Medifast, Inc. (MED) Q1 2019 Earnings Report, Transcript and Summary

Good day and welcome to the Medifast First Quarter 2019 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 today’s 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 first quarter 2019 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 ended March 31st, 2019 that went out this afternoon at approximately 4:05 P.M. Eastern Time. If you've not received the release, it's available on the Investor Relations portion of Medifast website at www.medifastinc.com. This call is being webcast and a replay will be available on the company's website. Before we begin, we'd like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. The words believe, expect, anticipate, and other similar expressions generally identify forward-looking statements. These statements do not guarantee future performance and, therefore, undue reliance should not be placed on them. Actual results could differ materially from those projected in any forward-looking statements. Medifast assumes no obligation to update any forward-looking projections that may be made in today's release or on today's call. All the forward-looking statements contained herein speak only as of the date of this call. And with that, I'd like to turn the call over to Medifast's Chief Executive Officer, Dan Chard.

Thank you, Katie. Good afternoon everyone. We're pleased to be with you to discuss Medifast's first quarter 2019 results. I will begin by providing a brief overview of our business performance. Tim will then review our financial results in more detail and share our 2019 second quarter and full year guidance. Finally, Tim and I will be available to answer any questions. Our first quarter results continue to show strength and momentum as we lapped Q1 2018's 40% year-over-year growth and maintained focus on building the business fundamentals and the operational foundation to deliver against our long-term growth objectives. Through our partnership with OPTAVIA Coaches, we continue to support clients on their journey to achieve optimal health and well-being as we pursue our missions to offer the world lifelong transformation, one healthy habit at a time. Revenue and profitability exceeded our expectations for the quarter. Our revenue grew 68% to $165.9 million. This marks the eighth consecutive quarter of year-over-year revenue growth and the ninth consecutive quarter of sequential revenue improvement. The first quarter was the largest revenue quarter in the history of the company, resulting in record quarterly diluted earnings per share of $1.70, ahead of our first quarter guidance of $1.50 to $1.55. Our financial results for the first quarter are supported by a record number of active earning OPTAVIA Coaches and record productivity per coach. We increased active earning coaches by 3,100 over last quarter, ending the first quarter with a total of 27,200, which represents an increase of 63% year-over-year. Average quarterly revenue per OPTAVIA Coach increased 10% compared to prior year period to $5,817. We believe we remain well on track to achieve our goal of having in excess of 30,000 OPTAVIA Coaches by the end of 2019 and 50,000 active earning coaches by the end of 2021. As a result of our solid start to the year and our confidence in the business, we are raising our annual guidance which Tim will review. Our successful first quarter can be attributed to our success in aligning the organization and field leadership behind a repeatable business rhythm, focused on achieving our long-term growth objectives. Our integrated coach model, along with the continued development of our OPTAVIA product platform, creates a strong foundation for continued business growth. We now have a full complement of OPTAVIA-branded consumable products to help our coaches build personalized plans to support clients. By leveraging our brand, scientifically proven plans and our Habits of Health system, we believe we can significantly extend our impact to our unique solution for those seeking change -- seeking to change their lifestyles to achieve improved health. We also believe there's a substantial opportunity in adjacent categories as part of our holistic approach to health and wellness. Our product development and marketing teams remained focused on delivering products that support healthy habit creation, working in tandem with our independent OPTAVIA Coaches to develop solutions that meet the needs of coaches and clients. Accelerating the success of our OPTAVIA Coaches will be essential to our growth over the next several years. And with that in mind, I'd like to review a few recent highlights that demonstrate our continuous efforts to align our corporate team with OPTAVIA Coaches as we work together to continue to execute on our strategic growth initiatives. In March, we hosted our first International Leadership Advancement Trip. This highly successful and new qualifying event was designed to reward business leaders who exhibited specific business development skills. It included trainings and development opportunities to further expand and advance the businesses. We had approximately 2,500 coach leaders and guests who qualified to attend this weeklong event. While this trip was largely to recognize our coach leaders for their excellent performance, the most important objective of this leadership event was to create alignment with this key group of leaders around our goal to move our mission forward by doubling the number of active earning coaches to 50,000 by the end of 2021. We look forward to hosting another International Leadership Advancement Trip again in 2020 to continue the training of our growing community of OPTAVIA business leaders and to focus together on achieving our long-term goals. OPTAVIA business leaders are the foundation of our domestic and international expansion strategy. In the first quarter, we continue to prepare for our upcoming international expansion into Hong Kong and Singapore. This includes investments in areas such as technology, supply chain, and the talent to support our long-term growth opportunities. Among other foundational technology initiatives, our technology teams have been hard at work readying our new mobile application for our launch into our two international markets at the end of the second quarter. Once we successfully implement this new model platform internationally, we will launch it into the United States. We are proud of the significant progress and technology we are making to support our scalable business model in the United States. In late February, we successfully launched our new scalable e-commerce platform. This new state-of-the-art cloud platform will improve our coach and client experience domestically and will also enable both multilingual and multicurrency capabilities, further preparing us for our international expansion plans. While the software of this new e-commerce platform is functioning as designed, we did experience certain acute challenges related to data conversion that resulted in an increased level of client inquiries, causing lower than normal service levels in March and early April. Specifically, all wait time escalated as both clients and coaches sought help managing through data challenges and addressing specific functional changes from our old platform. Our team acted swiftly by adding temporary personnel in April to bring the service levels back in line with our standards. Importantly, we do not believe this transitory issues had any material impact on our revenue or profit for the quarter, nor do we believe it impacted our OPTAVIA momentum or outlook. To support our business fundamentals and momentum, in early March, we also started to prepare for a new enterprise resource planning system, a leading cloud-based ERP platform that will enable our finance and supply chain functions to support our rapidly growing business for years to come. This important initiative is expected to be completed by year-end at an estimated SG&A cost of $5 million to $7 million in 2019. These investments are important to support our business momentum in the United States and our expansion internationally. Related to our international opening plans, I'm excited that, by June 30th, we'll be ready to sign up our first clients and coaches and ship our first orders to our new markets. I want to reiterate that our expectations for this inaugural year in these new markets is modest as our business model focuses on building a base of clients who are successful in achieving their health goals, and then developing a portion of those clients and successful OPTAVIA Coaches. Over time, we believe these markets will be an important part of our growth story. In the meantime, our teams will continue to expand significantly in the United States and leverage our domestic success to build on our business outside the United States. Medifast remains well-positioned to deliver long-term sustainable growth and value for our shareholders. Going forward, we expect to generate future growth by focusing on five key areas: first, continue to develop and refine our integrated coach model by focusing our message and aligning with our coach leaders; second, hire and train our expanding team of employees and partners who are dedicated and focused on delivering on our mission; third, leverage technology to optimize business efficiency; fourth, drive product innovation in support of our mission; and fifth, expand into new demographic segments and geographies. With this in mind, our team remains committed to our three-year goals to grow revenue to $1 billion; achieve operating margin of 15% or better; and grow the number of active earning coaches to 50,000 all by the end of 2021. Our 2019 guidance that Tim will share is reflective of our confidence in our ability to continue to grow the business to achieve these long-term objectives. In summary, we are incredibly pleased with our start to 2019. We're excited by Medifast's prospects over the coming years and believe we are well positioned as an innovator in health and wellness with differentiated products that can enable us to address a large and increasingly -- increasing market opportunity around the world. We have a strong balance sheet and cash flow to support our growth for many years to come. With that, I would like to turn the call over to our CFO, Tim Robinson.

Thank you, Dan and good afternoon everyone. I'll review our financial results for the first quarter ended March 31st, 2019. Then I will provide our second quarter guidance and discuss our 2019 outlook. As Dan commented, revenue in the first quarter of 2019 exceeded our expectations, increasing 68.2% to a record $165.9 million from $98.6 million in the prior year period. We ended the quarter with a record 27,200 active earning coaches compared to 16,700 active earning coaches in the same period last year and 24,100 active earning coaches in the fourth quarter of 2018. Average revenue per active earning coach for the quarter increased 10.2% to $5,817 compared to $5,278 for the first quarter of last year. Growth in productivity resulted in part from business initiatives, accelerating number of new coach conversions and new clients starting our plans, aided by the ongoing transition to higher-priced OPTAVIA products. OPTAVIA-branded products represented 73% of our total company consumable units sold in the first quarter compared to 58% in the prior year period. Gross profit for the first quarter of 2019 increased 67.3% to $125.1 million compared to $74.8 million in the prior year period. Gross profit margin as a percentage of net revenue decreased 50 basis points to 75.4% versus 75.9% in the first quarter of 2018. The decrease in gross margin percentage was driven by higher obsolescence and shipping costs. Selling, general and administrative expenses for the first quarter of 2019 increased $40.3 million to $100.4 million compared to $60.1 million for the first quarter of 2018 primarily as a result of higher OPTAVIA commissions expense, increased salaries and benefits, consulting costs related to IT projects to support our future growth, and increased credit card fees resulting from higher sales. SG&A as a percentage of sales decreased 50 basis points to 60.5% of total revenue compared to 61% in the first quarter of 2018. As OPTAVIA revenue increased in our overall sales mix, the commission rate as a percentage of total company revenue increased 340 basis points to 41.3% of total revenues in the first quarter of 2019 compared to 37.9% in the first quarter last year. We have been able to more than offset this increase, along with strategic investments Dan mentioned earlier, with the operating efficiency we have in other areas of SG&A. Our effective tax rate was 17.1% compared to 18.1% in the first quarter of 2018. This decrease is primarily a result of a 2.4% decrease related to the discrete accounting for taxes associated with share-based compensation, offset by a 3.5% benefit from a state net operating loss due to state apportionment. Net income for the first quarter of 2019 was $20.8 million or $1.70 per diluted share based on approximately 12.2 million shares outstanding. First quarter 2018 net income was $12.2 million or $1.01 per diluted share based on approximately 12.1 million shares outstanding. Our balance sheet remained very strong with stockholders' equity of $122.1 million and working capital of $92.4 million as of March 31st, 2019. Cash, cash equivalents and investment securities as of March 31st, 2019, increased $19.4 million to $120.4 million compared to $101 million as of December 31st, 2018. The company remains free of interest-bearing debt. Inventory increased $4.4 million to $43.3 million as of March 31st, 2019, compared to $38.9 million at December 31st, 2018 due to an intentional effort to maintain inventory levels to meet current and future demand. Our Board of Directors declared a quarterly cash dividend in the first quarter of $9.1 million or $0.75 per share payable on May 7th, 2019. The company did not purchase any shares during the first quarter. There are approximately 665,000 shares of common stock available for repurchase under our existing share repurchase program. Our management team and Board of Directors remain committed to enhancing the value for our shareholders. Turning to our guidance, we expect second quarter revenue to be in the range of $180 million to $185 million and earnings per diluted share to be in the range of $1.67 to $1.72 per diluted share. For the full year 2019, we are raising our guidance and now expect revenue in the range of $720 million to $740 million and earnings per diluted share to be in the range of $6.70 to $6.90 per diluted share. Our fiscal year 2019 guidance assumes a 21.5% to 22.5% effective tax rate. We do not expect our international activities to be material in 2019, and we do not anticipate reporting these results separately during the year. We expect the 2019 cadence of spending to be similar to 2018, with our annual convention spending occurring in the third quarter of the year and the cost of 2020 leadership advancement event to be incurred in the third and fourth quarter of the year. 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?

We will now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Frank Camma with Sidoti. Please go ahead with your question.

Good afternoon guys. How are you doing? Can you hear me?

Yes.

I'm sorry. My first question is just on the commission percentage which is now sort of more in line with where I see other direct sellers. You mentioned, Tim, it's because of the OPTAVIA. Now, the question I have about that is it's a more premium-priced product obviously. So, why just would that increase the premium? Did you change your commission formula? Or did you -- are you promoting certain products that would therefore drive up the percentage rate?

No, Frank, it's primarily related to the mix. As you know, we still have a small amount of Med Direct revenues, a small amount of--

Okay. So, you were talking in relation to total right now?

Yes, yes. So, our commission with revenues have grown. That's all. If the rate itself is--

Yes, okay. I think you meant in relation to just OPTAVIA revenue. I'm sorry. So--

No, that rate is stable.

Okay. Which kind of brings me to my second -- one of my other questions which is, obviously, it's very small now. It's like, what, 4.5% of revenue is sort of your other category, right? If you just do the math, the productivity times coaches comes about 1 58 of your total revenue. So that means the rest of it has to be Medifast Direct, your franchise revenue, et cetera. How do you -- I know you're not advertising really Medifast Direct, you're not pushing that. But how do you deal with the other revenue that you kind of contractually obligated to -- like the centers is what I'm talking about, like are you still actively supporting those centers? I guess if you just walk us through that, how that goes into the whole equation.

Yes, Frank. This is Dan. The answer is yes. We do -- we have continued to actively support those centers. We've had several of them convert to the coach model, so those naturally transition over, but those who remain; we continue to supply Medifast product to them.

Okay. So, they, in theory, could have OPTAVIA products then now, right, if they converted over?

Yes. Yes. If a center converted to the coach model, which means they would transition away from having a fixed location and transition their employees to be coaches, then they would have OPTAVIA-branded products. But for those who remain in the traditional Medifast weight management control centers, they only sell Medifast-branded products.

Okay. So, now you're -- up to 77% of your total revenue is OPTAVIA. What's the plan to really -- I assume Medifast Direct obviously has to stay on, whatever that is, it's such a small percentage of your revenue. And what's the plan to really phase out the rest of it? Or do you not have a plan because some of these historical health characters really like a certain product, for example. Just trying to figure that out.

Are you talking about the percentage of the units sold that are OPTAVIA-branded?

Yes, yes exactly. Or that are still legacy products for whatever reason, like a Medifast product. Like will it ultimately be 100% of your revenue will be OPTAVIA? Or will -- at some point or like does that Medifast brand go away in that channel ultimately?

Yes. We haven't -- I mean, while we have franchisees who we are supporting, there will be a Medifast brand. So, we're committed to meeting those obligations. As we said I think late last year, we talked about the next phase of testing for us related to our Med D business. It was looking at how we could convert those efforts from a direct-to-consumer to a client acquisition model for our OPTAVIA Coaches. So, in that case, we would use those advertising dollars to acquire a new client and turn them over to coach where we believe we will get a higher lifetime value and create more consistency with our coach model. So, that's something we've tested the messaging, and we'll continue to get closer to that eventual change over as we prove out that model.

Okay. Last quick question and then I'll hop-off. Just you saw a bit of, I don't want to say, stall but sort of flat line in productivity last quarter sort of sequentially. But now you saw a nice pop again to like a record. So, was that just another beneficial mix? Or was there something else unique that we should know about this quarter itself given that Health Coaches went up pretty sharply. Typically, I would expect actually some dilution there.

Yes, we continue to internally model to flat, which is what we've communicated before. But we continue to invest in initiatives to help improve productivity. And those initiatives include everything from simplifying our messaging in the field there also, streamlining their training. But there's nothing -- I mean, it's a lot of small things working together to help focus coaches on making it more simple to be a coach. So, there's not any one specific thing that we would point to, but more tied to a continued effort by both our coach community and coach leaders and the company in creating simplicity and focus and making it easier in terms of how they support clients.

Great. Thanks guys.

Thank you, Frank.

And our next question comes from Linda Bolton Weiser with DA Davidson. Please go ahead with your question.

Hi.

Hello.

So last quarter, you had talked a little bit about some intentional strategizing maybe by coaches to delay some sign-up of coaches because they would have more success gathering clients after the holidays. Is there any portion -- or can you quantify how much of the coach growth that you saw in the quarter could have been due to some of that delay, I guess, in signing up some of the coaches?

No, we really don't try to quantify it. The comment was really to kind of explain what the seasonality is. It's not that -- I mean coaches are continuing to support their clients, but the comment was that for those clients who are ready to become coaches, they often will have them wait until the new year to do that. But I mean all we look at is the seasonal slowdown as you go into the fourth quarter, which is still -- which we still -- we're still able to achieve a sequential improvement. But we don't try to model how many prospective coaches delay and move in. It's just a behavior that we're aware is out there. But there are many coaches who come onboard and are successful. It just happens to be the practice of some to focus on waiting until after the holidays to have their clients, the prospective coaches become coaches.

Okay. And then when you just look at the number of coaches, I mean, let's see, you added -- looks like almost around 3,000 sequential adds since the fourth quarter. And so your coach growth sequentially was about 13%. So, when you think about a 25% CAGR of coach growth, that really correlates to 6% to 7% sequential growth if you do the math. So, I guess I'm just wondering, it just can't continue to be this high growth forever. Is there any way for you to gauge or for you to be able to tell us at what point you'll settle into a normal cadence of just 5% to 6% sequential coach growth?

I don't think we -- I mean our focus is on making sure we have healthy coach growth, and we're not -- I mean we're providing to you what we think are -- well, not what we think, we're providing to you our long-term goals which are the ones that you described. And you're right. I mean if we continue at this rate, we'll -- we would exceed those initial growth long-term growth goals. But right now, we're focused on ensuring that we support the coaches and the clients in the best way and focus on and see the improvement work out. So, not really a projection for a slowdown per se, we're just looking at this quarter-by-quarter.

Okay. And then maybe I misunderstood, but I think one of you said in your remarks that you are shooting for achieving an operating margin of 15% or better. Whereas, I kind of thought your objective was that you could get to 15%, but any kind of upside from there, you envision reinvesting back in the business. So, are you changing the message a bit or did I just misunderstand what you said?

No, the message really hasn't changed. I think what we're trying to get across is that we think the business would run at a very healthy pace, at around 15%. We will seek opportunities to invest in future growth, however, to kind of keep the business growing at a very healthy pace. So, that's kind of where we've established our target at 15% or better but in no way did we mean to imply a change in any way in that communication change of strategy.

Okay. And then finally -- well, actually two more, if I could. The first one is when you mentioned the $5 million to $7 million of investment in your ERP system, is that -- like, in other words, we should expect higher SG&A expense than we otherwise would have? Or is that kind of always been in the plan for the year?

Yes, we called that out in last quarter's earnings call as well. We just thought that was a big enough amount that's discrete enough we should call it out. That's not a recurring event on an annual basis, but it is factored into our guidance for the second quarter and also for the year. But we just want to give some color around it's a fairly large project for us; it's not recurring normal operating expense.

Okay. And then last one, the -- in terms of the international rollout. When we think about the Health Coaches in Hong Kong and Singapore, will we first see that they will be clients first? Or could we have coaches first? And if we have coaches first, how is that possible? Is that because there's already been clients there and you'll be converting them to coaches? Or how is that going to work exactly?

Yes. We -- so they'll all start out as clients. As you know, the amount of time that somebody stays a client depends on what their health goal related to weight is. So we're not -- I mean, we're not signing up -- we won't be signing up coaches immediately, although there's nothing -- just like in the United States, to prevent somebody from buying a coach kit. But that's not our model. Our model is the one you're describing, which is to become a client first, create your own health journey, and then for those who decide they want to pay it forward and help other people achieve their transformation -- their health transformation, they become coaches and start to acquire clients. So, we're not sure exactly what that timing and process will look like compared to what we've seen in the United States, but we do know that we're focusing on creating the same model. In fact, the coach -- our coaches in the United States are the ones who will -- they'll be going out and doing the training. So, based on that, they'll be using the same model. We do have what we're describing as a coach candidate program that's been running for several months, which does allow some coach candidates to become clients and use product that is provided by our local office. And so some of those people are already -- we think about that as kind of end-market research and testing to allow some of those early-stage interested clients to experience the product and for us to get feedback from those clients.

Okay, sounds good. Thank you very much.

Thank you.

Thanks Linda.

[Operator Instructions] And our next question comes from Doug Lane with Lane Research. Please go ahead with your question.

Hi, good afternoon everybody. Let me start with the -- on the coach productivity numbers, which as we've seen have been very strong in the double-digits the last five or six quarters. Now, you're starting to anniversary higher numbers, and that number year-over-year is coming down. And it should, right? I mean we shouldn't have this kind of productivity be sustainable. We should be modeling productivity coming down to a more normal, I don't know if I want to say inflation, but something in low single-digits, mid-single-digits as a more sustainable kind of number.

Yes, I think to some degree, it's a little bit of science of large numbers. I think the numbers -- the value of the productivity growth is still very large. But you're right; we are overlapping the quarters last year where we saw significant growth. I think the fourth quarter; we saw 26% growth, this quarter about 10%. And we don't -- we've talked about modeling that flat sequentially because it's a very hard thing to predict. We know we're doing a number of things that should help coaches be more productive, but it's very hard to quantify what that might be in the future. So, although probably somewhat a little conservative, we think it's kind of the right way to think about the next quarter as opposed to kind of estimating a continued high rate of growth.

Yes, I mean you also had a -- I don't know if I want to say pent-up demand, but you had a sales force that had various constraints because of how your company was structured. And they were kind of unleashed, and so we did see sort of a spike in that productivity with everything that you're doing, which is all good stuff as far as developing healthy direct sales organization. But it was definitely an unsustainable kind of number to be in the 20s like that. And so 10% this quarter. And if I'm modeling out this year, I should be coming out of the year in the single digits, right?

Again, we don't really model that out, but my guess is, again, it will be in a similar rate as what we're seeing right now. But we don't have a great way to predict that. We don't see much of possibly for downward movement, but that's very hard for us to estimate where it's going to go. It is a number, to your point, though, at some point has a ceiling on it. We have yet to find it.

Okay, fair enough. And just one more thing on productivity, in listening to your discussions now we're starting to think about how the international numbers are going to come in, in the second half of the year, and it's helpful to fix your clients first then coaches. And I don't know if you know the answer or not or if you have any kind of assumption on where do you think international coach productivity will be relative to U.S. coach productivity. So, in other words, if you do start to get traction this year, next year, whatever, will that dilute the coach productivity number which you'll probably continue to give in aggregate company-wide, right?

Yes. Frank, I think the answer is we don't know with any great degree of precision, but what we do know is that the training is the same, the plan that we are using, meaning what we described as the OPTAVIA 5 & 1 Plan is the same. The products are unchanged and end markets, in these markets, the problem is equally acute in terms of talking about the need from clients or prospective clients who are overweight or obese and start by focusing on achieving their healthy weight. So, there's no reason to say that it will be different and yet there's always the possibility that we'll see some different nuances in the market. We just have to get a little bit of data behind us before we kind of definitively say whether it's the same, higher or lower.

I guess you know where they're being priced and these are dollar-paid currencies, right, Singapore and Hong Kong? So, are they being priced on parity with the U.S. product?

Slightly higher because there's some differences in how expensive it is for us to operate there. So, we're focused on keeping them within a pretty tight range. We don't want to create price disparity because we don't want to encourage any kind of diversion. So, we're keeping the pricing structure relatively intact. And as you know, our pricing structure is very simple, so we don't have -- we have Fuelings and they're all priced essentially the same. The products we're launching there are reflective of that single price point. We're not launching the Medifast brand, for example, so there aren't two tiers of pricing.

Right, that makes sense. And then just one last thing. Shifting gears to the gross margin where it's been down a little bit year-over-year in three of the last four quarters. And so again for an outsider modeling is it safe to say that gross margins in the near-term with this kind of strong growth could be down for the rest of the year? Or is this just sort of a one-time thing and they should get back to expanding as soon as the second quarter here?

Yes, I think we expect to see the gross margin rebound. I think there's a couple of discrete things this quarter and there's also some discrete things in the fourth quarter that I think were somewhat unusual by nature, some of it caused by just the extreme amount of growth that we've had. But they are discrete things that we don't expect to repeat. So, I think you'll see a rebound in the gross profit margin.

Okay. Thank you.

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Dan Chard for any closing remarks.

Thank you and thank you for all those who were able to join today. We extend a specific appreciation to all of our OPTAVIA Coaches around the country. Tim and I will look forward to speaking with you again when we report our second quarter 2019 results. Have a great evening.

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