Usana Health Sciences Inc: Form 10-Q for the period ended Jun 29, 2024

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is designed to provide an understanding of USANA’s financial condition, results of operations and cash flows by reviewing certain key indicators and measures of performance.

The MD&A is presented in six sections as follows:

• Overview
• Products
• Customers
• Non-GAAP Financial Measures
• Results of Operations
• Liquidity and Capital Resources

This discussion and analysis from management's perspective should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and Notes thereto that are contained in this quarterly report, as well as Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 30, 2023 (“2023 Form 10-K”), filed with the SEC on February 27, 2024, and our other filings, including the Current Reports on Form 8-K, that have been filed with the SEC through the date of this report. Forward-looking statements in Part I, Item 2 may involve risks and uncertainties that could cause results to differ materially from those projected (refer to the section entitled “Cautionary Note Regarding Forward-Looking Statements and Certain Risks” on page 1 and the risk factors provided in Part II, Item 1A for discussion of these risks and uncertainties).

Overview

We develop and manufacture high quality, science-based nutritional and personal care and skincare products that are distributed internationally primarily through direct selling. We use this distribution method because we believe it is more conducive to meeting our vision as a company, which is to improve the overall health and nutrition of individuals and families around the world. Our customer base is primarily comprised of two types of customers: “Associates” and “Preferred Customers,” referred to together as “active Customers.” Our Associates also sell our products to retail customers. Associates share in our company vision by acting as independent distributors of our products in addition to purchasing our products for their personal use. In 2023, we launched our Affiliate program in the United States, Canada, and Mexico and are evaluating introducing the program in other markets. This program offers another sales and compensation opportunity to individuals who are interested in selling USANA products. Affiliates are discussed and reported in the report as part of our Associates. Preferred Customers purchase our products strictly for personal use and are not permitted to resell or to distribute the products. We only count as active Customers those Associates and Preferred Customers who have purchased from us at any time during the most recent three-month period. As of June 29, 2024, we had approximately 468,000 active Customers worldwide.

We have operations in multiple markets, with sales and expenses being generated and incurred in multiple currencies. Our reported U.S. dollar sales and earnings can be significantly affected by fluctuations in currency exchange rates. In general, our operating results are affected positively by a weakening of the U.S. dollar and negatively by a strengthening of the U.S. dollar. During the six months ended June 29, 2024, net sales outside of the United States represented 90.1% of consolidated net sales. In our net sales discussions that follow, we approximate the impact of currency fluctuations on net sales by translating current year sales at the average exchange rates in effect during the comparable periods of the prior year.

Products

The following table summarizes the approximate percentage of total product revenue for our Direct-selling segment that has been contributed by our major product lines and our top-selling products for the current and prior-year periods as indicated:

(1) Represents a product line consisting of multiple products, as opposed to the actual USANA® Essentials / CellSentials product.

(2) Includes our Active Nutrition line.

Customers

Because we sell our products to a customer base of independent Associates and Preferred Customers, we increase our sales by increasing the number of our active Customers, the amount they spend on average, or both. Our primary focus continues to be increasing the number of active Customers. We believe this focus is consistent with our vision of improving the overall health and nutrition of individuals and families around the world. Sales to Associates accounted for approximately 50% of Direct-selling segment sales during the six months ended June 29, 2024, with the remainder of our sales generated from Preferred Customers. Increases or decreases in product sales are typically the result of variations in the volume of product sold relating to fluctuations in the number of active Customers purchasing our products. The number of active Associates and Preferred Customers is, therefore, used by management as a key non-financial indicator to evaluate our operational performance.

The table below summarizes the changes in our active Customer base by geographic region, rounded to the nearest thousand as of the dates indicated:

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Non-GAAP Financial Measures

We believe that presentation of certain non-GAAP financial information is meaningful and useful in understanding the activities and business metrics of our operations. Management believes these measures reflect an additional way of viewing aspects of our business that, when viewed with our U.S. GAAP results, provide a more complete understanding of factors and trends affecting our business. This non-GAAP financial information may be determined or calculated differently by other companies, limiting the usefulness of those measures for comparative purposes. We provide such non-GAAP financial information for informational purposes only. Readers should consider the information in addition but not instead of or superior to, our Consolidated Financial Statements prepared in accordance with U.S. GAAP, accompanying this report.

In analyzing business trends and performance, management uses “constant currency” net sales, “local currency” net sales, and other currency-related financial information terms to discuss our financial results in a way we believe is helpful in understanding the impact of fluctuations in foreign-currency exchange rates and facilitating period-to-period comparisons of results of operations and providing investors an additional perspective on trends and underlying business results. Changes in our reported revenue and profits in this report include the impacts of changes in foreign currency exchange rates. As additional information to the reader, we provide constant currency assessments in the tables and the narrative information in this MD&A to remove or quantify the impact of the fluctuation in foreign exchange rates and utilize constant currency results in our analysis of performance. Our constant currency financial results are calculated by translating the current period’s financial results at the same average exchange rates in effect during the applicable prior-year period and then comparing this amount to the prior-year period’s financial results.

Results of Operations

Summary of Financial Results

Net sales for the second quarter of 2024 decreased 10.6% to $212.9 million, a decrease of $25.3 million, compared with the prior-year quarter. The decrease in net sales was primarily the result of a decrease in active Customers and a decrease in average spend per customer, partially offset by modest price increases compared to the prior-year quarter. Additionally, unfavorable changes in currency exchange rates negatively impacted net sales by an estimated $5.3 million.

Net earnings for the second quarter of 2024 were $10.4 million, a decrease of 39.7% compared with $17.3 million during the prior-year quarter. The decrease in net earnings was the result of decreased sales and higher relative operating expenses combined with an increase in effective tax rate.

Three Months Ended June 29, 2024 and July 1, 2023

Net Sales

The following table summarizes the changes in net sales by geographic region for the fiscal quarters ended as of the dates indicated:

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Asia Pacific: The constant currency decline in this region was primarily the result of lower active Customer counts and lower sales per active Customer, partially offset by modest price increases throughout the region. This decline was primarily concentrated in China, South Korea and the Philippines. A local currency net sales decline of 8.3% in China was due to a decrease of 8.3% in average spend per customer, mainly influenced by promotional activity, while active Customers remained consistent with the prior year. A local currency net sales decline of 19.3% in South Korea was primarily due to a 16.3% decrease in active Customers and a 3.5% decrease in average spend per customer. A local currency net sales decline of 28.8% in the Philippines was primarily due to a 18.2% decrease in active Customers and a 13.1% decrease in average spend per customer.

Americas and Europe: The decrease in this region was primarily the result of lower active Customer counts and lower average spend per customer, partially offset by modest price increases. The decrease in constant currency net sales is largely the result of a sales decline in the United States, which had a net sales decline of 10.3% due to a 6.8% decrease in active Customers and a 3.8% decrease in average spend per customer.

Gross Profit

Gross profit decreased 70 basis points to 81.1% of net sales, down from 81.8% in the prior-year quarter. The decrease can primarily be attributed to unfavorable changes in currency exchange rates and loss of leverage on lower sales, which was partially offset by lower material costs, decreased scrap and freight charges as well as modest price increases.

Associate Incentives

Associate incentives decreased 50 basis points to 42.5% of net sales, down from 43.0% in the prior-year quarter. The relative decrease can primarily be attributed to decreased spending on Associate related incentive trips in certain markets and benefits from modest price changes.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 160 basis points relative to net sales and decreased $3.8 million in absolute terms. The relative increase is largely due to a loss of leverage on lower year-over-year net sales. The lower expense in absolute terms can be primarily attributed to a decrease in spending for meetings and events, advertising, and other professional services.

Income Taxes

The year-to-date effective tax rate increased to 43.0% from the 35.5% reported in the comparable period of 2023 or 37.7% for fiscal 2023. The higher effective tax rate can be attributed to: i) China’s increased relative share of taxable income, ii) a concentration of infrastructure costs in our corporate headquarters, and iii) generally softer operating performance, including the impact of unfavorable exchange rates, in our other markets around the world. The revised year-to-date effective tax rate resulted in a 48.4% rate for the second quarter of 2024.

Diluted Earnings per Share

Diluted EPS decreased 39.3% to $0.54 as compared to $0.89 reported in the prior-year quarter. This decrease can be attributed to lower net earnings.

Six Months Ended June 29, 2024 and July 1, 2023

Net Sales

The following table summarizes the changes in net sales by geographic region for the six months ended as of the dates indicated:

Asia Pacific: The constant currency decline in this region was primarily the result of a sales decline in Southeast Asia Pacific and North Asia. There were local currency declines in nearly all markets in the Southeast Asia Pacific sub-region, most notably in the Philippines, Australia, and Malaysia, which had local currency net sales declines of 27.5%, 10.4%, and 8.0%, respectively. The decrease in local currency net sales in the Philippines was primarily the result of a 23.4% decrease in active Customers and a 5.7% decrease in average spend per customer. The decrease in local currency net sales in Australia was primarily due to a 12.5% decrease in active Customers, partially offset by a 2.4% increase in average spend per customer. The decrease in local currency net sales in Malaysia was primarily due to a 10.9% decrease in active Customers, partially offset by a 3.6% increase in average spend per customer. The decrease in constant currency net sales in North Asia was primarily concentrated in South Korea, which had a local currency sales decline of 21.8%. The decrease in local currency net sales in South Korea was primarily due to a 16.8% decrease in active Customers and a 5.9% decrease in average spend per customer.

Americas and Europe: There were local currency sales declines in most of the markets in this region. The decrease in constant currency net sales was primarily concentrated in the United States and Canada, which had local currency net sales declines of 13.4%, and 10.3%, respectively. The decrease in net sales in the United States was primarily due to a 5.7% decrease in active Customers and a 8.3% decrease in average spend per customer. The decrease in net sales in Canada was primarily due to a 3.0% decrease in active Customers and a 7.2% decrease in average spend per customer.

Gross Profit

Gross profit remained consistent at 81.1% of net sales for the six months ended June 29, 2024 compared to the six months ended July 1, 2023. While currency exchange rates and a loss of leverage on lower sales continue to be a detriment to the gross profit margin, these were offset by benefits from decreased scrap charges, favorable changes in market and product sales mix, modest price increases, and lower freight expense.

Associate Incentives

Associate incentives decreased 60 basis points to 42.2% of net sales, down from 42.8% for the six months ended July 1, 2023. The relative decrease can primarily be attributed to decreased spend on promotional incentives, as well as modest price increases. These improvements were partially offset by an unfavorable shift in market sales mix.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 150 basis points relative to net sales and decreased $6.4 million in absolute terms. The relative increase can be attributed to leverage lost on lower net sales. The lower expense in absolute terms can be primarily attributed to a decrease in spending for meetings and events, advertising, and other professional services.

Income Taxes

Income taxes increased to 43.0% of pre-tax earnings, up from 35.5% of pre-tax earnings for the six months ended July 1, 2023. The higher effective tax rate can be attributed to: i) China’s increased relative share of taxable income, ii) a concentration of infrastructure costs in our corporate headquarters, and iii) generally softer operating performance, including the impact of unfavorable exchange rates, in our other markets around the world.

Diluted Earnings per Share

Diluted EPS decreased 23.9% to $1.40 as compared to $1.84 reported for the six months ended July 1, 2023. This decrease can be attributed to lower net earnings.

Liquidity and Capital Resources

We have historically met our working capital and capital expenditure requirements by using net cash flow from operations and by drawing on our line of credit. Our principal source of liquidity is our operating cash flow. Although we are required to maintain cash deposits with banks in certain of our markets, there are currently no material restrictions on our ability to transfer and remit funds among our international markets. In China, however, our compliance with Chinese accounting and tax regulations promulgated by the State Administration of Foreign Exchange (“SAFE”) results in transfer and remittance of our profits and dividends from China to the United States on a delayed basis. If SAFE or other Chinese regulators introduce new regulations or change existing regulations which allow foreign investors to remit profits and dividends earned in China to other countries, our ability to remit profits or pay dividends from China to the United States may be limited in the future.

We believe our current liquidity is adequate to meet our cash requirements and sustain our operations through cash flow from operations. Maintaining a capital structure that emphasizes sufficient liquidity and adaptability in the prevailing economic climate is our top priority. We actively assess potential acquisition opportunities and investments in complementary ventures. While we continuously aim to preserve ample liquidity and ensure business continuity amid uncertainties, we also explore initiatives such as stock repurchases. These strategic decisions have the potential to impact our liquidity, enabling us to navigate these challenging times effectively.

Cash and Cash Equivalents

Cash and cash equivalents increased to $332.4 million as of June 29, 2024, from $330.4 million as of December 30, 2023. Cash flow provided by operating activities was $25.7 million partially offset by cash used in financing activities of $13.3 million, cash used in investing activities of $5.6 million, and the unfavorable effect of exchange rate changes on cash and cash equivalents of $4.8 million.

The table below presents concentrations of cash and cash equivalents by market for the periods indicated:

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During the six months ended June 29, 2024, our China subsidiary remitted profits through an annual dividend of $75.8 million to the United States, inclusive of net proceeds from a dividend hedge and net of applicable taxes.

Cash Flows Provided by Operations

As discussed above, our principal source of liquidity comes from our net cash flow from operations.

Net cash flow provided by operating activities was $25.7 million for the first six months of 2024. Net earnings combined with adjustments of non-cash items contributed positively to our net cash flow provided by operating activities, partially offset by cash used to pay accounts payable, accrued associate incentives, and the 2023 annual employee bonus.

Net cash flow provided by operating activities was $22.4 million for the first six months of 2023. Net earnings combined with adjustments of non-cash items contributed positively to our net cash flow provided by operating activities, partially offset by cash used to pay accrued associate incentives and the 2022 annual employee bonus.

Line of Credit

Information with respect to our line of credit may be found in Note F to the Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

Share Repurchase

Information with respect to share repurchases may be found in Note I to the Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

Summary

We believe our current cash balances, future cash provided by operations, and amounts available under our line of credit will be sufficient to cover our operating and capital needs in the ordinary course of business for the foreseeable future. If we experience an adverse operating environment or unanticipated and unusual capital expenditure requirements, additional financing may be required. No assurance can be given, however, that additional financing, if required, would be available to us at all or on favorable terms. We might also require or seek additional financing for the purpose of expanding into new markets, growing our existing markets, mergers and acquisitions, or for other reasons. Such financing may include the use of debt or the sale of additional equity securities. Any financing which involves the sale of equity securities or instruments that are convertible into equity securities could result in immediate and possibly significant dilution to our existing shareholders.

Critical Accounting Policies

There were no changes during the quarter to our critical accounting policies as disclosed in our 2023 Form 10-K. Our significant accounting policies are disclosed in Note A to our Consolidated Financial Statements filed with our 2023 Form 10-K.

We have no material changes to the disclosures on this matter made in our 2023 Form 10-K. For a discussion of our exposure to market risk, refer to our market risk disclosures set forth in the section entitled “Quantitative and Qualitative Disclosures About Market Risk” in the 2023 Form 10-K.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information that is required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods that are specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial and Accounting Officer), as appropriate, to allow timely decisions regarding any required disclosure. In designing and evaluating these disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

As of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a- 15(e) under the Exchange Act). Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as a result of material weaknesses in internal control over financial reporting related to information technology general controls (ITGCs) as described in Part II, Item 9A of our Form 10-K for the fiscal year ended December 30, 2023 (the “2023 Form 10-K”), the disclosure controls and procedures were not effective as of June 29, 2024.

Changes in Internal Control Over Financial Reporting

Other than with respect to the remediation efforts addressed below, there were no changes in our internal control over financial reporting during the fiscal quarter ended June 29, 2024, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Remediation Efforts to Address Material Weakness

As previously disclosed in Part II, Item 9A of the 2023 Form 10-K, we are implementing measures designed to ensure that the control deficiencies contributing to the material weaknesses are remediated, such that the relevant controls are designed, implemented, and operating effectively. The remediation actions are ongoing and include:

• Enhancing our IT organization that is responsible for the development, monitoring, and testing of the ITGCs to ensure sufficiency of resources with the appropriate knowledge, experience, and training; and
• Developing a training program addressing ITGCs and related policies, to educate control owners on the principles and requirements of internal control activities, including maintaining adequate evidence of the controls’ operation, and ensuring timely and consistent performance of the controls as designed.

During the first half of 2024, we began the process of developing a detailed remediation plan to address each control deficiency. Additionally, we engaged a third-party consultant with expertise in ITGCs to assist with risk assessment and control design, educating and training ITGC control owners, advising on relevant IT policies, and providing guidance with regard to sufficient control documentation to support the controls’ operation. In the coming quarters, we will continue our efforts to ensure that the control deficiencies contributing to the material weaknesses are remediated. This includes, but is not limited to, reviewing and updating IT policies, analyzing current processes and control documentation, and establishing the appropriate level of responsibility and ownership of ITGCs. The material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of these material weaknesses will be completed prior to the end of fiscal year 2024.

Our business, results of operations, and financial condition are subject to various risks. Our material risk factors are disclosed in Part I, Item 1A of our 2023 Form 10-K. The risk factors identified in our 2023 Form 10-K have not changed in any material respect.