Medifast, Inc. (MED) Q2 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Medifast Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Ms. Katie Turner for opening remarks. Thank you. Ms. Turner, you may begin.

Thank you. Good afternoon, and welcome to Medifast's Second Quarter 2013 Earnings Conference Call. On the call with me today are Michael MacDonald, Chairman and Chief Executive Officer; Meg Sheetz, President and Chief Operating Officer; and Timothy Robinson, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ending June 30, 2013, that went out this afternoon at approximately 4:05 p.m. Eastern Time. If you've not received the release, it's available on the Investor Relations portion of Medifast's website at www.medifastnow.com. This call is being webcast, and a replay will be available on the company's website. Before we begin, we'd 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. The words believe, expect, anticipate and other similar expressions generally identify forward-looking statements. These statements do not guarantee future performance, and therefore, undue reliance should not be placed on them. Actual results could differ materially from those projected in any forward-looking statement. Medifast assumes no obligation to update any forward looking projections that may be made in today's release or on the call posted on the company's website. All of the forward-looking statements contained herein speak only as of the date of this call. And with that, I'd like to turn the call over to Medifast's Chairman and CEO, Michael MacDonald.

Thank you, Katie. Good afternoon, everyone, and thank you for joining us. On today's call, I will provide you with an update on our strategic initiatives and discuss the areas of our business where we realized greater efficiencies in an effort to improve Medifast's future growth and profitability long term. Tim will review the financial results for the second quarter in more detail and discuss the third quarter and full year 2013 revenue and EPS outlook. I will then provide closing remarks. We will open up the call to take your questions. In the second quarter, we continued to focus on profit improvement throughout our Take Shape for Life, Medifast Direct, Medifast Weight Control Center and Wholesale Physicians sales channels. This focus resulted in earnings of $0.51 per share, ahead of our second quarter expectations and versus our guidance of $0.45 to $0.50. We further improved our overall operational performance in the quarter and remained focused on planning our investments and initiatives to maximize profitability long term across our multiple sales channels. We are especially pleased with our ability to expand our margins and realize higher profitability despite our net revenue for the second quarter being slightly below our expectations. This really speaks to strong expense management of our executive team, and more importantly, the overall strength of Medifast business model. We believe that the efforts we continue to make across our sales channel to enhance margins and profitable growth will translate into even greater earnings and cash flow generation. Specifically, we believe over the next few years, the greater improvement should flow through our P&L as we execute the sale of our corporate Medifast Weight Control Centers and transition them to the franchise model, realize an improvement in acquisition, retention and conversion in our Medifast Direct sales channel, further increased client and coach acquisition and retention and Take Shape for Life and gain a stronger contribution of revenue from our international expansion with Medix throughout Mexico and South America and see our international growth elsewhere as well. I will now take a few moments to discuss our second quarter results across our multiple sales channels in a little more detail and provide you with an update on our strategic initiatives. Revenue in the direct sales channel, Take Shape for Life, increased 10% to $61.4 million in the second quarter of 2013. We ended the second quarter with approximately 11,800 active health coaches, an increase of 17% as compared to the same period last year. The average revenue per health coach per month for the quarter increased to $1,690 compared to $1,683 in the second quarter of 2012. In the quarter, we conducted a new market development initiative in 5 key cities across the U.S. that focused on client acquisition and the health coach business opportunity. In April, nearly 1,000 of our top health coaches came together for 4 days of training and networking at our annual Go Global event in Dallas. At that event, we announced our new integrated compensation plan, and our health coaches were educated on how to build a solid business based on these changes. It was an exciting event where we heard much positive feedback about our evolved compensation plan and the behavior it will drive. It was great to see many of you just a few weeks ago, and we appreciate you making the trip to Nashville for our Take Shape for Life Annual Convention. It was a tremendous event with over 3,000 attendees, a 27% increase versus the prior year. At the convention, our team unveiled new products, new health coach tools to increase our coaches' ability to attract new clients, retain existing clients and help them further grow their businesses. Notably, the Dr. Wayne Andersen's new book, Discover Your Optimal Health, has now launched and is a fantastic aid to promote healthy living and the role weight loss plays. We're pleased to announce it just earned a spot on the prestigious New York Times best seller list, appearing fourth in the Advice and How-To category. The press and attention gained from this book launch will further help share our Take Shape for Life message nationally. And beginning in May, health coaches are now able to receive their health coach certification through COPE, the MacDonald Center for Obesity Prevention and Education, a joint effort between the MacDonald Foundation and the College of Nursing at Villanova University. In fact, we had over 1,700 health coaches arrive in Nashville early this year to get certified or recertified at convention. Medifast Direct channel revenue decreased 4% to $21.5 million. This was in part due to our team's pullback in marketing spend for this channel in the quarter as we evaluated the more challenging consumer discretionary spending environment. We took an approach to closely manage advertising and marketing investments based on what we saw as some consumer caution in the second quarter. Also, as we shared in the first quarter of 2013, in addition to the continued focus on Direct response and call to action marketing, we allocated a portion of second quarter spend to brand building and awareness creation messaging. This has resulted in a significant improvement in brand awareness from 25% to 40% over the last 18 months and from 32% to 40% in the last 6 months alone and is expected to contribute to overall revenue growth for the company long term. In line with this marketing adjustment, our total company advertising spend in the second quarter of 2013 decreased 11% to $8 million. But importantly, our total company revenue to spend ratio improved to 12.1:1 versus 10.3:1 in the second quarter of 2012, which highlights our focus on spending efficiency. We believe it is important to invest in both our brand awareness and consideration over the long-term while we drive demand generation in the immediate term. In the second half of 2013, we will continue to see reduced advertising spending versus last year, and we'll be focusing our back half spending to more immediate term demand generation for the Medifast Direct channel. We continue to invest in new site and digital content and have made significant improvements to the user experience on our website. Our team is more engaged with current prospective clients than ever before across our blog, e-mail campaigns and social sites. We also seamlessly completed an e-commerce upgrade to allow us to be more nimble in the future and have started the process to make our sites completely mobile, e-commerce friendly by the end of 2013 as more and more consumer traffic, customer traffic, comes from tablets and smartphones. In the back half of 2013, we will also introduce new state-of-the-art display, network and search methods to drive qualified traffic to our site. And we're excited to introduce new Direct response television spot that will generate demand while continuing to build a Medifast brand recognition. We continue to improve our fully integrated marketing approach across online and offline activities, and this new DUR [ph] campaign will tie in very closely to our online campaign. In the second quarter, the Medifast Weight Control Centers and Wholesale Physicians channel revenue decreased 8% to $14.2 million. Consistent with our expectations, same-store sales for corporate centers opened greater than 1 year decreased 20%, but we are able to realize a $300,000 profit improvement as compared to the second quarter of 2012. The increase was primarily the result of savings from the staffing realignment completed in the first quarter of 2012, and reduced advertising spend. We ended the second quarter with a total of 86 corporate locations, 85 of which are comparable store base and 36 franchise locations. In June, we hosted a successful franchise owners' conference that generated strong attendance in both the franchisees, as well as corporate leaders. This was a great opportunity for us to strengthen our relationships and renew everyone's focus as we move the franchise business model forward. Looking ahead, our focus is franchise location expansion with both existing and new franchise partners. We still expect to open 5 to 7 franchise locations in 2013 with one opened in the first quarter and the remainder opening in the second half of the year. Regarding our plans for the corporate centers, today, we announced our intention to sell the existing corporate centers and transition them to the franchise model over the next 12 to 18 months. This will allow the company to optimize franchise performance, heighten focus on franchise location expansion with both existing and new franchise partners and provide a strong foundation for future growth and profitability. We plan to keep a small number of corporate centers to facilitate research and testing and serve as examples that highlight the Medifast Weight Control Center business model. We are continuing to share more information about this plan as it progresses. On the international front with Medix, we are excited to be opening 2 Weight Control Centers in the third quarter. We believe the Weight Control Center model will be helpful in driving incremental business through the Medix existing doctor network. Medix continues to work with the extensive physician network while it also plans to open approximately 30 Weight Control Centers over the next several years. We are also excited to announce that Medix gained approval for the majority of our products in Colombia, and the first order to Colombia has now been shipped. As you're aware, this is a long-term partnership with Medix, and we are being prudent with the rollout to ensure a successful start. This partnership is a great example of how we're expanding Medifast products and programs internationally through new complementary distribution channels. Going forward, we are advancing towards our entry into Canada, and we will continue to explore ways to grow the Medifast brand to help fight obesity on a global basis. Our emphasis will be on entering new markets with the low capital investment and the focus on increased profitability. In summary, we have improved our operational performance and managed our investments appropriately. Our team continues to focus on profitable growth through the remainder of 2013, while we aggressively put plans in place for 2014 to drive revenue growth across our multiple sales channels. We are in the midst of developing product and program expansion opportunities into adjacent categories, evaluating several branded and private label partnership opportunity and working on finalizing the approval of our products in Canada, which when combined, all create great optimism about our future prospects and our ability to grow as a healthy living company. I'll now turn the call over to Tim Robinson, our Chief Financial Officer, to review our second quarter 2013 financial results in more detail and provide you with our outlook for the remainder of 2013.

Thanks, Mike. I'll now review our financial results for the second quarter ended June 30, 2013, in more detail. For the second quarter, net revenue increased 4% to $97.1 million from net revenue of $93.6 million in the second quarter of the prior year. The Take Shape for Life sales channel accounted for 63.3% of total revenue. Medifast Direct accounted for 22.1%. Medifast Weight Control Centers and Wholesale Physicians accounted for 14.6% of total revenue. Gross profit for the second quarter of 2013 increased 4% to $72.9 million compared to $70.1 million in the second quarter of the prior year. Our gross profit margin increased 10 basis points to 75.1% versus 75% in the second quarter of 2012. Margin improvement during the quarter was a result of pricing adjustments, including offering fewer customer discounts, partially offset by increased commodity and shipping costs. Selling, general and administrative expenses in the second quarter of 2013 decreased $3.2 million to $62.3 million versus $65.5 million in the second quarter last year. As a percentage of net revenue, selling, general and administrative expenses decreased to 64.2% from 70% in the second quarter of 2012. Excluding the previously disclosed FTC's charge of $3.7 million in the second quarter of 2012, SG&A in 2012 would have been $61.8 million or 66.1% of net revenue. Take Shape for Life commission expense, which is a variable based on product sales, increased by approximately $2.4 million as Take Shape for Life sales grew 10% compared to second quarter of 2012. Salaries and benefits decreased by approximately $900,000 in the second quarter of 2013 as compared to last year. The decrease in salaries and benefits is primarily due to the 2012 restructuring efforts and continued optimization of staffing levels at the Medifast Weight Control Centers and in corporate. The savings were partially offset by the hiring of an increased salary for key executive positions. Sales and marketing expense decreased by $1.4 million in the second quarter of 2013 as compared to the second quarter last year. Operating income was $10.6 million or 11% of net revenue compared to $4.6 million or 4.9% of net revenue in the second quarter of 2012. Excluding the previously mentioned charge in the second quarter of 2012, operating income increased $2.3 million or 210 basis points. Operating income for the second quarter of 2012 would have been $8.3 million or 8.9% of net revenue, excluding the onetime expense. Our effective tax rate was 35% compared to 48.9% in the second quarter of 2012. This decrease in effective tax rate was primarily the result of the absence of non-deductible costs associated with the FTC settlement in 2012. Second quarter net income was $7.1 million or $0.51 per diluted share based on approximately 14 million shares outstanding compared to net income of $2.8 million or $0.20 per diluted share for the comparable quarter last year. Excluding the FTC charge, net income in the second quarter of 2012 would have been $6.5 million or $0.47 per diluted share. The company's balance sheet remains strong with stockholder's equity of $104.6 million and working capital of $70.3 million as of June 30, 2013. Cash, cash equivalents and investment securities for the second quarter of 2013 increased $18.1 million to $78.1 million compared to $60 million at December 31, 2012. As we communicated last quarter, the company paid off the remaining value of its outstanding long-term notes and remains free of interest-bearing debt. Based on the strategies Mike outlined, our team here at Medifast remains optimistic for the remainder of 2013. Now to review our guidance briefly. We expect third quarter 2013 net revenue to be in the range of approximately $93 million to $96 million or an increase of approximately 2% to 6%. Earnings per diluted share are expected to be in the range of $0.38 to $0.42 and assume a 35% effective tax rate. This compares to reported earnings per diluted share of $0.52 in the third quarter of 2012 based on a 19.7% effective tax rate. Excluding the favorable tax rate in the third quarter of 2012 and assuming a 36% effective tax rate, net income would have been $5.8 million or $0.42 per diluted share. We now expect full year 2013 net revenue to increase between 5% and 8% or in the range of $375 million to $385 million, and earnings per diluted share are expected to remain in the range of $1.70 to $1.80 per share. Our guidance includes our expectations that the effective tax rate will be in the range of 34% to 35%. Expansion in new markets and continued growth in our acquisition conversion of brand awareness will contribute to our net revenue increase, while an ongoing focus on increasing our operational efficiencies and ensuring the right pricing and discount mix to drive client acquisition and retention to help deliver our earnings per diluted share improvements. That concludes our financial overview. Now I'd like to turn the call back over to our Chairman and CEO, Michael MacDonald.

Thanks, Tim. We believe our multi-channel weight loss and weight management business model allows us to benefit from an overall more diversified go-to-market approach. We're excited about our future growth prospects in each of our 3 sales channels, and we will consistently work to make the necessary adjustments to improve our operational efficiencies and overall effectiveness across our distribution channel in 2013. In addition, we continue to believe that our vertically integrated operation and increased capacity allow us to continually improve the long-term leverage of our business model for increased margin expansion and long-term profitable growth. In closing, we are pleased with our results for the first half of 2013. Going forward, we are intently focused on managing the controllable aspects of our business model to drive sales, improve our margins and deliver increased earnings and cash flow generation. Our Medifast team continues to be optimistic about our long-term growth prospects, and we will continue to execute our strategic plan. We appreciate your interest in Medifast. And with that overview, Tim, Meg and I are available to take your questions. Operator?

[Operator Instructions] Our first question is from Scott Van Winkle of Canaccord Genuity.

The first question, Tim, where is the Medix revenue that you would have generated in the quarter? What does it show up in the segment results?

It shows up in the Wholesale results, our Wholesale channel results.

Wholesale channel, okay. Before I get into the business stuff, did you buyback any stock in the quarter? And if you didn't, with, what, $80 million of cash, I'm wondering your thoughts there.

Yes, we did not. We previously discussed, I think, or announced, I think, in the last earnings call, our plan was to do that in the second half. We still have those plans. We're just evaluating all of our strategic alternatives before we make the final decision on the quantity.

Okay. And then, sorry, one more numbers question. Last quarter, we talked about losing a couple of shipping days because of the timing of Easter. I assume that benefit rolled into this quarter. If you took out those 2 lost shipping days or 2-day benefit this quarter, does that mean sales overall were roughly flat on a year-over-year basis?

Our expectation in the prior quarter was that we were going to lose more than we lost. I forget -- I don't have the rate on the tip of my tongue exactly how much we rolled into the next quarter, but we were anticipating several million dollars. It was much smaller than that. So you're correct. Some of that revenue did roll into the second quarter, which -- but not as anywhere near the significance we thought when we gave our guidance for the first quarter.

Got you. Got you. And then on Take Shape for Life, I mean, the coach number is excellent. Was there a lot of additions late in the quarter? Because I believe Mike said that the average revenue per coach per month was up year-over-year, but if you had 17% growth in coaches and sales were only up 10%, I would assume productivity was down.

We definitely had more coaches coming in, which was great. And so from, I mean, numbers, on a month-over-month basis, it's a number of active paid health coaches that received a check. So in the summertime, it can vary because people can pull their business down and pick it back up. So in this case, we feel that we're trending well.

Got you. So when you calculate revenue per coach per month, that's only against the coaches that received the check?

Correct.

And then one more and I'll get back in the queue. On the ad spending, I certainly appreciate the commentary about the consumer environment. When you're thinking about curtailing or slowing the spend on the action-oriented piece of it, what's the driver there? Do you see the economics or the return on that last dollar spent start to fall off and you say, "Okay, we're going to cut it off at this level"? I'm wondering if with sales down in the Direct sales side and your advertising down year-over-year, I'm wondering what was the trigger to make you decide to kind of turn off the spigot, so to speak, during the quarter.

Scott? It's Mike. One of the things that we did very carefully was we not only analyzed the Medifast Direct channel, we also had meetings with our franchisees who were spending 20% to 20-something percent in advertising over the second quarter. And when we had the meetings with a lot -- even our partners, there was a unanimous view that the effectiveness of the advertising in a consumer environment wasn't as good as it was in the past. And basically, if you looked at the second quarter, the consumer growth was about 0.4% in the consumer economy, and we were up 4% versus that, and a lot of other people were negative in that environment. So we were really trying to evaluate, not just what we saw on the net direct sites ourselves, but also looking at what our partners did and what was going on in the whole environment. And we got cautious of that. And we're going to do more direct response in the second half versus branding. We think the branding helped us a lot by taking our awareness way up. But also, we don't have as many franchises out there as we would've liked yet and we feel branding will be more effective as we get a broader base for customers to go to because when you're branding Medifast, Take Shape for Life is not necessarily, as you know, an advertising channel. So we really looked at it. We spent -- even at our current rate, we spent quite a lot of money just to focus on the Med Direct and clinic channel. And we're just trying to make sure we balance that effectively. And I think that's really what we try to do in a prudent way. And by the way, we're looking at it and we see the sales pick up with what we're doing, we'll put more into it. So we have the ability to do that because 60% of this is in the digital space anyway.

The next question is from Kurt Frederick of Wedbush.

I have a few. I think I'll start maybe on the Weight Control Centers. I just wanted to -- the guidance reflects the sale of any Weight Control Centers in 2013?

No, no, Kurt, the guidance does not.

So when we think about the sales or the refranchisees, the corporate centers, is it correct to assume that corporate centers in aggregate are kind of breakeven EBIT margins and that's going to flip over to like the franchise 40% margins?

When you look at the corporate centers, Kurt, I would say to you that out of our 86 centers, you probably have 40-something that are in the profitable area. Then you have probably a bottom 10 that are not doing well. And there's a bunch of them that are still in a ramp-up phase from when they were opened. So I would say that when you look at the whole thing, clearly, you're at a little bit of a loss, actually, on the company-owned and very, very positive on the franchise model.

Okay. So when the company owned is sold, like how like if you sell it today, like how quickly does that margin shift take place?

Tim, do you want to take that one?

Sure. Well, it's almost immediate as it happens. So if you think of in 100% increments, let's say, we get 100% of the revenue today, plus we carry the SG&A associated within our books. As it transitions, whether it happens in one swoop or it happens in phases, we end up with about 40% of the revenue. So for that $100 worth of sales, and we still sell the food to the franchisee, and we end up with somewhere about 40% of the revenue we enjoy today. But the SG&A drops off our books. And that would happen as soon as the sale occurs. I mean, the beauty of it is we sell it, but we retain a good amount of that revenue. Obviously, we are highly motivated that, that franchisee will be very successful for that reason.

Okay. So assuming that the SG&A in the store essentially is going with it. What about like the regional staff you have? Is there some sort of transition period? Or did they go with the sale?

If you have people out in the field, Kurt, if somebody bought, as an example -- say somebody decides to buy the entire region of Texas and there was a district manager with Texas, that would go with the sale.

I mean, the benefit of a center is that our center staff is so good with our clients. So that's an important piece of what makes the centers successful.

Okay. And then just on the -- I guess the companies or the centers you're going to keep, I think you talked historically before some of the mature centers doing 20%, 25% margins. Now it's much lower than that. Is it reasonable that you're going to have that same 20%, 25% margin for the stores you're going to keep?

Well, I don't think that at this point, we know specifically which centers that we're going to keep. So I guess it's hard to answer that question at this point. But we plan to run the centers that we keep to be a model for others to look up to. So we will certainly expect that those clinics will be very well run and hold a very nice margin. But it's hard to answer that question not knowing exactly -- we haven't identified which clinics we're keeping versus which ones that we would sell.

Okay. This one final question is on just some of the margins in general, not just [indiscernible] across the company, is there anything coming in the back half of the year that would negatively impact margins as far as raw materials or anything else that should be coming up?

No. At this point, from a raw material perspective, we are confident in where we are for the remainder of the year for the margins to stay stable.

[Operator Instructions] The next question is from Michael Halen of Sidoti & Company. Michael Halen - Sidoti & Company, LLC: I guess just a follow-up on the last question. Just based on the third quarter '13 guidance, the rapid year-over-year margin that you recently experienced over the last several quarters are expected to slow. So I guess can you give us a little color in terms of what SG&A is going to look like here in the third quarter?

Mike, are you talking about gross margin? Michael Halen - Sidoti & Company, LLC: No, I'm talking about the net margin. I guess that's the main one, right? Because based on the revenue that you gave us and the EPS guidance, it seems like that net margin is going to be pressured a little bit compared to this quarter. And just in relation to the gains that we've seen here year-over-year.

There's nothing singular that would stand out that makes the third quarter look differently. It's really volume related, largely volume related. Our estimate, as far as gross profit margin, is relatively similar to the first 2 quarters. We don't see much of a change there. There's no singular SG&A item, advertising spend, as Mike talked about already, will depend. So our outlook does include probably some small increase in spend, but there's no one single item that I can speak of that would -- that is causing that. Michael Halen - Sidoti & Company, LLC: Okay. So in regards to the small increase in ad spend, I know that's been a new metric, so can you give us a little more color on how you expect it to shake out as of now or even if you could just give us the total ad spend of the third quarter and fourth quarter of 2012 would even be helpful.

Yes. I don't think we have that to give you. I think that what Mike said before is really what's relevant as when we talk about our total ad spend, we've been very cautious with that, but we are looking at our focus on the call to action type advertising. So the activity there is where we're thinking about the increased slowdown in the branding and so more of a shift to call to action. I mean, I think overall, the best way to try to categorize it is we're going to be conservative. And if we see certain things working really well, we'll quickly increase our spend in those areas. But based on what we're seeing lately, we're kind of taking -- we're kind of monitoring that. And so...

The real reality here, Mike, if you look at it is that Take Shape for Life, which is a higher relationship channel, it's obviously -- it's obvious the economy is not impacted them as much as the consumer environment of the Internet and our clinic business, which are similar to our competitors, NutriSystem and Weight Watchers. So we're trying to look at it very carefully, what's going on with our competition, and also looking at what's prudent on our part. But our goal is to continue to improve our profitability and our cash flow while we're also developing our international opportunity and also some new areas of opportunity and better coverage in Take Shape for Life so we can leverage our revenue going forward. But we feel we're still in a very good position, because we're still growing in a positive nature. And our biggest channel is growing at double digits, and we feel that we've got good momentum there. So that's really where we see the opportunity in the second half.

We have no further questions in the queue at this time. I'd like to turn the floor back over to management for any closing remarks.

No, I just want to thank everybody for participating in the call, and we look forward to delivering the $1.70 to $1.80 in EPS for the full year. Thank you.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.