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Medifast, Inc. (NYSE:MED)

Q1 2010 Earnings Call

May 5, 2010 04:30 am ET

Executives

Katie Turner - IR

Michael McDevitt - CEO and CFO

Brendan Connors - VP, Finance

Analysts

Scott Van Winkle - Canaccord Adams

Tom Kaplan - East Shore Partners

Operator

Greetings and welcome to the Medifast Inc first quarter 2010 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions).

As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Katie Turner Investor Relations for Medifast Inc. thank you Ms. Turner you may now begin.

Katie Turner

Thanks. Good afternoon and welcome to Medifast first quarter 2010 conference call. On the call with me today are Michael McDevitt Chief Executive Officer and Brendan Connors, Vice President of finance. By now everyone should have access to the first quarter earnings release for the period ending March 31 2010. This will release went out at approximately 4 pm eastern time today.

If you have not received the release, it is available on Investor Relations portion of Medifast website at www.choosemedifast.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 are generally identifying forward-looking statements. These statements do not guarantee future performance and therefore undue reliance should not be placed on them. Also descriptions of Medifast objectives, strategies, plans, goals or targets contained herein are considered forward-looking statements. Actual results could differ materially from those projected in any forward-looking statements. Medifast assumes no obligation to update any forward-looking projections that maybe made in today’s release or on the call posted to their website.

Medifast does not comment on issues or items currently or potentially in litigation with adversarial third parties and/or under investigation by appropriate regulatory or law enforcement agencies as the state or federal government. All of the forward-looking statements contained herein speak only as of the date of today’s call. And with that I would like to turn the call over to Medifast's Chief Executive Officer Michael McDevitt.

Michael McDevitt

Thank you, Katie. Good afternoon everyone and thank you for joining us. On today’s call I’ll provide highlights of our first quarter results and then Brendan will review the financial results for the quarter in more detail. We will then open the call up for your questions.

In the first quarter of 2010, we delivered record sales and earnings. This performance represents our 42 consecutive quarter of profitability. Revenue for the first quarter increased 75% to $60.6 million due to strong growth in each of our three primary distribution channels, including Take Shape For Life, Direct Response, and our Medifast weight control centers. This strong topline performance drove our first quarter profitability as we leveraged fixed costs and expenses with our vertically integrated operations. The first quarter of 2010 provided a strong starting point to what we believe will be another successful year for Medifast.

We attribute our success to Medifast's strategy of providing the best selection of quality portion controlled weight loss products within a multi-platform program that allows Medifast to best meet the many different client support and education needs in their weight loss or weight maintenance. Increasingly the Take Shape For Life, Direct Response and Medifast Weight Control center channels provide a complimentary source of support for health coaches and clients to connect and share Medifast’s clinically proven weight loss programs. Each of our sales channels provide clients with a differentiated level of support they desire to achieve their health and weight loss goals.

In the past thirty years, over 20,000 doctors have recommended our products to more than 1 million clients who have lost weight, and maintained their weights. The credibility of our products and the results they produce continues to resonate extremely well with new and existing clients. This credibility, our strong team members and our superior product offerings create the foundation that supports every channel within the Medifast business model.

It is reflected in our Take Shape for Life sales channel through the personal testimonials and stories of our health coaches and health professionals that continue to use and recommend Medifast products.

The growing awareness and strength of our brand has helped to increase our Take Shape for Life active health coaches 78% to over 7100 compared to 4000 coaches last year. And our Direct Response sales channel, our focus on clinical research and innovation has helped us to target more effective advertising, leading to 43% sales growth in this channel for the first quarter of 2010. On our planned 30% increased marketing and advertising spend, we generated a 2.8 to 1 revenue to spend ratio during the first quarter of 2010 compared to 2.6 to 1 ratio in 2009.

This led to strong improvements in operating income. And of course in our Medifast weight control centers, the efficacy of our portion-controlled meal replacements and personalized support programs are the gold standard of weight loss. Personal counselors provide one-on-one support and develop an individual program for each and every client that walks through the doors.

The focus on client service and support helped generate record clinical revenues. Same-store sales for clinics open greater than one year increased 30% year-over-year. In 2009 we expanded our clinic into a number of new markets and had 27 clinics in the comparable store base located in Florida, Maryland, Texas, compared to 21 clinics last year.

We ended the first quarter with 27 corporate and 18 franchise centers. In today’s competitive environment we believe that Medifast clinically-tested, physician-recommended products that deliver significant weight loss results represent a significant value for consumers demonstrated by our continued growth and financial results.

We will continue to focus on the investment and innovation of our corporate infrastructure to reach even more consumers in new and existing markets through innovative sales and marketing strategies and new product introductions through the production and manufacturing capacity we have in place to support our future growth.

We communicated on our fourth quarter call, that we plan to initiate a number of events to provide opportunities for us to offer additional training for our existing health coaches while continuing to attract new health coaches. As a reminder historically Medifast only hosted one annual convention each year.

In 2009 we increased our focus on the concept of weekly Super Saturday. In a select number of cities health coaches host a group event for potential clients to introduce them to the Medifast program. the event also provides existing health coaches the opportunity to offer additional program training. Thanks to the outstanding work of our field leadership team, Super Saturdays continue to be huge success.

This year we are launching a new series, a quarterly hosted regional events called Super Regionals. These events can best be described as many annual convention and will be held at different locations across the country. In the first quarter, we hosted five Super Regional event. In Philadelphia, Atlanta, San Diego, Sarasota and Salt Lake City. Results in each city were outstanding.

We believe that as our base of health coaches continues to grow, the need for increased outreach and training will be critical to our success. If these first quarter events are any indications, 2010 has the potential to be another strong year for Take Shape for Life. As a reminder in the Takes Shape for Life sales channel, approximately 99.9% of sales generated for Medifast products and the remaining 1% was generated from the sale of our health coach starter kit which is a non-commissionable item.

Of the 99% of our sales relating to product, approximately 8% of the sales are to health coaches for their own personal consumption, and the remaining 91% are sales of Medifast products to end using consumers of the health coaches. In addition although we have health coaches in every major US market, due to the viral marketing aspect of Take Shape For Life approximately 60% of Take Shape For Life channel sales are generated from just seven geographic locations. As a result we continue to be optimistic about Medifast opportunity for future growth within those seven areas, and as we expand in our current markets and enter new US markets.

In a Medifast weight control center sales channel, we believe that there is very strong consumer demand to the one-on-one accountability of MWCC and its supportive, consistent environment for many clients to meet their health and weight loss goals. We anticipate a robust future expansion plan, and throughout 2010, we will continue to expand the infrastructure necessary to manage the build-out process and requirements of this retail model.

We anticipate adding 13 clinics throughout 2010, an increase of approximately 48% to 57% from the number of corporate centers at the beginning of the first quarter. With this planned expansion, we will also maintain our focus on continued, comparable, same-store sales growth.

Overall, the first quarter was very strong for Medifast as we successfully increased net sales and leveraged our fixed costs and corporate expenses. Going forward we are confident that our vertically integrated operations and increased capacity will allow us to continually improve the long-term leverage of our business model by expanding our margins and long-term profitability growth.

We are excited to build upon our record achievements during the first quarter throughout 2010. Now I’d like to turn the call over to our Vice President of Finance, Brendan Connors, to review our financial results in more detail.

Brendan Connors

Thanks Mike. Revenue for the three months ended March 31 2010 increased 75% to $60.6 million compared to $34.6 million in 2009. The Take Shape For Life sales channel accounted for 52% of total revenue. Direct response accounted for 27% and Medifast weight control centers accounted for 11% of total revenue. Focusing on our sales channels in more detail, our direct sales channel Take Shape For Life experienced revenue growth of 94% to $37.6 million compared to the same period last year.

This growth was driven by increase client product sales and increased revenue generated per health coach as a result of the record increase in the number of active health coaches. The number of active health coaches increased 78% to approximately 7100 compared to 4000 in the first quarter of 2009. The Direct response sales channel, revenue increased 43% to $16.4 million in part due to 34% increase in advertising dollars spent as Medifast continues to experience a more effective advertising expense.

As Mike mentioned earlier, we achieved a 2.8 to 1 revenue to spend ratio in the first quarter of 2010 as compared to a 2.6 to 1 ratio the same period last year. This more effective advertising spend contributed to the increase in the overall operating profit. In addition the company recognizes $2.1 million in revenue related to the freight bill to customers associated with the shipment of products sold in the quarter compared to $9,25,000 in the first quarter of 2009.

Revenue in the Medifast weight control center sales channel increased 75% to $6.6 million. This is due to a 30% increase in comparable store sales for units opened greater than one year as well our 27 corporate centers being opened in the first quarter of 2010 compared to 21 in the first quarter of 2009.

Gross profit for the first quarter of 2010 increased 78.6% to $45.8 million compared to $25.6 million in the first quarter of the prior year. The company's gross profit margin increased a 140 basis point to 75.5% in the first quarter versus 74.1% in the first quarter of 2009. Overall, the gross profit margin improvement was primarily due to improved pricing on raw materials and packaging as well as increased manufacturing efficiencies.

In addition, due to the growth of the business, shipping revenue has increased and is now recognized in the company's consolidated revenue. Previously shipping revenue was netted against shipping expense and the company's cost of sale. Selling, general and administrative expenses increased $15.9 million or 74% to $37.6 million in the first quarter of 2010.

As a percent of net sales, selling, general and administrative expenses decreased 40 basis points to 62%, compared to 62.4% in the first quarter of 2009. The largest increases in SG&A expense were related to higher variable expenses such as Take Shape For Life commission expenses that's directly related to product sales and personal expense. Take Shape For Life commission expense increased $8.4 million in the first quarter of 2009 due to the 94% increase in sales.

Salaries and benefits increased by approximately $3.3 million as compared to the first quarter of 2009. The increase includes the hiring of additional expertise in critical areas such as Take Shape For Life, Medifast Weight Control Centers, and IT support the strong growth in 2010 and beyond. In addition salaries and benefits includes items such as personnel expense due to accrued 2010 bonuses or the corporate bonus based on strong first quarter 2010 results. Personnel expense also included a one-time [accelerated] investment of an executive deferred compensation plan to meet the payout obligation of the firm. The plan has fully funded and the company has no additional liability.

Operating income for the first quarter of 2010 was $8.2 million compared to $4 million in the same period a year ago. Operating margin expanded 190 basis points to 13.5% from 11.6% for the same period last year. This improvement was due to strong net revenue growth that helped drive improved gross margins, increase leverage of sales and marketing expenses, and the overall strength of the Medifast business model.

First quarter net income increased 94% to $4.9 million or $0.33 cents per diluted share compared to $2.5 million or $0.17 cents per diluted share for the first quarter of 2009. Operating cash flow rate increased to $14.2 million for the first quarter of 2010 compared to $5.3 million in the same period last year.

Our balance sheet remains strong with stockholder's equity of $55.3 million and working capital of $33.1 million as of March 31 2010. Cash, cash equivalents and investment securities increased 72% or $11.7 million to $28 million as a result of improved operating cash flows. Now focusing on a few items as it relates to our financial outlook for the balance of 2010.

We continue to expect gross profit margin improvement in the range of 50 to 100 basis points in 2010 as compared to the prior year due to a decrease in the cost of each units sold and continued manufacturing efficiencies. We also continue to anticipate the full year 2010 advertising expense to increase about 15% to 20% compared to last year. Our full-year tax rate is expected to be in the range of 39% to 40% and full year diluted shares outstanding of 14.8 million to 15 million shares.

In 2010, we plan to open 13 to 15 new Medifast weight control centers. That concludes our financial overview. Now I would like to turn the call over to our CEO, Michael McDevitt.

Michael McDevitt

Thank you Brendan. I would like to conclude by thanking our employees, health coaches, franchise partners, Board of Directors and our valued clients for their continued support. We are very excited about our future and look forward to delivering great results in the second quarter and remainder of 2010. We would now like to open the call to your questions. Operator.

Question-and-Answer Session

Operator (Operator Instructions). Our first question comes from Scott Van Winkle from Canaccord Adams

Scott Van Winkle - Canaccord Adams

The first question is didn't you end February with 6650 distributors, that would imply if I am right there, there was a very big March, is that true and what drove that or are we just seeing that acceleration throughout the quarter?

Michael McDevitt

It is true from month-over-month standpoint. in the first quarter, we did see the number of health coaches continue to grow which is very common when you are dealing with this kind of compound growth that we are seeing inside the health coaches, so March was a very strong month. March is commonly one of the stronger months in the weight loss period.

A lot of people obviously assume that January is, but sometimes it takes a little bit of time for consumers to make the decision on what they want to choose in the weight loss industry before they actually put that purchasing, so you are correct in your assumption. March was very strong and I think that leads to a stronger function in what we continue to do for the remainder of the year.

Scott Van Winkle - Canaccord Adams

Then I guess would be that April was good given the trend and now you had the Chicago event going on in May, can you talk a little bit about what you think, I think the advertising is already started, hasn't it?

Michael McDevitt

The advertising has started for [minimal] basis. The event is towards the end of May, so we are going to be ramping up that advertising over the course of the month. We are very excited about what we continue to see in trending for the Take Shape For Life health coach recruiting business. This [Technical Difficulty] what this will do, we are very confident it's going to be builder for the business as it's a test of going into a new market.

We talk on how we have those seven geographic areas that generate roughly 60% of sales for Take Shape For Life. We got a lot of Medifast Direct Response consumers who are unaware of what the Take Shape For Life offer is and we are going to do our best to really make that Take Shape For Life opportunity both available and make their awareness grow inside the Chicago market. So anxious to have this first test out there, expectations are always low on an initial test. But we are going to learn a lot and hopefully have many more these in the future

Scott Van Winkle - Canaccord Adams

The shifting income or the shifting revenue in the quarter, did you give the dollar amount? And I am wondering what was the offset that makes sense, so I can (inaudible). I apparently missed that change and I don’t know if that came out near K or something, I didn’t catch it.

Michael McDevitt

Sure, the revenue from shipping in the first quarter of 2010 was $2.1 million, last year it was $925,000. Expense is just included in our cost of sales figure.

Operator

Thank you, our next question comes from Tom Kaplan from East Shore Partners.

Tom Kaplan - East Shore Partners

Just looking at that press release versus the 10-Q, but can you just explain to me why the revenue was restated in the press release and the cost of sales changed versus the 10-Q from Q1'09?

Brendan Connors

Year over year, it’s included in both Q1'09 and Q1 2010. The shipping revenue is now included, that is just because now it is material enough because of our growth, the per GAAP revenue recognition policy.

Tom Kaplan - East Shore Partners

So the delta is just the offset, the shipping revenue and the shipping expense.

Brendan Connors

Yes, right.

Tom Kaplan - East Shore Partners

If the 60.58 in the quarter is the revenue number and the Take Shape For Life is 37.6, 16.4 for Direct marketing and (inaudible) 6.6. That adds up to slightly greater, what does that imply about the sales from the doctor channel if anything?

Brendan Connors

Moving forward we are going to be including the doctor sales included in the franchisee sales. The physicians that we attract now are more so weight loss clinic type of physicians for the wholesale model which is a very similar model to our franchisees. So moving forward, all future doctor wholesale accounts be included in our franchisee figures. They are actually included in that clinic figure that we spoke to.

Operator

Thank you our next question comes as a follow up from Scott Van Winkle from Canaccord Adams

Scott Van Winkle - Canaccord Adams

Brendan, were there any kind of one-time in mature expenses in that first quarter I mean you had some litigation, you had an auditor change. It looks like you spend some time evaluating second kind of auditor change after the acquisition of your original. I am wondering if there was anything kind of one time in that first quarter that bumped up SG&A.

Brendan Connors

The one piece that you will be able to see inside the balance sheet aspect, it didn’t have one time effect to SG&A because we did have an accelerated aspect to a vesting schedule for deferred compensation of roughly about $500,000 due to the schedule. That is a one-time impact and we will be looking forward and will not be carrying them.

Scott Van Winkle - Canaccord Adams

Okay so that's non comp expense, that's just buried in SG&A, and what is that total number for non-comp expense in the quarter if you have it.

Brendan Connors

To speak on the change year-over-year in compensation expense is about $3.3 million change year-over-year in compensation expense. Included in that is about a $500,000 one-time impact that Mike just spoke on. I was wondering how much of that was non-cash.

Michael McDevitt

That was all in cash aspect

Operator

Thank you. At this time, we have no further question. I would like to turn the call back over to the speakers for any closing comments.

Michael McDevitt

Thank you very much for you participation today. We look forward to sharing our progress with you next quarter. And as a reminder we will be visiting with investors in the coming weeks and attending a number of investor conferences and we hope to see you there. Thank you very much.

Operator

Thank you. This does concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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