USANA Health Sciences Inc (USNA) 2016 Q3 法說會逐字稿

Good day, and welcome to the USANA Health Sciences third-quarter conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Josh Foukas. Please go ahead, sir.

Good morning, everyone, and thanks for joining us this morning to review our third-quarter results. Our call today is being broadcast live on the webcast and can be accessed directly from our website at www.usanahealthsciences.com. Shortly following the call, a replay will be available on our website.

As a reminder, during the course of this call, members of our management team will make forward-looking statements regarding future events or future financial performance of the Company. And those statements involve risks and uncertainties that could cause our actual results to differ, perhaps materially, from the results projected in such statements. Examples of these statements include those relating to our 2015 strategies and financial outlook. We caution you that these statements should be considered in conjunction with our disclosures, including the specific risk factors and financial data contained in our SEC filings.

I am joined this morning by our co-CEOs Dave Wentz and Kevin Guest; Paul Jones, our Chief Financial Officer; and Doug Hekking, our Executive Vice President of Finance.

Yesterday, after the market closed, we announced our third-quarter results and posted our management commentary document to the Company's website. Before opening the call for questions, we will first hear from Dave, who will briefly review the quarter's highlights. Dave?

Good morning, everyone. It's great to be with you this morning. I will keep my comments brief and then open the call up for questions. Now, while the third quarter was another solid quarter for USANA and included several important accomplishments, our top-line results came in below our expectations due to softer than expected sales in China. Let me address this first.

As we have communicated throughout the year, our top priorities for 2016 are transitioning to our new state-of-the-art production facility in Beijing and enhancing our information technology infrastructure around the world. Our growth in China has outpaced our manufacturing capacity and other infrastructure in that market, while our worldwide growth has required enhancements to our IT infrastructure as well. While these improvements take time to complete, they are absolutely essential to USANA's long-term growth potential.

Our team determined at the outset of 2016 that it was not in the best interest of the Company or its customers for the Company to run significant growth initiatives while focusing on these strategic objectives. Doing so could have produced a host of issues for the Company including product backorders and customer service challenges in China and other markets. So we have not offered any significant growth incentives in China or our other markets during 2016. And the growth we have achieved has been entirely organic from continued momentum within the sales force. While we projected this momentum to continue throughout the year, we saw our momentum slow this quarter, predominantly in China. Despite this challenge, I am pleased to report that during the quarter, we received all the necessary permits to begin production in our new China facility, and we now anticipate that the facility will be fully operational by the end of the year.

With the facility coming online, we are making preparations to begin offering growth initiatives in China in early 2017. That said, we still believe that we will be in a better position to fully drive growth in China and our other markets when the improvements to our IT infrastructure are complete. Notwithstanding these growing pains, we made several significant accomplishments during the quarter.

Obtaining the permits and product registrations I mentioned a moment ago is a meaningful accomplishment and is a result of the significant undertaking by our US and China operations and regulatory teams. We also made solid progress during the quarter on adding talent to our global executive and employee team, which is also essential in light of our growth. We made several key hires in China in various areas including sales, operations and government relations. Our objective is to assemble a China team that has the talent and experience to generate future customer growth in that market. We also made several key hires to our team in the US to help drive our strategic objectives around the world.

Next and perhaps most importantly, we accomplished one of the greatest innovations in USANA's history with the launch of our InCelligence product platform and our new flagship multivitamin CellSentials. At our international convention in August, we launched both of these. InCelligence, as you saw, is proprietary technology that is designed to support your body's natural ability to nourish, protect and renew itself. CellSentials is our new flagship multivitamin and is part of our InCelligence platform. These launches and our convention in general were a huge success, with new records for sales and attendance at our convention. And our 2017 convention has already sold out.

Now, in our releases today we revised our 2016 outlook in light of the challenges I just mentioned and our anticipated growth rate for the remainder of the year. Notwithstanding these challenges, I am confident in the strength of our underlying business in China and our other markets, and believe that the strategy we are executing will better position USANA for long-term growth.

Our balance sheet remains strong and we remain positioned to return value to shareholders, and we look forward to delivering another record year for USANA.

With that, I will ask the operator to please open the lines for questions.

(Operator Instructions) Tim Ramey, Pivotal Research.

Just wanted to ask a bit more about the tax rate impact. I believe you adopted this [2016-9] standard early in the year, and it didn't have any major impacts then. This was a fairly major impact. Why was it located in this quarter, and what do we think that impacts will be in future quarters?

Tim, this is Doug Hekking. The reason you saw the impact in Q3 is that when we saw the equity exercises take place. And so it's -- from a model and from a guidance perspective that we give out there, we typically haven't factored in or we are not planning on factoring in anything that hasn't happened because there's two variables.

First of all is the employee exercising their equity award, and it's also where the stock price is at at that time. So the reason you really didn't see it that much in the first couple quarters is we didn't have a great deal of exercise of equity by employees. In the third quarter, you saw that pick up, and so that was the reason you saw that thing. And going forward, like I said, we won't build anything in our guidance just because it's something that's outside our control. But we will recognize and explain it in detail when it does occur.

Okay. Is there such a thing as a -- as what we think the new normal tax rate will be is? Is it 31.5%? Or 32%, or X these large dislocations, I guess?

I would say if you exclude the excess tax benefit impact on the income tax lines, we are probably between that 34% and 34.5% if you exclude those. But when we couple all those things together, yes, there really is no new rate that we can go back and provide because this standard, by its very essence, introduces a lot more volatility to our earnings.

Okay. And I just wanted to ask a little bit more about the third-quarter China performance. By the numbers it was slower, but it didn't look bad. And looked like there was decent growth in associates and so on. What was the signal to you that perhaps -- to get your sales guidance, I did have to whack my fourth-quarter estimates. So it seems like it's more of a fourth-quarter impact than a third-quarter impact. What were you seeing that made you think that was the case?

Well, I think we were just expecting China to remain a little stronger even though we haven't done much to help it this last year. But the numbers just dripped a little lower than expected. We are excited for our convention. Next week, I guess, it will be -- I will be in China for another sold-out event with I think it's 11,000 approximately -- maybe it's 12,000 -- in the sold-out arena in Guangzhou. And so hopefully we can get the people back and working and excited about the new facility and our ability to deliver on whatever they want to grow it to. And so we're going to rally the troops next week and see what we can get going.

But it's a huge shift now. China has become a huge market. And to build back momentum, it's going to take some time because we have had our foot off the gas for a year, I guess. And we're going to start putting gas back on, but it will take a while for it to ramp back up. It's not going to be a light switch that we flip overnight.

Okay. Thank you.

(Operator Instructions) Eric Gottlieb, DA Davidson.

Touching on the tax charges again, I believe you said that the adjustments would be 3% in either direction going forward. And here we are, it's 16%. Is this a one-time thing? I know it's hard to predict the future, but is 3% the norm still?

I'm not sure where the 3% is coming from, Eric. But I think what we prefaced when we adopted this standard, what we said is it's going to go back and increase volatility and that effective tax rate. And it has the potential to have meaningful swings like it did this third quarter.

So, essentially, the result is just the exercise price being above both a strike price and that added fair value. And that access has typically been reported as a component of our stockholders' equity now gets pushed to that tax line item. And like you said, it had a pretty substantial impact this quarter. But I'm not sure on the 3%, where that is coming from, but we will see some volatility there as we see exercises. Or if it's stagnant, you don't see a lot of exercises, and it depends on where people exercise that -- we will see some difference in volatility on that tax line. And I wish I could give you great clarity, but we don't have great clearly to provide.

Okay. Well, the 3% came, I think, from a conversation we had, but I will check my notes.

I have a formal request. Given all the changes in taxes, I'm wondering if guidance could be -- for next year could be an EBITDA or pretax income or something that kind of takes that out and then move on.

I think that's -- we've always tried to go back and give an operating margin target. So we will continue to go back and do that. But I think your point is a good one. I think that's what people should be attaching to.

Okay. So how much of the IT investment is -- how much is the IT investment going to be when we are all said and done, and how much has already been spent?

The IT investment is just an ongoing increase in our IT resources. It's not a purchase of a software or big spend. It's just -- it's in our current running rate. We will continue to grow IT a little faster than other departments as technology becomes a bigger part of our business.

But we are flowing at that rate. We have hired a number of great people. We made a small purchase of some software, but it is all absorbed into our SG&A, and we're going to continue to just make sure that we are not adding more complexity on top of IT as they work to get the underlying system rewritten and more efficient, faster, and more flexible so that we can do more things in the future. So you are seeing the IT spend currently.

Okay. Well, on that note, you said that you can't fully unlock China, even though we have this new plant, until you have the IT infrastructure in place. So maybe the overall project we don't have an idea on. But when do you expect that with regards to China for that to be completed, or at least for that to be completed enough that we can unlock more value?

There's some pieces that will be done around March [of] April next year. There are some pieces that will be done in August of the following year. There's some other pieces in May of 2018, and there's some pieces in August of 2018. It is module by module, piece by piece, we are rewriting the code because we customize it and change it and add layers on top. And we need to go back, clean up the architecture and not do the whole thing in one piece. It's just a systematized rewrite. And that will be an ongoing thing for the future years of the Company where if there are five modules, every five years one of them will be rewritten in a sequential process.

And we were not diligent enough these past years. We just added more complexity on top, and now it's time for us to make that investment in time more to speak than in dollars. We need to invest the time in getting it cleaned up before we add more complexity on top.

So we are excited to have WeChat coming up soon in China. There will be an exciting thing for them. And then just other pieces will continue to roll out, some of them having more power to increase flexibility and make changes that we think will grow the Company faster.

Great. I appreciate the color on that. The incentive plans that you plan on launching in China, are they similar to the large programs you launched back in 2015?

No, no -- late -- the fourth quarter of 2014, first quarter of 2015, no, they wouldn't be that magnitude.

Okay (inaudible). You said before, China's return of approval is 18 months -- takes 18 months to improve InCelligence, give or take, and that's not a set thing. But to put it another way, how soon do you think InCelligence is going to be available in China? A range of time (inaudible)?

Product regulatory in China is three to five years. The more complex product, the longer it will take. So we are working on submitting updated formulas all the time, and it takes stepwise function. There may be some other formulas in between the InCelligence formula getting there that will be upgrades and improvements along the way.

Right. And then China associate growth, you highlighted greater China. And then you also said in China, the country is up 22% from last year. What was that sequentially?

The -- in just mainland China?

Let me grab that for you. China was down about 2% sequentially -- mainland China was down about 2% sequentially.

Okay. And then positively as far as Southeast Asia, I saw growth in sales per associate, and obviously something I calculate. But roughly 9% after two years of declining, what is driving momentum in that region?

Yes, you have to go -- but when we have gone back and we have looked at the sales per associate, if you strip out the currency and you do it year on year, the numbers have been pretty consistent. Southeast Asia-Pacific actually had a small pickup in currency during the quarter, and so that definitely played a role there. We are really not seeing much of a change in pattern in the average spend per associate.

Okay. Fair enough. I will leave you off there, and I will ask some questions off-line. Thank you for the additional color.

(Operator Instructions) Frank Camma, Sidoti.

Just following up on the InCelligence question here since it's not going to obviously be in China for a while. Looking back on it now, obviously important product launch for you guys. Where did you expect this product to do its best? It looks like so far it hasn't had much of a -- obviously it is very early -- but positive impact in the US market in particular, which I thought maybe in a market like that, it would. But another markets, perhaps it wouldn't. Just if you can engage early thoughts on expectations versus where it's coming in at.

Well, with this being a replacement of existing products, everyone just goes from the old product to the new product when it comes to our multivitamins. So there's not a big pickup with our existing customers. It's more of the new story and new reason to go back and talk to people and tell them about the advancement. Maybe they didn't decide to take the products at that time. Maybe with this renewed story, they can get more of those people to join.

So it's just an organic over time. Give them something new to talk about, something new and innovative that other companies don't have to differentiate themselves and stand out from the crowd. And we're hoping that they will just increase their messaging and go back to some people maybe that didn't decide to buy in the past.

So what do you think your biggest challenge is right now in the US? You've got the pretty good branding going on and awareness -- Dr. Oz. Just wondering what do you think right now is holding you back specifically in the US?

Frank, this is Kevin. I -- to answer your question, there are a few things that come to mind as we look at the US market and some areas where we are taking action. One is just from a differentiation perspective as we look at the United States, the challenge is how do you not become a commodity that is equal to other products that are sold in other areas. So how do you differentiate yourself?

Right.

We are continuing to focus on the strategy of personalization and continuing to personalize our products from a differentiation perspective, thus InCelligence. And that's part of the whole InCelligence technology is personalization for individual sales.

And so, as we look at that, that is an obstacle in the United States because of the GNCs of the world and so forth and so on that compete with us in our space. And so we are continuing to work on personalization and follow that strategy through.

And the other side of that is just not the pills or products that they are taking, but it's the technology side. Technology is also a big opportunity for us in the United States. When you look at others in our space who have truly captured the ability to easily do business with a company to attract a very strong customer base, so forth and so on, technology is another obstacle that we feel like we are on top of and look forward to really opening up some areas in many markets, not just the United States, as we increase in our technology side of things and doing business with USANA, which is also part of our personalization strategy as we differentiate USANA.

So those are a couple of obstacles we see in the US. Lastly, one thing that we are again very much focused on is new leadership development, and the new leaders that are out building and growing their USANA businesses with a customer base that loves our products. And as we go through maturity, maturity phases, which we are in in the United States, we are constantly developing ways to develop new leadership to share the USANA message.

And Dr. Oz is part of that, because that is a critical tool for them to say, boy, did you see the Dr. Oz show? Well, I represent USANA that you saw on the Dr. Oz show. Which is -- which has gained and is gaining more and more traction.

Right, okay. It seems like a great technology and product. Do you get any feedback that maybe -- it is a little bit -- it's a complicated message, though, compared to traditional vitamin. It seems like the messaging might be a little more difficult. Is that a fair statement or do you get any of that feedback?

No, I think we are trying to use technology to simplify things, to give people personalized, customized product offerings without them having to read a 40-page product booklet to try and figure out what products are right for them. With the right technology, we can let the experts let them know based on their lifestyle, based on their history, situations in life -- what are the best products for them without them having to think about it -- with them just getting a product recommendation and clicking order versus which products do you want? Oh, I don't know. Let me go learn about all of them and think about it and try and figure out the science here.

That makes it far more complicated, the less that we had in the past. We are going to use technology for mass personalization in a way that is scalable and allows people to get what's right exactly for them, not for men 40 to 70 or something. (technical difficulty) that individual to get value so that the products they end up with each day are the ones that are going to change their health the most and have the biggest impact without them having to think about it at all, just by giving us information.

That data is, of course, extremely valuable, as all companies know. When you know your customer better than anyone and you know what their wants, needs, dreams, concerns are, we can make sure we take care of them and have them -- have the best experience possible, which will keep them with us for a lifetime if they are getting the best results they could possibly get.

And I assume you could also data-mine that for maybe new products that would address --

Absolutely. When we know that the people who don't buy our products are interested in a particular health concern, we can move our R&D to fill that need, and thus capture those people that we may be losing. And so we're very excited about the data mining that our Company is able to do that many, many companies -- retail is not able to do what we are able to do because we will have so much information. In addition to all the social media and other things that people mine, we will have them giving us information about what they eat, how much they exercise, what they are worried about each day, and make sure that we take care of them better than anyone else can.

Okay, my final question is just on the inventory. Can you talk about how much of that build-up -- obviously you addressed the China issue. But how much of that build-up is really related to carrying the old food line? And also if you could add any color on how the SmartFoods line is doing so far.

We have a few million dollars that are attributed to the new food line and incremental inventory that we think we will start seeing decrease as we head into the 2017 year. As far as the performance, Kevin, I don't know if you want to touch on that. But I think what we have seen is pretty good adoption. I think people have been pretty pleased. The commentary that we are hearing about it, I think, is pretty positive.

Yes, our -- strategically, our focus is the healthy-aware consumer. Someone who is a little more educated and as it relates to health and what they are putting in their body. And this -- these new MySmartFoods is a definite step in that direction in providing a healthier solution and a healthier product for the healthy-aware consumer.

Our bars that were released are doing extremely well. The shakes -- whenever you're dealing with taste and switching over a product to taste, people sometimes would like to have what they are used to in the past. But we are seeing a great adoption rate globally and, in some markets, record sales with the new MySmartFoods.

Great. Thanks, guys.

Thank you. And that does conclude our Q&A session for today. I will now hand it back over to our speakers for any additional or closing remarks.

Thanks, everyone, for your questions today and for your participation on the call. If you have any follow-up questions, please contact investor relations at USANA at telephone number 801-954-7823. Thank you.

And that does conclude today's program. We would like to thank you for your participation. Have a wonderful day, and you may disconnect at any time.