Good afternoon, everyone. And welcome to the Medifast, Inc. second quarter 2016 earnings conference call. All participants will be in a listen-only mode. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Katie Turner. Ms. Turner, you may begin.

Good afternoon. Welcome to Medifast second quarter 2016 earnings conference call. On the call with me today are Michael MacDonald, Chairman and Chief Executive Officer, and Timothy Robinson, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ending June 30, 2016 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 Web site at www.medifastnow.com. This call is being webcast and a replay will be available on the company's Web site. Before we begin, we’d like to remind everyone that prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. The words believes, expects, anticipates, 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 posted on the company’s Web site. All of the forward-looking statements contained herein speak only as of the date of today’s 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'll share an overview of our performance in the second quarter, including an update on key initiatives. Tim will then review the second quarter financial results and guidance for the third quarter and full year 2016. Finally, we’ll open up the call to take your questions. Our success from early in the year continued through the second quarter of 2016. Our entire team has worked tirelessly over the last few years to better differentiate our business units and highlight their respective value propositions to clients and customers. We know this approach will yield the best results for each business unit. These efforts have resulted in a strong foundation for continued success. And while we still have significant plans to continue to develop the strategic objectives, it is proving successful as we saw Take Shape For Life post double-digit revenue growth in the second quarter, the highest level of year-over-year revenue growth for Take Shape For Life in three years. Take Shape For Life grew 10% compared to the second quarter last year, representing the sixth consecutive quarter of improvement in revenue growth. Take Shape For Life results fueled our consolidated financial performance in the quarter and helped us achieve greater leverage across our cost structure. Across the entire business, gross margin expanded 110 basis points in the quarter to 74.8% and our team remains focused on efficiently managing our expenses to support our revenue plans. On a consolidated basis, net revenue from continuing operations was $71.1 million, earnings per diluted share from continuing operations was $0.29 and adjusted earnings per share from continuing operations was $0.63. Revenue was in line with our expectations which when combined with the strength of our cost and expense leverage drove strong…

Thank you, Mike. And good afternoon, everybody. I’ll now review our performance for the second quarter ended June 30, 2016. Please note that the financial information I reference today will focus on our results from continuing operations. For the second quarter of 2016, we had no activity from discontinued operations. Compared to income from discontinued operation, net of tax, approximately $400,000 in the second quarter of 2015. Before I get into the operational results for the quarter, I want to take a moment to explain an important recent decision to record a $6.1 million non-cash expense for a software asset impairment. I will reference this expense several times during the call and will reflect the expense in our reconciliation of non-GAAP measures to help provide better insight into our ongoing operational results. The impairment expense is the result of a comprehensive evaluation, a recent decision to implement a new state-of-the-art proven direct sales software platform for Take Shape For Life and to cease work on an internally developed software platform. Technology solutions have evolved rapidly in the past several years and our business requirements have changed since the scope and design of our internally developed system was determined several years ago. The new competence of cloud-based software solution has significant advantage over the internally developed platform, better meets our current and future requirements and will be deployed to our field much more rapidly. In addition, implementation of new platform is more cost-effective over time. New software platform greatly enhances our coaches’ ability to manage their business activities and client communications. Additionally, the software is designed to process commission payments for health coaches, provide deep insights into our business trends, and provide an enhanced online experience for clients and coaches. We felt this is a very important step in preparing the…

[Operator Instructions] Our first question comes from Frank Camma from Sidoti. Please go ahead with your question.

Good afternoon, guys. How are you doing?

How are you doing, Frank?

Yeah, good. Hey, just couple of questions maybe on the guidance. So on the gross margin for this quarter you had, pretty high, obviously. You must be expecting that to pullback. I just wonder if you could discuss that little bit. Was that something extraordinary pulling that up?

No, we had done a number of things in the quarter from our perspective. One, we had a price increase that took place April 1. So we had a full quarter benefit of a price increase. We also had some really good work done on our supply chain operations around the costs of getting the product to the customer, primarily the delivery cost to the customer by redesigning packaging to be more efficient in our – the size and the footprint of the box. So those things will continue to be ongoing. I think when you look at the forecast for the full year, kind of the implied guidance for the fourth quarter is somewhat similar to what it was last fourth quarter. And I think, there, we are looking at opportunities to make some investments in the fourth quarter in the area of advertising. And also, we’ve got a lot of packaging design and things we need to do for the new OPTAVIA brand. So we took a conservative approach I think on the fourth quarter.

So it’s more of a G&A expense, specifically in that sort of investment for next year most.

We’d like to have the opportunity to make those choices in the fourth quarter if the right opportunities are presented to us.

Our fibrous platform is being implemented at that time, Frank. So once we have a new platform in for Med Direct, that would be the time to potentially increase our advertising.

I got you. I got you. Could you talk about any developments with the sports products that you rolled out and what learnings you’ve gotten from that and any maybe partnerships or new partnerships you might be…

We're still working on product development as an example on some of the products. So we don't have the product lines sold out yet, but we have signed up about seven colleges and universities and we also have the ECAC, the Atlantic Hockey League, and the CIA conference where we are sponsoring three conferences. So one of the things we’re doing, Frank, is really trying to get the right references and start to sign these people up. It does take some time. So we don’t expect that to be material this year. But it also helped us to prepare and experiment with the product lines. As Mona looks in the future at our OPTAVIA product line, she can determine what she wants to do with those types of products down the road. But we feel good about the progress we’re making and we’re going to have some good solid references of people working with us to give credibility to our approach.

Okay, good. As you walked away – you explained a little bit about the software and walking away from it. What type of investment does that require you to put up or is it more of a subscription model, this new system or – this option that you’re going with.

Yes, it’s a subscription model, Frank. So there’s very little upfront cost associated. There’s no acquisition. Other than as a public company in order to be SOX compliant, there's some servers we’re going to have to care, but they’re relatively insignificant. Just to make there’s adequate backup.

Okay, great. Last question for me is, we talked a little bit about ultimately an international strategy. Can you give us – it’s probably too early, but is there any way you can give us a sense of timing or what – you probably don’t want to disclose markets, just a little more clarity on that on what your…

We have Mona here for a minute. One of the key issues is the system, it’d allow us to do that. I’m going to let Mona answer that question.

Sure. Okay, great. Thanks.

Hi. So one of the most important part of actually going international is to be able to make sure that we have the right infrastructure and the right support and investing in this new IT platform enables us to have a multilingual, multicurrency platform and to be able to then start working on our cross-border sponsorship compensation plan to ensure that health coaches that come onboard in other countries are able to be compensated and vice versa. So there are some additional parts that goes into it. On top of that, as we introduce the OPTAVIA new product line and the reformulation, we need to go through regulatory approvals through the countries. So we are doing constant background work right now on making sure that we have the right infrastructure, the right tools put in place on our end, so that we could hopefully go international once we have all those in place.

Understand. And if I could just ask one follow-up to that, how do you decide what markets would make sense from a marketing standpoint or from a branding standpoint? Like, where would that OPTAVIA appeal to international customers, if you will, if that’s the right way to look at it?

What we do is really a cross reference of market on understanding the potential both from a product positioning standpoint that what Octavia presents as optimal well-being, which is a combination of not only losing weight, but weight maintenance and attractiveness of sustainable lifestyle and we cross-reference that with the opportunities and the market size of direct selling, which is the business model. So when you look at that, we assess the opportunities that are also geographically close to us, so that we’re able to do a cross-reference of actually starting our international expansion in the home country, in the US through the various ethic markets and then expand then with leadership and with people here going to foreign markets with us. So we have looked at what that looks like from a timeframe perspective, of regulatory approvals, but also time perspective of making sure that we have the right leadership that can go in with us and open those markets.

Great. Thank you.

Thanks, Frank.

Our next question comes from Mitch Pinheiro from Wunderlich Securities. Please go ahead with your question.

Hey, good afternoon.

How are you doing, Mitch?

I’m doing well. So couple of questions. Getting back to be the guidance issue for a second, so you're raising basically your guidance on an annual basis by $0.04 a share and you beat the second quarter here by, call it, $0.10 just for round numbers. So, in effect, is that $0.06 differential, is that sort of now in your model thinking about the investments for next year, maybe in the fourth quarter? Is that how it should be understood?

Yeah. I think that’s the right way to think about. I think we’re coming out of the second quarter favorable to where we expect to be and we have an opportunity now, I think, to make some investments in the latter part of the year to help 2017 get off to a great start. And we’re going to monitor some of the testing that we’re doing to see how that does. And as we see those things kind of prove success in customer acquisition, we’d love to make those investments into kind of getting a jumpstart. So that's exactly how to look at it.

The other thing we’re doing too, Frank, we’re also investing in the conversion of our product lines to OPTAVIA where we’re creating very exclusive new products for our network and I think that's a key area for us because the first 13 were the convention, but we expect to launch more in the first quarter, more as we go through the year because our goal is to have the product line changeover done by July of next convention. By the way, a very exciting thing out of convention is we had double the signups for our next convention which is the most we’ve ever had. And we had 3,400 people and our sign-up process was double what it was at the end of last year’s convention.

So okay. So let me back up and look at SG&A also then. You sort of – a big part of this quarter was simply that sales and marketing expense – advertising was down $2.9 million. So is this current level of SG&A spending sort you’re under-spending here. It's not a sustainable level that we’ll see that pop back up to higher levels that you hope to be supported by more gross profit coming out of some – your revenue growth next year. Is that how the SG&A kind of writes itself? Or are we at a new cost paradigm here and like a sub-60 SG&A is the right number to use?

I think that the – from an advertising perspective, it was a low quarter. And we constantly test and look at the cost of client acquisition and we kind of pull a lever forward and backwards based on how that works. But I think that is not where our expected levels are. I think as the brands further separate, the opportunities to have a bigger presence with Medifast Direct, without negatively impacting Take Shape For Life, will start to grow. And as those opportunities grow, our spending will grow.

And the other thing, I think, Frank, is even the decision we made on the asset impairment is that will lower our cost as we go forward versus increase our costs. So we are managing our cost base very, very efficiently. I don’t think there’s any question if you looked at the last few years we’ve done that pretty well. But we do need to put more money into advertising in the fourth quarter once we get the systems in place and we improve the processes and we have a very good consulting firm we’ve hired that are working with us on that. And that should be a big benefit.

For the last couple of years, you have been taking a lot of costs out. Are you at the point where you’re down to the bone? Or maybe where old costs – you were just too fat before.

Certainly, we’re always looking at opportunities to take any kind of cost out. But just I think to reframe that a little bit, when you look at most of the costs that have come out in the past, we took business units that were not profitable like the clinics, and that's where a lot of our cost cutting over the past several years have come from. Our employee base is about half what it was because we don’t have all the folks out there manning the clinics. So that’s largely where a lot of that’s come from. I wouldn’t really look at it that way. It's not we're looking for those types of things. I think that we’re looking to make investments to grow the business. And I think this past quarter is an example from a timing perspective with everything happening with the OPTAVIA launch, it wasn’t the right time for us to make those investments in advertising. But that time will present itself again and we do expect to ramp that spending back up again with profitable revenue growth.

And by the way, we’ve been investing in products and in Take Shape For Life and adding resources. We’re not cutting back the investment. I think where we’ve done a good job, Mitch, is we’ve restructured very well out at businesses that weren’t profitable to make each business profitable. And I think that’s where you’ve seen the bigger reductions.

Okay. That makes sense. And then, as I look at OPTAVIA, are gross margins going to be similar to your current Take Shape For Life product line?

Yeah. The 13 products we just launched are very, very similar product margins as our existing line.

Even with all the exotic ingredients and hard-to-find chia seeds, et cetera, you can still maintain – is it priced higher?

It is priced higher. Our core product line today, price point is about $18.95 and the new product line with the premium ingredients is about $22.95. So it’s different price points. Speaking of prices, you said you took a price increase in April. Can you quantify roughly the percentage?

The price increase affected part of our offering. The price increase really didn’t apply most – much of our acquisition offers that are out there. So we made sure the client acquisition was really not affected this time. So we have one quarter of history behind us. But it's very low single digits impact. I think if it applied everybody across the board, it will probably be about a 4% price increase and maybe we’re getting a flow-through of 1.5% or something like that.

Okay, that's helpful. And then, obviously, you're excited about OPTAVIA. What I've seen of it looks certainly on-trend, ingredients and new flavor profiles, and that's all a great innovation. But wouldn't you want that – are you going to do the same for Med Direct? Do you want the same type of – or are you going to stay with sort of the current format to stay differentiated? Don't you want to change to a more updated sort of product offering?

I think the intention really is to keep Med Direct on trend as well. I think our priority was the OPTAVIA line and I think the strategy will be different, however. They will not be the same. So, in ten years, not to have the same products sold in each of those channels. So we will have some planning to do with Med Direct for what that product looks like, what those offerings look like in the future, but they will be different in the offerings in OPTAVIA.

Okay. And then – and so, I guess, we should expect Med Direct to stay sort of status quo until you get around to July when you can sort of have a fully differentiated business. Is that what I heard before?

I think what you’re going to see, we would expect, Mitch, some levels of improvement in Med Direct, but I believe over the next 12 months, until you have a totally differentiated product line, you’ll continue to see – Med Direct will improve, but we won't see step function improvement until you see a differentiated product line. And our goal really is to make sure that we’re focusing on creating a great experience for this whole OPTAVIA experience. And, clearly, that’s – our business is 80% Take Shape For Life and 13% Med Direct. So I think we need to understand that’s the basis of our business. We’re really a very strong direct selling company and our goal is not to try to be Nutrisystems.

Got you. And then, I guess, the last question is on, like, the July convention and what that means for a sort of health coach growth. Should we expect growth off of that 12,800 that you ended this quarter with?

Coach growth is somewhat seasonal. So when you think about sequential growth, as you go into the latter part of the year, people – that's around the holidays, we always see a little bit of help. But I think the momentum on a year-over-year basis is – we feel we’ve been pretty consistent. So we expect to continuing to see health coach growth throughout the year on a year-over-year basis. But there is some sequential quarter seasonality.

And so the third quarter is roughly – the range in earnings per share is roughly flat with last year? Is there a large amount of – you would expect a little bump with health coaches. I would just – thought with such a – with strong attendance and a lot of enthusiasm there, is the convention expense in this quarter also weighing on the third quarter? Is that what's driving it to be flattish rather than maybe a little pop here?

You always do have your convention expense which always happens in July relative to third quarter. That has some impact certainly. I didn’t calculate it, but the impact probably more than several cents. So that definitely has some impact. But on a year-over-year basis, that’s not very different.

Okay.

I think the third quarter, as you start to attract new coaches, newer coaches are less productive than your average coach, so you – kind of period of growth, usually is some downward pressure. In all honesty, we haven't seen that in the past couple of quarters, which is a great thing. To see your average revenue per coach go up at a time when you’re growing is different than the trends we have seen in the past. So what basically means is that your existing coaches are increasing their productivity as well as you’re getting new coaches. So that's a really good sign. Look, definitely, there’s some opportunities in the third quarter, hopefully, if we hit on all cylinders to do better than our guidance. But we like to make sure we set a guidance level that we feel very, very comfortable that we’re going to be able to achieve and always like to have upside.

That’s a good thing. Okay. Well, thank you for your time and the questions.

Thanks very much, Mitch.

And ladies and gentlemen, at this time, we’ve reached the end of the question-and-answer session. I’d like to turn the conference call back over to management for any closing remarks.

I just want to thank everybody for participation on the call today. Thank you very much.

Ladies and gentlemen, that does conclude today's conference call and we do thank you for attending. You may now disconnect your lines.