Medifast, Inc. (MED) Q2 2020 Earnings Report, Transcript and Summary

Good afternoon. And welcome to the Medifast Second Quarter Fiscal 2020 Earnings Conference Call. All participants will be a 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 Scott Van Winkle. Please go ahead.

Good afternoon, and welcome to Medifast's second quarter 2020 earnings conference call. On the call with me today are Dan Chard, Chief Executive Officer, and James Maloney, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ended June 30, 2020, 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'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 identified forward-looking statements. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon 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 call. All the following 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, Scott, and good afternoon to everyone joining us. Thank you for taking time to be with us today. On the call with me today is Jim Maloney, who recently joined us as Chief Financial Officer. Jim brings the Medifast great experience as public company CFO, as well as an International Operating and Food Industry Expertise. With years spent in businesses including LB Foster company, First Insight, HJ Heinz and Ernst & Young, Jim will bring important insights and understanding to the business. And I'm very pleased to introduce him today. And we're all excited that he's joined the team. After I've provided some updates on our business performance over the course of the last quarter, Jim will review the Q2 financial results in more detail. We'll then open up the call to take your questions. I'm pleased to say that Medifast had a strong second quarter as the trends we saw in April accelerated during the period. Revenue increased 80% to $220 million and non-GAAP adjusted earnings per diluted share increased 12% to $1.96. This growth is driven by robust year-over-year and sequential improvements in the number of active earning coaches, with 36,500 coaches at the end of the quarter, which was a new record level. Productivity per active earning coach also increased during the quarter to $5,851. A substantial increase quarter-over-quarter and approaching all time record high levels. The COVID-19 pandemic has clearly been the dominant issue over the last three months, impacting the low teen and personal lives of almost every single person across the world. With this in mind, we commissioned a U.S. focus survey to shine light on behavioral changes as it relates to healthy habits among consumers during the health crisis. The survey uncovered that 88% of Americans are currently experiencing stress and 82% are concerned about at least one aspect of their physical or mental health. To reflect our understanding of this unique and broad based consumer health challenge, we've worked with our coaches to refine how we position and support our business for the balance of the year. In Q2, we introduced a key initiative that combined co-skill development and incentives as well as product promotions for new clients. This initiative ran from March through May, and helped drive significant increases in two of our key growth metrics, new client acquisition and co-sponsorship. We're encouraged by the early results as it demonstrates the relevance of Optavia even during this global pandemic, as well as our ability to adapt quickly and successfully to a shifting business environment both in the context of the pandemic, but also related to changing environment beyond a pandemic. Our focus as we move into the third quarter remains on continuing to drive demand for our products and services, while providing an exceptional experience for our coaches and clients. With new learning and insights about the current business environment, we've significantly modified our programs for the back half of the year. The pandemic led to the decisions to develop a digital first approach to the business with the production of a high profile virtual event called Optavia together live, which was being live across the globe from July 24 through the 26. The event replace our plan in-person convention, which was due to be held in Atlanta at the same time. Instead of our anticipated audience of 10,000 of our Optavia coaches at the Atlanta convention, Optavia together live allowed us to attract more than 50,000 unique registrants including coaches, clients, and prospective clients. Our week was further magnified with over 140,000 views on Facebook, as coaches hosted watch parties and live events on social media. While we're still analyzing the impact of events, initial indications are incredibly positive. To build effectiveness further, we have added an incentive to promote leadership development within the ranks of our coaches. This incentive began on August 3, and will run through the end of the month. This incentive will partially replace the qualification program we would typically run for the 2021 leadership advancement trip, which has been cancelled because of the ongoing uncertainties around the travel environment. As an organization, we continue to successfully manage our business operations in this new dynamic business environment. All employees not engaged in manufacturing and distribution continue working effectively remotely. We're leveraging technology to ensure strong productivity and business operations and we continue to invest in new technology to support our growing business. Our new ERP system went live on May 1 with a supportive Deloitte. We continue to work to optimize this important technology, and anticipate driving new capability and enabling significant scalability as a result. Our investments in supply chain, including the opening of our Hong Kong distribution center early in the quarter went well, and we continue to invest in the resources to support our growth. We also opened our new call center in the Philippines on June 7, and we are scheduled to open an additional call center in Colombia on August 24. The restructuring of a call center operations is designed to improve service levels to our U.S. and Asia-Pacific markets, as well as optimize our overall cost structure. Asia-Pacific continues to be an important part of our mission, and showed sequential quarterly growth as we continue to drive our coach and client base in the region to enrich service and support. The opening of our Salt Lake City Technology Center to support our coaching client facing technologies remains on track for Q3. This center is another example of the initiatives we have been putting in place over the last year to improve client experience and address the short-term challenges created via rapid growth in late 2019. We continue to build on the operational improvements we saw earlier this year and our controls around financial payments are working effectively maintaining bad debt at historical levels. Each of our business operations have continued operating throughout the pandemic without any significant disruption. Manufacturing and distribution centers have continued to operate without any major delays, while our consumer supply chain continues to provide good service levels to our clients. Beyond supporting our coaches and clients, we continue to support our community by maintaining partnerships with national and local non-profits, No Kid Hungry and Living Classroom foundation. Both of these organizations are providing vital and increasingly relevant resources as the pandemic continues. We also recognize that racism and hatred continue to plague our world, and we must do better. As a first step Medifast plays $100,000 to non-profits that address social injustice and racial equity. We are committed to do better, both through monetary donations and through company diversity and inclusion programs. As the impact of COVID-19 continues to be felt, we believe our health and wellness services and products are becoming increasingly important. Our solution for physical health and mental wellness through lifelong transformation one healthy habit at a time along with our solution for financial health, in the form of business opportunity for clients that choose to pursue coaching is perhaps more relevant today than ever. With a large addressable market and industry leading products and service solutions, we're well positioned to drive long-term sustainable growth. We remain focused on driving shareholder value, leveraging our strong balance sheet and highly attractive and flexible operating model. We're in an enviable position to weather continued challenges. Our financial strength, resilient cash flow profile, recurring revenue model where 95% of our revenues are generated from subscription orders and a highly variable cost structure allows us to quickly adapt to any economic challenges, our core drivers to our business. We also remain committed to our dividend and have the capacity to utilize our share repurchase authorization to further drive shareholder value. It is now my pleasure to introduce you to Jim Maloney, who will walk you through the financial results. Jim?

Thank you, Dan. Good afternoon, everyone. It's my pleasure to speak with you today. I am honored to join this incredible team at Medifast. As Dan mentioned, I'm still getting up to speed on the business. We're so inspired by the company's unique business model for collaborative, culture and inspiring communities that they foster through their approach to the growing health and wellness market. Additionally, I look forward to getting to know all of you in the coming weeks and months, as I hit the ground running in work to propel this company into its next phase of growth. With that, let me walk you through our financial results for the second quarter ending June 30, 2020. Revenue in the second quarter of 2020 increased 17.6% to $220 million from $187.1 million in the second quarter of 2019. As Dan highlighted, we hit another record of active earning coaches ending the quarter with 36,500. This represents 19.3% growth as compared to 30,600 coaches in the same period last year and a 12% increase from the end of the first quarter. Average revenue per active earning coach for the quarter was 5,851, compared to 5,863 for the second quarter last year. We have now achieved two quarters of sequential growth, with the second quarter representing 9.7% improvement compared to 5,333 average revenue per active earnings coaches in the first quarter of 2020. Also of note Optavia branded products grew to 83% of our total company consumable units sold in the second quarter, up from 75% in the prior year period. Gross profits of the second quarter of 2020 increased 13.2% to $159.3 million, compared to $140.7 million in the prior year period. Gross profit margin as a percentage of net revenue decreased 280 basis points to 72.4% versus 75.2% in the second quarter of 2019. Decline in gross margin was anticipated in primarily the result of both increased promotional activity and higher production costs. SG&A for the second quarter of 2020 increased $17.8 million to $131.2 million compared to $113.4 million for the second quarter of 2019. The increase was primarily a result of higher of higher Optavia conditions expense, incremental professional services costs in connection with the Schedule 13D filing and increased expenses for coach incentive programs. SG&A as a percentage of revenue decreased 100 basis points year-over-year to 59.6% of revenue versus 60.6% in the second quarter of 2019. Non-GAAP adjusted SG&A increased $16.4 million to $129.8 million in the second quarter of 2020 and as a percentage of revenue decreased 160 basis points year-over-year to 59%. Non-GAAP adjusted SG&A excludes expenses in connection with the Schedule 13D filing of $1.2 million and severance related costs of $0.2 million. Income from operations increased $0.7 million to $28.1 million from $27.4 million in the prior year period, as increased gross profit was partially offset by increased SG&A. Income from operations as a percentage of revenue was 12.8% for the quarter, a decrease of 180 basis points from the year ago period. Non-GAAP adjusted income from operations, which excluded expenses in connection with the Schedule 13D filing and severance related costs increased $2.2 million to $29.5 million. Non-GAAP adjusted income from operations as a percentage of revenue was 13.4% a decrease of 120 basis points from a year ago period. Our effective tax rate was 22.1% for the second quarter of 2020 compared to 23% expenses in the year ago period. Net income in the second quarter of 2020 was $21.9 million, or $1.86 per diluted share based on approximately 11.8 million shares outstanding. Non-GAAP adjusted net income which excludes expenses in connection with the Schedule 13D filing in severance related cost was $23.1 million $1.96 per diluted share. This compares to net income of $21.4 million or $1.75 per diluted share, based on approximately 12.2 million shares outstanding in the prior year. Our balance sheet remains strong with cash, cash equivalents and investments securities as of June 30, 2020 of $145.4 million compared to $92.7 million at December 31 2019. The company remains free of interest bearing debt, and is well positioned in this challenging near-term macroeconomic environment. Our Board of Directors declared a cash dividends in the second quarter of $13.4 million, or $1.13 per share, which is payable on August 6, 2020. This reflected a 50.7% increase in the quarterly dividends over the prior year period, and is a direct result of our strong financial position and attractive business model. During the second quarter, the company repurchased 46,075 common shares totaling $5 million, leaving approximately 2,323,000 shares of common stock remaining under our stock repurchase program. Consistent with last quarter, and due to the ongoing uncertainties related to the COVID-19 pandemic, we are not providing guidance at this time. We would however, like to provide you some insight into the first month of the third quarter in that July trends are performing consistent with or better than the trends we experienced in the second quarter. We'll continue our focus on controlling our spending for the remainder of the year as previously mentioned during our call covering first quarter results. As Dan mentioned earlier, our in-person convention that was supposed to happen in July was replaced with the very successful Optavia together live virtual event. The Optavia together live event was less expensive than an in-person convention. Also as a reminder, we restructured our 2021 programming, which will not require an extensive role in the second half of 2020 for a 2021 incentive trip. This expense accrual total of $5.6 million in the back half of 2019 for the 2020 incentive trip. To close, I would like to reiterate that it is my pleasure to have joined the Medifast team. I am excited about the opportunities that lie ahead. And I look forward to speaking with you over the coming weeks and months. With that, let me turn the call over for questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Kara Anderson with B. Riley. Please go ahead.

So I just trying to kick it off with kind of a two part question about trends. Just wondering, if you can talk a little bit more about business trends within the quarter. Obviously indicated by April saw slight improvement and you did a lot better than that. So anything you can give us a little bit more color? And what drove that shift past April? And then second, within the quarter, just wondering, if you've got any impact from former clients returning to make purchases up behind a sort of big rush to stop by many with the pandemic?

Sure, I think the answer to your first question is we were finishing in April which is basically the insight that we gave you in the last call that was reflective of the first month of our promotion. So what we saw in as we moved through the rest of the quarter was continued activity related to promotion, which we ran through May as well. So if you remember, we started out with the training and foreign health incentive in March added in April, both of those together and in May had just the essential start to kind of continue on. So the positive trends as we move through the quarter were really related to our coaches getting behind the program that was put in place, which included those three elements. Related to the second question, I think, we don't give that level of detail, but those who were coming to make purchases were primarily new clients. The promotion also applied to clients who had been, who hadn't made a purchase within the previous 12 months. But the majority of those clients who came back and participated in the program were clients to were new to Optavia.

Just kind of a follow-up to the promotions and incentives you ran. Is there any impact that rolls forward beyond the second quarter that we should consider the modeling kind of margins in SG&A?

No, I think the biggest question the thing was, we're watching very carefully is understand how a client, who comes in on the promotion acts in month two, month three. What we've seen so far is that the retention rate or repeat rates on the first month and for those who purchased in April, the second month is very similar, so not much difference to a typical client. So we view that as very positive. But that is something that we're watching very closely. We have not put any of those promote. We don't have any of those for the third quarter. We don't have any plan promotion. This similar to that we do, however, have what I mentioned earlier in the scripts, in business builder promotion, which essentially focuses on different parts of our leadership structure and the coaches which is meant to motivate and incentivize training, new coaches, who were previously clients.

And then just one housekeeping question and I'll jump back in the queue. Can you tell us what the commission paid within SG&A within a quarter? Or a percentage of SG&A revenue?

Jim will answer that one.

So the commission paid within SG&A is approximately 70% of the SG&A.

Just to be, as a percentage of SG&A. But to be clear that our commissioner's percentage of total is slightly elevated by approximately 1.3% but still within that kind of 42.5% range.

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

So just a follow-up on that when you say 70% of SG&A. Is that the GAAP SG&A? Or the adjusted SG&A to the onetime items?

That would be the non-GAAP piece.

Okay, thank you. And then Dan, at the end of February you were looking for low to mid-single digit growth this year. And here we are through the end of June and you're up 13%. So what changed between the end of February and the end of June that turned so positive, so quickly?

Yes. I think that's a great question. I think what we saw early in the year were the challenges of starting the year with a lower percentage of the new clients and new coaches. As we put in place the programming which was really a result of looking at the business in a very different way as we are all facing the realities of what a global pandemic looks like. We put in place the program that we described and found essentially that one, our coaches were able to break through in a period that we've assumed that they would not be able to. And that new clients were far -- I'll say far more ready than we anticipated to take on this health and transformation journey that our coaches talked about. So, stepping back, I'd say that our message was relevant during this period of time despite the challenges. The offer that we put together for our coaches to help them break through was relevant for them. And the consumer side of the promotion was motivating to new clients who are coming in. So those three things kind of brought together a turned out to be a very strong quarter for us.

Thanks, Dan. No, that's fair. And then looking -- shifting gears to your Asia strategy here. Any change in thinking, given the geopolitics that are underway currently?

No. We see -- it's hard to kind of pull apart what's having a bigger app impact the geopolitics or the pandemic or the two combined but we still view our two markets in southeast in Asia-Pacific region, as an important part of our future. Each time we add new elements to support those markets as a good and positive impacts on coaching client experience. So you can hear from -- you could hear from my earlier comments that we're making investments in call center as well as continuing to put together programs and enhance our training there as well.

Okay, that's great. Just one last thing. What and I realized is just a couple of weeks ago, but what are the learnings from the virtual convention this year? And how do you envision that event changing in a post-COVID environment?

Yes. I mean, so certainly the event up to be together live was a reaction to the travel restrictions. We fully anticipated being together in Atlanta for what is our traditional in person convention. What we learned was one, I mean huge credit to our team internally who reprogrammed the entire back half of the year. So we found that we were able to quickly pivot work through the whole new dynamic of event planning. What we saw from our coach community and client community was a very strong uptick. Obviously, having the far greater number of registrants, sign up with over 50,000 and then seeing after a significant number 140,000 shares. And so, what we saw beyond that is a lot of watch parties. So even those numbers that we're talking about were probably larger than the numbers that I just shared. But, in terms of what we've learned, far greater reach, more efficient spend. And we'll, we've had nothing but positive comments from all of our coaches and clients. So we think it will be very positive and certainly some things we can learn and continue to leverage on a go forward basis even beyond the pandemic, which is the catalyst for doing it online in the first place.

But it doesn't sound like you want to abandon the in-person of that so I mean there important as well, aren't they?

Yes, no, absolutely. This was -- this is certainly replaced our convention, but it doesn't in the long-term, it replaced it out of necessity. Conventions are very effective for the in-person training, allowing the difference coach stands to get together and have that interaction. This was allowed us to address a much larger market more efficiently. So I'd say that to your question that would most likely work together in the future.

Our next question comes from Stephanie Wissink with Jefferies. Please go ahead.

Hi, this is Seb Barbero for Steph Wissink. I had a few questions. Number one gross margins were down 280 basis points in the quarter effective a product and production costs. Was product from almost no longer pressure in Q3, should we expect gross margin to normalize towards 75% plus in the back half of the year?

Yes, so, we would expect that without promotions to get to a more historical level in the next quarter. So significant portion of the decline in the margin was due to the essential start promotion in Q2. So, as Dan was mentioning, that we're not going to be promoting in Q3, we should expect that to get back to normal levels.

And the inventory was down 20%, the payrolls were up 30%. Any additional color that you could provide us with here?

Yes, the inventory being down is really a reflection of the strong uptake on the promotion. So we had historically carry a little bit more inventory than we currently are. And so it's really reflection of a stronger than anticipated promotion, we would expect those inventories to move up closer to the historic levels. And your second question was around, what was around payroll?

On payables.

Payables is really just a function of the timing of payments this quarter versus comparable periods. There really isn't anything unusual. It's just that the timing of the payments occurred are occurring a little bit later in, I guess in August, most of those payments will be made.

And lastly, on the buyback front pretty muted this quarter cash balance of $145 million at quarter end. Should we expect a more active stance in the back half of the year?

Yes, I think we've answered this question pretty consistently the same way, which is that, as it relates to capital allocation, we'll continue to review on an active basis. How to best return value to our shareholders that will be in a combination of dividends share buyback. And primarily those two things. And I think that will be looking at whether that continues which of those makes sense. As in the past, we will buy when we're there are opportunities to do share repurchase and we remain committed to stronger dividend.

Our next question comes from Bill Baker with GARP Research. Please go ahead.

Yes. And by the way, I've got conference was pretty good. I enjoy Dr’A’s presentation. I guess what the [Indiscernible] encouraged to see this quarter was the [indiscernible] and this is happening even before you're starting this strives to increase the coaches in Q3? And the productivity was pretty high [Indiscernible] effect that [Indiscernible] lockdown people how things better to do to make that happen.

Bill you broke up a little bit. But I think, you’re asking the question about what drove improved coach productivity? And the answer to that is you're right. And we were back up to the historic high levels that we saw at the end of 2018, beginning of 2019. I think it's a reflection, again of our coaches being very active having a highly relevant message and having a lot of potential prospects out there during the lockdown period have become either more aware or more having a greater need for what offer the coaches offer. So I think we look at it as a very positive sign of where the business is going and continue to watch it closely.

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

Thank you. I think we'd like to first of all, thank -- I thank all of you for participating. We appreciate you taking the time. I think in closing, just make a couple comments. We feel like the second quarter was a reflection of our continued ability to support a fast growing health and wellness community across our markets. It's supported by very large addressable market of both clients and coaches. We remain diligent and focused on leveraging our strong financials I think as we mentioned earlier, we have 95% of our revenue coming from recurring orders. We remain focused on investing to support our long-term growth by strengthening our operating infrastructure. You've heard several examples of that. And with that, we feel like we are ready now to continue to move through the rest of the year understanding how to make additional adjustments in this continuously changing environment. We feel like, we're well positioned to capitalize on the significant opportunities ahead. So thank you for joining.

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