Medifast Inc Q2 FY2020 Earnings Call

Good afternoon. And welcome to the Medifast Second Quarter Fiscal 2020 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. 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 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. 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 the 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 to Medifast great experience as a public company CFO, as well as 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. 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 lives of almost every single person across the world. With this in mind, we commissioned a U.S. focused 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 the 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 decision to develop a digital-first approach to the business with the production of a high-profile virtual event called Optavia Together Live, which was held across the globe from July 24 through 26. The event replaced our planned 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 the event, 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 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 to work effectively from home. 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 support from 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 our 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 by 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. 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 made a $100,000 donation 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 opportunities 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 the inspiring communities 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 and 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 a 9.7% improvement compared to $5,333 average revenue per active earning 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. The decline in gross margin was anticipated and was 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 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 the 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 and severance-related costs, was $23.1 million or $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 dividend 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 the 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 totaled $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. 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 got any impact from former clients returning to make purchases 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 as we moved through the rest of the quarter was continued activity related to the promotion, which we ran through May as well. So if you remember, we started out with the training and foreign health incentive in March and added in April, both of those together in May had just the essential start to kind of continue on. So the positive trends as we moved 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 not made a purchase within the previous 12 months. But the majority of those clients who came back and participated in the program 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 when modeling kind of margins in SG&A?

No, I think the biggest question we're watching very carefully is understanding how a client who comes in on the promotion acts in month two and month three. What we've seen so far is that the retention rate or repeat rates on the first month 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 promotions for the third quarter. We don't have any planned promotion similar to that; we do, however, have what I mentioned earlier in the scripts, a business builder promotion that 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 clear, as a percentage of SG&A. But to be clear, our commission's percentage of total is slightly elevated by approximately 1.3% but still within that 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 one-time 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 were 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 assumed they would not be able to. And that new clients were 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 were coming in. So those three things kind of brought together a turned out to be a very strong quarter for us.

Thanks, Dan. That's fair. Shifting gears to your Asia strategy, is there any change in thinking considering the current geopolitical situation?

No. It's difficult to determine whether geopolitics, the pandemic, or a combination of both is having a greater impact. However, we still see our markets in the Southeast Asia-Pacific region as crucial for our future. Every time we introduce new elements to support these markets, it has a positive effect on improving the client coaching experience. As I mentioned earlier, we are investing in call centers and continuing to develop programs and enhance our training efforts there.

Okay, that's great. Just one last thing. What, and I realize 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, huge credit to our internal team who reprogrammed the entire back half of the year. So we found that we were able to quickly pivot and 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'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 they are important as well, aren't they?

Yes, absolutely. This approach has definitely supplemented our traditional methods, but it won't completely replace them in the long run. Traditional conventions are highly effective for in-person training, as they facilitate interaction among different coaches. This new method has allowed us to reach a much larger market more efficiently. So in response to your question, I believe they will likely coexist 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. A 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 carried a little bit more inventory than we currently are. And so it's really a 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?

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 a little bit later, 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 and 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 there are opportunities to do share repurchases, and we remain committed to a stronger dividend.

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

Yes. And by the way, I've got to confer it was pretty good. I enjoy Dr. A's presentation. I guess what encouraged to see this quarter was the productivity and this is happening even before you're starting these drives to increase the coaches in Q3. And the productivity was pretty high even as people were locked down. How do you feel about that?

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. 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 who have become either more aware or more in need of what coaches offer. So I think we look at it as a very positive sign of where the business is going, and we 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’d like to first of all thank you for participating. We appreciate you taking the time. In closing, just a couple of 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 a very large addressable market of both clients and coaches. We remain diligent and focused on leveraging our strong financials. 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. 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.