LifeVantage Corporation (LFVN) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by, and welcome to today's conference call to discuss LifeVantage's Second Quarter Fiscal 2018 Financial Results. [Operator Instructions] Hosting today's conference will be Scott Van Winkle with ICR. As a reminder, today's conference is being recorded. And now I'd like to turn the conference over to Mr. Van Winkle. Please go ahead, sir.

Thank you, Melinda, and good afternoon, ladies and gentlemen. Welcome to LifeVantage Corporation conference call to discuss results for the second quarter fiscal 2018. On the call today from LifeVantage, with prepared remarks are Darren Jensen, Chief Executive Officer; and Steve Fife, Chief Financial Officer. By now, everyone should have access to the earnings release that went up this afternoon at approximately 4:05 p.m. Eastern time. If you did not receive the release, the release is available on the Investor Relations portion of LifeVantage's website at www.lifevantage.com. This call is being webcast. The replay will be available on the company's website as well. Before we begin, we'd like to remind everyone that our prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. These statements are based on the company's current expectation -- current expectation of the company's management and involve inherent risks and uncertainties, including those identified as risk factors in the -- in LifeVantage's most recently filed Forms 10-Q and 10-K. Please note that during today's call, we'll discuss non-GAAP financial measures, including results on an adjusted basis. Management believes these financial measures can facilitate a more complete analysis and greater transparency into LifeVantage's ongoing results of operations, particularly when comparing underlying operating results from period to period. We've included a reconciliation of these non-GAAP measures with today's release. This call also contains time-sensitive information that is accurate only as of the date of this live broadcast, February 7, 2018. LifeVantage assumes no obligation to update any forward-looking projection that may be made in today's release or call. Now I would like to turn the call over to the company's CEO, Darren Jensen.

Thank you, Scott, and good afternoon, everyone. I'm pleased to join you today and share our second quarter results and update you on the progress we're making on our fiscal 2018 initiatives. During the second quarter, we generated $49.5 million in revenue, representing both sequential and year-over-year increases. Although we have not seen significant sequential revenue growth yet, we have begun to see the green shoots of opportunity materialize from our initiatives. These early indicators have yet to materialize on our P&L but give us confidence in the initiatives we have undertaken. I'm very pleased with the continued solid trends in Japan. As you may recall, we have focused on turning around the sales in Japan over the last year and have made several enhancements to our leadership team and product offering. During the second quarter, revenue in Japan was up 12.9% year-over-year in local currency. And I'm confident that we have the right management team in place, good alignment between management and field leadership, we have reengaged our distributors and have continued to launch new products in the market. Japan is our second-largest market, and I'm appreciative of the work and support of our dedicated distributors and customers as well as our management team. Turning to an update on our initiatives. We continued to make progress against each during the second quarter and achieved some recent milestones early in the third quarter. Our key initiatives are focused on 3 goals: geographical expansion, distributor and customer acquisition and increasing average order size. First, to support our geographical expansion efforts, I'm very pleased to report that we have concluded our commercial test of our new Mainland China business model and formally launched in China on February 1. As you can imagine, we are excited for the launch and believe we are utilizing an innovative model that is on trend with the growth of e-commerce and social selling in China. Recall that this is not a direct selling model, but rather a model deployed through a third-party e-commerce platform and powered by in-country social marketers. Our distributors outside of China can refer Chinese nationals to become social marketers and then be compensated for the training of these social marketers. We have seen interest across our field leadership looking to participate in this new opportunity and business model, and we look forward to reporting on the development of this new market as the business builds. This is a new business model, and it is very early, but we are cautiously optimistic about the future impact this could have on our company. Based on the success of this model, we plan to evaluate its potential use in future markets where there are inherent barriers to traditional network marketing. Further supporting our geographical expansion and customer acquisition strategies, as early as late March, we expect to announce our global customer acquisition program. This is an initiative designed to expand the number of countries where preferred customers can purchase and use our products for personal consumption only. We plan to leverage existing infrastructure in regional warehouses to support these markets, limiting the need for additional investment to support this program. We believe this will allow us to enter these markets at a very low cost and allow our distributors to leverage their international relationships outside of their home countries. We plan to initially launch in 7 markets and to expand to additional markets over coming quarters. To drive customer acquisition, we are rolling out a new customer program whereby the company can direct -- where the company can directly acquire new customers, leveraging our marketing and public relation investments, such as our sponsorship of Real Salt Lake. We will be opening up lifevantage.com such that new customers can come directly to LifeVantage to shop for our products. Today, new customers are sourced only through our distributors, and there isn't a way for a potential new customer to simply order directly from us. After the initial order, these new customers will be assigned to distributors for ongoing support. This program will provide consumers easier access to our innovative products and referrals to our distributor force. Furthering these customer acquisition initiatives, we continue to build on our Red Carpet program. Red Carpet is designed to attract new distributor leadership by identifying experienced leaders who are in transition and attract them to the LifeVantage platform. A key aspect of our product strategy is to drive increased average order size. As we announced a couple of weeks ago, we launched Vitality Stack Packets. This completes the second phase of our Vitality Stack launch, combining 4 of our daily use products into packets for ease of use and improved portability. The Vitality Stack Packets include our Protandim Nrf2, our Protandim Nrf1, ProBio and Omega+ products. This stack and stacks that we plan to release in the future will become the primary protocols to support the biohacking culture we are creating across the company while increasing average order size and further diversifying our sales mix. The Vitality Stack launch event was held via a cybercast and where we had 120,000 views. We will continue the Vitality Stack launch at our Elite Academy in Indianapolis next week. We expect to see a building conversion of our order volume to this stack as we build upon the initial cyber launch. We have also made good progress developing our nutrigenomic story and the biohacking culture we've been building with distributors and customers. Biohacking is becoming the underlying message for our field, leveraging our core competencies and existing products and is supporting our unique position in the market. We are on the edge of this -- we are on the leading edge of this trend, are focusing on it across our field communication and marketing materials and have additional marketing and media assets in development to promote the story. The recent launch of Vitality Stack is a key component to supporting this story and providing nutrigenomic product solutions to leveraging this growing movement. Next week, we will begin rolling out the next phase of our LifeVantage digital platform to our top field leadership and expect to complete the rollout in mid-March. The new LifeVantage app is a custom-developed platform that will pioneer new ways for us to interact with our distributors and customers, integrating artificial intelligence and machine learning to onboard new distributors, assist them in finding new customers and tailor communications for them. This new platform is designed to support our customer acquisition goals and simplify all aspects of our distributors' interactions with customers. To sum it up, I'm pleased with our achievements against our key initiatives this year and look forward to seeing the impact of these initiatives on our revenue trends as the year progresses. With that, let me turn it over to Steve to run through the financial results. Steve?

Thank you, Darren, and good afternoon, everyone. Second quarter revenue was $49.5 million, representing a 1.1% increase year-over-year and a 0.7% sequential increase. Revenue in the Americas decreased 1.9% to $36.9 million, while revenue in Asia Pacific and Europe increased 11% to $12.6 million, including a 9.3% increase in Japan, all year-over-year. On a sequential basis, revenue in the Americas increased 2%, while revenue in Asia Pacific and Europe region decreased 3%. The gross margin during the second quarter was 81.6%, down from 84.7% a year ago. This decline is a function of product and geographic mix, the impact of free shipping to support our product bundling efforts and an increase in obsolete inventory associated with the evolution of our products. Commissions and incentive expenses continue to remain relatively consistent as a percentage of sales at 47.3% compared to 48.1% in the prior year. This variance reflects the timing of incentive and promotions from quarter-to-quarter. SG&A expenses as a percentage of sales were 29.6% compared to 35.2% a year ago. On a non-GAAP adjusted basis, SG&A expense as a percentage of sales were 29.2% compared to 31.3% in the prior year. This decline, to a large extent, relates to reduced compensation-related expenses and general corporate cost reductions. Operating income for the second quarter of fiscal 2018 was $2.3 million, up from $0.7 million last year. On an adjusted basis, non-GAAP operating income was $2.5 million compared to $2.6 million in the prior year. Adjusted EBITDA for the second quarter was $3.7 million compared to $3.9 million in the prior year. As many of you have seen or will see as other public companies report December quarter financial results, many U.S. companies will be taking a onetime noncash remeasurement adjustment of their deferred tax assets and liabilities as a result of the new federal corporate tax rate signed into law in December. Accordingly, we booked a $1.2 million onetime noncash revaluation expense of our deferred tax assets during the second quarter. Additionally, we anticipate that the recently enacted lower corporate tax rate will favorably impact our fiscal 2018 non-GAAP adjusted earnings per share by approximately $0.04. Second quarter net income on a GAAP basis was $0.3 million or $0.02 per fully diluted share, consistent with the prior year. On an adjusted basis, second quarter adjusted non-GAAP net income was $1.6 million or $0.11 per fully diluted share, which is consistent with the prior year. All of these adjustments are spelled out in our earnings press release. Turning to the balance sheet. We ended the second quarter of fiscal 2018 with $12.8 million of cash and $6.5 million of debt, which represents a $1.1 million increase in net cash during the quarter. As anticipated, there was a sequential increase in inventory to $16.8 million from $15.4 million to support new product launches, including Vitality Stacks, and the introduction of our current product lines into existing global markets. During the second quarter, we generated $2.2 million of cash from operations and invested $0.9 million in capital expenditures. For fiscal year 2018, we continue to anticipate CapEx in the range of $4 million to support our digital and technology investments, including upgrades to our core business systems to support our transformation efforts. With that, let me turn to our fiscal 2018 guidance. We are reiterating our non-GAAP adjusted earnings per share guidance range of $0.40 to $0.50 for fiscal year 2018. Based on the first half revenue and the timing of the revenue impact of our initiatives, we are now -- we now expect to be at the lower end of our prior revenue forecast guidance range or about $206 million. This guidance assumes some early success generating revenue in China during the second half of the fiscal year. As Darren noted, we are in the early days of our full launch in China, which is a difficult market to forecast, especially given the new business model we are rolling out. However, we have encountered interest and enthusiasm around the China opportunity, so we are cautiously optimistic. As we have discussed previously, we are in a transformational year, and we are confident with the initiatives in place to drive growth. The timing of the revenue impact of these initiatives is, of course, a challenge to predict. However, even if the revenue impact of these initiatives takes longer than we expect, we remain confident in our EPS guidance for fiscal 2018. Now let me turn the call back to the operator to facilitate the questions. Operator?

[Operator Instructions] And we will go to Steven Martin with Slater.

I know you said you're going to come in at the low end of revenue guidance. And I guess I'm going to ask the same question I've asked before, which is, you've launched new products, you've launched in new countries, you've got Japan sort of heading in the right direction, yet on a year-over-year basis -- oh, and you've gotten past all those registration problems you had a year ago, 1.5 years ago. And on a year-over-year or sequential basis, you're still sort of roughly flat. Tell me when we should expect, forgetting China, that the company is going to do more than $200 million of revenue.

Thank you, Steve. Well, I mean, when you look at the revenue that we're having right now, you do see that it's somewhat flat. And I would say that the initial impact of our initiatives that we've been taking have been helping to offset through challenges that we've been having in other parts of our business. For instance, we're behind where we thought we would be in Mexico because we're seeing some competition there that has impacted our sales level. In China, given the length of our commercial trial, we're a little behind on the launch where we wanted it to be. So conservatively -- forecasting that in an unforecastable market has been rather difficult. Also, with our Red Carpet program, that's really based on the availability of leaders that are in transition. So this has also been a challenge to forecast. Additionally, Germany did not ramp quite as quickly as what we were anticipating. So really, some of the initiatives that we've been taking have been helping us to grow slightly in this year-over-year but not to the extent that we wanted. Really, where we're seeing a lot of improvement have been especially with retention and increased basket size. So we see good things happening in some spots that are offsetting some others. But really -- I mean, when are we going to get off the $200 million side of it? A lot of that's tied into China and our efforts there as well as into our Red Carpet program and the recent launch with our Vitality Stacks. But as we said, between now and the next couple of quarters, we're being conservative in saying we're coming in towards the low end.

Okay. And in the Americas, your active independent distributors was down year-over-year. When is that going to reverse and at least be flat? Or is that not a possibility?

Well, it's always a possibility for sure to grow, and that's why one of our main focuses has been to drive additional customers and as well as distributors. I would say that part of the challenge there, one, we're still experiencing some of the impact from the changes that we made in our review from last year. But also, important behind it, there were also some changes that were made -- that we've made -- multiple changes that we've made to our compensation plan that were required by changes within the FTC that I think has over -- that has also had an impact on the number of distributors that come in as well as customers. So a lot of our efforts are focused on driving this number up, and we'll continue to focus on it until we get it moving in the direction we want it to go. But I can say, though, that we believe that, that is being offset tremendously by our increased retention levels of those distributors that we have.

So in China, are you going to have active independent distributors? And are you going to have preferred customers? Or is everyone just going to be a preferred customer?

In China, we operate on a retail basis. So we -- what we call it is a cross-border e-commerce opportunity. So we do not have any distributors per se in China because we sell our products through a partner platform. And what we work with are social influencers there, then go out and attract customers and drive them to a partner website in order to purchase the products. So it's not necessarily distributors in the classical way that you think of them. So one of the...

Right. So how is your business in China going to be? If I look at the 3 tables, okay, revenues, active independent distributors and active preferred customers, where is China going to show up there?

So in the short term, Steve, the product is going to be shipped directly from the U.S. to customers in China. So initially, it will be included in U.S. -- Americas revenue. As that business grows and it becomes more material, we will be breaking that out as a separate segment. It's a different business. It's not a direct selling business unlike the rest of LifeVantage. So both from a geographic standpoint as well as just the core business model, it's different. And we'll be breaking that out. And there are some -- there are going to be some differences in terms of the rest of the P&L model that accompanies that business, from margins down to our operating income. And again, as that becomes more material, we'll break that out in our disclosures.

Okay. Let me ask one more question. You did a good job of controlling your SG&A, and that was sort of a low -- a very good low number. Can I -- in modeling, is $14.6 million down from, I guess, about $16 million or $15.5 million, is that a good number to use going forward?

Yes, it's reasonable. The one thing that -- influence of our SG&A expenses is when we have events. We have higher costs coming through in those quarters. We did have an event this last quarter. We -- in November, we had an Elite Academy in Orlando. We have an event in Indianapolis next week. So in quarters where there are events, that's probably a reasonable rate, maybe a little higher. But in quarters where there aren't any events, it should be lower than that.

And one last one. Gross profit, you explained why it was down a little this quarter. What should we expect of that for the balance of the year?

Yes. I expect that that's going to increase slightly during the rest of the year. A lot of that is predicated upon our geographic mix of revenue and our product mix. But as I look at our forecast, I'm anticipating that's going to increase slightly in the second half of the year.

We'll next go to Dave Manovich, D&S Investments.

Let me dovetail a little bit on the questions, so the questions that were asked by the previous caller. And particularly in light of his focus on the growth of U.S. distributors. And also, Darren, your comment with regard to the focus that's there with regard to the Red Carpet program and how instrumental that can be for you bringing new leadership and new distributors into LifeVantage. That, coupled with the substantial focus that we have that you've articulated about our geographic growth, that we're expanding in Europe, that we have had a lot of effort that's been placed into Japan, that effort has been placed into Mexico and building up the business there, and now also, certainly a large initiative that goes into China, that I think it's safe to say that a good deal of our focus is with regard to geographic development that is outside of the United States. That a -- is that kind of a fair statement? And with that, we find that through the last number of years that America has continued to be flat. And as one of the individuals that, as a board member, that was there when we initially authorized the Real Salt Lake sponsorship, the question that I have is, are you considering or looking at continuing with that very expensive sponsorship on Real Salt Lake when it appears that it's had virtually no impact positively with regard to the Americas? Certainly, isn't going to impact, I don't think, the growth of distributors, and certainly has, because of its focus in the U.S., no impact on geographic areas outside of the U.S. Are you looking at continuing with the Real Salt Lake sponsorship, that expense? And if so, why?

Yes. David, this is Steve. And I guess, first of all, we really value our relationship with Real Salt Lake. They've been good partners with us. And this last quarter in particular, the last year, we've spent a fair amount of time evaluating that relationship and insofar as to retain an independent company to do a survey on the financial benefits and direct and indirect that came through our relationship with Real Salt Lake as well as looking at what we could do both at LifeVantage and RSL to further activate or enhance the benefit to the company. And through that discussion over the last quarter, we feel like both, one, we've received benefit, but we have a real opportunity to increase the benefit that comes through that relationship. One of the primary focus points that Darren talked about is the customer pool program, where we will be opening up our website to customers who want to purchase our product. And one of the -- we view one of the primary opportunities to take advantage of that is that relationship with Real. It's a primary kind of advertising tool that the company has. Clearly, kind of a dominant presence here in -- on the Wasatch Front in Utah. But we also have a presence in all of the major -- or all of the cities where MLS has teams. And so we believe that we get a benefit from that relationship. And through some of the additional work that we've done over the last quarter, we think we can further enhance that. And I'll tell you that if we feel like we're not getting the financial return at the end of this next season, we'll continue to reevaluate that relationship and make a decision that's clearly in the best interest of our shareholders as it relates to that relationship.

Yes. Because that is a -- over the 5-year period, is a relatively expensive spend of -- in the neighborhood of $12-plus million. And look, so what -- I just heard that over a time frame like that, with the other initiatives, particularly geographic that are well outside of the U.S., that we don't have any other place that we could -- will be more impactful to generating revenue growth to utilize that money other than on the jersey and on the stadiums for Real Salt Lake.

Dave, this is Darren. As we evaluate where to spend all of our marketing and sales dollars, obviously, we're looking at getting maximum impact. And I mean, at the beginning where you were talking about the importance of the United States and how it's been relatively flat for a while, that also, as you know, has been a concern of ours ongoing. And where we have made a change that's made it different this year is that our focus on driving additional customers and distributors to the company. And so as Steve pointed out, with the customer pool program, in previous years with Real Salt Lake, where we had a challenge was, as we direct Web traffic in and do advertisements, we were -- we had a very low conversion rate because it -- there was a requirement for them to make a purchase or to sign up completely through a distributor. So typically, we couldn't convert any of that advertising power and turn that into new customers. So we have been in negotiations and discussions with our distributor leadership on having the company collect those, allowing the company to bring in those orders directly from our website so we can run a much higher conversion rate and then drive those customers back into the distributor field as customers and as distributors. Because as we look at the engagement of our distributors, we know that one of the most important milestones for them in determining their business productivity and their retention within our business is the first dollar that they make with this. We call it the first dollar principle. So that's been a big focus of ours. And we believe that this program that we have that we're running this year during the RSL season, that's where we're going to be testing it and gauging as to whether or not it's effective. So this is a very important year for us, both on customer acquisition pushes, especially in the United States, and really leveraging that relationship the way that it should be.

Okay. In closing, I'd just say that all the investors that I have spoken to of late in the evaluation of our revenue gains and where we see investment being made, would -- no one would agree that the jersey sponsorship would be continued. That would be the feedback that I'd give you from myself and others that are shareholders that I've spoken to. So I'd suggest you spend some time talking directly with your shareholders and get their opinion on this particular marketing endeavor.

Well, thank you, Dave. And luckily, over this last little while, we've had the opportunity to actually speak with thousands of them on outbound calls. So it's something that we do. And especially those with concerns, we've been able to explain our strategy, and I would say the vast majority would agree that it's a very sound strategy. So thank you for your feedback.

And we'll next go to [ Eric Weisenberger ], private investor.

Yes. I just had a question about the Vitality Stack. Could you give us some pricing of that and when it's available and how it's delivered? Because I looked at the website, and I couldn't really find anything specifically on that Vitality Stack.

Yes. Thanks, [ Eric ]. Actually, it comes in 2 forms with us. One form we launched about 3 months ago, and that's where it would come in individual bottles, 4 individual bottles. That, in the United States, is priced at $149 and it gives you a monthly supply. The new one that we just launched a couple of weeks ago, which -- where the product is packed in individual packets, that product is $151. So that's the price. What was the other -- what were the other questions related to that?

No, that was it. I just couldn't find any price. And it's available now, I assume and that -- are those the prices preferreds will pay?

Yes, those are the prices. Yes, those are the prices that preferred customers as well as our distributors pay. All right. Well, thank you.

And that concludes our question-and-answer session. I would now like to turn it over to Darren Jensen for any additional or closing remarks.

Thank you, everyone, for joining us today. I hope you all share our excitement about the transformation happening at LifeVantage. We have made excellent progress against our fiscal 2018 initiatives, better positioning for the -- better positioning the company for the future. We look forward to updating you on our next call, and have a wonderful day.

And that does conclude today's conference call. We thank you all for joining us.