Medifast, Inc. (MED) Q3 2017 Earnings Report, Transcript and Summary

Good day and welcome to the Medifast Second [ph] Quarter 2017 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. And welcome to Medifast third quarter 2017 earnings conference call and webcast. 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 September 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 identifies 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 projection that maybe made in today's release or on the call. 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 third 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 fourth quarter and annual 2017 guidance. Tim and I will then be available to answer your questions. Our third quarter results reflect some early successes of our strategic growth initiatives and we are pleased to report revenue and earnings above expectations. The successful execution of our growth and operations initiatives positions us for the revenue and earnings acceleration we achieved in the third quarter. Third quarter revenue of 77.2 million, up 12.6% was above our revenue guidance of 72 million to 75 million. We also continue to see operational efficiencies across the organization, as we have allied and focused our resources behind our key growth initiatives. Combining this improvement with our accelerating sales, we experienced a 90 basis point improvement in SG&A costs as a percentage of revenue which drove third quarter diluted earnings per share of $0.55 ahead of our $0.48 to $0.51 diluted earnings per share guidance. As we have done this, we have also created a powerful and focused transformational message around optical health and well being that has resonated across our business. This is helped us fuel excitement, energy and enthusiasm from our corporate team, our field leaders, and their clients. We're experiencing solid business momentum and we have never been better positioned for the future. As we discussed on our Q2 call, we hosted our largest ever convention in Dallas, Texas this past July. At this convention, we officially rebranded our Take Shape For Life business unit to OPTAVIA and completed the rollout of our essential line of OPTAVIA products. We've been extremely pleased with the incredible positive response we've received from OPTAVIA coaches and clients and directly translated into tangible results. Revenue through our OPTAVIA coach model posted the largest quarter in the company's history. The third quarter also represented a record number of active earning OPTAVIA coaches which grew for the first time to over 14,000. We have a powerful message with distinct exclusive OPTAVIA products, enhanced business tools and incredible focused OPTAVIA coach community working together to take our business to its next level of growth. Focusing on our Q3 operating results in more detail. OPTAVIA reported its eight consecutive quarter of year-over-year quarterly revenue growth, up nearly 18%. Sequentially, this was up from a nearly 11% revenue growth we reported for OPTAVIA for the second quarter of this year. We ended Q 3 with 14,200 active earning OPTAVIA coaches, an increase of nearly 11% over the third quarter of last year. In August and September, we set a new high mark for the company as more OPTAVIA coaches joined our coach community than at any two-month period in our company's history. During the third quarter, we also continued to generate increased coach productivity resulting from higher new client acquisition and a higher average order value year-over-year. Just a couple of weeks ago, I had the pleasure of attending the OPTAVIA leadership retreat held in Sundance Utah. This annual retreat brings together some of our most talented and successful business leaders from our OPTAVIA coach community. The retreat focused on building the leadership skills to enable our mission of bringing the world lifelong transformation one healthy habit at a time. It was wonderful to hear their inspiring stories of success and aligned together behind the fourth quarter and 2018 initiatives. We worked hand in hand with our OPTAVIA coach community to develop enhanced business tools and resources to make it easier for them to grow their business and connect with new clients. Beginning next month, we will launch phase one of a new digital technology platform created to help OPTAVIA coaches to be even more successful. The new system enables OPTAVIA coaches to share information more seamlessly, leverage social media content and receive real-time business activity insights to help the coaches manage their business and improve client interaction. With OPTAVIA, we've created a powerful transformational message that is easily shared and is both inclusive and appealing to the diverse demographics which we believe will enable to expand our OPTAVIA community and positively impact normal lives. Looking ahead, our OPTAVIA coach community is now stronger than ever and very well positioned to build upon the current business momentum. We 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. OPTAVIA coaches inspire others every day as they share our vision and mission of offering the world lifelong transformation, one healthy habit at a time. Last month we also moved into our new corporate office in Downtown Baltimore, Maryland. As Medifast continues to establish itself as a national leader in the health and wellness space we are pleased to join this growing business community. Our new headquarters will honor Medifast’s rich history and will serve as a destination and home away from home for OPTAVIA coaches from across the country who represent an integral part of the company's business and culture. Now let me move to Medifast Direct, the rate of the year over year quarterly revenue decline improved gain in Q3. Medifast year-over-year performance is no longer a significant drag on our overall revenue trend. Our team has been working to find the right balance of advertising spend, placement and messaging to ensure we have a sustainable model to acquire a growing number of customers that supports the long-term profitable growth of the business. We continue to test our Medifast Direct platform as a digital lead generation tool that will support our OPTAVIA coach community. This ongoing testing is an example of our emphasis to move our direct response and OPTAVIA units to an integrated business model for the benefit of our coach community and our clients. We believe that this alignment will help to enhance our long-term success and will facilitate the expansion into new markets over time. In summary, we're very pleased with our accomplishments thus far in 2017. As demonstrated by our operational and financial results, the strategic initiatives to evolve our business have begun to generate an accelerated rate of growth in both revenue and profitability. We have positive business momentum in our OPTAVIA business unit. And when combined with our scalable infrastructure and strong balance sheet we are well positioned for the future. With that I would like to turn the call over to our CFO, Tim Robinson.

Thank you Dan, and good afternoon everyone. In the third quarter, revenue of 77.2 million exceeded our expectations. OPTAVIA formally Take Shape For Life accounted for approximately 84.1% of revenue, Medifast Direct accounted for 11.3%, Franchise Medifast Weight Control Centers accounted for 4.3%. And Medifast Wholesale accounted for 0.3% of net revenue. Revenue in OPTAVIA increased 17.5% to 66.4 million from 56.5 million in the third quarter of the prior year. As Dan mentioned, for the record of active OPTAVIA coaches at approximately 14,200 in the third quarter compared to 12,800 in the same period last year, and 13,500 in the second quarter of 2017. Average revenue per active earning health coach for the quarter increased to $4,693 as compared to $4,421 in the third quarter of last year. We launched the remainder of the OPTAVIA essential product line in July. So nearly the full complement of OPTAVIA products were available for sale during most of the quarter. While we don't plan to specifically report revenues by brand on a regular basis. we thought it would be helpful at this particular stage to report that 45% of our total revenues in the quarter were comprised OPTAVIA branded products. Our Medifast Direct revenue decreased 3.7% to 7.8 million as compared to 8.1 million in the third quarter of 2016. Total Medifast Direct advertising in the quarter decreased 100,000 from 1.7 million in the third quarter of 2016. Revenue in the Franchise Medifast Weight Control Centers decreased to 2.8 million from 3.7 million in the same period last year. The decrease in revenues in primarily driven by fewer franchise centers in operation during the period. We ended the quarter with 35 franchise centers in two reseller locations in operation compared to 55 franchised centers and one reseller location at the end of the same period last year. Medifast Wholesale revenue which is mostly comprised of revenue from healthcare providers decreased to 200,000 compared to 300,000 in the prior-year period. Lower revenue is consistent with our previously communicated strategic direction. This business unit will be fully integrated into our OPTAVIA coach model during the fourth quarter of this year. Gross profit for the third quarter of 2017 increased 11.5% to 58.2 million compared to 52.2 million in the prior-year period. Gross profit margin as a percentage of net revenue decreased by 70 basis points to 75.4% versus 76.1% in the third quarter of 2016. This decrease in gross margin percentage was driven by an increase in manufacturing costs as a company is no longer building inventory for the OPTAVIA launch. As you may recall, we were over producing in the prior year to build our initial inventory of the OPTAVIA brand. Selling, general and administrative expenses in the third quarter of 2017 were 48 million or 62.1% of revenues compared to 43.2 million or 63% of revenues in the third quarter last year. The increase in SG&A was primarily a result of higher OPTAVIA commission expense based on the growth and success of our OPTAVIA coaches. Net income in the third quarter of 2017 was 6.7 million or $0.55 per diluted share based on approximately 12.1 million shares outstanding. Third quarter 2016 net income was 6.1 million or $0.51 per diluted share based on approximately 11.9 shares outstanding. Our effective tax rate was 35.5% compared to 32.7% in the third quarter of 2016. The increase in the rate was primarily driven by an increase in state income taxes for the period. Our balance sheet remains very strong with stockholders equity of 108.2 million and working capital of 89.1 million as of September 30, 2017. Cash, cash equivalents and investment securities as of September 30, 2017 increased 18.9 million to 95.7 million compared to 76.8 million at December 31, 2016. Our Board of Directors declared $0.32 quarterly dividend during the quarter payable on November 9. So turning to our guidance, we expect fourth quarter revenue to be in the range of 71.4 million to 74.2 million and earnings diluted share to be in the range of $0.46 to $0.49 per diluted share. We are therefore narrowing our 2017 full-year revenue guidance range to 295 million to 298 million and are raising our full-year earnings per diluted share guidance to be in the range of $2.15 to $2.18/ per diluted share. Our fiscal year 2017 guidance assumes a 33% to 34% of effective tax rate. 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 will come from Frank Camma with Sidoti.

I was wondering, I know Dan you gave some comments about international markets over time, is there something we might get more detail on early next year? Can you just tell us about the timeline as when you might be prepared to actually give a little more detail on it?

Yeah. This has been a pretty common question. Where we are at this point, is it in December. So next month, we will go live with our new platform that will be the final piece to enable us to actually make those decisions and we’ll make more specific announcements post December. We don't have an exact timeline at this point, but certainly as soon as we do, we will be sharing that with you.

Could you talk a little bit, I was impressed with the – obviously, I mean all the metrics are good here, but the productivity numbers that you achieved and you had a good number last quarter too. Can you just talk about the sustainability of that, because I know sometimes when you're growing coaches, you often get sort of a counter or a decline almost in productivity, since newer coaches tend to be a little less productive. Can you just talk about that relationship when we see that going?

Yeah. I think to your point, I mean there's typically a ceiling on productivity. Two things are happening. One, we're seeing the transition from the Medifast brand to the OPTAVIA brand among our coach community, those products have a slightly higher price. So a portion of that productivity is related to the higher price product, but I think the more important part of it which makes up the majority of that improvements relates to the communication and the excitement related to the launch of OPTAVIA. So while the number won't continue to go up, we should continue to see that number be at a very healthy level and maybe see a little bit more growth in the near future.

My last course just on, Tim called out the gross profit margin, which I think we had modeled correctly, but -- and obviously benefit of last year for utilization. Can you just tell us like where you are relative to utilization, your planned level, how we should kind of think about that going forward since that was a little pressure on the gross margin.

Sure. I think what you saw this past quarter is normal. I think what you saw last year this time was effectively as we overproduced, you have a higher level absorption of your overhead costs into your standard costs. So when volume goes up, it's a good thing for margins and it spiked. So our utilization of our plan is still under 50%, so there's a great opportunity I think to continue to improve margins with volumes. But I think it was more of a indication where we were last year this time than it is this year this time.

Our next question comes from Linda Bolton Weiser with DA Davidson.

So in terms of the OPTAVIA line, you rolled out the rest of the skews at the conference. Is that something where you're going to add more or over time or is this a full line and can you just explain how your innovation process works? So is this something where over a long period, you'll be flowing in new skews as to freshen up the line or maybe replacing? Is that process going to be something that's going to start or is this kind of it for the line for it for the time being?

Great question, Linda and I’d say that what we completed at the convention was the complete rollout of the line as it existed kind of from a flavor profile with Medifast. Now what you'll see is a consistent refresh. So as an example and these are fairly minor rollouts, but this is past several weeks, we launched two – several new snack products under OPTAVIA and we’ll continue to roll out products to keep the flavors kind of new and current and we’ll continue even from a brand extension standpoint to look at other categories that may fit our positioning of the health of wellness company.

And then if I'm doing the math right here in terms of your guidance for the fourth quarter. It does sort of imply that the direct selling revenue growth could be over 20% that it looks like by the numbers. So am I doing the math right on that?

Yeah. I mean, Linda, the consolidated revenue bottom end of the guidance is 14% l high end of the guidance is 19%. And the other business units have historically had a little bit of a drag. So certainly, your math is not off. It's certainly possible to be over 20%.

Okay And then it sounds like you’ve been, in terms of the Medifast Direct piece, you’ve been experimenting or adjusting or something the level of advertising spend and I think you said it was one 1.7 million. So should we consider that normal now or is that a number that's still going to go lower or how should we think about that spending level?

I think what you'll see in the future is probably around that level. Our biggest initiative for Medifast Direct is the testing we're doing to use Medifast Direct as a way of bringing new clients in for our coach community. So we've been working on that for several quarters. As we do that, it's possible once we kind of identify the key levers in doing that, it’s possible that we could wrap up again, but I think for your modeling purposes in the foreseeable future, we’re going to keep it about where it is.

And then just in terms of your cash balance, your cash flows, I mean it looks like it was pretty strong in the quarter, the cash balance is higher than I had projected. So you're really doing quite well on the cash flow front and you have your dividend, which you've increased. I remember somebody saying at one point that maybe you were kind of thinking about some sort of a, you want to maintain a 3% dividend yield. But as your stock has risen here, I wonder if -- is that still the terminology the way to think about it, because that would imply a very big dividend increase of like 40% if we were to look at a 3% yield on your stock now. So how should we think about the way the board and management is thinking about that?

Yeah. So Linda, we initiated the dividend at the end of 2015 and we initiated a 3% yield and last year, we raised to 28% and brought it back up to 3% yield. Those decisions for next year haven’t been made yet. That decision the board will evaluate coming up in December, but I think what we've said is that we would like to be a strong dividend payer and we have been ever since we initiated the dividend. So that exactly now hasn’t been determined, but I think the growth story with the strong dividend is a powerful combination.

And is that decision, is that typically announced in December?

The past two years, it has been so. The past two years, it was declared in December, payable in the first quarter.

And then just finally, I think you referred to the phase 2 of the IT platform, is it just two phases and then it will be completed and sorry if I missed it, but when did you say that was targeted to be completed, the phase 2?

Our projection is to go live December 1 and I think like any company who is selling online, it won’t be our final investment in IT, but this is a significant one related to the OPTAVIA launch. So, it has some important branded components that will be rolled out on December 1 that the coach community has been waiting for and then some basic enhancements on some of the general technology that we use to facilitate the business.

And then -- I'm sorry, that's the last one and that's the final. Is there another phase that has to be completed in 2018?

Yeah. That's phase 1. So this is not phase 2, this is phase 1 and this will be complete for what we needed to do on the front end, meaning we’ve upgraded our shopping cart as well as made it capable of being multi-country, multilingual, multi-currency. So those are the most important elements that we're updating. We're also giving our coaches a new back office, so essentially a way for them to look at and manage their business much more simple and much more information rich. So those are the -- there are also a number of other elements that will help them share their stories more effectively on social media. So this will be the most, the most important kind of technology introduction of the last year, but again, we'll continue to invest in our systems as we go forward to make sure that we meet the expectations of how we do business and how we allow our coachmen to leverage technology in our businesses going forward.

The next question will be from Doug Lane with Lane Research.

Looking at the third quarter, we had a nice beat on the top line and the full year top of the revenue estimate range came down a little bit. So did you lower the fourth quarter a little bit?

Yeah. So we're coming out of the third quarter very pleased with the momentum we have. Our guidance in the quarter implies 14% to 19% growth coming off of 12.6%. Historically Doug, we've been a little seasonal in the fourth quarter, so we’ll be looking year-over-year for as long as I've looked back, fourth quarter is a little softer, primarily because of the holidays and what we don't exactly know is we have very strong momentum right now, whether we can blow through that seasonality, but based on our modeling, which historically has seen some seasonality late in the fourth quarter, so we have that factored in.

Yeah. I mean, not to knit, but you had a really -- a strong convention and then you come out with a quarter in the third quarter that looks pretty solid, so you’re kind of wondering, it's the only, not finding the ointment, but the only thing that really stuck out was that why are we not raising full year numbers because it seems like things are really starting to get traction, but we understand and also I'm sure that you want to put a number out there that's very doable. So I don't think it takes away from the obvious strength in the business. Just shifting gears a little bit, Dan and thinking about the new IT platform and then the opportunity from there to talk about expansion outside the US. You’ve been there a year, can you talk about from a management infrastructure, where you are. I mean, it’s a big undertaking as you know from your previous life and I wonder from where we sit today, should we see one or two or more sort of high profile hires in the next year or so as you look towards moving overseas.

Yeah. We should expect to see that, as we determine exactly and finalize where we're going to go. As you're pointing out, it's fairly typical to start making those plans in advance of any announcements and in advance of an opening, certainly makes it a lot of work to do to get there.

Yeah. I'm just trying to -- we've been talking about it and we know it’s out there and I’m just trying to get a feeling for what the hurdles are between here and there, if you will?

Yeah. I think the major ones have been -- I think the first thing we’ve focused on is making sure that we have a platform technology, platform that's capable of supporting a multi-country, multi-language, multi-currency that will be complete with this rollout that we were just talking about. The other thing that's been happening is testing to ensure that our products; our pricing; our concept; our message are well received in the potential target countries. That's a completed portion of the phase -- what we need to do and the last thing that you're pointing out is getting the people too to manage that and I think that's the right next sequence and that's the way we're thinking about and looking at it as well.

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

Great. We would like to thank everyone for your interest in Medifast and appreciate the participation in today's call. We look forward to speaking with you again as we report our fourth quarter and full year 2017 results and have a nice evening.

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