. I'll turn the call back over to our presenters for any additional or closing comments.

Thanks, April, and thank you, everyone, 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.

That does conclude today's call. Thank you all for your participation. You may now disconnect.