Medifast, Inc. (MED) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the Medifast Second Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note this call is being recorded. I would now like to turn the conference over to Katie Turner. Miss Turner, please go ahead.

Thank you. Good afternoon and welcome to Medifast second quarter 2015 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, 2015 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 statements. Medifast assumes no obligation to update any forward-looking projections that may be made in today’s release or on today’s call. All the forward-looking statements contained herein speak only as of the date of today 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. In a moment I will share an overview of our second quarter performance along with the progress update on our key areas of focus in 2015. Tim will then review the financial results in detail. We will open up the call to take your questions. I'm pleased to report that both our revenue and earnings per share were in line with our guidance for the second quarter. Revenue from continuing operations was $72.2 million as compared to our guidance of $72 million to $74 million. Earnings per share from continuing operations ended the quarter at $0.48. If we exclude the extraordinary legal and advisory expenses resulting from 13D filings, earnings from continued operations was $0.50 per diluted share, which is at the high end of the guidance of $0.47 to $0.50. Second quarter revenue was down 3% versus the same period last year but importantly this result marks another quarter of improvement in the rate of decline as we work diligently to position Medifast for return to consolidated top line growth. This sequential improvement in the rate of decline was achieved despite the closure of eight franchise Medifast weight control centers in the second quarter. Additionally we were pleased to see the successful consumer adoption of the price increase we implemented on March 1 as well as our very strong inventory and cash management as demonstrated in the second quarter results. Our team continues to efficiently manage our business to maximize our profitability. Earlier in the year I shared our top 2015 focus areas. I like to take a few minutes now to share the progress we made on these focus areas in the second quarter. Our top objective is to advance the growth in simplification of Take Shape for Life, with the focus on growing the number of health coaches in the business. As I mentioned on the quarter 1 call we are focusing on easy to follow duplication process for health coaches to grow their businesses. We introduced several of these concepts at our global conference in Tucson, Arizona in April, including an increased emphasis on the full trilogy of optimal health to highlight the financial transformation we see along with the physical transformation. We also communicated an easy to follow preferred path, for health coaches showcase with business opportunity and to streamline signup process to help them get started faster. At Go Global we also introduced the new 3 plus 3 plan for those who have reached their goal late or for those who simply seek a sustainable nutritious eating program to complement their active lifestyle. And we introduced the new product kit, featuring Optimal Health bars and shakes to go with it. By reaching new people along their journey to Optimal Health, we can impact more individuals and open up additional growth potential for Take Shape for Life. We continued the Each One Reach One incentive program through the second quarter which rewarded coaches for sponsoring new coaches to our corresponding Be Slim club orders. Much of the second quarter we spent planning for our national convention at Orlando, Florida held July 9 through July 12. Well this year's theme was Awaken, Connect and Transform. Nearly 2,700 coaches clients and guests heard the inspiring stories of top health coaches and field leaders through some 24 training seminars and workshops to gain the tools and knowledge to grow their businesses, and celebrated the right advancements of many successful coaches in attendance. As always National Convention represented a time of key launches and this year we introduced brand new business building and client attraction collateral materials, new 30 day product kits and a special upsell offer for Be Slim club members who place orders over a certain threshold. We also unveiled a revamped Take Shape for Life website, mobile site enhancements and a host of exciting new training tools all with the goal to unify our messaging and simplify the coach and client experience. Additionally, we introduced our new Take Shape for Life feel first department, constructed to provide concierge level support for health coaches with business related questions. The concept development for these new tools and initiatives was led by dedicated task force of corporate and field leadership working together to ensure seamless well integrated effort. Overall the energy level excitement and engagement from the field were outstanding and united all attendants around this year's powerful event theme. All of these initiatives are focused on growing the number of health coaches. The continued optimization of our Medifast direct response business is another key priority. While new customer acquisition still proved to be challenge in the quarter, we've improved our retention metrics, increased the average order value and we grew the percentage of customers who signed up for our Medifast Advantage order replenishment option. Revenues are down 10% in the second quarter compared to the same period last year but this represented a continued improvement in the year-over-year rate of decline for Medifast Direct. Our team is focused on improving our performance as the year progresses through a number of initiatives. We recently completed a customer survey, representing nearly 1,100 Medifast Direct customers who had purchased more once and more than $250 over the past 24 months. Here are just a few example of the results. 92% of customer surveyed said Medifast foods were convenient. 85% said the plan fit their lifestyle. 78% said the plan was effective for them and the list goes on. We will be sharing these results in marketing and creative assets throughout the back half of the year. We continue with our website testing and improvements and implemented a new selective system landing page where customers can choose among our two week and four week kit options. We also made progress on our customer journey power [ph] project. We are evaluating and updating all transactional and marketing email communication and targeting the content appropriately to each unique customer segment. And we advanced our work on new kits and offers so that we can test different price points and upsell as the year progresses. We will stay true to our test and measure approach in everything that we do. That goes for our advertising approach as well. Second quarter Medifast Direct advertising spending was down 20% versus the same period last year and the ratio spending in net sales in Med Direct in the quarter was 30%. We continued our weekly optimization of networks, day parts, unit lengths and created executions so that whole world gets better television campaign during the April-May fights. Digital advertising spending was consist throughout the quarter and we brought on partner specialists as we strive for continuing efficiency improvement in brand and generic search engine marketing, digital display marketing, affiliate marketing. Looking ahead to the third and fourth quarter we expect total back half 2015 advertising spend to be at similar levels to last year. Product and program innovation represents our third focus area. Our teams have been focused on fully leveraging the new products and categories launched in 2014, the largest new product introduction year in history we also have been working on our plans for the back half and into 2016. We recently launched two new snack items, Rosemary sea salt and Multigrain Crackers both of which are low in fat, low in cholesterol, no trans-fat added kosher and only 40 calories. We watch consumers become increasingly interested in overall healthy lifestyle, green label options, performance nutrition and are hard at work on projects that will meet customer needs in these areas. Additionally we have updated the merchandising of our product imagery and implemented new product icons that allow us to promote the positive and highlight the absence of negatives when it comes to the ingredients in our vast product offering. In addition to the focus on our top three initiatives I also wanted to note that we’re advancing our plans to continue building strong core competencies across our direct selling, direct response and wholesale business units to provide the means for each unit to perform at its highest levels. We will leverage the research findings of our attitude awareness and user study along with great learning gains in our product concept test research and issues [ph] like field survey to fuel our go forward strategy and tactics which include expansion of our target customer demographics, we will come to that as we get further along. We continue to be proud of the recognition our company has received. In the second quarter Take Shape for Life was named to direct selling news, Global 100 and North American 50 list, was also recognized under direct selling association top 20 list. Medifast was also named today as a Gold Winner in the Couple of Year [ph] category and Best in Biz awards 2015 international. I am pleased to have achieved our second quarter revenue and earnings guidance and we are confident that we have the financial flexibility, people and operational plans in place to execute on our strategic goals. On behalf of the Board of Directors and management team we look forward to executing on our opportunities for growth, while enhancing shareholder returns. With that I'd like to turn the call over to our CFO, Tim Robinson, who will discuss our second quarter results in more detail and our outlook for quarter three and full year 2015.

Thank you, Mike. I’d now like to review our performance for the quarter ended June 30, 2015 in more detail. Please note that the financial information I reference today will focus on our results from continuing operations. For the second quarter of 2015, income from discontinued operations, net of tax, was $400,000. In the second quarter, net revenue decreased 3.3% to $72.2 million from net revenue of $74.7 million in the second quarter last year. The Take Shape For Life sales channel accounted for approximately 72.4% of revenue, the Medifast Direct channel accounted for 19%, the Franchise Medifast Weight Control Centers channel accounted for 6.5% and the Medifast Wholesale channel accounted for 2.1% of net revenue. Focusing on our sales channels in more detail, revenue in direct sales channel, Take Shape For Life, decreased approximately 3.1% to $52.3 million compared to the same period last year. The decrease in revenue for this channel is primarily driven by a decrease in the number of health coaches, as compared to the second quarter of the prior year, an offset by an increase in the average revenue per Health Coach. This revenue resulted we marked the second consecutive quarterly improvement in the rate of decline on our way to resuming growth. We ended the second quarter with approximately 11,800 active health coaches and the average revenue per health coach per quarter was $4,423. While this marks a slight decline from the first quarter active Health Coach count we continue to be very encouraged by the improvement in newly sponsored coaches so far this year. Our improved coach sign up process and our increased focus on business building are having a positive impact. Our Medifast Direct segment revenue decreased 10% to $13.7 million, as compared to $15.2 million in the second quarter of 2014. While still a decline, this marks the fourth consecutive quarterly improvement in the rate of decline and results were in line with our expectations. Revenue in the Franchise Medifast Weight Control Centers channel increased to $4.7 million in the second quarter from $3.8 million, for an increase of 22.3% as compared to the same period last year. The increase was driven by the conversion of corporate centers to franchise centers, partially offset by franchise center closures and the decrease in sales franchise centers open greater than one year. We ended the quarter with 52 franchise centers in operation compared to 73 centers at the end of the same period last year. Wholesale channel revenues, which is comprised of revenues from physicians and other wholesale partners decreased to $1.5 million, compared to $1.7 million last year. This decrease was fueled by the loss of few large accounts resulting from Medifast enforcement of business partner compliance requirements. Gross profit for the second quarter of 2015 was $53.2 million, compared to $55.6 million in the second quarter of the prior year. Our gross profit margin decreased 70 basis points to 73.7% versus 74.4% in the second quarter of 2014, so it increased from 73.3% in the first quarter of this year. The decrease in the prior year was primarily the result of an increase in cost for certain more ingredients, higher manufacturing variants due to reduced volumes, and in increase in obsolescence for single products due to expiration dates. These cost increase was partially offset by price increases initiated at the end of the first quarter. Selling, general and administrative expenses in the second quarter of 2015 were $44.5 million versus $45.7 million in the second quarter last year, a decrease of $1.2 million. As a percentage of net revenue, selling, general and administrative expenses were 61.7%, up from 61.2% in the second quarter of 2014. Second quarter 2015 selling, general and administrative expenses include $300,000 in extraordinary legal and advisory expenses, resulting from 13D filings. Excluding these items, selling, general and administrative expenses as a percentage of sales would have been 61.3% in the second quarter of 2015, which is consistent with the prior year. Sales and marketing expense decreased by $800,000 in the second quarter of 2015 as compared to the second quarter of 2014. This was primarily driven by a decrease in advertising spending partially offset by new Take Shape For Life conventional centers earned during the quarter. Second quarter operating income from continuing operations before tax was $8.8 million, or 12.2% of net revenue as compared to $10.1 million or 13.5% net revenue in the second quarter of 2014. Second quarter income from continuing operating net of tax was $5.8 million or $0.48 per diluted share based on approximately 12.2 million shares outstanding compared to $6.6 million or $0.50 per diluted share for the comparable quarter last year, based on approximately 13.1 million shares outstanding. Excluding expenses associated with extraordinary, legal and advisory expenses is resulting from 13D filings income from continuing operations would have been $6 million or $0.50 per diluted share. Our effective tax rate was 33.8% compared to 34.4% in the second quarter of 2014. This decrease is largely due to an increase in permanent differences, which were primarily driven by higher taxes and interest income and partially offset by an increase in state income taxes. Our balance sheet remains strong as stockholders' equity of $88.2 million and working capital of $63.3 million as of June 30, 2015. Cash, cash equivalents and investments securities for the second quarter of 2015 increased to $65 million compared to $61.4 million at March 31, 2015. We repurchased approximately 100,000 shares during the second quarter and we currently have 1.1 million share authorization for repurchase as of June 30, 2015. Now turning to our guidance. We expect the third quarter net revenue from continuing operations to be in the range of $65 million to $68 million and earnings per diluted share from continuing operations to be in the range of $0.40 to $0.043 per diluted share. We now expect full year revenue from continuing operations to be in the range of $270 million to $280 million and full year earnings per diluted share from continuing operations to be in the range of $1.70 to $1.80. Our revised full year guidance reflects the decrease in the revenue forecasted from a Medifast direct channel in part due to the delayed timing of several e-commerce initiatives that are now expected to launch in the late third quarter. Additionally, the unexpected closure of eight Medifast franchise weight control centers is factored into our second half projections as well as the impact of our enforcement of business partner from client’s requirements within the wholesale business. It's important to note however, that we continue to be optimistic regarding improvements expected to Take Shape for Life in the second half. Fiscal year guidance excludes expenses resulting from 13D filings. We do not anticipate any additional expenses resulting 13D filing for the balance of the year. So that concludes our financial overview. Now I'd like to turn the call back over to Chairman and CEO, Mike MacDonald.

Thanks Tim. In summary we continued to expect our strategic initiatives will help us to generate improved results and that the actions we've taken will drive performance across each of our business unites. We appreciate your interest in supporting Medifast and with that business review Tim, Meg and I are available to take your questions. Operator?

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from the Scott Van Winkle of Canaccord Genuity. Please go ahead.

Hi, thanks everyone. First question can we talk a little bit more about Take Shape for Life and earlier this year there was a lot of success with the initiatives, the Each One Reach One program which continued in Q2. And I guess I hope for maybe some sequential stability or even a little bit growth on health coach number from Q1 to Q2. I realize Q1 is kind of the diets you are using but a lot of diet companies get some strength in Q2 as well. Can we talk about the health coach number a little further?

Sure Scott this is Meg. So overall we feel very confident in the growth of coaches. So from a sponsoring perspective, the numbers the outlook is very positive, so far going into details…

So Scott we have with the coach count is active health coach counts which approaches that earned income during the quarter. So there is a segment approach to the coach set that come to now with earning income and not yet earning income. What we're seeing is some really positive trends as far as new signups, new signups are growing. At the end of the quarter however the percentage of our people that were inactive was a little higher than what we expect. So we look at the overall health of coach count we’re seeing positive trends but we trended down a little bit as far as the percentage of active coach as of the end of the quarter. So sponsorship was really a positive thing for us, very positive at the end of the first quarter and continued to be positive in the second quarter.

Great. And is there anything kind of specific on sponsorship that’s different than Each One program in the back half of the year. Obviously you had a lot of things come out of convention. I am wondering if there was anything incremental that’s specific to the sponsorship side of the business.

Yeah, so we have a new recognition trip, an incentive trip that was launched at convention that does have many different components that will in one part really promote the addition of the Each One, Each One which is really making sure we bring on coaches with active clients and active coaches as well. So that initiative although launched at convention the criteria went live July 1. So people right now are actively earning towards that trip and they earn through January.

Got you, okay. And then on the direct response side of the business, obviously happy with the moderating decline year-over-year I am wondering what’s the expectation for that business, at this point something you want to grow you are looking to stabilize what should we expect over maybe in the back half of the year or certainly going into next dive season the first half of the year on Direct response?

Yeah clearly Scott one thing we have done in direct response and you probably noticed that we are actually charging the higher price on our direct response website than we are charging in Take Shape for Life. One thing that we are trying to do is make sure that we are causing less conflict in the system so we rebuild the Take Shape for Life business which is most critical but we are still spending 30% on advertising to drive the Med Direct business and we’re going to get more aggressive with Med Direct as we go into that September time frame but we haven’t had the systems completed as we talked. As soon as the systems get done you will see us move to more aggressive position in the Med Direct space to start to improve that. But the reality is with us being 70 some percent multi-level and we want to clearly try to expand that businesses as our core business. We’re going to balance that spending. We’re not going to be out there trying to compete with a NutriSystem who is spending $140 million on the brand.

And I think it’s important to there was a couple of projects as mentioned in the script that we have moved to Q3 and Q4 on purpose so that we could focus some of our launches for convention and as these are over we have a full progress some of the major initiatives that will help drive great testing for the end of this year to lead us into diet season 2016 so we feel like we have a good plan in place.

Okay and then Tim I missed the end of the call and your commentary on share repurchase I think you talked about the authorization. Was there any other color on what the plans are in the share repurchase?

The issue on share repurchase is our strategy is we’ll do share repurchase if we feel the stock is undervalued and we’ll work closely with our Board in those discussions to do that. We bought back I think was 100,000 share and we still have an authorization Scott for 1 million plus going forward but it’s really look at saying is we’ll buy the shares if we feel the shares are undervalued.

Great, thank you very much.

The next question comes from Mitchell Pinheiro of Imperial Capital. Please go ahead.

Hi Mitch.

Hi good afternoon. So embedded in the forecast for the second half here are we looking for Health Coach sort of flatten out here on a year-over-year basis, is that kind of implied or are you still think it leaks down a little bit?

Yeah we’re expecting it to be flat year-over-year so that would return us to where we want to be.

Okay. And then does anything change in the Med Direct channel in the second half I mean in sort of a growth rate wise?

The only that changed is if we look -- if you the trajectory of Med Direct over the past four or five quarters you will see a marked improvement in quarter-over-quarter as far as rate of decline. And I think the low point was probably a 29% decline, this quarter was 10% and it was in the peak the prior quarter. And what we were projecting in our original guidance is that we would return pretty early in the second half hopefully to flat and then possibly to growth. But as based a number of initiatives the timing of some initiatives which we originally expected to go live in June. And so it's really just a delay. So I think we painted the first half quite honestly, we met our expectation about what we thought that channel would be and we were pleased with that but the be a kind of a resumption the growth is kind a be delayed a little bit we believe. So if we come out of the year I think towards the end of the year and get that channel back to flat in fourth quarter I think we would think that will be someone successful. And we assume that that would happen sooner in our original plan.

Yeah and I think with the systems and we are working on not sure we able to have much more aggressive -- in that September-October timeframe which we have not been able to do. So we really this is a rate of decline and keeping prices relatively high and very limited offers. So we feel we'll be able to get more aggressive as there is more flexibility in our systems to make us more competitive in that space.

And thing that we' were able to in that channel worked. So we -- in the marked improvements in customer retention, average order value, the percentage of customers that are on our ownership program who we know have a much higher lifetime value. So those initiatives we completed in each one of them really have work. The customer acquisition strategy which is really where we're struggling currently, those initiatives did not go live. And so I think that's what we're hoping we'll really make the big difference and start the flow through in the fourth quarter.

And by the way our customer acquisition particularly for Life is improved considerably. So we feel very, very good about the new customer growth that we're seeing over the last 45 days coming out of the Take Shape for Life so that's a very positive indicator we're not seeing that for a while. So that's a good thing for us going forward.

And then okay. And then lastly just what we're seeing are reasons for the franchise closures?

So we had eight centers that closed and all eight of those centers were part of the June 2014 acquisition by franchisee. And after one, approximately year trying to make that business more profitable they made the decision to close those locations which were all located in Virginia.

Correct they're keeping the other half in the Maryland location open.

Got it. Okay thank you very much.

[Operator Instructions]. The next question comes from Frank Camma from Sidoti. Please go ahead.

Good afternoon guys.

Hey Frank how are you.

Good, good. Hey just clarification on the active health coach. When you say you expected to be relatively flat for the second half, did you mean over the Q3 and Q4 of last year or do you mean from the current level?

Yeah so if you look at Q4 last year we had a pretty good dip and I don't think we necessary expect that to happen again. So I think we expect that from where we are today a slight improvement or flat. We think there is an upside there but I think it built into our estimates. That's what we assume.

Certainly okay. And on the direct side now it's smaller for you, but are you noticing any kind of like a change in the competitive landscape. I mean NutriSystem apparently doing pretty well what their new marketing campaign or revised marketing campaign just wondering if you could comment on that at all.

I think Frank no I give credit to NutriSystem. I think they've done some very good stuff. And from our standpoint I think one of our limitations has been systems not the ability to make the offers that are required. I think we're going to have a chance in the fourth quarter to do that and as we start improving I think we will be more comparative. But as I said before, that's a small business for us. That is a core business and with us having 42% brand awareness versus their 95, we can never spend enough money to compete with that in a direct -- we want to be more of a direct response business, make offers and get people to buy our products versus a direct marketing. So we got to be very specific in offers and get people to buy and that’s how we are trying to move the business but I think I compliment NutriSystem on what they have done.

Okay. Just a final question on the commodity cost going up, is this something you expect kind of longer term, is it will you see that pull back a little just wondering if you could give a little color on that?

Yeah, so with this particular product we don’t know it’s a specific event driven and cause this particular [indiscernible] green to go up and little hard for us to forecast whether that will be a month, three months or six months. But it is a specific ingredient it won’t be permanent. So but it’s a little hard for us to forecast right now.

Got it. And as obviously like it’s also, I think you said it’s also a volume issue as well right I mean it’s…

Yeah so we’ve done a really good job, I think our supply chain folks have done, I think an excellent job in reformulating products, finding new vendors and all those kind of things that keep our margins intact. But there is a little bit lag effect where you have certain fix costs associated with manufacturing that you can’t, you don’t necessarily adjust or you can’t adjust quickly. So when you take the absorption of your fixed cost with this manufacturing volume your standard cost goes up a little bit and that’s kind of what we called in the past quarter. We will get that under control. I don’t expect that we’ll see margins lower than what we had this quarter. The obsolescence piece that we had was one specific product and we don’t anticipate -- we have pretty good control over this we don’t anticipate that reoccurring next quarter. So I am pretty comfortable with the margins.

The one thing Frank I think that was very positive if you looked at the first half, it’s one of our best EPS halfs in the history of Medifast and was one of the strongest cash generation halfs that we’ve ever had. So on those sides I think we are in pretty good shape. I wish it was just reinvigorating the revenue and that’s really what we are focused on and we are seeing sequential improvement but we’ve got to accelerate that especially in the Take Shape for Life world because that’s where the biggest..

Okay, thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Chairman and Chief Executive Officer, Mike MacDonald for any closing remarks.

Thank you for your interest in Medifast and participation on today’s call. In closing our team is focused on returning the company to growth. Initiatives we have in place are starting to work. We expect to continue to see improvements in each quarter as they take hold. We look forward to providing you an update on our business when we report results for the third quarter of 2015. Thank you and have a nice evening.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.