Medifast, Inc. (MED) Q4 2016 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Medifast fourth quarter and full year 2016 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 event is being recorded. I would now like to turn the conference over to Katie Turner. Please go ahead.

Good afternoon. Welcome to Medifast's fourth quarter and fiscal year 2016 earnings conference call. On the call with me today are Daniel Chard, Chief Executive Officer and Timothy Robinson, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ending December 31, 2016 that went out this afternoon at approximately 4:05 P.M. Eastern Time. If you have 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 I begin, we would like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. 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 forward-looking statements contained herein speak only as of the date of today's call. And with that, I would like to turn the call over to Medifast's CEO Dan Chard.

Thank you Katie. Good afternoon everyone. We are pleased to be with you today to discuss our fourth quarter and full year 2016 financial results. I will provide a brief overview of our financial results, discuss our recent business performance and provide an update on my first few months at Medifast. Tim will then review our financial results in more detail and share our guidance for he first quarter and full year of 2017. Finally, Tim and I will be available to answer your questions. I have spent much of the past several months getting to know our talented field and corporate teams. I am excited about the company's future direction and believe that we have a significant opportunity to grow our business domestically and expand internationally. In 2016, we made solid progress on our key initiatives and also began setting the stage for accelerated growth in 2017 and beyond. We are pleased to report the return to growth on both top and bottom line in 2016. Revenue of $274.5 million was in line with our expectations. Income from continuing operations was $1.49 per share, while adjusted earnings from continuing operations was a $1.89 per share, which is at the high end of our expectations for the year. In line with this performance, we announced a 28% increase in our quarterly dividend last December. Going forward, our focus will be to accelerate our topline revenue growth with continued improvement in profitability. The company is in the fortunate position of being surrounded by powerful macro trends that we believe will support our long-term growth. We have a large addressable market in the U.S. and internationally as people increasingly focus on adopting healthier lifestyle, including but not limited to, weight management. We responded to these trends by creating a compelling highly effective product portfolio. Our products are in turn supported by programs that include one-on-one client support from our dedicated community of health coaches who help their clients achieve their healthy weight and adopt and incorporate healthy habits into their lives. I am very excited and confident about the future of Medifast. Our product innovation and a focus on supporting healthy habits has resulted in some of the best weight management and wellbeing solutions in the industry. We believe we have a clear path to build our brand by focusing our message, expanding our product offer, strengthening our partnerships and penetrating existing and new markets. This work will support the next level of accelerated revenue, profit growth and total shareholder return. Now let me focus on our operational performance in greater detail. Take Shape for Life reported its fifth consecutive quarter of year-over-year growth, up 8% for the fourth quarter. Our health coach community continues to get stronger, as demonstrated by both the growth in Q4 active learning coaches and coach productivity year-over-year. Tim will review these numbers in more detail during his financial review. On a sequential basis, from the third quarter to the fourth quarter, our growth slowed beyond seasonal expectations. This was reflected in both new coach acquisition and in coach productivity. This period followed the introduction of our new lifestyle brand, OPTAVIA and the associated products and programs. While we saw high adoption rate for the first 13 exclusive OPTAVIA select products, which launched at our Take Shape for Life 2016 Annual Convention in July, the demand outpaced our production and we were quickly faced with supply challenges causing us to remove the most popular items from our product offering for a few months. This contributed to a slow momentum as we moved into the fourth quarter. We have since taking steps to make sure that we can fully support the demand for the next 20 new products which were introduced at our Go Global event last month in Atlanta. As a result, you will notice that our year-end balance sheet reflects a higher inventory position as we prepare for the anticipated strong adoption rate for our newly introduced OPTAVIA Essentials line of products. Additionally, we are ensuring all existing for both clients and health coaches in order to provide continuity order size. By avoiding distractions, this will offer a smooth transition for clients and coaches, most of whom we expect will transition this year from the Medifast branded products through OPTAVIA Select and Essentials lines. For clarity, we now have our Medifast classic line as well as 20 new OPTAVIA Essentials products, which feature our most popular forms and flavors. We will add approximately 27 new SKUs to this line by August of this year. All OPTAVIA Essentials products are formulated without artificial flavors, colors or sweeteners, plus they contain additional Vitamin D and the GanedenBC30 probiotic for digestive and immune health. Lastly, our 13 OPTAVIA Select products which were launched in the third quarter of last year have the same attributes offered in the Essentials line plus the addition of unique flavors and ingredients from around the world and a non-GMO designation. We have been pleased to see the trends that suggest strong adoption of our OPTAVIA products from both new clients, existing clients and health coaches. I referenced earlier, our February Go Global event in Atlanta. This event was for qualifying business coaches who are aspiring to advance to business leader status. I am pleased to report that it was the largest Go Global event in the company's history with over 1,000 attendees. This is a good barometer for the health of our coach community. The excitement of the event was inspiring and the agenda included leadership workshops, opportunities to learn and collaborate with other successful business coaches and presentations from both field and corporate leaders that highlighted our vision and strategy for the future. All this activity will culminate in what we believe will be the largest and most significant national convention in our company's history. The convention is in Dallas in July and will conclude the one year transition of the OPTAVIA brand and from that point forward, Take Shape for Life will be officially known as OPTAVIA. Now let me move to our Medifast Direct business. Our team has been working for quite some time to refine our approach while also significantly reducing the costs of new customer acquisition. While we expected a decline in this business year-over-year, we expect the decline to slow by the fourth quarter of 2016 as a result of our second half actions. Although the declines continued at a similar level throughout the full year of 2016, we are now beginning to see some improvements in this business in the first two months of 2017 and expect that to continue as we implement several initiatives throughout the remainder of the year. As we have shared in our past calls, our ongoing focus over the past two years has been returning Take Shape for Life to growth as it represented 80% of total revenue. This has included making strategic decisions that have clearly impacted the performance of Medifast Direct. For example, we made the strategic decision to limit Medifast Direct's ability to offer discounts and other typically attractive promotions in order to prevent competition with our Take Shape for Life channel where customers have a significantly higher lifetime value. The impact of these initiatives led to a $2.5 million year-over-year decline in revenue for the fourth quarter in Medifast Direct. On a positive note, our ability to acquire online customers at a reduced rate is allowing us to begin testing our Medifast Direct online customer acquisition platform with a client and lead generation tool for our health coach community. Our research shows that when we assign a health coach to a customer, there is a much better outcome for everyone. The additional lifetime value along with the potential to gain an additional health coach over time is a very compelling financial model that could not have been accomplished with our historical customer acquisition costs. This testing is an example of our focus to move to an integrated business model for the benefit of our Take Shape for Life coach community. We are optimistic that this alignment will boost for long-term success. Lastly, our team continues to work closely with our franchise Medifast Weight Control Center partners to continue to deliver a compelling offering. Also notably, during the third and fourth quarters we worked with several of our franchise partners to convert franchise locations to authorized reseller locations. This strategic shift enables them to leverage their current locations to offer a broader set of our products and services, while retaining the ability to offer Medifast products and programs under a similar economic model. Overall, we are pleased with our operational and financial performance in 2016. Our teams accomplished a tremendous amount during the year and returned the total company to growth. Our strong disciplined approach to the business has served the company well and will provide us with the necessary foundation to embark on our next stage of growth for 2017 and beyond. I have been impressed with the dedication of our health coaches, our partners and our employees as we provide a path for lifelong transformation towards better health and wellbeing for our customers and clients. When I joined last October, our Board of Directors sent strong message of confidence when they challenged us with a very aggressive long-term goal to reward shareholders. We have aligned all of our senior executive goals and long-term incentives around the same three-year objectives. This objective is to achieve an annual total shareholder return over the next three years of no less than 15% and upwards of 35%. Of course, we are aiming for the top end of that range and in order to achieve that goal, we are challenging our field and corporate leaders to double the size of our health coach community over the next three years. The alignment of our management team objectives is an important step as we drive forward as one integrated team with a single common goal. In summary, our team remains committed to delivering value to stockholders. The health of our business, our significant cash generation and the strength of our balance sheet puts us in a position to continue enhancing stockholder value through both our existing dividend and share repurchase programs. Our first quarter dividend, a 28% increase year-over-year, will be paid out on May 9. As of December 31, 2016, we have over $76 million of cash, cash equivalents and investment securities on the balance sheet with no debt and approximately 850,000 shares of common stock available to buyback under our existing repurchase program. We are very pleased with our achievements and our 2016 financial performance and we are very optimistic about the opportunities ahead. With that, I would like to turn the call over to our CFO, Tim Robinson.

Thank you Dan and good afternoon everyone. 2016 was a pivotal year for us as we returned to revenue and profitability growth and positioned the company for future growth. Before I go through the details, I just want to remind everybody that the financial information I share here today will reference our results from continuing operation. In the fourth quarter, net revenue increased approximately 2% to $62.5 million from net revenue of $61.3 million in the fourth quarter of last year. The Take Shape for Life business unit accounted for approximately 82.8% revenue. The Medifast Direct business unit accounted for 10.9%. Franchise Medifast Weight Control Center business unit accounted for 5.8%. And the Medifast Wholesale business unit accounted for 0.5% of net revenue. Revenue in Take Shape for Life increased 8% to $51.8 million from $48 million in the fourth quarter of the prior year. We are pleased to have our fifth consecutive quarter of positive year-over-year revenue growth at Take Shape for Life. There were approximately 12,500 active health coaches in the fourth quarter compared to 11,900 health coaches in the same period last year. Average revenue per active earning health coach for the quarter increased to $4,158 as compared to $4,039 in the fourth quarter of last year. We believe that our increased emphasis on key Take Shape for Life strategies, the increased engagement level of our field leaders and the operational improvements in health coach experience and lastly the increased resources added to the Take Shape for Life team are having a cumulative impact that translated into momentum and will in turn drive sustainable growth. Our Medifast Direct business unit revenue decreased 27% to $6.8 million as compared to $9.3 million in the fourth quarter of 2015. Dan articulated the challenges in this business unit and a little about our future vision that simplifies our strategy to shift our emphasis to an integrated business model driving online customers into our coaching model thus gaining incremental lifetime value and diminishing any remaining conflicts between our current business units. Total Medifast Direct advertising in the quarter decreased 28% to $1.6 million from $2.2 million in the fourth quarter of 2015. Revenue in the franchise Medifast Weight Control Center business unit decreased slightly to $3.6 million from $3.7 million in the same period last year. The decrease in revenue was primarily driven by fewer franchise centers in operation during the period. We ended the quarter with 37 franchise centers in operation and 19 reseller locations, compared to 61 centers at the same time last year. As a reminder, a resale location is a designation for a prior franchise center who we have authorized to sell Medifast products without the brand restrictions associated with franchise model. The reseller locations, they also offer additional products and services beyond our franchise model. The economics for Medifast and the reseller are similar to our franchise model. Medifast Wholesale revenue, which is mostly comprised of revenue from healthcare providers, was flat compared to the prior-year period at $300,000. We are currently not focused on expanding this area of our business as we have significant number of healthcare providers in our Take Shape for Life coach community. Additionally, in order to increase focus in the largest part of our business, we recently discontinued efforts to market our sports nutrition products to college and universities and have shifted our efforts to leverage the formulation for future introductions in our Take Shape for Life business. Gross profit for the fourth quarter of 2016 increased 4.1% to $47.1 million compared to the prior year period. We are pleased to see our gross profit margin as a percentage of net revenue expand by 160 basis points to 75.4% versus 73.8% in the fourth quarter of 2015. The increase was driven primarily by price increases and improvements in our supply chain operations such as shipping efficiency. Selling, general and administrative expenses in the fourth quarter of 2016 were $40.5 million or 64.8% of revenues versus $39.7 million or 64.7% of revenues in the fourth quarter last year. The increase in SG&A was a result of higher Take Shape for Life commission expense, which is in line with the 8% sales growth Take Shape for Life experienced in Q4 compared to the same period in the prior year. Sales and marketing expense decreased $1.1 million in the fourth quarter of 2016 as compared the fourth quarter of 2015. Fourth quarter operating income from continuing operations before tax was $6.7 million or 10.7% of net revenue compared to income from continuing operations before tax of $5.9 million or 9.7% of net revenue in the fourth quarter of 2015. Income from continuing operations in the fourth quarter of 2016 was $4.1 million or $0.34 per diluted share based on approximately 12 million shares outstanding. Fourth quarter 2015 income from continuing operations was $3.9 million or $0.33 per diluted share based on approximately 11.9 million shares outstanding. Our effective tax rate was 38.2% compared to 34.3% in the fourth quarter of 2015. the increase in the effective tax rate was due to an increase in the effective state tax rate and a reduction in research and development credits. Our balance sheet remains strong with stockholders equity of $96 million and working capital of $76.9 million as of December 31, 2016. Cash, cash equivalents and investment securities as of December 31, 2016 increased $9.7 million to $76.8 million compared to $67.1 million at December 31, 2015. We continue to have approximately 850,000 shares remaining on our repurchase authorization as of December 31, 2016. Now turning to our guidance. We expect first quarter net revenue from continuing operations to be in the range of $69 million to $73 million and earnings per diluted share from continuing operations to be in the range of $0.45 to $0.48 per diluted share. We expect 2017 full year revenue from continuing operations to be in the range of $290 million to $300 million and full year earnings per diluted share from continuing operations to be in the range of $2 to $2.10 per diluted share. The fiscal year 2017 guidance assumes a 34% to 35% effective tax rate. Our non-GAAP financial measures includes adjusted income from continuing operations and adjusted earnings per diluted share from continuing operations. Please refer to the tables in today's press release for a reconciliation of all non-GAAP financial measures. Well, that concludes our operational and financial overview. We appreciate your interest in Medifast and Dan and I are now available to take your questions. Operator?

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

Good afternoon guys.

Hi Frank.

Hi Frank.

Yes. You did call out, Dan, a couple issues with the end of the quarter or during the quarter that one of the things I have always felt was surprising about Medifast is that your business is a lot less seasonal than some of the other commercial weight loss providers, granted Direct is not a big piece of the business any more but my point is obviously it looks like it's become more seasonal. But you said some of the items you weren't able to our ship. I just wonder if you could just talk about that a little bit more? Like did you see a catch-up later? Like you built the inventory and then of course did you then ship those in Q1 of this year? I am just trying to figure that out?

No. Frank, those were related to the new product that we launched. So we weren't out of stock of all the products. What really was happening, we build up a lot of energy around the launch of OPTAVIA 13 products, the 13 products that we launched at the convention last year. The demand was higher than anticipated and very quickly we ran out of stock. So a lot of the purchasing was incremental during that period of time. So it didn't come back once we had those products back in stock. But it did dampen some of the excitement that we have built up to it. Since then, as I mentioned, we looked at how we calculate the enthusiasm and demand that's coming out for these new products. We have just launched 20 marks the couple of weeks ago in Atlanta and we have made those adjustments. So it didn't come back. But we have made the adjustments. So I am sure that we don't have that kind of operational slowdown again.

Okay. And can you talk about like the average sales per health coach since it was really strong all year long? So is that related to that issue too where you kind of had a buildup and then the excitement tapered off? Or is that a totally separate issue? I am just trying to figure it out, when you look at it on a sequential basis?

On a sequential basis, sequentially we were up 6.5% in productivity per health coach in the third quarter. We were up just shy of 2% in the fourth quarter. So it had to have some impact on productivity. It had an impact on our sponsoring rate and bringing in new coaches. As Dan mentioned, I think the excitement buildup from convention, we had a lot of momentum coming out here. We just had a little bit of a damper on the momentum when we couldn't deliver the new products that were really we centered all the excitement around.

And then, I don't know if you mentioned this, but did you see productivity then pick back up in Q1 as you would expect this year? Are you able to talk about that?

Yes. Let me give you a little insight to that. I think that coming out of the end of the year, that slowdown continued a little bit into January. So what we can say is that we are seeing that reverse. After Go Global, which just happened in February, we launched 20 new products. We have plenty of inventory. But also the event was like a really good event and we are seeing pretty sharp uplift in sponsorship of new coaches and we are seeing a pretty sharp uptick now in revenues starting in the third week of February. So we think those corrections we put in place, we are clearly noticing a change.

Okay. My last question relates to Take Shape for Life business model. Since you mentioned your goal longer term is to double over the next three years. And I understand that's just a goal. So when we look at the build this year, should we rely more on growth in active health coach versus productivity? Is that kind of the way when you did your guidance? Is that how you looked at it?

Yes. That is the way we are looking at it and we are focused on continuing to maintain or improve productivity. But our focus is on building and transitioning people, increasing our sponsoring races, transitioning our new health coaches to business coaches and then to business leader. So we are looking for both growth in the number of health coaches, but also progression in our overall leadership pipeline.

Okay. Great. Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Dan Chard for any closing remarks.

Thanks for your questions and participation in today's call. We look forward to speaking with you again when we report our first quarter of 2017 financial results and have a nice evening.

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