USANA Health Sciences Inc (USNA) 2017 Q2 法說會逐字稿

Good day, and welcome to the USANA Health Science Second Quarter Conference. At this time, I would like to turn the conference over to Mr. Pat Richards. Please go ahead, sir.

Good morning. We appreciate you joining us this morning 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 2017. We caution you that these statements should be considered in conjunction with the disclosures, including specific risk factors and financial data contained in our most recent filings with the SEC.

I'm joined this morning by our Chief Executive Officer, Kevin Guest; our President, Jim Brown; our Chief Financial Officer, Doug Hekking; our Executive Vice President of Legal and Investor Relations, Josh Foukas; and 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.

Before opening the call for questions, we'll first hear brief remarks from Kevin.

Thanks, Patrique. Good morning, and thank you for joining us to review our second quarter results. While the second quarter presented some challenges for USANA, our business still generated solid results. Although sales came in below our expectations, we still generated our second-highest quarter of sales in the company's history. We had a tough year-over-year comparable as we're comparing against the highest sales quarter in the company's history, but the fact remains that we typically see more of a lift in our second quarter sales, and we didn't see the full extent of that this quarter. And in fact, sales were soft in several of our markets, primarily due to lower overall customer growth across the business, including several markets where we've delivered consistent customer growth in the past.

For instance, sales were down 4.8% in Southeast Asia Pacific, really 1.7% after you adjust for currency, and customers were down 3.9%. These declines were really the result of softer results from the Philippines where we experienced both sales and customer declines in the quarter. The Philippines has been and still is an excellent market for USANA, but we are seeing that market mature in terms of Associate leadership, and we are now focusing on developing the next level of Associate leadership to drive growth again in that market. That kind of development takes time, but it's underway.

Additionally, while Indonesia now has about 18 months of operations and is growing, its growth rate has been slower than we originally anticipated and consequently, its contribution to the region has been lower than originally anticipated. We still have high expectations for Indonesia and expect it to follow the pattern we saw in the Philippines, which is a slower startup and ramp-up followed by solid growth.

In the Americas and Europe region, sales were down 10.2% or 8.7% after you adjust for currency, again, due to an 8.2% decline in active customers. The U.S. continues to be a challenging market for USANA and we are working on a variety of initiatives to change the trend in this market. But this quarter, we also saw customer declines in Mexico and Canada, 2 markets that have generated consistent customer growth for us in the past. I believe our soft results in Canada and Mexico are due in large part to the challenges we've had with MySmart Foods, and I will address that in more detail in a moment.

Now to counter the declines we saw in Southeast Asia Pacific and the Americas and Europe, we generated growth in Greater China and Northern Asia. While Greater China and specifically, Mainland China grew, it did so at a slower rate again as a result of lower momentum. To address this, we ran a successful short-term promotion in China during the quarter, which excited our sales force in that market and helped drive incremental sales and customer growth this quarter. And to that effect, we plan to run additional promotions during the second half of the year (inaudible) focus to generate (inaudible) and momentum across our sales force. In particular, we have several initiatives that will be announced next month at our international convention in Salt Lake City that we believe will create excitement and momentum. And since that came after that, this is an important sentence I'm going to reread in case it was missed because of the feedback. We have several initiatives that we will be announcing next month at our international convention in Salt Lake City that we believe will create excitement and momentum. While slower customer growth is the most significant factor affecting our results in these regions, there are a few other factors that I want to address. First, in 2016, that was a transitional year for many groups within USANA as we named several new chief officers, including Jim Brown as President, Walter Noot as Chief Information Officer, Dr. Rob Sinnott as Chief Science Officer, David Mulham as Chief Field Development Officer, and of course, my transition to sole CEO. While the addition of these executives strengthened our management team as well as our prospects for generating long-term growth, it takes time for new executives to settle into their positions, identify their key operating initiatives and begin executing those initiatives. For example, Walter Noot is leading our IT group on several major technology initiatives to ensure that our systems are not only able to handle the growth we've achieved over the past several years but position USANA to deliver a superior customer experience in the future. We have noted on previous calls that as we progress through these IT enhancements, we will have much more flexibility on a host of business drivers, including promotions and incentive offerings. Building our systems the right way, however, requires time and investment and that process is now underway. Additionally, Dr. Sinnott is leading our R&D team in enhancing our process to deliver, discover and develop and commercialize new products. Product science and innovation are at the core of USANA's business, and we've delivered on that front with our new Incelligence platform that we launched last year and are expanding this year. However, as we reported a few quarters ago, our new MySmart Foods products have not been as well received by our customers as we originally anticipated. Frankly, we developed and commercialized products that are incredibly healthy but do not resonate with our customers from both the convenience and taste perspective. As a result, we've seen a decline in food sales over the past few quarters, particularly in the Americas and Europe region. As concerns have grown from a wide variety of customers who had previously been loyal to USANA food as food consumers, this is obviously not acceptable to us. We've gone back to the drawing board on our foods line with Dr. Sinnott's leadership, we are enhancing not only the foods line but our overall product development and commercialization process to ensure that all our product offerings meet the desires and demands of our diverse customer base. Again, this is absolutely essential to the long-term growth of the business, but it takes time and investment to implement.

Finally, David Mulham is leading our worldwide sales team to drive sales and customer growth across the business. David has been a leader on our field development team for some time but has only recently taken on our worldwide sales function and specifically, the responsibility for the Americas and Europe region. In this regard, the U.S. market is a key focal point for David and he's been working both with his internal team as well as our Associate leaders to identify a variety of growth initiatives for this market. Again though, these initiatives take time to implement, fully vet with our sales leaders and execute, and we're working through this process with David's leadership. These are just a few examples of the key initiatives we've been focused on during the first 6 months of 2017.

In the short-term, these issues have certainly detracted from the typical momentum of our business, but that wasn't a -- and that was apparent in our second quarter results. That said, I am completely confident that we have the right talent working on the right initiatives to drive long-term growth for USANA.

With that, I'll finish by telling you that I'm confident in the overall strength of our business and that the management team we have in place around the world will deliver. We look forward to making additional exciting announcements later this year and I believe that we're on track to produce another record revenue year for USANA.

Now I'll ask the operator to please open the lines up for questions.

(Operator Instructions) Our first question comes from Frank Camma of Sidoti.

Hey, I remember the convention when you launched MySmart Foods. I think it was 2 years ago. And it seemed like at the time, the Associates were very excited about the products and at least there was a good bit of buzz at the convention. What have you learned from that? Because I'm assuming you did some studies ahead of time with your sales leaders and everything and got their buy-in on some of the product, but what have you learned from that as far as it kind of fading off, if you will, that you can use in future product development?

So this is Kevin. Just from a -- in talking to our field leadership, one of the key things that we learned was that convenience is a key driver to our consumers and the complexity of separate flavor, mixing and 3 steps in the process to get to the point from a convenience factor was a big deterrent in the usability for our demographic, and it's had an effect on us globally. And so although we were trying to be more personalized by offering different flavor options and that they could add their own flavors, the inconsistency that they were receiving as they were mixing the drinks and creating the drinks also caused an issue. But one of the key concerns we saw in our group was convenience of grabbing a shake and running out the door and taking the kids to school, or whatever they might be doing. So something we certainly learned as it relates to a food, and especially, a meal replacement and/or something of that category, convenience is a key driver and the change really complicated the offering versus the convenience factor. So that was a key issue that we learned. We also learned that on a global basis, that it's a little more consistent as it relates to flavor and taste, and not so individualized in that as we were looking at our chocolate base and our vanilla base, that those are very widely accepted globally and we didn't have to be as specific on a regional basis as it related to flavor and taste. And then the last thing we learned is that as our customers have been accustomed to a certain taste and just product that they're consuming that when that is changed, change is very, very hard and they weren't really open to making such a huge change. And so I don't know, Jim or Doug, if you want to address anything else that we learned?

One thing I will add also from a comparable perspective quarter-over-quarter, we really saw a spike in sales in MySmart second quarter of last year. And the comparable this year, that is totally -- we're in decline from a food's perspective that we talked about, and it's had a dramatic effect from a customer basis and a customer interaction. And so that has really created a different layer on the comparables as we look at quarter 2 of last year and quarter 2 of this year.

And maybe a little bit more flavor on that, Frank, and this is Doug. In the convention of 2015, we did this as really kind of just a convention thing to go back and get feedback and input from the field and was really launched on more of a permanent basis last year at convention. So Kevin talked about that spike in sales. And so that's where -- that comes from a little bit. And the other thing I'd probably tell you is that this disproportionately hit the Americas and Europe region far more than it did the other regions of the company.

For sure.

Do you think maybe some of that is also because there's also a lot more competition in that space, protein shakes and such, or is that a separate issue? Like it's specific to those markets.

It certainly is a competitive marketplace. One of the things, again just from an overall business perspective, what we've seen, especially in America, is that many of our leaders were using our foods as their entry lead-in product that they were offering and then use that to get them exposure into the rest of our product offering. And so it is a highly competitive marketplace, but we've been able, over the years, to differentiate ourselves, especially in the meal replacement weight management category. And a point of good news, we launched this week, our first step in the RESET kits, which is back to what our customers love and need. And we've seen just a few days in, we probably -- we've seen a huge excitement and success and so we have strategies in place to be back on track that are well, well underway and they're already hitting the marketplace.

Okay, great. Moving on to China. Is there any reason to believe that the state, the investigation -- internal investigations that you have going on would impact sales, recruiting? I'm assuming no, since there's no media attention to that over there, but I just wanted to confirm my suspicion.

Frank, this is Josh. Yes, that's a correct assumption. You're right.

Okay. And the other question related to China is your inventory levels went down year-over-year, and I assume some of that is the promotion driven, but so are you still -- and you've been doing that, I think you said for the last 4 weeks of the quarter. And I'm assuming that's still ongoing into Q3. That's part of the question. The second part of the question is, are inventory levels enough that you can support promotions going forward specifically in China?

This is Jim. Yes, the inventory levels went down mostly just from the controls that we put in place. Over the last year, we've implemented the same ERP, MRP system that's in the U.S. into China. And with the new manufacturing facility, we have just a complete control system that allows us to actually reduce our inventory. With the third quarter, yes, that's manageable. We're not going to see any issues with inventory with promotions. We planned those out weeks in advance so that we can react to that.

And Frank, this is Doug. No, that promotion terminated at the end of the quarter, so there's nothing going forward in the third quarter from that promotion.

Okay. And I guess, to be fair, I guess your inventory was probably a little bit high last year because you were building inventory in anticipation of closing the old factories, is that not correct?

Yes, that's correct. We took a very conservative approach on inventory, meaning back orders were what we did want to have. So for a while there, we had much more. And now we're able to manage that and bring it down.

Okay. And my final question is just on South Korea because the numbers, I mean, kind of stuck out to me as being really good there, which I thought was surprising given what the environment there and competitors. So I just wondered if you could point out anything that kind of drove that, if there was anything specific I'm missing.

Well, our business is driven by leadership engagement and boots on the ground that are actually out sharing and building their independent businesses and growing their customer base. And in Korea, it starts with top leadership. We have an incredible general manager there, who is connected with our Associate leadership. Our business model works really well there and as I've been over there this year and interacted with our leaders there, we have a really, really solid young group in Korea that is working really hard and the excitement level is as high as I've ever seen anywhere in the world in a USANA group. And so it's just the combination of momentum, getting a group of really, really solid leaders that are working hard and watching their momentum just grow and grow. It's what we saw earlier in the Philippines, which we hope to see again in the Philippines with our leadership and leader development. But really the political climate and what's happening there has nothing to do with our business that I've seen, and has everything to do with people that are out building their business.

That's great. It's good to use boots on the ground, especially in that territory, right?

Yes, right. Yes, I shouldn't have used that probably.

(Operator Instructions) We will take our next question from Tim Ramey of Pivotal Research Group.

Can you describe a little bit about what the promotion in China was? And I was surprised to hear that you ended it at the end of the 2Q, given that the quarter was a deceleration. Is there further promotion expected in China? How should we think about that?

So this is Kevin. Yes, there are further promotions that we will run in China. We have to be careful as we're running promotions that it doesn't become expected behavior. And so as we are thinking strategically about how to implement our promotions with our sales force, if we're not careful, it will become a perception that it's actually part of our normal course of business and so as we start and stop, they become accustomed to certain promotions. And so we very purposefully don't run them for a long term from that perspective. Secondly, the nature of the bonus was a what we call a fast start, which -- it helps people get paid quickly as they out -- go out and build their customer base in the business, and so it's a fast-start promotion. That has been very well received in China, obviously. But again, the acquisition costs increase, and so you see our payout go up for our incentive line. And so from a long-term perspective, it has to be managed because it's not sustainable long-term. And so we're managing as best we can the incentive line while we're growing the top line. And so there are several other factors, but those are a few of the key factors that we consider on why we would run it just for a few short weeks. Then lastly, with all of those things said, we're managing long term for the long-term good of the business. And so there we're -- there are a lot of moving parts. And so that's why we chose to only keep it at 4 weeks. And like I said, yes, to your answer, we will run future promotions in the second half of the year in China.

And Tim, this is Doug. Maybe a little bit of flavor there. This is a very similar promotion that we ran in the fourth quarter of 2014 and first quarter of '15. And it really is rewarding on the sales of new customers coming in the business, right, and sales growth in that area. But it definitely is a big influence in that market. But I think if we do it too long and stuff it starts losing effectiveness, too. And that's something local management over there is very savvy to. And they want to go back and help manage that, make sure they're supporting the sales that they're generating.

Do you think the promotion was effective? Do you think you have better momentum coming into the 3Q? Or is it too early to say?

Too early to say. I think the last time we ran it, we saw a little bit better tail than we expected. But it's very premature to go back and start commenting on that at this point.

Okay. And I know you're not likely to comment much, but the FCPA investigation, number one, I assume that as long as that is ongoing, you're not likely to repurchase shares. Is that a fair statement?

S

Tim, this is Josh. With respect to those 2 issues and how they relate to one another, we're not going to comment there. But again, what I would do, I would direct you back to the earnings release, where again, we included the disclosure on kind of the nature and the scope of the internal investigation, which is being led by the Audit Committee. And then we also -- you saw the disclosure on the share repurchase authorization, but I would just refer you to the release.

Okay. And are you using a third party to help you with that investigation, or is this all an internal investigation?

Oh, no. We're -- and again, I'm going to limit my comments, but we are certainly using the most qualified advisers.

Okay. And to echo Frank's comment, South Korea numbers are remarkably strong, given what we're hearing from others in that market. It sounds like you think that there's some sustainability to that, but I'd love to hear your comment on how sustainable you think that might be.

Tim, I would probably hesitate from giving too much flavor going forward, but if you look at the last several quarters, I mean Korea has been a strong growth market for a pretty consistent period of time now. And to Kevin's point, I think the leadership in market has really been a catalyst to pushing that market in the right direction. But it's been several quarters now. We don't think this is an anomalous quarter as far as their performance.

Okay. And you highlighted the impact of MySmart Foods on North America. You cited Mexico and Canada being weak. I assume that means that the U.S. itself was not as weak. Is there anything you can share from a growth initiatives perspective on -- other than just reformulating MySmart Foods, maybe getting better supply chain management going there? Should we now expect that business to have a more steep negative trajectory as has been developing so far this year?

I wouldn't -- I would say no. I think we're at a point where it's leveling off, and we're now in the point of executing on our strategy to build that back up and bring that back up. And so I wouldn't say that we're going to see a steep drop-off or a steeper drop-off, but we're going to see certainly a leveling out and a building and growth in that area.

Yes, this is Jim. Kevin mentioned it earlier, but RESET being launched in the U.S. this week and rolling out in both Canada and Mexico, and in the short-term, it's going to have a huge impact. That was a missing component. It was a short-term weight management program that was an introduction into the business and it's been missing for a while. And we think that is the first start of getting the foods back on track.

Yes, and real quick, the U.S. launch this week, we'd expect Canada sometime in August and Mexico beginning in the first part of the fourth quarter, just a little clarity. But Tim, to your point on the U.S., the trend in the U.S. has been pretty consistent, it's just that we saw Mexico and Canada change path from what they had been and that's why they were highlight. But Americas and Europe, without a doubt, has been a challenging region. And I think the foods that we've talked about has been a big catalyst to why that's been happening.

(Operator Instructions) We will take our next question from Doug Lane of Lane Research.

Can you review for me anyway what the mix is these days between food, nutrition and personal care? And then maybe talk a little bit about what the trends are in the nutrition and personal care since we've been talking mostly about food this morning?

Yes. And Josh, correct me if I'm wrong, but it's about 83% nutritionals, 11% foods. I think foods are down a little bit, so I'd have to go back and grab that. And then the skin and personal care is about 5% to 6%. The rest is filled up by a variety of different things. But yes, it really is a market-by-market discussion. It's a pretty uniform composition. It means that most of the markets are pretty heavy on the nutritional supplements. The foods, we think there is great opportunity there as we go back and execute this and roll it out, we think there's some real opportunity. But you've seen -- what we've seen in our nutritionals, as we've seen a growth in what we call the optimizers, which is really more of the targeted nutrition. And we've seen that element picking up there. And the personal care line has been pretty consistent. It hasn't been overwhelming as far as what it's contributed, but it's been pretty consistent as a percent of sales.

Yes, it sounds like it hasn't really moved that much over the years. On the food, you had a lot of news in the last year or so. And so I'm trying to maybe get straight in my mind how much of the lower-than-expected sales in food comes from the lack of receptivity of some of the new products versus your supply chain issues, so they can't get it, versus maybe with a food product, they ordered too much. So they're just working off inventories, but they really like it. I mean, is there any way to get color on what the factors are there?

I would say, there really is no excess inventory. So that really isn't an issue. I think the primary thing is what Kevin articulated earlier. It's a convenience and it's a pallet issue. And obviously, some of the supply chain challenges that we've had haven't helped that matter, but I think it's primarily a simplicity and a flavor profile. Yes, and the other thing is the formula that we have gone to, that we had some struggles with, it was really a meaningful change in the formulation. And so it was quite a bit different than what we had in the past. It was very, very healthy. It just didn't meet that pallet profile that they were looking for.

So the strategy there is just to continue with what you're doing, but trying to refine it, just so it tastes better. Reformulate it just so it tastes better so people like it? Or you're going to move on to something else?

We're going back and reformulating like a second phase of it for the future. But right now, we're going back to very similar formulas that we've had in the past with the convenience factor, involve single-serving pouches instead of gusset bags and there are a lot of areas. But again, as Kevin said earlier, one of the major areas that we learned from was we made this very customizable with up to 7 different flavors and really, the market didn't react well to that. Going back to vanilla and chocolate with maybe some variations of that and the ease of use, it was a major learning and we're just going back in that direction.

We will hear from Tim Ramey once again of Pivotal Research Group.

The preferred customer accounts in North America took a sequential decline after the boost in the 1Q and you reclassified distributors. Do you think you're having difficulty keeping those folks active? Or is this really more to just weakness in Canada and Mexico?

Well, I think definitely a part of it is kind of the weakness in the business model. We're learning how to go back. I mean, because so much of our focus historically really had been on the social side, and we've had a robust PC population in these markets. But I think just the general direction of that business has definitely been the primary catalyst there.

Okay. So nothing structurally wrong with your approach to the preferred customer base?

We're still looking at the data and stuff, but I think our communication could always go back and be improved, and dialogue and we're doing this other stuff. But structurally, I don't think so, but we're still evaluating the data from that change.

Yes, Tim. This is Josh. And so you saw us execute on that in the Q1 in the U.S. And what we're really doing, to Doug's point, is learning now. As we interact with leaders, as we interact with that really not new segment of customers. They've always been customers. But now that they have been through this invitation process, we're learning from them. And we'll take that and kind of bake it into our evaluation on how to proceed in these other markets.

And Josh, just a follow-up for you. Maybe asking the question a slightly different way. If it wasn't the FCPA investigation, is there a reason why you didn't buy back shares in the 2Q?

Yes, I'm not going to comment on that one, Tim.

(Operator Instructions) And there are no further questions.

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.

That concludes today's conference. Thank you for your participation. You may now disconnect.