Medifast, Inc. (MED) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Medifast Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this call is being recorded. I would now like to turn the conference over to Katie Turner. Please go ahead.

Good afternoon and welcome to Medifast third 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 September 30, 2015 that went out this afternoon at approximately 4:05 PM 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. Today I will share an overview of our third quarter performance along with an update on the progress we have made regarding our key areas of focus for 2015. Tim will then review the financial results and guidance in more detail and then we will open up the call to take your questions. I am encouraged by our third quarter results, which reflect the meaningful progress we have made stabilizing and improving our business, led by our largest business Take Shape for Life, the sales trends of continue to improve for the third straight quarter. Revenue from continuing operations was $65.9 million and in line with our guidance expectations. Although third quarter net revenue decreased 4% compared to the same period last year, this was a positive improvement from the double-digit year-over-year decrease in the third quarter of last year. Most impressively our gross margin expanded 110 basis points and we effectively managed our expenses, resulting in earnings per share above our guidance expectations. Earnings per share from continuing operations was $0.45, approximately $0.02 above the high end of our guidance expectations. These positive results are strong evidence of our team's ability to execute on our top initiatives as we work to improve our Take Shape for Life, Med Direct franchisee, and wholesale channels and position Medifast for a return to consolidated topline growth. I would now like to provide you with an update on our top business initiatives, which we outlined earlier this year. We continue to believe it is important to optimize each of our sales channels. Therefore, we must continue to effectively differentiate our channels in the marketplace. As evidenced by our third quarter results, we have made progress against these three initiatives. First, the growth and simplification of Take Shape for Life, second, the optimization of Medifast Direct Response and lastly, product and program innovation. We are very pleased with the positive improvement within Take Shape for Life in the third quarter. We are now seeing tangible results from the actions that the new team put in place throughout the year. Mona and her team are working tirelessly and I believe we have just begun to see the impact of their changes. Health coach growth and productivity are key metrics for determining performance within this channel. The total number of active earning health coaches in the third quarter increased to 12,000, up from 11,800 in the second quarter of this year. We're seeing meaningful increases in sponsorship of new coaches year-over-year. In addition, to this sequential increase in the number of health coaches average revenue per coach for the 2015 third quarter was 4,145 compared to 4,025 last year, demonstrating increased coach productivity as a result of both higher client acquisition and higher average order values. We believe these positive improvements reflect the early success of issues we put in place to simplify and improve the health coach journey from the initial sign up to new standardized trainings on their business path to sustainable leadership development. We want our health coaches to fully understand not only how to educate and encourage their clients to reach their optimal health, but also how to take advantage of and maximize their business opportunity. These efforts are vital to attracting new health coaches and they are essential for the retention of existing health coaches. As reminder, some of the changes we put in place earlier this year included transforming the health coach sign-up process into a single step, allowing health coaches to get started right away; Each One Reach One incentive plan, which rewarded coaches for sponsoring new coaches who acquire new clients with these Slim orders. Simplified business development techniques and enhanced training that focused on easy-to-follow and easy-to-duplicate methods for health coaches to grow their businesses; and lastly, and teaching and promoting the importance of the full trilogy of optimal health as a lifestyle, which extends beyond just weight loss in order to expand the growth potential of Take Shape for Life as we reach more people on their health and wellness journeys. Many of these objectives were introduced at our Go Global event this past April and at our national convention in July. At our Take Shape for Life Advanced Leadership Retreat in October, we continued our focus on training our community of coaches on personal and business development strategies to help and grow and build their businesses. This was an important opportunity for coaches to learn more about strategic planning and the power of our simplified and unified processes. In addition, we expanded our leadership council at the event, which includes top corporate and field leaders working together in full alignment on key areas of development. We are making meaningful progress on the execution of our key initiatives that simplify the business, provide effective training, and further differentiate the value proposition Take Shape for Life has to offer. We know the return to top-line growth in Take Shape for Life takes time to manifest itself and we believe our third quarter performance illustrates meaningful progress. The second key area of focus is the continued optimization of the Medifast Direct Response business. While retention and lifetime value metrics continue to improve in the third quarter, new customer acquisitions still proved challenging, as revenues were down 16% in the quarter. We continue to test a variety of product and program options within Medifast Direct in order to find the right combination to drive improved results. To this end, we began the fourth quarter with our October launch of the new Medifast Achieve Plan aimed at improving the value of new customer acquisition. Achieve is a simple and flexible plan with a wide variety of product options for customers on their self-guided weight loss and weight maintenance journey. We are offering multiple 2-week and 30 day kits that have shown signs of increasing participation in Medifast Advantage. The program provides automatic monthly delivery to the customer, which promotes plan compliance and higher lifetime value. Our team plans to learn from these results as we continue to manage the efficiency and placement of our advertising investment. Rebuilding consistent momentum in the Medifast Direct channel takes time and we believe it is important for us to continue to evaluate additional opportunities for new products and programs, specifically for today's on-the-go, health-focused consumer. We are focused on exploring these new opportunities and are deep in the strategic planning process for 2016. The new products and product categories we launched in 2014 and 2015 to date are key to driving our third focus area: product and program innovation. Looking ahead into next year, we will address several key consumer trends that are becoming increasingly important to consumers. These include the desire for products to promote weight maintenance while also supporting an overall healthy lifestyle. Additionally, healthy and convenient snacking products, sports and performance nutrition offerings, and clean label options are all on trend. Our team continues to research and evaluate each of these strategic areas, as we expect they will greatly influence consumer preferences. New product imagery and newly introduced product icons across our offering, allowing us to promote attributes which are in line with these trends. Medifast has an impressive history of developing products with high efficacy and consumer appeal. Moving forward, we believe that future expansion into new categories is vital to our ability to expand customer lifetime value and extend product penetration across wider consumer demographics. Lastly, before I turn the call over to Tim, I wanted to share the success of our third annual National Optimal Health Day in September. Across the United States, teams of health coaches and clients participated in more than 400 health-focused events in their local communities, such as yoga in the park, our group exercise classes. More than 13,000 people accepted the optimal health challenge to build a healthy body, a healthy mind, and healthy finances while participating in National Optimal Health Day activities. We are very pleased with the positive publicity generated for Take Shape for Life and even more proud of our success and increasing awareness of the importance of achieving optimal health through proper nutrition and healthy habits. We remain well positioned with our financial strength, our talented people, and the right operational plans in place to deliver revenue growth, increased profitability, and enhance our returns for our shareholders. With that, I would like to turn the call over to our CFO, Tim Robinson, who will discuss our third quarter results in more detail and our outlook for the remainder of the year.

Thank you, Mike. I would now like to review our performance for the quarter ended September 30, 2015 in more detail. Please note that the financial information I reference today will focus on our results from continuing operations. For the third quarter of 2015, we had income from discontinued operations, net of tax of $100,000. In the third quarter, net revenue decreased 4% to $65.9 million from net revenue of $69 million in the third quarter last year. The Take Shape For Life sales channel accounted for approximately 75.7% of revenue, the Medifast Direct channel accounted for 17%, the Franchise Medifast Weight Control Centers channel accounted for 6.1% and the Medifast Wholesale channel accounted for 1.2% of net revenue. Focusing on our sales results in more detail, revenue in our direct sales channel, Take Shape For Life was $49.9 consistent with the third quarter of the prior year. This is the third straight quarterly improvement in the quarterly year-over-year revenue trend. And in fact, the first quarter with flat to positive sales since the fourth quarter of 2013 for Take Shape for Life. There were approximately 12,000 active health coaches in the third quarter compared to 12,400 for the same period last year. As Mike stated, on a sequential basis, this is an increase of approximately 200 active health coaches when compared to the second quarter of 2015. Average revenue per active earning health coach for the quarter increased to $4,145 from $4,025 in the third quarter of last year. We continue to be encouraged by the improvement in our newly sponsored coach count so far this year and the increased level of coach productivity. We believe that our improved coach sign-up process and our increased focus on the business building are having a cumulative positive impact. Our Medifast Direct segment revenues decreased 16% to $11.2 million as compared to $13.4 million in the third quarter of 2014. The decrease in sales within the Direct segment was primarily driven by continuing challenges with new customer acquisition. Advertising in the quarter was down 30% in part to align spending with the early October launch of Medifast Achieve Plan. Revenue in the franchise Medifast Weight Control Center channel decreased to $4 million from $4.2 million in the same period last year. The decrease in revenue was primarily driven by fewer franchise centers in operation during the period and a slight decrease in sales per center. We ended the quarter with 62 franchise centers in operation compared to 69 centers at the same period last year. Wholesale channel revenue, which is comprised of revenues from healthcare providers and other wholesale partners, decreased to $800,000 compared to $1.5 million last year. This decrease was fueled by the loss of certain accounts resulting from Medifast's enforcement of business partner compliance requirements, as we anticipated on the last earnings call. Gross profit for the third quarter of 2015 was $49.2 million compared to $50.7 million in the third quarter of the prior year. Our gross profit margin increased 110 basis points to 74.6% versus 73.5% in the third quarter of 2014. The increase from the prior year was primarily the result of price increases taken earlier in the year and improved manufacturing and shipping efficiencies recognized during the quarter. Selling, general and administrative expenses in the third quarter of 2015 were $41.2 million versus $44.1 million in the third quarter last year, a decrease of $2.9 million. As a percentage of net revenue, selling, general and administrative expenses decreased to 62.5%, from 64% in the third quarter of 2014. The decrease was driven by reduced expenses resulting from 13D filers and reduced marketing and advertise expenses incurred in the quarter. Sales and marketing expense decreased by $1.4 million in the third quarter of 2015 as compared to the third quarter of 2014. This was primarily driven by a decrease in both advertising expense and expenses associated with the Take Shape for Life annual convention. Third quarter operating income from continuing operations before tax was $8.1 million, or 12.3% of net revenue as compared to $7.5 million or 10.9% of net revenue in the third quarter of 2014. Operating income from continuing operations before tax for the third quarter last year included $1.6 million in extraordinary legal and advisory expenses from 13D files incurred in the period. Third quarter income from continuing operating net of tax was $5.4 million or $0.45 per diluted share based on approximately 12 million shares outstanding compared to $5.3 million or $0.42 per diluted share for the comparable quarter last year, based on approximately 12.6 million shares outstanding. Excluding the extraordinary, legal and advisory expenses income from continued operations for third quarter last year would have been $6.4 million or $0.51 per diluted share. Our effective tax rate was 33.4% compared to 29.7% in the third quarter of 2014. This change was due to decreases in the permanent differences primarily associated with lower benefits from domestic manufacturing deductions and research and development credits taken in the prior year. Our balance sheet remains strong as stockholders' equity of $86.8 million and working capital of $63.3 million as of September 30, 2015. Cash, cash equivalents and investments securities for the third quarter of 2015 increased to $66.5 million compared to $52.6 million at December 31, 2015. We repurchased 261,211 shares during the quarter for approximately $7.2 million and we currently have approximately 850 shares authorized for repurchase as of September 20, 2015. Now turning to our guidance. We expect the fourth quarter net revenue from continuing operations to be in the range of $60.5 million to $63.5 million and earnings per diluted share from continuing operations to be in the range of $0.31 to $0.35. We now expect full year revenue from the continuing operations to be in the range of $272 million to $275 million and full year earnings per diluted share from continuing operations to be in the range of $1.72 to $1.76. This year guidance excludes approximately $1.4 million in expenses resulting from 13D filings net of tax. That concludes our financial overview. Now I'd like to turn the call back over to our 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?

[Operator Instructions] The first question comes from Scott Van Winkle of Canaccord Genuity. Please go ahead.

Good afternoon, guys. It is Mark Sigal on for Scott. First, I wanted to turn to the Q4 guidance. Can you talk about some of the drivers on the expense side? I mean It sounds clearly like you shift some advertising expense from Q3 into Q4. Just curious as to how the expenses fall?

Yes, we actually are going to take our advertising up in Q4 to help drive Med Direct into fourth quarter. So we are going to spend more than we did last year in the fourth quarter because we are finalizing our new program in Med Direct we decided that we wanted to do it in the fourth quarter more aggressively to prepare not only for fourth quarter, but to help get ready for the diet season in January.

So Mark, sequentially quarters, our SG&A will be down in total as a percentage of revenue. It will be up slightly because of advertising shift.

Okay. And are there any other moving pieces off of a consistent level of sales in Q4? It is a significant step down in earnings. So is there anything else besides advertising, anything on mix that we should be thinking about or anything of that nature?

No. I think one of our biggest SG&A items, as you know is compensation in Take Shape for Life. And as Take Shape for Life improves as a percentage of total sales, it takes your SG&A percentage rate up a little bit. But there is really nothing else forecasted for the fourth quarter that would be abnormal or anything unusual.

Okay. And then just on Take Shape for Life, you guys raised prices earlier this year, streamlined the sign-up process, and have run some pretty successful promotion. What levers are there to pull in the upcoming diet season and how are you thinking of adding on to the measures that you have already taken to reaccelerate the coach growth?

Yes, we are continuing. In October, we completed a leadership event, where we really focused on helping leaders look at the quantitative value of their business and really how to run it more effectively. So we hope to see the benefit of that through the rest of this year. In January, we are actually going to do some amazing virtual New Year's, early January events, virtually versus what we typically do, which is fly our leaders around. And our leaders are very excited because they have already set up multiple events to continue to train on all the materials that were launched at convention. So we continue to really work on how we are going to get more engagement from our leaders, which is already happening, but then also bringing that down to the levels in the field. So January is our big start to really get this really through the entire field.

We also have promotions that we do to drive Take Shape for Life, whether they be our recognition trips that we do for people in the field. So that will be a benefit in the fourth quarter.

Okay. And then just lastly, on Med Direct, you guys have been doing a lot of backend work with apps and styling the systems to get Med Direct back ready for prime time and a heavier ad spend. Can you just update where you are on backend system design and how much work is left to be done?

For Med Direct, we obviously in our last call discussed that we delayed some of the projects for our Med Direct platform to prioritize some of the Take Shape for Life initiatives. We have launched a new program in our Med Direct platform. We are in the process of testing that right now, so it's not a huge launch. It is something that we want to see in test and that is how we are operating within our Med Direct platform. We anticipate that we will continue to test through the remainder of the year with a focus on January. But again, going back to the fact that we have actually minimized some of the efforts we can do in Medifast Direct to prioritize some of the initiatives in Take Shape for Life. So we will continue to balance that and right now, we are really excited about the return to growth that we have in our Take Shape for Life platform.

Got it, okay. And sorry - one last quick one. Last quarter, I think the level of inactives in Take Shape for Life was a little above historical levels. Has that come back down this quarter?

Yes. So traditionally, we due to historic - due to the historic nature of what we were doing, we had high levels of attrition happening in the August/September time frame. So renewals would come up. This year, we actually are definitely getting lower.

Yes. So I think if you look from first quarter, we had a very high percentage of active participants in our coach count. And from second quarter, we declined a couple percentage and it was very stable between second and third quarter. So the percentage of people of total coaches that are active is stable, about the same as the prior quarter. What changed is the level of activity per coach has improved, and the number of coaches has improved.

The other thing I think that is important, Mark, we are starting to see good signs in new customer acquisition in Take Shape for Life, which is extremely positive for us. Because that is an area that is very, very important for us, and we are seeing that improve.

We are seeing the inflection point on a lot of our key indicators that we watch.

All right. Thanks for the responses.

You’re welcome.

The next comes from Frank Camma of Sidoti. Please go ahead.

Good afternoon, guys.

Frank, how are you?

Good. So it looks like you are making some traction in Take Shape for Life. I just wanted to drill down on that a little more. Did you increase the commission structure at all? Was that - you mentioned a couple initiatives, but I was just wondering…

No, we didn't increase. We don't touch our commission structure and we don't have any plans to do that. What we do is create incentives that are on top of the commission structure, where people exhibit certain behaviors. And in our case, the behavior that we've been working on this entire year now is having coaches bring in new coaches who bring in with them a client that has volume that brings in revenue. And so that campaign alone is what is driving some of the activities. But those of the types of things. And we are doing some really fun one-off incentives here and there to engage and excite our field as we move through the rest of the quarter.

I think what it has done, too, is it just really increased the level of awareness to what kind of a successful model looks like. So I think there has definitely been much more emphasis on understanding the business opportunity this year. And I think that the reinforcement, the training reinforcement to that, which is still happening right now, it is really having a cumulative effect.

Okay, good. Obviously, you had a nice little growth in the active health coach count. I'm just wondering: are new health coaches, do they tend to be a little less productive from a revenue standpoint? I'm just trying to understand the sequential decline in the revenue per health coach, even though it obviously was an improvement year-over-year?

Yes, so new health coaches like anything right, when you come in and you are new, the number of average clients that you have tend to be less. You may come in with one or two clients and the average coach of course has more than that. So that is very true. Where we have seen an improvement, though, is really since the February/March time frame is that the new coaches coming in are little bit more productive than they used to be because of the programs like Each One Reach One, which really emphasizes when you bring in a new coach that new coach comes in pretty quickly, almost immediately with new clients right away. So it’s really the responsibility of the sponsoring coach to help the new coach become productive right away. And that was one of the big focuses this year in the program that we rolled out with Each One Reach One. So the answer yes, new coaches are less productive, but new coaches are more productive now than they were before.

And after our fall training that we did with our leaders, we actually came up with a goal tracker that they are actually using with new coaches coming in. So when someone says I want to align my business with a particular goal, whether it is monetary, personal, whatever that is, we are able to actually step them through, which aligns completely with what was launched at our convention. So we are very excited and the coaches are responding well to that and the productivity of our health coaches has increased.

Good. Okay. And a final question is just if you could talk a little bit, remind me about the seasonality? You're not as really seasonal as I would think compared to some other commercial weight-loss.

No, we are not, Frank. We generally – we're usually around 53 in the first half and 47 in the back half. But we don't have a huge seasonality.

Why is that, though? Since most people, especially the fourth quarter, do people – do you find that your typical customer it might be I don't know how to say it, but a little different of a needs base? Or I'm just trying…

I think it is because of our health network. I really do believe it is because of Take Shape for Life. There is a lot of Take Shape for Life people that are on autoship, 95%. They are very dedicated to keeping their weight off on a long-term basis, so I believe that's a difference. It's a positive difference for us versus a direct response type of an approach that we also have, which can be a little bit more cyclical.

Right, Take Shape for Life, it is a network of people who believe in lifestyle changes and behavioral changes. And although our Med Direct platform believes that they are helping people as well, it is just more of a direct-to-consumer, direct-to-response, quicker, short-term impact.

You have a little bit of stabilization in your revenues because some portion of revenues is coming from health coach consumption of the product, but it is a small percentage. Somewhere in the neighborhood of 6% of our revenues come from personal consumption. But the majority of the revenue all comes from the end consumer. And because it is a lifestyle thing, it is not so much thought of as a diet, as you might find in Med Direct. People stay on it, consume the product to maintain their weight, and they don't react quite as much to diet seasons.

True. Okay. I guess a final question that relates to that is what do you – this is kind of a general comment not so much on your Company in particular. But direct selling in the U.S. obviously not a great environment over the last couple years. I am just wondering if you care to make any comments on that?

I think the one thing that helps us a lot, Frank, in the environment is we sell directly to the consumer. We don't have distributors and things like that, which are legitimate, but more complicated. So I think the thing that for us is I do think some of the direct selling companies are doing a lot better, and I think people are just waiting for some of the other situations to get resolved. But overall, I think that the direct selling is a big industry. It is over $30 billion in the U.S. market. We feel good about being in it; we think it is going to be a huge growth area for us. And I think these things will get resolved and look at USANA. USANA just had a terrific quarter. Now obviously, they did great overseas in China, places we are not, but they're an outstanding company. So I feel very good, by the way, to be a member of the DSA and the opportunity there. And I think they're tightening, by the way, all of the ethics policies in direct selling to even make it better. So I think we can do very well in the market. And our recruiting is going up, so I think some of the negative halo effect did hit us last year, but I think it is getting better.

And you're coming off such a relatively low base that incremental adds make a meaningful difference.

Yes, absolutely.

Okay, great. Thanks, guys.

Thank you.

That concludes the question-and-answer session. I would now like to turn the conference back over to Michael MacDonald for 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 working. We expect to continue to see improvements each quarter as they took hold. We look forward to providing you with an update on our business when we report our fourth quarter and full-year 2015 results. Thank you and have a nice evening.

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