Hello, and welcome to the Medifast Second Quarter Fiscal 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to your host today, Katie Turner. Please, go ahead.

Good afternoon, and welcome to Medifast second quarter 2019 earnings conference call and webcast. On the call 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 June 30, 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's 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 of 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. Thanks for joining us, and as always, for your interest in Medifast. I'll begin by providing a brief overview of our business performance for the second quarter, then Tim will review our financial results in more detail and share our third quarter and full year guidance. After our initial remarks, Tim and I will take your questions. This has been yet another transformative quarter for Medifast. We saw revenue growth of approximately 60%, which was very strong and ahead of the 55% growth we saw in the same quarter last year. This marks the ninth consecutive quarter of year-over-year revenue growth and the 10th consecutive quarter of sequential revenue improvement. The second quarter was the largest revenue quarter in the history of the Company, resulting in record diluted earnings per share, outstanding results to say the least. Powered by the strength of our coach, coaching-led model, the Company has been in rapid phase of growth which is reflected in the results we've shared today and during the past two years or so. As a management team, we're sharply focused on delivering sustainable shareholder value for the long-term as the business continues to develop and grow. We've been consistent in our view that we can double revenue every three to four years, and that we can continue to deliver on that goal well under the foreseeable future. We're investing wisely in our organization, our capabilities and our footprint to deliver on that goal. And today's results are yet another affirmation of the positive strategic direction we embarked on a couple of years ago. Our OPTAVIA Coach community continues to grow and develop every single day. We added more active earning coaches during the quarter, just completed, than in any other quarter in the Company's history.…

Thank you, Dan, and good afternoon, everyone. I'll review our financial results for the second quarter ended June 30, 2019, then I'll provide our third quarter guidance and discuss our 2019 outlook. As Dan commented, revenue in the second quarter of 2019 grew strongly, increasing 59.5% to a record $187.1 million from $117.3 million in the prior-year period. We ended the quarter with a record 30,600 active earning coaches, compared to 19,700 coaches in the same period last year and 27,200 coaches in the first quarter this year. Average revenue per active earning coach for the quarter increased 7.1% to $5,863, compared to $5,474 for the second quarter last year. Growth and productivity resulted in part from business initiatives, accelerating the 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 75% of our total Company consumable units sold in the second quarter, compared to 64% in the prior-year period. Gross profit for the second quarter of 2019 increased 58.5% to $140.7 million compared to $88.8 million in the prior-year period. Gross profit margin, as a percentage of net revenue, decreased 50 basis points to 75.2% versus 75.7% in the second quarter of 2018. The decrease in gross margin percentage was driven by higher product cost, obsolescence cost associated with a specific slow moving product and the cost of client with new FDA labeling requirements. It's important to note that we recently announced a price increase, effective August 1st, designed to bring our gross profit margin back to expected levels. SG&A for the second quarter 2019 increased $41.7 million to $113.4 million, compared to just $71.7 million for the second quarter of 2018, primarily a result of higher OPTAVIA commission's expense, increased consulting costs related to IT…

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Linda Bolton Weiser with D.A. Davidson.

So in terms of the higher IT spending in the third quarter is -- can you just give a little more color? Because you had been planning these various IT projects the whole year long, and we had put in some additional spending into the guidance for these types of things. So is it that something has gone awry with the implementation of the projects? Or are things taking longer? Or is the cost being higher than the budget? Or just give a little bit more color. And then also, if costs are going to be normalized in the fourth quarter, I had normalized in my model, so what is making me now shift the $0.30 of EPS from the third to the fourth quarter? In other words, why am I raising my fourth quarter by $0.20 or $0.30 a share in order to get to the annual guidance? What's going to be better than I would've expected, if you're saying costs will just be normalized, which I already had in my model? Thanks.

Sure. Linda, it's Tim. Yes. So a couple of things. So our ERP project is going -- actually it's going very, very well. The total expected spend for the project has not changed, but there's been a shift in the timing of some of that spend. The Q3 now will be kind of the pinnacle quarter as far as spend based on where we are now in the project plan. So we had looked at tangible go-live date in early Q4. We made a determination that it is a better decision now to make that go-live date in very early Q1. So we've shifted a lot of our testing work into the third quarter. So, the Q3 by far is a highest spent quarter. The spending starts to wind down in Q4. And there's -- there will be a little bit of spending in Q1 of next year, but not very significant. So we're on-track. The scope of the project has expanded a little bit more in the areas of supply chain that will help us with some efficiencies. There's been some delay in a few of the interfaces that were being built that has now -- just about now caught up. But there's definitely a little bit of a more spend focused in to the third quarter than the fourth quarter. And that differential is -- between quarters is about $1 million -- $1 million plus in Q4 than in Q3. That's kind of on the IT spend. The other side of things is, in Q3, we've messaged all along, that we have the cost of convention in Q3 in addition to half the cost of the International Leadership Advancement Trip. I know you were -- you actually mentioned, you saw that this is, by far, the biggest event…

Okay. So I haven't done the math, but that $3.5 million shift -- that's $0.30 or so, $0.25, $0.30 so whatever it is, per share of EPS, I guess, roughly?

Yes.

Okay, all right. So you also mentioned some labeling costs. Is this completely new FDA regulations or is this pertinent to some of the issues raised by a report that went out about mislabeling? So this is just new FDA requirements or is this to correct some of the labeling on your products? Thanks.

Yes. There's nothing wrong with the labeling of our products that I know of. This is a FDA regulation. It effects all packaged consumer food products. It's a change in the nutrition fact panel on all foods. So where you put the calories and where you put the percentage of different elements of vitamin A, vitamin D, all those kind of things. So every food manufacturer has to make this change. There's a deadline to make it. So you have to choose when to implement it. We've made a decision to implement that in July of this year. So starting with all products made from this point forward will have a new label on it. There was discussion about trying to phase it in, but the logistics of phasing are very complicated. There's slightly less cost if we phased it in. But what you're seeing is basically, all the packaging that's left over in our manufacturing operation that no longer can be used because it has the old nutrition fact panel on it. So it's a one-time event. This represents the full cost of all that packaging for every SKU we have. There'll be no ongoing cost associated with this. But it's aligned with the timing when we began to implement the new label. So one-time event.

And that was all in the second quarter, actually. Right?

Along the second quarter.

Okay, got it. And then, in terms of the app development, which is kind of tied to the international launch, I guess, I'm surprised, you said in a couple of months because I really thought -- I got the impression it would be maybe just in a few more weeks that it would be available. Are you just trying to be conservative, or do you really think it's going to be pretty soon? And if it's really is a couple of months from now, that's a couple of months after you've actually launched the international. So does that kind of somehow slowdown the -- I know you don't have anything in the numbers for international, but is it going to somehow flow the ramp though or impede the expansion of that initiative because that app is not available more quickly?

Hi, Linda this is Dan. The focus is to get it out in September. So that with the reference, it's a more specific day for you. And with regards to whether that slows anything down, the answer is no. We're rolling out -- we opened up the two websites and the English only right now. Those are -- will also be translated as we go forward. We're rolling out the material as we go forward. So this is the -- the app is one of many additional implementations that's going to be part of the opening period, but we're actively signing up coaches, signing up clients, shipping products. And the training is actively taking place in Hong Kong and Singapore by U.S. leaders and very soon to be taken over by the international leaders. We had -- as you know, because you were there at the convention, where we had our first two coaches from Hong Kong and from Singapore, the international convention, as well as a brief discussion from there -- the coaches who trained them. And so, I think it showed everybody kind of what the process is and what we've been doing to get ready for the opening. So we're very optimistic and feel good about what we've seen so far, including what you saw at the convention.

Okay. And just one last thing, can -- do you have to have a commission expense number in the quarter? I know you gave it in the Q, but do you happen to have that?

The actual number?

Well, you usually say in the Q how much it increased year-over-year in millions of dollars, usually that's what...

Yes, that'll come out tomorrow in the Q.

Okay. Thanks a lot.

Thanks, Linda.

Thank you. And the next question comes from Steph Wissink with Jefferies.

Good afternoon, everyone. I would like to unpack the productivity that you saw in the quarter, really nice, strong high single-digit gain. I think you suggested some business initiatives, if you could just extrapolate a little bit more on the growth and productivity, that'd be great.

Sure. How are you doing, Steph? This is Dan. Productivity is a function of a lot of things and started growing as almost immediately as we started to focus the message. So creating a simple, easy to communicate, focused message as part of that. It also has a lot to do with the training. So if -- as you know we have three, kind of, critical training events that start in October of every year with our advanced leadership training trip. Those -- that happens at Sundance, Utah. It's followed-up by the International Leadership Advancement Trip, which is part of an incentive trip, but also includes a lot of training. And then, the last one is the convention, which we just held, which is, in this case -- we had over 11,000 registered attendees. And so, each of those trainings plays a fundamental role of moving the message forward about how to communicate, about how to train the rest of the coaches outside of those events. And so, that training is a -- also a fundamental and critical part of it. Another part of it is the launch of our OPTAVIA brand, which took place two years ago. We still sell our Medifast-branded products, by focusing on the lifestyle brand that has some attributes that are very favorable to market trends, we believe that's also had a -- had been an important health. There's been a small portion of that improved productivity that has to do with the prices -- the higher price associated with OPTAVIA products, but the majority of it is those other things that I mentioned.

Okay, that's great. And then, two more tactical questions. One is on your comments on cost inflation. So if we back out the pieces that Linda asked about on the growth margin side, on the FDA labeling, and I think you mentioned some obsolescence as well, but if we just look at the higher product costs, how should we think about inflation over the course of the next six to 12 months? And then your pricing increase going into effect today, how should -- how does that compare to the anticipated inflation over the course of the next year?

Sure. So our -- if you think about our long-term goals, we've laid out pretty clearly we're -- we anticipate about a 76% gross profit margin now through 2021. And you can see, the past couple of quarters we've been slightly below where we'd like to be, and we knew that we planned to implement a price increase truthfully from the beginning of the year. We were trying to find the right timing to do it. So part of the slowdown, I'll say, in the gross profit margin, was really a delay in this price increase. So what'll happen is, when we do the price increase, you'll see our margins bounce back. I'd anticipate for Q3 that our gross profit margin will be in excess of 76%, and that we hope by the end of the year, we may be able to bring the annual gross margin back to that 76% level. So it's really intended, really just to bring us back to those levels. So for -- potentially depending on what our long-term inflation is in product cost, the margins could exceed 76% next year. We don't have clear line of sight to inflation in the first half of next year, but we did have some very specific products, primarily products that we don't manufacture, like bars. We use partners to manufacture. We had cost increases that came into beginning of the year and effected, primarily, a little bit of the second quarter more than the first quarter. So we view this as bringing on our gross profit margins back to the desired levels. It may bring it back a little bit higher than that.

Okay, that's great. And last one for us is just on the buyback. I think you mentioned 71,000 shares in the quarter, almost 600,000 left in the program. How should we think about capital allocation with the stock having pulled back quite substantially? How do you prioritize the use of that buyback program opportunistically? Thank you.

Sure. So we've talked about our capital allocation strategy in kind of three components, primarily two. Right? So we've demonstrated, over a number of years, that we've given back to shareholders the majority of our free cash flow. So I think the correct measure is over five years, about 70% of our free cash flow. When we initiated dividend in 2015, we began to focus a little bit more on the dividend, attracting some different mix in our shareholders. And our dividend, today, is very strong, as you know, we've increased it numerous times. But along with that, we've been very successful in our business. We've generated a lot of cash flow, and we've been supplementing the dividends with buybacks. And we've been spending a fair amount of time with our Board as well talking about the cadence of those buybacks and what our long-term strategy will be there. What you've seen so far is not a consistent rhythm of buybacks. You've seen more opportunistic buybacks, but that is something we're definitely thinking about for a long term. We have very, very strong cash flow generation, and we want to make sure we're using that cash in a way that gives our shareholders the best value. So I think you can continue to expect buybacks from the Company. You can continue to expect to see strong dividends from the Company. And that's primary use of our cash flow. We're not very capital intensive, a little bit more this year than most years with the expansion of manufacturing, but we're not that capital intensive. So we expect to use it primarily just to drive shareholder value.

Great, thank you.

Thank you. And the next question comes from Doug Lane with Lane Research.

Hi, good afternoon everybody. While we're on the subject, Tim, do you have a CapEx number for this year with the added spending that you're doing?

Yes. We estimated our CapEx to be about $15 million for the year.

Okay. And will we see something similar to that next year or will it start to come back to more traditional levels?

It'll roll back to -- I'll say, proportionally, more historical levels to -- the CapEx this year -- the unusual CapEx is in our manufacturing operation, which is just building capacity in our distribution center in Maryland building capacity. So those'll be -- those projects will be completed this year.

Okay, thank you. Moving on, I want to see what changed over the last three months because I don't think people are expecting the lumpiness in the quarterly EPS growth that you're telling us for the third quarter. After going 50% plus in the first half then mid-to-high teens in the third quarter then back to 50% plus in the fourth quarter. So I know you had a bigger convention this year, everybody expected that because you've got more coaches. And you said you're going to redo the ILAT trip. So did anything change on convention expenses and the ILAT trip from where we were three months ago?

The expense associated with the convention is a little bit higher than what we would have expected three months ago. The logistics associated with the venue were a little bit more challenging. It kind of a good problem, right, is that we planned these events and these locations years in advance and the sheer numbers of people challenged us in this particular venues. So we had to bust people around. We had to have A and B track sessions with duplicate resources. So fortunately, with next year, with Atlanta, you can see we have a venue that will hold over 20,000 people, everybody in a single venue. So we thing on a percentage of sales basis, the convention will be able to return next year to more historical levels. Now we knew to some degree, convention was going to be more expenses, don't get me wrong, but where we able to get some leverage is with ILAT, last year was our first year, very successful. This year we raised the bar as far as the qualifications to reach that event. And so, on a percentage of revenue, the cost of ILAT's going down. So in the third quarter, you have kind of two things going in opposite directions, you have convention, a higher percentage of revenue than prior years; you've got ILAT, a lesser percentage than last year; and then in the fourth quarter, the only thing left is ILAT, which is a lesser percentage. And that's why fourth quarter looks so much stronger than the third quarter. It's really just the timing of how those two things play against each other.

But it sounded like the biggest delta versus three months ago was the ERP moving around of those expenses, where you were going to go live early fourth quarter. And now it sounds like you moved that too early Q1. And so, does that mean some ERP spending in the fourth quarter is now going to be in the first quarter of next year, in addition to the third quarter having more because you're moving up testing projects?

Yes, that's exactly right, Doug. I mean, we will -- we'll have a little spillover in the 2020, less than $1 million, a little spillover due to the go-live date being Q1 that cost -- again, a relatively small percentage of the total cost. But the other thing is that, when you delay -- when you change your timing of the event you start to focus on different things, and we were able to pull some things into the project in Q3 that we didn't originally think we were going to be do as far as capabilities go, and we made that decision back in June. So that had an impact on the actual spend in Q3. We think it's definitely the right thing to do for the business. Our total budget for this year will be in line with what we've been forecasting since the very beginning of the year. We feel really good about it. But you're right, that's the timing of spend, but our full year spend will be right in line with what we said we were going to do.

Okay, all right. And just shifting gears on inventories here, they've been up for the past three or four quarters, and I get the explanation in the verbiage here. But just going forward now with international opening and the launch of the new system, should we start to see inventories come down now in absolute dollar amount beginning in the third quarter?

Yes. We're very much focused operationally on improving our inventory turns. When you're growing at the rates that we were growing last year, you can imagine, the one thing you don't want is to not have enough inventory and that stopped their momentum. So we were building inventory at very rapid rates to make sure that didn't happen. And we were fortunate we did that. Right? Because we had what we needed to support the business. We think we locked in a little bit on what that momentum, that trend looks like right now. We're focused on improving our turns. This particular quarter, we had to build international for the first time. We switched over to the new habit to health system and I think that we had double inventory, right? We had inventory, the old habit to health systems and a full production run of new habits to health system, and that was -- that's pretty substantial as well. So I think you won't see necessarily the gross dollars grow much. We're focused on improving the terms and -- but, proportionally to the business, as the business grows, inventory will grow and roll dollars. But we feel that the inventories are at -- I'm not -- certainly not saying at the maximum level. We feel we can improve our turns and inventory, and we're focused on doing that.

Okay, that makes sense. Thanks.

Thank you. And as there are no more questions, I would like to turn the floor to management for any closing comments.

Thank you, and thank you all for your continued interest in Medifast. I think this completes an important milestone for us this quarter as we set a goal to exceed 30,000 coaches two years ago. We did that in half a year ahead of our anticipated 2019 close, as a reflection of the incredible work that our coaches do day in and day out. So we, now, as the management team are firmly turning our focus on the next set of goals, which we'll focus on, by the end of 2021, achieving 50,000 coaches, $1 billion in revenue and continuing to leverage our operating structure to deliver 15% or better operating margin. Overall, we feel like as the management team we'll continue to deliver on those goals in the predicable way through our repeatable business rhythm, and we're very focused on delivering long-term sustainable growth to our shareholders. So thank you for your participation and your investment in Medifast.

Thank you. This concludes today's teleconference. Thank you for attending today's presentation. You may now disconnect.