Medifast, Inc. (MED) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Medifast second quarter 2017 earnings conference call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Katie Turner of ICR. Please go ahead.

Good afternoon. And welcome to Medifast second quarter 2017 earnings conference call. On the call with me today are Dan Chard, Chief Executive Officer, and Tim Robinson, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ending June 30, 2017 that went out this afternoon at approximately 4:05 PM Eastern time. If you've not received the release, it is available on the Investor Relations portion of Medifast website at www.medifastnow.com. This call is being webcast and the replay will be available on the company's website. Before we begin, we would 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, 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 can differ materially from those projected in any forward-looking statements. Medifast assumes no obligation to update any forward-looking projection that they make on today's call or in today's press lease. All the forward-looking statements contained herein speak only as of the date of this call. And with that, I would like to turn the call over to Medifast CEO Dan Chard.

Thank you, Katie. Good afternoon, everyone. We're pleased to discuss our second quarter 2017 financial results with you today. I'll provide a brief overview of our financial and operational business performance. Tim will then review our financial results in more detail and share our third quarter and annual 2017 guidance. Finally, Tim and I will be available to answer your questions. We're pleased with our performance to date in 2017. Our second quarter financial results reflect the successful execution of our strategic growth initiatives as our teams work to position our business for an accelerated growth. These efforts helped us generate revenue and profitability above our expectations for the quarter. Revenue of $75.7 million exceeded our guidance of $72 million to $75 million. We continue to see strong leverage across our scalable infrastructure with gross profit margin expansion of 130 basis points. And we also managed our expenses well to report earnings of $0.63 per share ahead, ahead of our guidance of $0.51 to $0.54 per share. Importantly, we believe we have a solid business momentum for the second half of 2017 and we are well-positioned for future growth and to create value for our shareholders. As many of you know, we hosted our annual national convention three weeks ago in Dallas, Texas where we officially rebranded our Take Shape For Life business segment to OPTAVIA. This change is the result of several years of research, business development and product development. Today and going forward, we will no longer reference Take Shape For Life and will refer only to OPTAVIA when discussing the results of our most significant business segment. This includes describing our Take Shape For Life coaches as OPTAVIA coaches moving forward. The evolution to OPTAVIA marks a significant milestone in our company's history. Before we go into greater detail about the success of our national convention, I would like to review our second quarter results for OPTAVIA. OPTAVIA recorded its seventh consecutive quarter of year-over-year quarterly growth, up 10.6%. This was also a sequential quarterly acceleration from the 2.3% growth for the first quarter of this year. At the end of the second quarter, we had 13,500 active earning coaches, an increase of 5.5%. In May, we set a new high-mark for the company as more OPTAVIA coaches were sponsored and joined our coach community than at any time in our company's history. During the second quarter, we continued to generate increased coach productivity, resulting in higher new coach sponsorship, higher new client acquisition and a higher average order volume value year-over-year. Our coach community adoption and the integration of the OPTAVIA brand culminated with the full transition to this exclusive branded product line at our national convention in late July. I am excited to share with you that our 2017 national convention was the largest event in our company's history, with over 4,100 OPTAVIA coaches and clients in attendance. Our community came together to see and understand the new OPTAVIA business tools and products and learned how to integrate them into their businesses. For 1,700 new OPTAVIA coaches, it was their first time at a national convention. It was also my first time at our national convention as CEO. And it was a tremendous experience to interact with our incredibly enthusiastic community of OPTAVIA coaches, who inspire others every day to spread our vision and mission of offering the world lifelong transformation one healthy habit at a time. With OPTAVIA, we have created a powerful transformational message that is easily shared and is both inclusive and appealing to diverse demographics, which we believe will enable us to expand our OPTAVIA community and positively impact more lives. The brand transition included the announcement of the launch of 22 OPTAVIA Essential Fuelings and two new OPTAVIA snacks, which completes our full launch of the Essentials line. Now, OPTAVIA coaches and clients can choose from more than 60 delicious, convenient, interchangeable, scientifically-designed OPTAVIA Fuelings. Each fueling is free from color, flavors or sweeteners from artificial sources, contains its patented probiotic and is full of essential vitamins and minerals. Our product development team has done an amazing job over the last few years to help us test, create and bring these products to market. At our 2017 national convention, we also announced our OPTAVIA business kits, a revamped On-The-Go Kit, with the essential tools and accessories to jumpstart our new coaches; the OPTAVIA Answers, a fully interactive knowledge base of key information and resources for our coach community; OPTAVIA Experience, a new service and support organization; OPTAVIA Learn, which is an innovative training approach; and OPTAVIA Path to Achievement, a new way for Medifast to recognize the success of its leaders. We have worked hand-in-hand with our coach community to develop business tools and resources to make it easier for them to grow their business and connect with new clients. It is an exciting time for our company. Our corporate and fields teams have worked very hard over the last several years to ensure a very well-planned and seamless business evolution. We believe our OPTAVIA coach community is stronger and very well positioned to build on the momentum created by our record-breaking annual event. We also continue to make progress in preparing for future growth, which includes deeper penetration of our existing US markets, as well as expansion into new markets over time. We are pleased that the Direct Selling Association recently recognized us as one of the top 20 largest direct selling companies in the United States. This accolade is a testament to our dedicated OPTAVIA coach community that works tirelessly to spread optimal health and well-being across the country. Now, let me move to Medifast Direct. We continue to experience meaningful improvement in the trajectory of our direct response business, which represented 12% of our revenue in the quarter. The deceleration of the year-over-year quarterly revenue decline continued in Q2 and we remain encouraged by the improvement. As we have communicated previously, our efforts are focused on the right balance of advertising spend, placement and messaging to ensure that we have a sustainable model to acquire a growing number of customers to support our long-term profitable growth. We're still in the very early stages of testing our Medifast Direct platform as a digital lead generation tool that will support our OPTAVIA community. This testing is an example of our focus to move our direct response and OPTAVIA models to an integrated business model for the benefit of our coach community and our clients. Over time, we believe that this alignment will help enhance our long-term success and will serve as an opportunity for expansion into other markets. In summary, we're very pleased with all we've accomplished thus far in 2017. We have positive business momentum, with our recently rebranded OPTAVIA business segment. And when combined with our scalable infrastructure and strong balance sheet, we believe we are well-positioned for future growth and value creation for our shareholders through improve results as well as through our existing dividend and share repurchase program. With that, I'd like to turn the call over to our CFO, Tim Robinson.

Thank you, Dan. And good afternoon, everyone. In the second quarter, revenue was $75.7 million, exceeded our expectations. OPTAVIA, formerly Take Shape For Life, accounted for approximately 83% of revenue. Medifast Direct accounted for 12%. Franchise Medifast Weight Control Centers accounted for 4.7%. And Medifast Wholesale accounted for 0.3% of net revenue. Revenue in OPTAVIA increased 10.6% to $63.5 million from $57.4 million in the second quarter of the prior-year. As Dan mentioned, there was approximately 13,500 active Medifast coaches in the second quarter compared to 12,800 in the same period last year and 13,000 in the first quarter of 2017. Average revenue per active earning coach for the quarter increased to $4,713 as compared to $4,479 in the second quarter of last year. Our Medifast Direct revenue decreased 7.5% to $8.6 million as compared to $9.3 million in the second quarter of 2016. Total Medifast Direct advertising in the quarter increased slightly to $1.9 million from $1.6 million in the second quarter of 2016. Revenue in the Franchise Medifast Weight Control Centers decreased to $3.4 million from $4.1 million in the same period last year. The decrease in revenue was primarily driven by fewer franchise centers in operation during the period, combined with the decline in activity within the centers and a decrease in resellers. We ended the quarter with 36 franchise centers and two reseller locations in operation compared to 57 centers end of the same period last year. Medifast Wholesale revenue, which is mostly comprised of revenue from healthcare providers, decreased to $230,000 compared to $300,000 in the same period last year. The lower revenue was consistent with our previously communicated strategic decision to reduce emphasis on this area of our business based on the significant number of healthcare providers in our OPTAVIA coach community and our enforcement of business partner compliance distribution requirements. Gross profit for the second quarter of 2017 increased 8.2% to $57.6 million compared to $53.2 million the prior-year period. We were pleased to see our gross profit margins as a percentage of net revenue expand by 130 basis points to 76.1% versus 74.8% in the second quarter of 2016. The increase was driven primarily by a change in product mix and efficiencies realized within our supply chain. Selling, general and administrative expenses in the second quarter of 2017 were $46.3 million or 61.1% of revenues versus $48.2 million or 67.8% of revenues in the second quarter last year. The decrease in SG&A was primarily a result of the $6.1 million asset impairment cost incurred during the second quarter of 2016, partially offset by increased commission expenses from increased sales and increased personnel costs. Adjusting for the impairment charge recorded in the second quarter of 2016, adjusted selling, general and administrative expenses as a percentage of net revenue increased 190 basis points from 59.2% in the second quarter last year compared to 61.1% for the second quarter of 2017. Sales and marketing expenses increased $437,000 in the second quarter of 2017 as compared to the second quarter of 2016. Net income in the second quarter of 2017 was $7.6 million or $0.63 per diluted share based on approximately 12.1 million shares outstanding. Second quarter of 2016 net income was $3.4 million or $0.29 per diluted share based on approximately 11.9 million shares outstanding. Excluding impairment costs, net of taxes, net income in the second quarter of 2016 would have been $7.5 million or $0.63 per diluted share. Our effective tax rate was 33.8% compared to 33.3% in the second quarter of 2016. The increase in the rate was primarily driven by a decrease in domestic manufacturing deductions, partially offset by reduced state income taxes for the period. Our balance sheet remains very strong, with stockholders' equity of $104.2 million and working capital of $85.6 million as of June 30, 2017. Cash, cash equivalents and investment securities as of June 30, 2017 increased $11.8 million to $88.6 million compared to $76.8 million at December 31, 2016. During the quarter, we announced our 10b5-1 program starting on June 14, 2017 and we continue to have approximately 850,000 shares remaining on our repurchase authorization as of June 30, 2017. Our Board of Directors declared a $0.32 quarterly dividend during the quarter, payable on August 9. Now, turning to our guidance. We expect third quarter revenue to be in the range of $72 million to $75 million and earnings per diluted share to be in the range of $0.48 to $0.51 per diluted share. We are reiterating our 2017 full year revenue guidance range of $290 million to $300 million and are raising our full-year earnings per diluted share to be in the range of $2.05 to $2.15 per diluted share. Our fiscal year 2017 guidance assumes a 33% to 34% effective tax. Well, that concludes our operational and financial review. We appreciate your interest in Medifast. 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.

Hey, guys. Good afternoon.

How are you doing, Frank?

Hi, Frank.

Good. Hey, the health coach growth was good and I think everybody was expecting that. Well, I've got a couple of questions. First of all, I know that you said you mentioned it back in May that was a record, I think, of recruitment. And, obviously, that's pretty well before your conventions. So, I'd like to hear like a little bit about that. But I'm probably more interested to hear any comments, especially since before you officially rolled everything over on the huge jump – I think it's the highest point I've ever seen for the average revenue per health coach. If you could talk about that, especially if you can give any color as to how sustainable that might be.

Sure, Frank. I think what you're seeing is a reflection of a couple things. One, we're going into convention, the anticipation of the launch of OPTAVIA going out, the actual realization of the launch of the new brand. So, I think it's – the productivity is a reflection largely of transitioning completely over to the new OPTAVIA, which, as you know, has a higher price point, but it's a reflection of the enthusiasm related to the launch of the new line. So, those are the kind of the two factors impacting productivity for our coaches.

Hi, Frank. Specifically, on the May, May was a record month for us of new coaches joining OPTAVIA. And as a matter of fact, the second quarter, if we go back at least three years is probably the best quarter we've had in three years as far as attracting new people in OPTAVIA. There's clearly a lot of momentum built around the brand. I think also the kind of chemistry, I'll say, between the health coach community and the company is really better than probably it's ever been. So, I think we've really been in sync with coordinating programs and reporting and tools for the coaches to help them with their kind of spreading the mission. So, it's been all positive.

Yeah. Definitely saw that at the convention. So, that was pretty evident. How do you feel about – and I guess, it's a little hard to tell since it's right before the convention, but the inventory level because, obviously, if you look at it year-over-year, it's a pretty big increase, but you're going into convention. So, I was wondering if you could discuss that a little bit more.

Sure. Yeah, obviously, going from one brand to two brands, and offering both brands, you had to stock up enough inventory to supply either the Medifast brand or the OPTAVIA brand early on. And then we're seeing a pretty quick shift over to the OPTAVIA brand as of convention and we now have a full complement of the Essential line product. So, into the third quarter, we will really be able to measure a true adoption because all products are now available in OPTAVIA. But we knew we were going to have to build the inventory up not knowing exactly how the adoption rate would go. And so, you'll start to see that come down now. I don't anticipate that we'll get inventory back down to the $13 million range where we once were. That's not actually a goal of ours. But just start to see it come down this quarter and also the following quarter to probably a level that will be somewhat sustainable in that $15 million to $16 million.

Is part of that delta or increase because you actually have – you have some more expensive inputs too, right – you have a number of new SKUs, so that must impact things.

Yeah. That's really what it is. When you build inventory, when you build products, very often, many of these products have certain minimum order quantity associated with them. So, when we split brands, we actually have the twice the inventory at the time of manufacturing than we had before. And you just have to work that planning. It's not like you can just ballpark – so, it's not like you can just produce half, right? You're still producing a full run of products. That's what really built the inventory up. And then, over time, you'll start to plan on those inventory turns by SKU and it will work its way down. The inventory is not a concern to me at all.

Okay. Just to turn real quick to Medifast Direct, the numbers were actually kind of better than I expected, especially if you look at it from a sequential standpoint and what's going on in the industry. You increase your marketing spend, but really not by anything material. Any feel for why that would have kind of held in there like that, given what's going on?

There are a couple of things. One is, we've refined our message. Part of direct-to-consumer marketing is testing and refining and we've done that. So, we have a good feel for what works best from a messaging standpoint. I also think – we're also improving the mix. We're getting more efficient and kind of focused on using some of the social media advertising as well as affiliate advertising. So, I think it's really messaging and more efficient spending. And so, I think we're very optimistic about where we ended the quarter and as well as where we're going. In addition to that, you’ve heard in the release that part of what we're doing is more and more to test how we leverage some of these digital capabilities to improve and promote improved performance within the coach community. So, we're excited about that. And I think you'll hear us talking more about that in the future.

Great. My last question to that end is, so when can you – when or – it will since you will maybe use that as lead generation for the coaches, can you kind of like crank up the ad spend or when does it make sense to? Obviously, you just converted the brand, but do you have to wait until next diet season? Do you wait later this year? Just any thoughts on that?

Right now, I'd characterize where we are as very much in learning mode. What we don't want to do is anything that will disrupt what's happening with the coach community. This testing is meant to be something that will help support, not distract or make [indiscernible] confidence. So, we're moving up today relatively slowly to make sure that we do it in partnership with our coach community and to make sure that it's a very positive thing. But I think we're confident in kind of where we're going and kind of the speed. And we don't have a specific timing on when we'll start – using your words – kind of crank it up and use it as a major driver.

Okay, thank you.

Thanks, Frank.

The next question comes from Doug Lane with Lane Research. Please go ahead.

Yeah. Hi, good afternoon, everybody.

Hi, Dough.

Dan, can you talk about – or Tim, can you talk about when the return is going to be on all the investments this year? And after the major rebrand this summer at the convention, large turnout, big new product introductions as well as a whole new look to the products, so there seems to be a lot of news there that you would think would generate a lot of activity and the third quarter numbers are kind of – little bit of sales growth, mid to high single digits and EPS kind of flattish. So, when do we start to see the return from all this activity.

I think – and the way we're looking at it, Doug, is that leading into the convention, we just – which is the quarter we're reporting, if you look at sponsoring, it is one of the leading indicator. As Tim mentioned, it's the strongest sponsoring quarter we've had in the past three years. You saw that our convention had a record attendance, which is another reflection. We're seeing strong adoption of the product, which is reflected in the flow-through of the increase pricing that is translated into increased coach productivity. So, I think the answer is we're seeing it already and we anticipate that that will continue to flow through to the back half of the year. Anyway, that's really the key. I think our coaches are more excited than we've seen them in a long time. And that's kind of a qualitative assessment, but they're very positive about the future. Each of the new products that we launched had a net improved kind of overall taste. And so, we anticipate that we will start to see the flow-through on the retention side. We have some – as we always have, but there continues to be a strong reflection in the results of people using our products in terms of the efficacy of our programs. Our coaches are getting better at sharing those stories. We dramatically kind of, let's say, streamlined the communication. We're very focused now that we have an exclusive brand for the coaches. So, I think we're very optimistic about where we were in the second quarter. And as we're leaving the convention at the beginning of the third quarter, where that’s going to take us through rest of the year.

My impression was very similar. It seemed like it was a very positive event. And so, I guess I'm commenting on the third quarter outlook. And again, new to the story here, so maybe there is some explanation there. The sale is up 5% to 10% or 5% to 9%. It's good, but it seems like with all this going on, it could be better. And the EPS, if I'm not mistaken, is flat or maybe down a little bit and maybe I can give a little background there on what's going on. And I guess, can we look at the December quarter to see those numbers start to accelerate already? And if they do see sustainable into 2018? But I just want to make sure I'm framing that right in my mind.

I think people you see coming out of convention is the building of confidence that yields a higher – new sponsorship of coaches. And typically, you'll see then, as you attract those coaches, they will attract the clients and then the orders come from there. So, there is some of the delayed reaction from convention to sponsoring of coaches to actually production. So, if you look at the guidance, you'll see kind of an implied – you'll see an acceleration in the fourth quarter. And certainly, that as far as year-over-year growth rates. Our fourth quarter last year was impacted somewhat by a shortage of product and that carried through the first quarter this year. So, we don't anticipate any of that this year. So, we expect the first quarters to be a very, very strong quarter year-over-year. And I think – we do think that that's sustainable, that momentum is sustainable and we have to make sure that we have a really good cadence of programs, marketing programs, to make sure that we help people keep focus each quarter. That's something that we also acknowledged in the fourth quarter last year. We had a little bit of miss as far as the momentum building activity. The big boost out of convention would yield results more in the fourth quarter that we'd see in the third quarter.

Okay, that's fair enough. I understand that. And then looking at – you're mostly a domestic company. You're bigger than USANA and NuSkin, but still a lot smaller than Herbalife. So, how should I think about it going forward strategically. Emphasis on US where there seems to be still a lot of runway versus a shift to international expansion where a lot of your peers have substantially most of their business outside the US. So, how should we think about that?

I think you're pointing out the right areas for – these are the same areas we're focused on. We have plenty of runway left for penetration in the US. Our business – we have coverage across the United States, but we have some really strong pockets of activity with our OPTAVIA coaches. So, we have plans in place that we're working, I’d say, increase penetration in our existing markets. And then, as you pointed out, international is a big opportunity for us. We've been thinking about it and planning forward for quite some time. Towards the end of this year, we will have completed some of the technology infrastructure that was needed for us to start realizing some of that opportunity. From a macro standpoint, we know that that the trend – the health trends, particularly related to being overweight and obese, are not just a US phenomenon. And part of the reason for our rebranding was to create a brand that had relevance internationally. So, I think we view both opportunity domestically to increase penetration and we also look over the horizon for international expansion to drive a significant portion of our future growth. And as I said, we'll put the technical and business infrastructure in place to be able to do that.

Okay. So, will we hear more about an international expansion next year as plans materialize and become a little bit more concrete? I doesn’t sound like it will be happening in 2018, but it sounds like maybe we'll be talking about more in 2018.

Yeah. I think you can anticipate hearing more about the plans and we haven't put any dates together. And as soon we do, we will be sharing those with you. Like I said, we're in the process of the readiness phase. The specific answer to your question, yes, you'll be hearing more in 2018.

Okay, great. And just one last thing, Tim. What are our priorities for free cash flow here? You're somewhat limited with a balance sheet that's obviously in great shape. How much stock buyback can you do? And I don’t know if you’ve articulated any strategy on acquisitions. But are we just looking for dividend increases or maybe I'll just let to articulate what is your strategy for use of free cash flow?

Sure. Our board, on a quarterly basis, we talk about our capital allocation strategy. And it's really three parts. We think a very strong dividend that we initiated at the end of 2015, we increased it, I believe, 28% at the end of last year. We have a stock buyback program. Authorization is 850,000 shares. We initiated 10b5-1 plan last quarter, which we had not had before, which will enact a buyback under certain conditions even when we're in quiet periods, which we weren't able to do before. And then, the third arm of that is opportunities. And as we think about international expansion, we will be opportunistic where it makes sense. If we can accelerate our plans, we would certainly do that. I wouldn't want to define as a key element of our strategy. We're not focused on that. But it's certainly something that could help to escalate those plans if the right opportunity came along. So, they really are the three tenets of our capital allocation something.

Okay, that makes a lot of sense. Thanks, everybody.

Thanks, Doug.

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

Well, we just want to thank you for your interest in Medifast and your participation in today's call. We look forward to speaking with you again when we report our third quarter 2017 financial results. And we wish you all a good evening.

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