Medifast's (MED) CEO Dan Chard On Q1 2018 Results - Earnings Call Transcript

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About: Medifast, Inc. (MED)
by: SA Transcripts

Medifast, Inc. (NYSE:MED) Q1 2018 Earnings Conference Call May 3, 2018 4:30 PM ET

Executives

Katie Turner - ICR

Dan Chard - CEO

Tim Robinson - CFO

Analysts

Frank Camma - Sidoti

Linda Bolton Weiser - DA Davidson

Douglas M. Lane - Lane Research

Presentation

Operator

Good afternoon and welcome to the Medifast First Quarter 2018 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 Katie Turner for opening remarks. Please go ahead.

Katie Turner

Good afternoon. Welcome to Medifast first quarter 2018 earnings conference call. On the call with me today are Daniel Chard, Chief Executive Officer, and Timothy Robinson, Chief Financial Officer.

By now, everyone should have access to the earnings release for the period ending March 31, 2018 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 Web site at www.medifastinc.com. This call is being webcast and the replay will be available on the company's Web site.

Before we begin, we’d like to remind everyone that prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. The words believes, expects, anticipate and other similar expressions generally identifies 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 projection that maybe made in today's release or on today’s call. All the forward-looking statements contained herein speak only as of the date of this call.

And with that, I would like to turn the call over to Medifast Chief Executive Officer, Dan Chard.

Dan Chard

Thank you, Katie. Good afternoon everyone. We're pleased to discuss our first quarter 2018 results with you today. I will provide a brief overview of our financial and operational business performance. Tim will then review our financial results in more detail and share our 2018 second quarter and full-year guidance. We will then be available to answer any questions.

We started off the year with a strong first quarter as the momentum we built throughout 2017 continue to accelerate into the first quarter of 2018. Our corporate team and our field leaders are aligned behind our strategy to extend our unique offer to a growing client population throughout the United States and soon internationally.

It is clear that our mission to offer the world lifelong transformation, One Healthy Habit at a Time is resonating in the U.S market. We ended the first quarter with a record of 16,700 active earning OPTAVIA Coaches to support the clients in achieving their health goals.

The growth of our OPTAVIA Coach base along with improved revenue per active OPTAVIA Coach combined to deliver financial results that exceeded our expectations for the first quarter. Quarterly year-over-year revenue growth accelerated from a 25% growth in the fourth quarter of 2017 to nearly 40% growth in the first quarter of 2018. This mark the fourth consecutive quarter of year-over-year growth and the fifth consecutive quarter of sequential revenue improvement.

The first quarter was also the largest revenue and profit quarter in the history of the company. Our team continues to focus on generating operating efficiencies to maximize profitability as we continue to grow. Gross margin expanded 100 basis points to 75.9% and SG&A cost as a percentage of revenue decreased 170 basis points. These improvements contributed to a record operating margin of 14.9%.

Combined, the acceleration in our revenue and our operating efficiencies, drove first year -- first quarter diluted earnings per share of $1.01 ahead of our first quarter guidance of $0.84 to $0.87 diluted earnings per share. With this strong start of the year, we're raising our annual revenue and profit outlook which Tim will discuss in just a minute.

To give you a feel of how our business is developing, let me share a few recent highlights to illustrate how corporate and field leaders are partnering to execute on key strategic initiatives. Just last month, we had the pleasure of hosting our Annual Global Leadership event, in Florida. It was the largest global event in the history of the company with approximately 1,400 OPTAVIA Coaches in attendance. This represented a 40% year-over-year increase.

This event is for qualifying OPTAVIA Coaches who aspire to advance to become stronger leaders and mentors within the OPTAVIA Coach and Client Community. In addition to a series of presentations and workshops, the event provided our first opportunity to formally outline our international expansion plans to extend our business offer to Hong Kong and Singapore in the first half of 2019.

OPTAVIA Coaches heard from both field leaders and corporate executives on how to participate in our expansion and why is it important for them to join us at the upcoming training events planned for our July convention in St. Louis.

We also announced two new exciting OPTAVIA Fuelings: Caramel Macchiato and Silky Peanut Butter Shakes at this event. These incremental products are designed to make healthy habit creation easier for our OPTAVIA community of coaches and clients.

Our product development and marketing teams continue to work on new innovative product offers to support future categories in the delivery of our brand promise of creating healthy lifestyle tied to incorporating new healthy habits in their daily routines.

Our technology investments are focused on improving our enterprise and mobile technologies to support our business operations and enable our OPTAVIA Coaches as they support their client and trainer teams. A good example is the recently announced agreement with Gatheredtable for perpetual license to their software, which will help our coaches and clients make healthy eating second nature.

Operationally, we're preparing for the opening of our distribution center in Nevada, in June. We’ve partnered with a leading global logistics provider to open scalable operations designed to support our growing business here in the United States as well as our upcoming shipments to our new Asian markets. Along with our company-owned East Coast distribution center in Maryland, we're well-prepared to support the growing needs of the company.

In summary, we're successfully executing our strategy of aligning our corporate and field leaders behind a repeatable business rhythm capable of delivering long-term sustainable growth. Our results have been at accelerating growth rate, improving operating efficiency and increasing fuel productivity.

Our focus moving forward will continue to beyond delivering above average returns to our shareholders by continuing to develop our U.S business and expanding our offer into Asia through the opening of two key gateway markets in Hong Kong and Singapore. We're optimistic and excited about the future opportunities ahead of us.

With that, I will turn the time over to our CFO, Tim Robinson.

Tim Robinson

Thank you, Dan, and good afternoon, everyone. Before I begin, I want to remind everyone that starting this quarter we’ve changed how we report sales. Going forward, simplifying the line of changes in the way we now manage the business, review operating performance and allocate resources.

We previously disclosed entity wide disclosures for sales by channel, OPTAVIA, Medifast Direct, Franchise Medifast Weight Control Centers, and Medifast Wholesale. Through the interchangeability nature of the customers among sales channels, sales migration to OPTAVIA and realignment of the internal operations, we will now be operating and reporting as a single sales channel. This change in our financial reporting structure is a testament to our success in transforming and restructuring the business and a reflection on how the business is managed today.

Secondly, I wanted to inform you about an important accounting change we made beginning January 1, 2018. As most of you are aware, the updated Financial Accounting Standards Board revenue recognition standard requires companies review the way they recognize revenue. As required, we've completed our view and adopted a new standard in 2018 on a modified retrospective basis.

As a result, on a net basis, we recorded an after-tax transition adjustment to reduce retained earnings as of January 1, 2018 by $2 million. This is comprised of $5.6 million of revenue offset by $3.6 million of inventory costs, commissions expense, shipping cost, credit card fees, and related income taxes. The adoption of this new accounting standard primarily impacts the timing of revenue recognition for product shipments. As product revenue will be recognized upon customer receipt and delivered at the time of shipment. A reconciliation of this is contained within our press release issued this afternoon and in our Form 10-Q filed with the SEC.

I will now like to review our financial results for the first quarter ended March 31, 2018. First quarter 2018 revenue exceeded our expectations increasing 39.6% to $98.6 million from $70.6 million in the prior year period. As Dan mentioned, we ended the quarter with a record 16,700 active earning OPTAVIA Coaches compared to just 13,000 in the prior year and 15,000 in the fourth quarter of 2017.

Average revenue per active earning coach for the quarter increased 18.3% to $5,278 compared to $4,463 for the first quarter of last year. The growth in productivity is very encouraging and result in part from improved field training initiatives and the accelerated rate of new productive OPTAVIA Coaches in the quarter. The increase in the mix of higher priced OPTAVIA products also contributed to the increase in productivity of our coaches.

OPTAVIA branded products represented 58% of our total company consumable units sold in the first quarter compared to 17% in the prior year period. Gross profit for the first quarter of 2018 increased 41.4% to $74.8 million compared to $52.9 million in the prior year period. Gross profit margin as a percentage of net revenue increased 100 basis points to 75.9% versus 74.9% in the first quarter of 2017. The increase in gross profit margin was a result of improved inventory management and shipping expenses.

Selling, general and administrative expenses for the first quarter of 2018 were $60.1 million or 61% of revenues versus $44.3 million or 62.7% of revenues in the first quarter last year. The increase in SG&A was primarily a result of higher OPTAVIA commission expenses resulting from the growth and success of our OPTAVIA Coaches.

Our effective tax rate was 18.1% compared to 29.5% in the first quarter of 2017. This decrease in the rate is result of a decrease in the Federal Statutory rate pursuant to the Tax Cuts and Jobs Act as well as the discrete accounting for taxes associated with share-based compensation. Excluding the discrete accounting for taxes associated with share-based compensation, our effective tax rate would have been 23.1% for the first quarter of 2018.

Net income in the first quarter of 2018 was $12.2 million or $1.01 per diluted share based on approximately 12.1 million shares outstanding. First quarter 2017 net income was $6.1 million or $0.51 per diluted share based on approximately 12 million shares outstanding.

Our balance sheet remains very strong with stockholders equity of $113.6 million and working capital of $92.9 million as of March 31, 2018. Cash, cash equivalents and investment securities as of March 31, 2018 increased $10.4 million to $109.2 million compared to $98.8 million at December 31, 2017.

Our Board of Directors declared a quarterly cash dividend in the first quarter of $5.7 million or $0.48 per share payable on May 8. Our management team and Board of Directors remain committed to enhancing value for our shareholders.

Now turning to our guidance. We expect second quarter revenue to be in the range of $99 million to $102 million, and earnings per diluted share to be the range of $0.94 to $0.97 per diluted share. We are raising our previous guidance for the full-year of 2018 and now expect revenue in the range of $385 million to $395 million and earnings per diluted share to be in the range of $3.55 to $3.65 per diluted share. Our fiscal year 2018 guidance assumes a 21% to 22% effective tax rate.

Well, that concludes our operational and financial overview. We appreciate your interest in Medifast and Dan and I are now available to take your questions. Operator?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Frank Camma of Sidoti. Please go ahead.

Frank Camma

Hey, good afternoon, guys. Thanks for taking the questions.

Dan Chard

Hi, Frank.

Tim Robinson

Hi, Frank.

Frank Camma

Hi. Obviously, good quarter. Question on the guidance. Tim, by my model, it looks like really where you blew out the number was on the productivity and more importantly, you think that productivity is going to be sticky, which is great. Going forward, can you explain like how you get the confidence in that given, sort of the trend line historically and the fact that you're adding new people? So typically I would think they would be little less productive?

Tim Robinson

Well, I think one of the things we’re seeing, Frank, is that our field is starting to use some new training methods and systems to help them bring people on and overseeing is that training is being more effectively executed. So, despite people being new, that doesn’t seem to be the issue. Its -- it doesn’t seem to be an issue. It's really a reflection of a better way to train and a lot of other things we’ve a clear positioning now. We have a new exclusive brand that’s creating some excitement as well with OPTAVIA. And [multiple speakers] …

Frank Camma

Part of that is still right because you're selling a higher mix of those higher-end products, therefore, obviously, the revenue was higher.

Tim Robinson

Yes, that’s a piece of it as well.

Frank Camma

Okay. And so, second part of that question is just as you open -- as you announce the markets, obviously, and start recruiting to the second half of the year, can you just tell us sort of what that does to the algorithm of active health coaches in the U.S.? In other words, do you, though -- will you go out and recruit individuals that have people that have Hong Kong national experience, Singapore, et cetera, like how do we think about that and how actually grows your U.S. base prior to opening up in '19 numbers?

Dan Chard

So we just had a big meeting with all of our sales leaders and really what we communicated to them was that the strategy of who you or how you go about bringing people into their -- into the business as clients or sponsoring as coaches, it doesn’t really change. This opens it up a little bit. I think as you're pointing out to creating some excitement around people who may have contacts in Hong Kong and Singapore, but we really anticipate that they will continue to use -- they can continue, probably a little bit there's excitement around it, confidence, but they won't be changing the strategy of how they bring people in per se. But to your point, there are more people because of that additional component of people who might be -- have an interest in those Asian markets.

Frank Camma

Okay. And my last question and then I will hop out, is will you have a summer conference as well like you normally have like a big one, or is this -- is that different than the Orlando one you just had? Or is that -- how does that work?

Dan Chard

Yes, we will. We will have our annual convention that will be held in July in St. Louis.

Frank Camma

Okay. So that’s different than the one that you just had with the sales leaders and typically remind us, would you then add even more incremental products in the summer, or is it possible or, I mean, is that …?

Dan Chard

Yes, we will be announcing the two that we mentioned earlier, but one more line that will be reflective of our strategy to add with the next healthy habit. So we haven't announced it to the field yet what that product is, but we anticipate that will build excitement going into and coming out of convention.

Frank Camma

Great. Thanks for taking my questions.

Dan Chard

Thank you, Frank.

Operator

The next question is from Linda Bolton Weiser of DA Davidson. Please go ahead.

Linda Bolton Weiser

Yes, hi. So you mentioned in the opening of your new distribution center in Nevada, I guess you said for June. So typically I’ve seen in these models where when you open a new distribution center it reduces shipping cost even further and it helps your gross margin even more. So is that what we should expect after you open that?

Tim Robinson

Yes, Linda, we do expect that really in 2019. I think this year its little more neutral just because of some start up cost involved in 2018. Not material, but I think the flow-through of the improvements will start to see more in 2019.

Linda Bolton Weiser

Okay. And then, can you say how much -- I mean, obviously there's a fix in the variable portion of SG&A, so the variable portion would've risen a lot to go along with your sales growth, but did the fixed portion of SG&A increased much? Can you quantify that? And also how much in the $3 million to $5 million of incremental spending for the international expansion was recorded in the first quarter?

Tim Robinson

Yes. So I would say really a nominal amount of the spending was in the first quarter. I don't have the exact number, but certainly less than a $1 million. So majority of that you'll see hit in the second half of the year. And I’m sorry, what was the first part of your question?

Linda Bolton Weiser

It was related to like can you give a quantification of how much the fixed SG&A portion will increase?

Tim Robinson

Our fixed is pretty kind of it goes along the word fix, our fix is pretty stable. So I would say really when you look at our commissions expense, it's a significant portion of our SG&A, near 50% of our SG&A. So that piece is the piece that really moves things like manpower, other driving cost, rent things that are fixed are quite stable.

Linda Bolton Weiser

Okay. And then in terms of just keeping up with your high growth rate, are you able to just keep expanding and fitting more into your plant production and that you have -- that's your own plant and then I guess you can work with outsourcers to expand that. But is there any risk that you're going to run into some kind of difficulty with being able to supply all the demand?

Dan Chard

No, we don't think we will have problems here. We’ve done a really good job at planning. We’ve a really good planning in inventory control group, procurement group that works with third parties to pick up overflow when we need it. So we’ve relief valves. As the business grows, we can produce some those products in-house or we can produce them outside without a material change in our margins. So we are working very closely with our suppliers to be able to pick up additional line right now. We’ve also been building inventory for the Nevada warehouse. So we will operate for a short period of time with three distribution centers as we transition. So we’ve been building up inventory for that kind of June launch, and so that’s the kind of an indication that we were able to flex with -- in pretty short amount of time. So we're comfortable with our ability to produce and deliver products to meet the demands.

Linda Bolton Weiser

Okay. And then, Dan, I think when you were speaking you alluded to some announcement or something about another kind of product that would address another element of the optimal path to life, I guess? So are you talking about like another category, like a new neighbor category to weight management? And I know you don’t want to say what it is, but you are talking about something that’s like a new category entry, right?

Dan Chard

Correct. I mean, there -- its a category that we already participate and will -- be participating in a different way and it will tie to one of the healthy habits that we communicate. I mean, what we currently do is healthy eating, the other ones are sleep, hydration and exercise. So it's not that its super secret. It's just that we haven't announced it yet, but we anticipate it will generate some excitement moving into the convention and coming out.

Linda Bolton Weiser

Okay. And then do you have to have an operating cash flow number for the quarter and CapEx for the quarter?

Tim Robinson

Yes, our CapEx for the first quarter was of about $1.3 million for the first quarter and free cash flow before dividends was about $16.5 million.

Linda Bolton Weiser

So that’s operating cash flow minus the CapEx?

Tim Robinson

Yes.

Linda Bolton Weiser

Okay. And then -- so with this high growth and strong balance sheet and cash flow, I'm a little surprised that you haven't gone back to doing some share repurchase, because I think you did do some a few years ago. Is that something that you're thinking about or is there a reason why you wouldn't pursue that right now or …?

Dan Chard

Yes, that’s been something we’ve been discussing with the -- at the Board level for and -- have been in the past and we will continue to do so. So, we don't have anything to announce at this point, but certainly we see that -- I mean, we are confident in our future. So we will determine here very soon whether we use part of our cash for repurchasing our stock.

Linda Bolton Weiser

Okay. Well congratulations. Thank you.

Dan Chard

Thank you, Linda.

Operator

The next question is from Douglas M. Lane of Lane Research. Please go ahead.

Douglas M. Lane

Yes. Hi, everybody. You’re talking about the OPTAVIA commissions, you mentioned almost 50% of the SG&A line, and now that you’re following potential purposes a pure play direct seller. Is there any thought to breaking that out in future P&Ls?

Tim Robinson

I mean, that’s something we will definitely consider. It's not something we talked about on a regular basis as far as commissions as a rate of -- a percent of sales extremely stable. It's been stable for a number of years. So, traditionally our commission expense is somewhere around 42% of OPTAVIA sales and very stable. So we can definitely consider breaking that out. It's not something we mind disclosing.

Douglas M. Lane

No, I mean, it's sort of -- I know you’ve evolved at this point, but certainly other direct sellers break it out discreetly and be able to separate the fixed part from the commissions, which are two, obviously, entirely different animals. Was the commission expense around 42% in the first quarter?

Tim Robinson

Yes. It's been stable for quite some time.

Douglas M. Lane

Okay. And then -- and stepping back here with this kind of acceleration in growth that we've seen over the past four quarters, you mentioned several drivers. You’ve got obviously a lot of new product activity, you've got systems and tools for your coaches that you’ve implemented. You’ve got a new brand name, rebranding the whole thing and then the opportunity for international exposure, I’m sure is generating excitement as well. Can you rank those? I mean, is there any way to rank those as far as what’s generating the accelerated growth and the increased activity among your coaches?

Dan Chard

Yes, we’ve talked about that. It's hard to quantify I think. I think certainly the training model that our field is using would be in the top two. And then, I think we have really completely eliminated some of the cross-channel friction by a new brand that’s very on trend. So that’s -- that was -- those will kind of go together, meaning clear positioning in new exclusive brand. And then I think kind of the -- kind of the capstone would be confidence in the future. We're doing a better job of partnering, of supporting, and of projecting where we’re going as we go forward, and that that helps our Coach community be more effective in what they do so well already.

Douglas M. Lane

No, I mean, if all grows together, it makes a lot of sense. On the international expansion, are we -- are you already starting to see some movement towards building a business ahead of that? In other words, people that are looking to participate in Hong Kong and Singapore, did that sort of build as get closer over the rest of the year?

Tim Robinson

I think it builds as we get closer to rest of the year. And there's not a lot they can do other than build locally prior to our opening up the markets. But there's certainly a lot of excitement and people are starting to think about who they know, who might have contacts in those markets. So there is a motivation to kind of think more broadly than they have in the past, and I think that will have a positive impact, but no real activity at this point.

Douglas M. Lane

Okay. All right. Thank you.

Tim Robinson

Thanks, Doug.

Operator

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

Dan Chard

I’d like to thank all you for your interest in Medifast and a particular thanks to our community of OPTAVIA Coaches across the country for everything they did to make this quarter a successful one. We appreciate all of your participation in today's call. And Tim and I look forward to speaking with you again when we report our second quarter 2018 financial results. Have a nice evening.

Operator

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