Good afternoon, and welcome to the Medifast Fourth Quarter and Fiscal Year 2022 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 Reed Anderson with ICR. Please go ahead.

Good afternoon, and welcome to Medifast’s fourth quarter 2022 earnings conference call. On the call with me today are Dan Chard, Chairman and Chief Executive Officer; and Jim Maloney, Chief Financial Officer. By now, everyone should have access to the earnings release for the quarter ended December 31, 2022, and went out this afternoon at approximately 4:05 p.m. Eastern Time. If you have 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 also be available on the company’s website. Before we begin, we would like to remind everyone that today’s 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 upon them. Actual results could differ materially from those projected in any forward-looking statements. All of the forward-looking statements contained herein speak only as of the date of this call. Medifast assumes no obligation to update any forward-looking statements that may be made in today’s release or call. Additionally, in an effort to provide investors with additional information regarding results as determined by GAAP, this call will disclose various non-GAAP financial measures. A reconciliation of each of the non-GAAP financial measures to the most comparable GAAP financial measures is included in the earnings release for the quarter ended December 31, 2022 is shared on the company’s Investor Relations website. These non-GAAP financial measures are not intended to replace GAAP financial measures. And with that, I would like to turn the call over to Medifast’s Chairman and Chief Executive Officer, Dan Chard.

Thanks, Reed, and welcome to the call everyone. We’re grateful that you’re taking the time to be with us today. On the call with me is Jim Maloney, Medifast’s Chief Financial Officer. I’ll provide some context on the fourth quarter and full year 2022 as well as some detail on how we are continuing to develop our business. Jim will then take you through the specifics of our financials in some more detail. Looking at the fourth quarter, there are many things to be encouraged by as we continue to recalibrate and adjust to the changing global macroeconomic environment and shifts in consumer behavior related to the fast moving economic disruption that peaked in Q2 of 2022 and impacted our business dynamic. Revenue was a little ahead of expectations in large part driven by the enhanced stability that we have been able to bring to customer retention rates, which have now returned to and remain at historical levels. We continue to take steps to mitigate cost pressures, drive efficiency, and build financial resilience in our model. The 80 basis points of compression in adjusted gross margin we experienced in Q4 was largely driven by inflation and partially offset by pricing changes and the optimization of shipping costs. We expect the price increases to have an additional positive impact on margins throughout the course of 2023. We’re closely managing our SG&A expenses, which decreased 420 basis points as a percentage of revenue on an adjusted basis driven by developments in our internal labor and field operations related to both field compensation plan optimization as well as field support automation. The number of active earning OPTAVIA Coaches was down against Q3 of 2022, but up compared to the prior year period to 60,900 Coach productivity is down both sequentially and year-over-year. We…

Thank you, Dan. Good afternoon, everyone. Revenue in the fourth quarter of 2022 decreased 10.7% to $337.2 million from $377.8 million in the fourth quarter of 2021. We ended the quarter with approximately 60,900 active earning OPTAVIA Coaches, an increase of 1.8% from the fourth quarter of 2021. Average revenue per active earning OPTAVIA Coach for the fourth quarter was $5,538, a year-over-year decline of 12.4% driven by continued pressure from last year’s disruption in customer retention, continued softness in customer acquisition, and the unoptimized coach and customer tenure. Gross profit decreased 16.1% to $233.6 million reflecting lower revenue in Coach productivity and gross profit margin declined 440 basis points to 69.3% mainly due to expenses associated with the restructuring of external manufacturing agreements to optimize our supply chain for 2023. Excluding these onetime expenses on a non-GAAP adjusted basis, gross profit decreased 11.7% to $245.8 million in gross profit margin decreased 80 basis points to 72.9%, primarily reflecting inflation outpacing pricing adjustments, partially offset by lower shipping costs due to reduced express shipping compared to the prior year. SG&A expenses decreased 13.1% to $200.9 million, and were 170 basis points lower as a percentage of revenue, primarily reflecting lower coach compensation expense, lower internal labor expense, and field operation efficiencies partially offset by expenses related to donations to support the Ukrainian relief effort. On a non-GAAP adjusted basis, which excludes Ukraine donations, SG&A decreased 16.8% to $192.5 million, and were 420 basis points lower as a percent of revenue to 57.1%. Income from operations decreased 30.4% to $32.6 million, reflecting decreased gross profit partially offset by lower SG&A. On a non-GAAP adjusted basis, which excludes one-time expenses related to the restructuring of external manufacturing agreements, and Ukraine donations, income from operations increased 13.7% to $53.3 million. As a percentage…

Thanks, Jim. In closing, we have built a robust business over the course of the past 6 years, developing a coach-based model and a transformational system that is a powerful force for personal health and wellness change for coaches and customers across the United States and around the world. We change lives for the better, and we do it in a unique and effective way. It’s a differentiated approach that stands out in the marketplace, and provides truly personalized wellness journeys to individuals who have traditionally struggled to achieve positive outcomes in the past. Clearly, some of the changes we saw last year have had and will continue to have a residual effect on our business as they work their way through our annual business cycle. There’s much work to be done to empower our coaches to achieve the best possible outcomes, despite some of the issues they face. We are developing and implementing significant customer acquisition initiatives that will help us drive momentum and a return to historical norms and tenure, and are working hard as a team to ensure that we drive incremental change to the key metrics that power our economic engine. I remain highly confident in our ability to reestablish our growth rhythm over the course of the coming months. We are building a business that is capable of delivering solid performance in all economic environments, and we have an accomplished leadership team that has a strong record of achieving positive results in complex environments. With that, I will turn the call over to the operator for questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Linda Bolton Weiser with D.A. Davidson. Please go ahead.

Hi, good afternoon. So I was wondering what particular metrics, or KPIs would you be watching so that you would feel more comfortable to start giving annual guidance again. So are you mostly just watching new customer growth or coach productivity, or – I mean, what would make you feel more comfortable about reinstating guidance on an annual basis? Thank you.

Thanks, Linda. Yeah, I think what we are looking at right now is the continued effect of what we saw last year, which was effectively a 15% reduction related to change in retention in our coach and client base. So the most important metrics that we track, all but one, have returned historical norms. So that’s an important part of the answer your question. So that means customer retention is back to and is sustained at normal rates. Our customer satisfaction and co-satisfaction, which are a driver of repeat rates, are supporting that, and our customer to coach conversion, have also returned to historical normal rates. So the one final and has been the most elusive metric that continues to perform at lower than historical norms is related to our customer acquisition. And what we see happening is partly because of the impact of inflation on disposable income, and partly also because of a change in what we’re seeing in more recent months, and some of the algorithmic changes in our social media platforms that our coaches use. We’re seeing that number have a lot of weight on it. So once we see that return, we expect to be able to offer better guidance. And what we’ve seen so far, which we are still very much at the beginning of our – this part of our journey of returning to operating in a normal environment or making the new environment or our growth environment. We’ve seen our focus be able to start turning specifically to that one final metric. It’s that specifically that’s impacting our return to or slowing our return to healthy coaching client tenure mix. And it’s also impacting the speed of our return to our target revenue growth, and disrupting our ability to effectively provide guidance. So that’s why the disruption has been extended into this year, and that’s why our Q1 guidance reflects that continued decline of our revenue.

Okay. Thank you. That’s helpful. So would you want to actually see a return to positive year-over-year new customer growth? Or would you want to see just an improvement in the year-over-year decline?

For this year, I’d say we’re focused on starting to see the turn, and the year-over-year decline leading to the positive year-over-year growth. And we started at a deficit last year, because of the loss of that 15%. And that deficit got wider as the environment for acquiring new clients became more difficult, and because that 15% of clients we lost, normally a portion of those would become coaches and would have turned that tenure. So those are kind of the headwinds we’re facing. So we’re – what we saw in January was the beginnings of our ability to impact, but we still are closing that gap. That’s – yeah, improvement to the year-over-year first, and then movement towards year-over-year growth.

So, I understand, are you saying the new customers were less down year-over-year in January versus fourth quarter? Is that what you’re saying?

Yeah, what we saw in January was an improvement in our tenure, which means that we brought in a higher number of customers. So that was comprised of both new customers and also customer, lapsed customers, who had not bought for the last 6 months. So we saw that that number start to improve relative to those we had lost.

And another way to bridge that, Linda, as we mentioned during the second half of 2022, customer acquisition efforts were more difficult. So the lower customer acquisition in the second half of 2022 is really impacting Q1, because simply there are just less customers as we entered 2023 than there were in 2022 when we entered 2022. And, as Dan mentioned in the prepared remarks, that the Commit to Health program, we saw it being successful in improving customer count in January. It’s just too early to tell how successful that program will be until we move out in the next several quarters.

So here’s a way, Linda, to think about the path ahead and this kind of build on Jim’s comments. So there are 3 things we’re focused on right now. Program is one, training is the other and then improving our offer. So what you’ve seen us do so far in the third and fourth quarter of last year is introduced programs, which were specifically focused on providing coach and coach leader incentives around bringing in more clients. What you saw in Q1, or the January program was a customer acquisition offer, which focused on price for the first month, so $75 off the first month of a premier program. And then an incentive through our rewards program, which provided an incremental 20% off what is normally 10%, and that’s focused on ensuring that we have repeat. So as we look towards the rest of the year, what you’re going to see the programs focusing on are continued, I’ll say, optimization of our customer – of our coach incentive structure, and also a return to some of the programs that were pre-pandemic to build leadership structure. So I think about that as leadership incentive programs like the trip that we used to have. So as we work through those programs, we think that that will have a positive impact on building back that client base that has been impacted. The training that’s taking place right now is going through the first quarter, and will continue into the second quarter is essentially focused on retraining, call it, 95% of all of our coach leaders. So that we consider our coach leaders, executive directors and above, and that will result in roughly 25% to 35% of all of our active coaches being retrained. And their retraining is focused on operating in the new environment, and managing and changing some of their acquisition efforts, including moving towards a different approach on how to leverage social media, so leveraging it, but also bringing back into the mix some of the in-person activities. The last thing that we are focusing on is the offer. So I think about the offer as that first time order. So we’re looking at ways to make that more value-added in the current environment so that would include things like the continued development of the OPTAVIA app. We’re looking at accelerating the launch of some of the additional Healthy Habit products. We postponed some of those last year as we were facing this uncertain environment with inflation. And then last thing on the offer side is continuing to offer more support for expansion into the Hispanic segment of the United States. And, ultimately, we believe there is an opportunity for us to expand beyond the U.S. borders into Latin America.

Okay. So we’re picking up from various coaches that were in contact with that there’s some promotion – price promotion similar to the January program being offered in February. We’re actually seeing different promotions being offered by different coaches. So I’m curious can coaches run their own price promotions? And if that’s the case, how does that work in terms of customers ordering directly on your website? Just – what’s going on out there with – I thought everybody bought it one price. So how is it that different coaches can be running different price promotions to different sets of customers?

So the answer is, yes, our coaches have the ability to run their own promotions. And it’s done through coordinated – well, through interaction and integration within our systems. So they call them health credits. It allows them to manage promotions on their own. And typically that’s done for new client acquisition efforts. So the company or corporately, we have really focused on that program that we talked about 75% – or $75 off the first order, and then a 30% Premier Rewards for the second. But, yes, there are coaches who run their own programs to supplement or in some cases to fill in gaps are related to what their specific cadence is in terms of client acquisition.

So are they taking that – for their own run promotion are they taking that hit to their own profit margin? Or are you helping them fund by working with individual coaches? Like, how is that working?

They’re doing it from their own profit margin. So they’re using their own commission structure to fund those things.

Okay.

That’s just to be clear. That’s something has been consistent for many years. We typically partner with coach leaders talk about, if it’s a – in this case, a price promotion, we get part of the way there. They get the rest of the way there and we target specific different levels of price promotions together. But – so that’s really what you’re seeing.

Okay. So, is there any way you can kind of give us some idea, some metrics or data points about the different profit margins in 2023? So, I would assume gross margin would be down sequentially in the first quarter, because of the January promotion, but then what should we see? Should we see further decline or stabilization? Or can you give some cadence of how the gross margins should progress through the year?

Yeah, it’s going to be difficult to talk about the year. But for Q1 specifically, we’re expecting year-over-year to gross margin to be impacted in 2 ways: one is the program that you just mentioned, the Commit to Health program that will have a decline in gross margin impact to it, because that is affects price; and secondly, we will lose leverage with the lower volume in Q1 versus Q1 of last year. But we do expect in the long-term, Linda, that there’s enough programs in place that we have internally to get back to 15% operating income. We’re looking at procurement programs, we’re also looking at value engineering programs, and as Dan mentioned, G&A programs. So, for the G&A programs, just to give you an example of that would be automation of our customer service, and you’re starting to see that actually last in 2022. So that’s why I’m confident that we can get back to 15% or that operating target is because we just achieved it in Q4. So as long as we have the leverage in sales, 15% operating income margin in the long-term is achievable.

Okay. And in terms of these different procurement programs, and value engineering and all that, is there any way to quantify like cost savings that you would expect in 2023? Or are these multiple-year programs you can’t really put a finger on the 2023 effect?

Yeah, they are multiple year programs. We are targeting a gross amount between 300 to 400 basis points in the long-term. So it’s going to be multiple years. So, I would say that you could almost think of it as you know 50% of the cost savings will be within G&A and 50% of the cost savings in the long-term will be within gross margin.

Okay. Thank you. And then, do you have a CapEx number for calendar 2022?

Yeah, the CapEx number for 2022 was approximately $16 million.

And then, do you think that will be higher in 2023 or about the same? Or what do you think about that?

Yeah. In 2023, we are seeing that it’s approximately the same expectation. We’re expecting that for 2023 to be about the same as 2022. So the exact number for 2022 was $16,681 million.

Okay. And then, when we think about your dividend, I mean, this – as you say, you’re unsure about the macro environment. And there’s even this issue – this is a whole separate question, but there’s some drugs recently that have been getting some publicity that have been helping people with weight problems, especially a very obese people, Wegovy and Mounjaro, these are drugs that are out there. So there’s a lot of things that you’re unsure of. How would you think about your dividend kind of going forward? Does that point to kind of lower dividend increases? And to what extent do you use – like are you willing to put debt on your balance sheet in order to pay your dividend? Or would you rather pay back the dividend to preserve the balance sheet? What are you thinking about that?

Yeah. So when you look at the whole capital allocation, I’ll call it, a program for 2023 and beyond. Our plan is to continue to invest in organic growth, maintain or continue to grow the dividend then consistently apply funds to stock repurchases. So any excess funds, we would be funding through stock repurchases. But we do plan on maintaining a conservative balance sheet. We would be willing to do a low amount of leverage.

Okay. And then what about – just follow-on thoughts, Dan, maybe on these drugs that are out there. And it seems like the whole a lot of weight loss companies are having difficulty? And I know you’re not just weight loss, you’re wellness, but it seems like everyone’s having problems. Do you think the drugs are affecting your business at all?

Yeah, we don’t get a lot of comments from our coaches about the drugs. But, certainly, it’s something that we’re watching very closely. I think equally kind of concerning to us or not concerning, but equally kind of generating our – or grabbing our attention is the number of companies that are offering coaching. So that’s a core component is becoming more and more common. There are also a lot more companies who are talking about developing healthy habits. And so, I think, those 3 things together and some players that are coming in at the high and low end of the spectrum as long in terms of pricing spectrum, but also more, I’ll say, developed technology, all those things are things that we’re looking at and are very aware of. I’m not sure exactly where the drugs are going to go, I think, there’s a little bit of controversy that will kind of play out over the upcoming months. There was an article in The Wall Street Journal about the lack of oversight and regulation about the advertising. So, I think, there’s going to be a little bit of kind of correction, I think, in that market. But, yes, we’re watching them closely. But at this point, our coaches aren’t seeing a lot of impact yet.

Okay. Thank you very much. I appreciate it.

Thanks, Linda.

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

Well, let me conclude by saying thanks for your questions and for joining us in the call today. As you’ve heard during the course of the call, we have an important mission at Medifast with our commitment to Lifelong Transformation, One Healthy Habit at a Time. We remain highly dedicated to that mission, and while at the same time creating stockholder value for the long-term regardless of what else is happening in the economy. That’s what we’re focused on today, and that’s what we’ll be focused on for the quarter ahead. Thank you for joining.

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