LifeVantage Corporation (LFVN) Q3 2012 Earnings Report, Transcript and Summary

Welcome to today's LifeVantage Third Quarter Fiscal 2012 Conference Call. [Operator Instructions] Hosting today's conference will be John Mills with ICR. As a reminder today's conference is being recorded, and now I'd like to turn the conference over to Mr. John Mills with ICR, Please go ahead, sir.

Great. Thank you. Good afternoon, ladies and gentlemen and welcome to LifeVantage Corporation's Fiscal Third Quarter 2012 Conference Call. On the call today from LifeVantage are Doug Robinson, President and Chief Executive Officer; Carrie McQueen, Chief Financial Officer; as well as David Brown, President of President of LifeVantage Network. By now everyone should have access to the earnings release, which went out this afternoon at approximately 4:00 pm Eastern Time. If you have not received a release, it is available on the Investor Relations portion of LifeVantage's website at lifevantage.com. This call is being webcast and a replay will be available on the company's website as well. Before we begin, we would like to remind everyone that the 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 up on them. These statements are based on current expectations of management and involve inherent risk and uncertainties including those identified in the Risk Factor section of LifeVantage's most recently filed 10-Q and 10-K. These risk factors contain a more detailed discussion of the factors that could actual results to differ materially from those projected in any forward-looking statements. LifeVantage assumes no obligation to update any forward-looking projection that may be made in today's release or call. Based on a number of participants on today's call, during the Q&A session, we ask that you please limit the number of your questions to 3 and then join back into the queue. And with that, I would like to turn the call over to the company's CEO, Mr. Doug Robinson. Go ahead, Doug.

Thanks, John. Good afternoon, everyone. On today's call, I will briefly review our record Q3 results, then I will provide a general update on our business and growth initiatives and will also update you on the investments we're making to our infrastructure to ensure we are positioned to capitalize on the tremendous opportunities ahead of us. After that I will turn the call over to Carrie McQueen, our Chief Financial Officer for a more detailed discussion of third quarter results and provide an update to our increased guidance range for the full fiscal year 2012. First, let me provide a quick review of our financials. We generated record revenue of over $36 million during the third fiscal quarter, a 263% increase, compared to the third quarter of last fiscal year. Our operating income for the quarter increased to $6.4 million, which translates to an operating margin of 17.7%. We also strengthened our balance sheet during the quarter ending Q3 with approximately $17 million in cash and no debt. Our financial performance continues to exceed our expectations, and based on this and our expectations for the final quarter of the fiscal year, we are raising our fiscal 2012 guidance range for revenue and operating income. We are increasing our fiscal year and revenue guidance that we provided last quarter from a range of $105 million to $115 million to new range of $120 million to $125 million. As a reminder, our 2011 fiscal year revenue was $39 million. We're also increasing our operating margin guidance from a range of 13% to 15% to a new range of 16% to 17%. Last fiscal year's operating margin was 9.5%. Our strong performance in the first 9 months of the year underscores the expanding awareness of our products Protandim and TrueScience, growing success of our current distributors, our ability to attract new distributors and the strength of our overall business model. Approximately 70% of our new global customers each month are preferred customers. We define preferred customers as those that product buy directly from LifeVantage for personal consumption. They do not acquire product to sell to others. They acquire it for personal consumption, do not have an interest in and are not eligible for commissions. We believe this speaks to the strength of our product offerings and the stability of our growing consumer base. As we have stated previously, we expect to provide additional metrics on our fourth quarter conference call to help you evaluate and measure the results of our company. We're very proud of all that we have accomplished. Our success is highlighted by our inclusion in the Direct Selling Global 100, which publishes an annual list of the top revenue-generating direct selling companies in the world. We think this achievement is even more impressive as you consider that 3 short years ago, on May 18th, 2009, we took our first order from a distributor in this new sales channel. While we are pleased to have earned a spot on this list, especially given how young our company is, we believe we've only scratched the surface of what we can accomplish in the coming years. At the beginning of this fiscal year, we outlined a plan for significant investment in various areas of our business. With our rapid growth rates, we continue to make appropriate investments in our infrastructure to support higher sales volumes and expand our platform for the future. As you can see from our higher operating margin, we are successfully leveraging our business model while increasing our investments in our infrastructure. As we complete the first 9 months of this year, we are pleased to report significant progress against our ongoing strategic and tactical plans. Now, let me provide a general update on our business, our growth initiatives and an update on the areas of our business in which we continue to invest. We're continuing to benefit from independently published studies that outline the efficacy of Protandim and further bolster the science behind our products. Strong scientific backing is the foundation of LifeVantage and critical to our business. The science community and the media are constantly and consistently interested in the Nrf2 molecule, which is the biochemical messenger that Protandim has been shown to activate. There's a tremendous proliferation of Nrf2 research and you can go to pubmed.gov to review this research. For those of you who are new to our story, I would like to provide a little background on our flagship product Protandim, the Nrf2 Synergizer, and the science behind it. Protandim was shown in earlier studies to activate the transcription factor Nrf2, a signal to the cell's DNA, to regulate a network of protective genes. A recent study further investigates Protandim's ability to increase production of the body's Nrf2 regulated protective genes, sometimes referred to as survival genes, which include genes that encode antioxidants enzymes as well as anti-inflammatory and anti-fibrotic proteins. To compliment the strong science behind our company one key area where we are investing is in research and development. We have a strong foundation with our products, but we are committed to building upon and leveraging this research to expand our product portfolio. We recently announced that we have initiated scientific research to examine the effectiveness of reducing oxidative stress through Nrf2 activation in pets. Pets are an extension of one's family and we believe that LifeVantage products have the potential to enable pets to live healthier and more comfortable lives by reducing the oxidative stress in their bodies. Billions of dollars are spent on pets every year to improve their lives, and we believe that we have an answer to reduce oxidative stress. We are in the early stage of research and development for this product as we want to verify safety and efficacy prior to bringing a new pet product to the market. In the coming quarters, we will be providing additional information concerning the timing and specific details of our pet product development. We also have been and will continue to invest in sales and marketing to support our distributors that are in the field, educating consumers and medical professionals about our products. Further, as many of you are aware, we partnered with Donny Osmond to act as a spokesperson for LifeVantage. Donny is eager to share his personal experience and use his celebrity status to help spread the word about LifeVantage and the importance of reducing oxidative stress. Just a few weeks ago, we held our Annual Global Convention at the Anaheim Convention Center. We were extremely pleased by the record attendance at this event. We had doubled the numbers of distributors in attendance compared to last year. We also are proud of our geographic diversity, particularly our expanding international distributor presence. We had individuals from Australia, Japan, Puerto Rico and Mexico. Participants in attendance from outside the United States increased 500% compared to last year. I believe that anyone in attendance of the event would agree that the energy, passion and enthusiasm at the annual convention were higher than ever. We could not be more pleased with the great group of individuals from around the world that distribute our products and help educate the public about our solutions to combat oxidative stress. The primary goal of these events is to educate all ranks of distributors and help enable them to achieve an elite rank status. We are especially concentrating on our mid-level distributors with additional training events. We are developing a larger middle class of distributors, who are building large sales organizations, selling a significant amount of product and thus receiving significant monthly commission checks. We want our distributors to achieve the financial success they're striving for and we're working to create more distributor leaders. Complementing our growth -- strong growth in the United States is our continued international growth. Expanding our international presence in accordance with our internal long-term strategic and tactical plans continues to be a key area of focus for our company. In order to properly expand into new and existing international markets, we must always be aware of constantly changing international regulations for ingredients and business operating models. As an example, it is not uncommon for foreign governments to change regulations with or without explanation, so we are constantly evaluating regulatory changes and new hurdles. We always review banking and leasing arrangements to determine the most cost-effective way to operating in international markets. We are also constantly reviewing whether our investment in a particular market will meet our internal return on investment requirements. When entering a new market, we must decide if the country has the appropriate leadership on the ground or whether we need to build an organic operation from the ground up. These are just a few of the criteria we use to ensure our existing countries and potential new countries meet our long-term internal revenue and profitability goals. We have been selling into Japan on a not-for-resale or NFR basis for 2 years now and have had a considerable level of interest in our products. In the third fiscal quarter of this year, sales into Japan were $10.5 million, compared to $1.8 million in Q3 of last year. As we continue to grow our sales into Japan on an NFR basis, we are evaluating the opportunity to expand operations on the ground in Japan. In order to do so, we must evaluate all of the criteria I just mentioned to be certain that we are doing so strategically. The Japanese government has recently issued a directive indicating that one of Protandim's ingredients, Ashwagandha may only be used in a product registered under the pharmaceutical regulations in Japan. We may continue to sell the product in its current form on an NFR basis and are reviewing other options such as reformulation and registration under the pharmaceuticals act in Japan in order to expand operations on the ground. We have also been selling our product in Mexico since January 2010. Recently, the Mexican government issued new regulations that now make one of our Protandim ingredients, milk thistle, unacceptable for use in a nutritional supplement. If a product contains milk thistle, it must be registered as an herbal medicine, a type of product that we believe may not be sold in a direct-selling model. As a result, we are examining our product options under the new regulatory requirements in Mexico. This is not a material development from a revenue or bottom line standpoint. We previously announced that we have been exploring the Australian market and are completing the necessary regulatory requirements for that market. I'm pleased to say that we have now crossed the necessary hurdles associated with entering the market and have had a soft launch in Australia this month, and we'll be shipping product in the fourth quarter. We believe Australia meets all the requirements I just reviewed, and fits our long-term strategic and tactical plan as well. To support our key initiatives I've just mentioned including new product development, increased marketing, ongoing corporate events and distributor support, we need the proper physical and human capital infrastructure as well. We have reached an important leverage point in our business model. Due to our rapid growth rate we continue to add important human capital to help maximize sales. We have been hiring in areas, including corporate administration, finance, marketing operations, sales, customer service and product development. I would like to reiterate that we are being mindful of increasing our investment in personnel as well as other areas of our infrastructure at a responsible rate to ensure continued profitability and continued leverage in our business model. We are at a point where we need to spend to support our sales, but this year we have done so in a manner that has allowed us to leverage our business while improving our operating margins on a year-over-year basis. On our last quarterly conference call, we discussed our move to a new, more efficient corporate headquarters here in Salt Lake City, as we had outgrown our prior location. We now have over 130 employees in our corporate office and are pleased to be in this new location. In addition to our headquarters in Salt Lake City, we have a small office in San Diego. Our senior management team and board of directors have decided that our company will be best served by consolidating all of our operations into our Salt Lake City office, and extending an offer to relocate to those impacted by this decision. Carrie McQueen, our CFO, lives in San Diego, and unfortunately for family and personal reasons, Carrie is not in a position to move to Salt Lake City. Carrie helped transition LifeVantage into a successful company it is today, and has been a tremendous contributor to our business, including managing the strong improvements to our balance sheet and contributing to the overall strengthening financial position of our company and we sincerely thank her for all her efforts. We are beginning a national search for a new CFO, and we expect that Carrie will continue to serve as our CFO, until we find the right person as well as help with the transition process. In first 9 months of fiscal 2012, we made tremendous progress with our business. We executed on all fronts and are well positioned to deliver another record year of revenue growth and operating profitability. This all leads to our ultimate and constant goal of improving shareholder value while educating people around the world about a way to enhance their health and wellness. In addition, as we have mentioned before, we are working towards listing on a national stock exchange. Making the switch is one of our goals as part of achieving operational excellence across the board in order to maximize shareholder value. We believe that finding the right time to make this switch is extremely important. Now, I'll turn the call over to Carrie to review our financial results.

Thank you, Doug, for the kind words. To reiterate what Doug said, I do remain committed to the continued growth and success of LifeVantage, and I believe the company has tremendous potential in the coming years. I do regret that I won't be with LifeVantage to participate in the continued growth, but as I'm sure many of you can understand. I'm simply not in a position to move for family and personal reasons. I look forward to helping LifeVantage conduct a search for new CFO, and assisting him or her in the transition in any way that I can. With that said, I'll move on to discuss our very strong third quarter results. As Doug has said, we are very pleased with our third quarter results and our ability to continue to improve our financial performance. We are proud to be reporting our 13th consecutive quarter of net revenue growth and our 7th consecutive quarter of generating operating income. Our results in more detail. In the third fiscal quarter of 2012, we generated record net revenue of $36.2 million, which represented a 263% increase over the third fiscal quarter of 2011. On a sequential quarterly basis, our revenue increased 43% from $25.3 million in the second fiscal quarter of 2012. Gross profit in the third fiscal quarter of 2012 increased to $31.2 million from $8.4 million in the same period last year, reflecting our higher sales. Our gross margin in the third fiscal quarter of 2012 increased to 86.2%. Total operating expenses for the third fiscal quarter of 2012 were $24.8 million, which represents 68.5% of revenue. This is a significant percentage decrease from operating expenses of $7.6 million or 76.2% of revenue in Q3 of fiscal 2011. On a sequential basis, operating expenses as percent of sales were stable. The increase in operating expenses on a dollar basis was primarily due to increased sales commissions, which are a direct result of our increased revenue. The dollar increase also reflects continued investment in personnel and infrastructure to position the company for future growth. The decrease in operating expenses as a percent of revenue from the same period in the prior fiscal year is due to improved leverage of our fixed expenses and infrastructure. As Doug mentioned, we expect to continue making strategic investments into our infrastructure in coming quarters, and we're confident we will leverage these investments and achieve a higher operating margin in fiscal '12 compared to fiscal '11. Sales and marketing expense increased to $19.7 million in the third fiscal quarter of 2012 from $5.4 million in the third fiscal quarter of 2011, and from $13.9 million in the prior quarter. The increases from both periods are primarily due to commissions paid to distributors due to the higher sales volume and, to a lesser extent, in supporting our growing events and distributor services team. We expect sales and marketing expense will continue to increase in proportion to our revenue growth. In the third fiscal quarter of 2012, general and administrative expenses increased to $4.6 million from $2.1 million in the third fiscal quarter of last year, and from $3 million in the prior quarter. The increase reflects higher personnel costs related to our expanding operations. While there will be periodic increases as we continue to build infrastructure, we expect general and administrative expense to reflect a lower growth rate than that of our sales and marketing expense. Our research and development costs increased to $378,000 from $116,000 in the prior year period and from $312,000 in the prior quarter. Continued investment in R&D is a priority for our company and we have committed up to 2% of total net sales to the R&D effort. The specific timing and recognition of these expenses will vary depending on the projects we undertake. In the third fiscal quarter of 2012, we generated operating income of $6.4 million, compared to $792,000, in the third fiscal quarter of last year, and compared to $4.3 million in the prior quarter. Operating income margin improved to 17.7% in the third fiscal quarter, compared to 7.9% in the same period last year and 16.9% in the prior quarter. As we experience periods of rapid growth, you will see fluctuations in our operating profit and expenses as we invest in our infrastructure to support our business. For those of you modeling our business, it is important to keep in mind that our third quarter spending plans were set based on our previous revenue expectations for the quarter. As we look toward the final quarter of this year, we anticipate that we will generate full year operating margins of 16% to 17%. Net loss for the third fiscal quarter of 2012 was $4.8 million, compared to $9.8 million in the third fiscal quarter of last year. This quarter's net loss includes a final change in fair value expense of $10.7 million related to our derivative warrant liabilities. I'll provide additional detail on derivative liabilities when I discuss our balance sheet. Turning briefly to our year-to-date results, in the first 9 months of fiscal 2012, we generated revenue of $81.6 million, a 242% increase compared to revenue of $23.9 million in the same period last year. Our gross profit increased 248% to $70 million, compared to $20.1 million in the first 9 months of last year. Gross margin in the first 9 months of fiscal 2012 was 85.8%, a 170 basis point increases compared to the same period last year. In the first 9 months of fiscal 2012, operating income increased to $14.1 million, compared to $1.7 million in the same period last year. Net income was $7.6 million, compared to a net loss of $3.6 million in the same period last year. Net income especially as compared to prior periods, does not yet accurately reflect our operating performance due to the changes in fair value from the derivative liabilities mentioned earlier. A top priority as stated in prior quarters has been to continually improve our balance sheet, eliminating the derivative liability and showing positive stockholders' equity. As of March 31st 2012, the company eliminated the balances in both, short- and long-term derivative liabilities. With the warrant modification approved on December 29, 2011, and the exercise of certain other warrants in March of 2012, the company has now removed all derivative warrant liabilities from its balance sheet, and has recognized the final changes in fair value of these warrants in its income statement. As shown our balance sheet now reflects significantly improved stockholders' equity and beginning in the fourth quarter of fiscal '12, we will present financials, which we believe will more accurately represent our operating results and financial achievements. With a stronger balance sheet, no derivative liability, positive stockholders' equity and net income driven directly from our operating results with more predictable tax and interest expenses. While we will begin to evaluate our business in terms of our net income, operating income and operating margins are still an important metric and will continue be an important measure with which to evaluate our performance, especially in comparison to prior year periods. Returning to our balance sheet. As of March 31, 2012, we continued to make solid improvements in our overall financial position. At the end of the third fiscal quarter of 2012, our cash and cash equivalents increased $16.9 million, up from $6.4 million at year end fiscal '11, reflecting the strong revenue growth and operating profits generated by the business. We generated $3.6 million of operating cash flow in the third fiscal quarter of 2012, compared to $2.3 million in the same quarter last year. Total stockholders' equity grew to $22.5 million, compared to a deficit of $20.8 million as of June 30, 2011 due to strong revenue growth, operating profits and the elimination of $19.9 million of derivative liabilities. As a result of our balance sheet improvements and NASDAQ's new requirements, I'm pleased to report that we have started the application process with NASDAQ. We'll update you on our progress during our fourth quarter conference call. Additionally, during the third fiscal quarter, we repurchased approximately 229,000 shares of company stock, for a total cash expenditure of $325,000. We have put in place a Rule 10b5-1 repurchase plan pursuant to which a broker that we selected, who will continue to repurchase shares of our common stock in accordance with prefect criteria including the stock price. Additional share repurchases may be made under this plan throughout the next 2 quarters if the prefect criteria are met. Turning to our outlook, as Doug mentioned, we are raising our full year fiscal 12' revenue and operating guidance range. For the full fiscal year ended June 30, 2012, we expect to generate revenue in a range of $120 million to $125 million, compared to our previously announced revenue range of $105 million to $115 million, a significant increase from the $38.9 million in revenue reported in fiscal '11. We expect to generate operating income in the range of $19.2 million to $21.3 million, which equates to an operating margin between 16% and 17%, and represents a 650 to 750 basis point improvement from our operating margin of 9.5% in fiscal 2011. As evidenced in our last few quarters of operating margin improvement, we're now experiencing substantial leverage from our business model. We will continue to build our infrastructure, but we also expect to report improved operating margins over last year's fiscal results. We are very pleased with our progress thus far in fiscal '12 and we look forward to finishing the year on a strong note. Operator, we are ready to open the call for questions.

[Operator Instructions] And for our first question, we'll go to David Rothman [ph] with Phoenix Capital Management.

I have one question regarding the listing process. Carrie, can you give me a rough -- a very rough guesstimate as to when you expect we will be listed on NASDAQ?

I can tell you that we have been working very hard to make sure that we meet the minimum listing requirements of NASDAQ, which is what allowed us to get our application filed recently. There will be a several-week period of Q&A and comments back and forth between ourselves and NASDAQ, and then subsequent to that when we are prepared to be listed, we'll have a discussion internally about the best time to actually pull the trigger and start trading on NASDAQ.

There's a little bit of discrepancy over the minimum stock price for NASDAQ, could you enlighten me or us?

Yes. The NASDAQ requested of the SEC, several months ago to lower the minimum listing price to a $2 or a $3 hurdle, depending on the specific markets you are applying to, and the SEC approved that request, I believe on April 19th and that was the final requirement that we had not yet met, was the listing price.

So basically, we're in a position now to be listed on NASDAQ, when the company, when LifeVantage determines, after they're through with Q&A, when the company determines that it's best to do so.

Yes. So, 2 things remain. Q&A and comments between NASDAQ and ourselves and make sure that they are comfortable with our company, our financial position and then subsequent to that a decision from the company when the right time is.

Phenomenal. I look forward to talking with you guys in about 4.5 months. Oh, and if you have a chance, we'd like to -- I'd like to ask is there any way that you guys would consider pre-releasing revenue, so that there is not such a long period of time between financial news out on the company?

We, at the very minimum, will make sure that we are through our annual audit process, and make sure that we have our financials in order, the audit complete, the board satisfied, and as you know, the 10-K is a much lengthier document, and we'd like to make sure that we've got our messaging completely nailed down before we release portions of it.

[Operator Instructions] We'll now go to Jeff Porter with Porter Capital.

Can you clarify the situation in Japan? As I understand it, we're selling on a not-for-resale basis? Can we continue to operate the same way as we have been subsequent to their change in their regulations?

Yes, Jeff. This is Doug. Thanks for your question. Thanks, certainly, for your support. The simple answer is yes, for some period of time. In fact that's exactly what we're planning to do, is to stay on a not-for-resale basis while we, a coincident with that, really look in and dive into the regulatory requirements, the changes over there, what have you, all the while assessing our operations. As you heard just now in our prepared remarks, we're growing significantly in Japan, and we're doing everything we can here domestically, but also in country to support that growth, because it is without a doubt a significant and very, very important market for us going forward. So we're paying, very, very close attention to it, and we'll bring forth the requisite organization necessary to grow that market exponentially.

Great, and one more clarification. You said in your prepared remarks that 70% of our sales were for preferred customers, which would imply that they are directly consuming. That seems like a really high number, and I guess is great news in light of the recent scrutiny that other MLMs have been given in the stock market. Do you expect that to continue to be our trend or over time, will that number drop somewhat as our distributor channels grow?

Jeff, let me answer that. This is Carrie. The number that we reported today is something that we've discussed, I think in Q&A previously. And the measurement that we've used is, of new people coming to the company every month, at least 70% of those are coming to the company purely and -- signing up purely for consumption reasons, whether they are preferred customers or retail customers, as opposed to distributors who are interested in or could earn a commission. That number has been consistent for at least 2 to 2.5 years. We expect it to continue, I do think we will see some differences as we go into international markets. Different markets just have different behaviors, but certainly within the U.S. market it's been very consistent and I wouldn't expect that to change.

Well, that's -- from an investor's standpoint, that's fantastic news. Thanks a lot.

[Operator Instructions] We'll now go to Mark Gordon with PMG Enterprises.

Great third quarter, very much looking forward to how things are going to progress in the future. My question has to do with the Mexican market. Doug, you made some comments regarding that and how the milk thistle may not be approved in Mexico. What does that mean for the future sales and will the network marketing channel be the channel that will be able to continue to market this product or are there some other hurdles that we have to get over in Mexico.

Mark, thank you again for your question. It's kind of a multi-pronged approach that we're taking to this. What often happens is, we find ourselves reacting from a management standpoint to various different government entities and regulatory bodies and what have you. My preference is to be much more proactive, but at times we have to react. And in this case, we're reacting to a recent ruling as it's come down in Mexico, on this very ingredient, milk thistle. So, what we're doing and what you can be assured that we're doing is that we're looking at alternatives, we're looking at the efficacy of potential reformulation, such that we know that the product or products that we put forth will be efficacious, and helping this fight against oxidative stress. So we're assessing all of that on a multi-pronged approach from a regulatory standpoint right now, from a science and an R&D standpoint, what have you. It's a little premature to full understand what course of action we're going to take on a go-forward basis, but we are assessing it on multiple fronts. And I have to stress as I said in my prepared remarks, that regardless of our chosen path if you will, it will not be a material development from a revenue standpoint, top line or bottom line as it relates to the Mexico market.

[Operator Instructions] And that concludes today's question and answer session. Mr. Robinson, at this time, I'll turn the conference back to you for any additional or closing remarks.

Well, thank you very much everyone, thank you again for your attention to all things LifeVantage. Obviously, we're very, very excited about our third quarter. And as we are staring very, very closely at the conclusion of fiscal '12 and even planning for fiscal '13, we're very bullish on our future. We will be out in the marketplace at various different investor conferences in the coming months and we hope to see many, if not all of you, at various different venues. So until our next opportunity for our fourth quarter call, again, thank you very much and have a fantastic day.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation.