Medifast Inc Q3 FY2020 Earnings Call

Good morning and welcome to the Metaphase third quarter fiscal twenty twenty earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key, followed by zero. 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 Bedfast's third quarter twenty twenty earnings conference call. On the call with me today are Dan Chard, Chief Executive Officer, and Jim Maloney, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ended September 30, twenty twenty that went out this afternoon at approximately 4:00 or 5:00 p.m. Eastern time. If you've not received the release, it is available on the investor relations portion of Metaphase's website at www.medevackedinc.com. The call is being webcast and a replay will be available on the company's website. Before we begin, we would 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 on them. Actual results could differ materially from those projected and any forward-looking statements contained herein speak only as of this date. And with that, I'd like to turn the call over to 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 is now a little more than three months into his role as our Chief Financial Officer. After I provide some updates on our business performance over the last quarter, Jim will review the Q3 financial results in more detail, and we will then open up the call to take your questions. I'm pleased to say that despite the wider issues felt by the retail sector during the global pandemic, Metaphase has seen strong acceleration in growth during the third quarter. Revenue increased forty-two point eight percent to two hundred seventy-one point five million, and earnings per diluted share increased one hundred twenty point five percent to two dollars and ninety-one cents. This growth was driven by significant year-over-year and sequential improvements in the number of active earning coaches which grew to forty-two thousand one hundred independent coaches in the third quarter, a new record level. Average revenue per active coach also increased sequentially to a record level of six thousand three hundred twenty-nine dollars, driven by an increase in both the number of clients supported by each coach as well as an increase in average client spend versus Q2. This important shift forward in coach productivity comes as a direct consequence of our continued focus on building tools, programs, and processes that allow coaches to be as efficient as possible, as well as the relevance of our health and wellness offer in an environment where consumers are looking for lasting solutions to their health and wellness needs. While the COVID-19 pandemic continues to cause economic and social uncertainty for businesses, we feel confident in our ability to drive long-term sustainable growth to deliver on our mission to offer the world a lifelong transformation, one healthy habit at a time. Since the end of twenty nineteen, we have taken a number of important steps to accelerate the growth of our business, coupled with some quick responses to the pandemic. These initiatives are now delivering meaningful progress, which is represented in the numbers we have announced today. Importantly, we feel that the adjustments we've made to our business over the last two quarters have created some important learnings that are now being used to further optimize our ability to deliver against our long-term growth vision. The company's focus continues to be on supporting our growing community of optimal coaches as they develop and focus on the four competencies that drive our business success: namely attracting new clients, supporting clients on the optimal weight five and one plan, sponsoring new coaches, and developing coach leaders. The specific adjustments we made to our business during the second and third quarters consisted of supporting coach-led training, a compelling incentive structure, and a refined approach to how our coaches are leveraging social media. With the new programming in place, our community leaders drove sustainable gains in both new clients and new coaches. A deep dive into this new cohort of clients shows us that we have tapped into a new group of consumers that may not have previously tried our products but whose behavior is entirely consistent with our existing core client base as measured by retention and lifetime value. We're also very encouraged to see higher levels of coach conversion from this new client cohort. We're excited by these trends and are looking forward to building on their success in the coming months ahead. The health and focus of our coaching client community remains strong, with our coaches highly engaged and enthusiastic about the opportunity that lies ahead for us all. We just returned from our global climate summit in Sundance, Utah, where we met with top leaders to discuss plans for the upcoming year. I believe that the company and the field are more aligned around our mission than at any point in our history, and I'm enthusiastic about the prospects of driving operational and transformational success in twenty twenty-one. With a revised coach-initiated training structure, robust levels of client acquisition, strong trends in coach conversion, and new insights around how to leverage new incentives and promotional structure, I believe we are well positioned to drive continued growth. As we look to take advantage of the opportunities to scale over the next few years, it's important that we continue to build our technology, our manufacturing, and distribution operational platform in order to give us the infrastructure to power our growth. With that in mind, we began taking deliberate steps earlier this year to ensure that we have the necessary runway to continue expansion. Like many similar businesses, we made some proactive moves at the start of the pandemic to ensure that we would be able to handle both changes in demand and changes in working practices. We prioritized production of our highest volume products, limiting our assortment to ensure that we could meet the product demand across the core items and mitigate the risk of disruption to our supply chain. This approach resulted in an uncharacteristic shortage of stock in our less popular items. While this created some headwinds to our client experience, it also accelerated some of our long-term efforts to consolidate our Metaphase brand and products to create deeper focus around our Optavia brand. Furthermore, we have been accelerating our long-term supply chain initiatives to ensure that we create the bandwidth to handle our anticipated growth over the next several years. Specifically, we have bolstered our management capabilities in the space with the addition of Loren Walker as our new head of global supply chain operations. Lauren is a seasoned supply chain executive with critical experience in driving long-term sustainable growth in both direct sales and fast-moving consumer goods businesses. She most recently served as Chief Supply Chain Officer at Young Living Essential Oils, overseeing the company's integrated supply chain as well as engineering, enterprise project management, and new market expansion. Prior to Young Living, she held several roles with Amway Corporation, most recently serving as Vice President in the Manufacturing and Technical Support Organization. She has also held various positions at industry-leading companies, including Church & Dwight, Johnson & Johnson, and Procter & Gamble. Lauren is an exciting addition to the team, and we are already seeing meaningful benefits from her involvement within the first two months of her tenure. Next, we've made intentional moves to increase our capacity in both powder and bar manufacturing, as well as distribution. We’ve done this through relationships with an expanding network of co-manufacturers whose facilities have been qualified to manufacture our products. This new manufacturing capability came online in October and will continue to scale as we move into the next year, ultimately more than doubling our current manufacturing capacity by the end of twenty twenty-one. We're also scaling our distribution capability to match our manufacturing capacity. In addition to our supply chain enhancements, we continue to focus on our technology investments and capability. At the beginning of the year, we announced the opening of our new technology center in Utah to further enhance our coach and client support capabilities and strengthen our growth platform. We have now occupied the new space and are building out our capabilities amidst the challenges of this pandemic. The key initiatives from our technology team have included the alpha testing of two new apps focused on coaches and clients. The first app to be a Coach Connect, is designed to further increase the productivity of our coaches by giving them access to customized tools to manage their Optavia coaching business. Testing is now complete, and we will launch the beta version of the app in the United States in the first quarter of twenty twenty-one. The second app, the Impact Client app, is focused on creating easy access to meal planning tools to help improve the client's experience on the optimal weight five and one plan. Alpha testing is also complete, and we will launch the beta version of this app in the United States in the first quarter of twenty twenty-one. During the quarter, we also completed the deployment of a new cloud-based system designed to allow us to quickly scale our call center capability around the world to support our growing community of coaches and clients. As a reminder, we currently contract with a partner to provide call center support through the call centers in the United States, the Philippines, and Colombia. Each of these recent technology enhancements followed the successful implementation of our new ERP system during the second quarter of this year. Whether through our supply chain or technology programming, we are consistently investing in future growth, all while driving strong momentum and margin improvement despite the inherent challenges of the COVID-19 pandemic. Our team, including our loyal independent coaches and clients, continue to successfully adapt to the ever-changing environment, and we're proud to be successfully helping clients achieve lifelong transformation, one healthy habit at a time during this unique period in society. Our focus continues to be on growing the number of individuals who are seeking greater health and wellness and providing a holistic approach to achieving greater health in our daily lives. We believe we can effectively and efficiently reach our target audience through our community of coaches who are increasingly leveraging social media channels to share their success with the Optavia Habits of Health system. We benefit from an increased societal focus on the importance of health and wellness and a powerful coach-powered system that is clinically proven to drive improved results. Our growth vision is to achieve long-term sustainable growth in our revenue in the mid-teens by penetrating the large addressable market in the United States and then continuing our expansion in Asia Pacific markets and ultimately developing other large markets throughout the world in the years to come. Before I turn the call over to Jim, I want to note that our commitment to lifelong transformation is not just in our work with coaches and clients, but also through our active support of the communities in which we live and work. We recently executed our week of service program supporting Living Classrooms and their work to help young people achieve their full potential. We also continue to support No Kid Hungry, particularly through an initiative in our recent After Being Together Live event. This is a business that is focused on changing the lives of many, not the few, and I'm proud of the work that the company, our employees, and our coach community are doing to create opportunities for people from all walks of life to deliver the best possible version of themselves in whatever way possible. Let me now turn the call over to Jim Maloney, who will walk you through the financial results.

Thank you, Dan. Good afternoon, everyone. It's been a pleasure getting to know many of you over the past few months, and I look forward to continuing this dialogue. With that, let me walk you through our financial results for the third quarter ended September 30, twenty twenty. Revenue in the third quarter of twenty twenty increased forty-two point eight percent to two hundred seventy-one point five million dollars from one hundred ninety point one million dollars in the third quarter of twenty nineteen. As Dan highlighted, we hit another record active earning coaches, ending the quarter with forty-two thousand one hundred. This represents thirty point seven percent growth compared to thirty-two thousand two hundred coaches in the same period last year and a fifteen point three percent increase from the end of the second quarter of twenty twenty. Average revenue per active earning coach for the quarter was six thousand three hundred twenty-nine dollars compared to five thousand seven hundred fifteen dollars for the third quarter last year and up from five thousand eight hundred fifty-one dollars in the second quarter of twenty twenty. We have now achieved three consecutive quarters of sequential growth. Also of note, our branded products grew to eighty-three percent of our total company consumable units sold in the third quarter, up from seventy-eight percent in the prior year period. Gross profit for the third quarter of twenty twenty increased forty-two point seven percent to two hundred four million dollars compared to one hundred forty-two point nine million dollars in the prior year period. Gross profit as a percentage of revenue was seventy-five point two percent, consistent with the third quarter of twenty nineteen. Operating expenses for the third quarter of twenty twenty increased thirty-six point eight million dollars to one hundred fifty-nine point five million dollars, compared to one hundred twenty-two point seven million dollars for the third quarter of twenty nineteen. The increase was primarily a result of higher Optavia commissions expense due to increased Optavia sales and increased salaries and benefits-related expenses, partially offset by a decrease in sales and marketing expenses. Operating expenses as a percentage of revenue decreased five hundred eighty basis points year-over-year to fifty-eight point seven percent versus sixty-four point five percent in the third quarter of twenty nineteen. Income from operations increased twenty-four point three million dollars to forty-four point six million dollars from twenty-point three million dollars in the prior year period, primarily as a result of increased gross profit, partially offset by increased expenses. Income from operations as a percentage of revenue was sixteen point four percent for the quarter, an increase of five hundred seventy basis points from the year-ago period. Our effective tax rate was twenty-two point eight percent from the third quarter of twenty twenty, compared to twenty-two point seven percent in the year-ago period. Net income in the third quarter of twenty twenty was thirty-four point five million dollars or two dollars and ninety-one cents per diluted share, based on approximately eleven point nine million shares outstanding. This compares to net income of fifteen point nine million dollars or a dollar thirty-two per diluted share, based on approximately twelve point one million shares outstanding in the prior period. Our balance sheet remains very strong, with cash, cash equivalents, and investment securities of one hundred sixty-nine point nine million dollars as of September 30, twenty twenty, compared to ninety-two point seven million dollars at December thirty-first two thousand nineteen. 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 quarterly cash dividend in the third quarter of thirteen point four million dollars, or a dollar thirteen per share, which is payable on November 6, twenty twenty. This reflects a fifty point seven percent increase in the quarterly dividend over the prior year period and is a direct result of our strong financial position and attractive business model. There are approximately two million, three hundred twenty-three thousand 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. However, we would like to provide you with some insight into the first month of the fourth quarter in that October's top line year-over-year growth trends are performing consistent with the year-over-year trends we experienced in the third quarter. As Dan mentioned earlier, in Q4 twenty twenty, we intend to further invest in our supply chain technology and coach incentive programming, which will affect our operating margins in Q4, but will enable our long-term growth and operating income objectives. In closing, we are proud to report another strong quarter, especially in such a time of uncertainty and challenges. We believe the company is well positioned in a significant position of financial strength, and we are excited about the opportunities ahead. With that, let me turn the call over for questions.

We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Carrie Anderson from B. Riley FBR. Please go ahead.

Hi, good afternoon. So I just wanted to start by talking about the stockouts. You mentioned a little bit of a headwind to the client experience. Just wondering if you can talk about how that compares to some of the disruption you saw last year in the supply chain and whether or not we saw any impact from that disruption to the client experience in the quarter or if it's something we would expect to impact future quarters.

Sure, it was very different compared to what happened last year. Last year was an operational disruption, meaning that we were switching out the structure of our pick lines. This year, as we entered into the second and third quarter and recognized that growth was happening at an accelerated rate, we deliberately determined to ensure that we could effectively supply our top items by pulling out about thirty-six of our SKUs and holding them to allow us to be more efficient in producing our top-selling items. So we can say that none of our top-selling SKUs ever went out of stock and no one was without feelings during the quarter. We started in the second quarter and came online in October with several new co-manufacturer relationships that effectively take our manufacturing capacity up. By the end of the next fiscal year twenty twenty-one, our capacity will be roughly double.

Ok, great. And then, you know, clearly the promotion you ran in April, May, and then the subsequent incentives worked in your favor. Just wondering if you can discuss any plans for running some more promotions in the future and what that might look like.

Yeah, we feel like we learned a lot through these promotions. They were obviously a reaction to the pandemic environment, but as it turns out, we were able to attract a new group of clients who probably wouldn't have tried Optavia previously. So it had to do with both a training program that was in place in the field, a specific offer that was both for a coach incentive as well as a client promotion, and then a very specific social media strategy. We brought in a large cohort of clients that came in the second quarter. Our big question, as you remember last quarter, was whether they would act as a traditional client, both in terms of their retention and lifetime value and coach conversion. We were pleased to see that they are acting almost identically and, in some cases, a little better than those that came in through traditional means. So, to answer your second question, yes, we do anticipate using a similar type of promotion as we head into the next year.

Got it. And then as we approach the holidays, and we're seeing a rise in COVID cases, how should we think about coach growth over the next quarter or two? Is there any seasonality or otherwise disruption we should consider when we think about building out our models?

Yeah, it’s hard for us to project the impact of wave two or wave three. That’s the reason we’re not providing guidance. We believe we’re well positioned to work through the fourth quarter. In the past, we’ve been able to achieve sequential improvements from quarter to quarter. We’re not sure if that will be the case this time around because of the changes and promotions, but we feel highly confident.

I'm just housekeeping question for me. What was the commission rate in the quarter?

Yeah, this is Jim. It was approximately forty-two percent, which is pretty consistent with last year.

Yeah, I see that. And then what was DNA and stock-based compensation?

So the depreciation, no damage. Yep, hold on for one second. So for the quarter, it was five point three million dollars. The share-based compensation for the first three quarters was four point two million.

Awesome. Thank you so much. That's all for me. Thanks.

The next question comes from Sebastian Barbiero from Jefferies. Please go ahead.

Congrats on a good quarter. I repeat, questions number one, I was wondering if you could talk to the growth cadence EPS. Did you see a big boost coming out of this promotion out of the quarter?

Yeah, what we saw in Q2 and Q3 from a gross marketing standpoint was consistent retention rates with what we typically see historically. So, think about that large cohort of new clients that came in during the second quarter went on to repeat the same way our typical cohort of clients would. We also saw a slight improvement in coach conversion. As you know, we ran what we described as a business builder promotion in August that ran all the way through October. So we saw that this new cohort repeated at the same rate and converted to coaches at a slightly higher rate, which is why we saw a larger than typical acceleration in our active earning coaches in the quarter.

You mentioned a higher standard of climb. Can you give me some more details on that, please?

Yeah, so the promotion we ran in the second quarter was an offer. There was training and an offer alongside a social media strategy. The offer was for any client who hadn’t purchased in the last twelve months to come in and purchase the essential starter kit at a discounted rate. In the second quarter, we had an active earning productivity practice of running coach at roughly five thousand eight hundred. That number reflected a price discount, and so as those same clients repeated in the third quarter, they repeated at full price, which was the upside benefit.

And then talking specifically about the peak stocks, is there any risk to the remaining eighty percent? You say you’re focused on any risk of them going out of stock?

As I said earlier, we managed the out-of-stock risk by holding production on our slow-moving items. None of our high-moving SKUs ever went out of stock. We believe there is no risk of them going out of stock. In October, we began to add back manufacturing capacity tied to new relationships with co-manufacturers. As we move into next year, we have more than adequate manufacturing capacity to supply the growth we anticipate, with the slow-moving items coming back into stock.

Should we expect them to come back January 1st?

Some of them will never come back. Part of our strategy is to consolidate our brands to just Optavia. The slow-moving SKUs will likely not return, roughly seventeen of those items. However, we don't believe this will have any type of volume impact because we have duplicate SKUs aligned with the Optavia brand.

The next question comes from Linda Bolton Weiser from D.A. Davidson. Please go ahead.

Hi, could you give us an update on your international business? It’s been more than a year now since you launched it. What is the year-over-year growth rate of international? Is it very high growth or just modest? Can you give us a little bit of color on that?

As we said before, we don’t plan to report specifically on international. We’ll give you a couple of highlights. Asia Pacific continues to grow at a consistent rate. It has been impacted, we think, by both the pandemic and, probably even more so, the political unrest in Hong Kong. We continue to add additional support for the business, including native language support with the Philippines call center and additional support in terms of translating materials. We’re confident this will be a meaningful part of our business in the long term, but at this point, it’s not about the 10 percent level.

Thanks. I seem to recall that there were some pretty big trip expenses related to your incentive trip in the second half of last year, if I'm remembering correctly, and that you've benefited from not having those in the second half of this year. How much of a benefit was that in the third quarter? And then what would be the number that would be in the prior year period for the fourth quarter?

As I mentioned, our sales and marketing expenses were lower this year versus last year in Q3. Overall, for the full six-month period, we’re talking about five point six million dollars. I would say most of it was accrued in Q3. That’s why you're seeing some of the benefit in Q3.

Could you just discuss the ultimate potential of the number of coaches in the U.S.? Would you suggest we look at other direct sellers, even if they sell different products like Avon or Tupperware, and gauge your potential in the U.S. for the number of coaches, or would that not be a good comparison?

There are significant differences between a coach and a distributor, so I think it would be difficult to compare. We conducted work on the addressable market for the business, and the interest in coaches. We believe there is roughly a decade worth of growth with what we've been doing and the ability to expand beyond that as we continue to modify our offer to coaches and make the business model more attractive.

Great, thanks. Do you think you're getting benefits from the pandemic in terms of people wanting the ease of having the delivery of food products and the weight gain during the pandemic?

We actually conducted some modeling and hired an outside firm for that, which included both quantitative analysis and qualitative surveys. We believe there is a very small benefit tied to the pandemic that has to do with what you stated earlier, perhaps some weight gain, and also higher awareness and concern about health. We found that well over eighty percent of Americans are now concerned about their health during the pandemic. That's the quantifiable pieces. The part that's been helpful for our coaches is that people are far more available; they’re less busy because they’re working from home, not traveling as much, which allows more time to focus on their health.

Thanks. Can I ask about your thoughts on cash flow use? Are you leaning heavily towards raising your dividend, which typically you announce in December, or might you consider switching more towards share repurchase?

All those discussions are ongoing at the board level, so as we get more input over the next quarter, you'll see those decisions being made. We typically do not share details on capital allocation until decisions are finalized.

Thank you very much.

Thanks, Linda.

The next question comes from Doug Lane from Lane Research. Please go ahead.

Yes, hi, good afternoon, everybody. The coach numbers you mentioned were pretty impressive. Certainly, I had what we were expecting. That’s good evidence that whatever you’re putting in place is working in developing your new cohort down the line, hopefully into coaching and leadership positions. So, looking ahead to when we get back to a more normal consumer mobility environment, what learnings have you gathered this year that changes how you go to market once we return to some sort of normalcy?

We have learned that there’s a group of potential clients who, with the right offer and the right messaging on social media, are attracted to our program. Our training and social media efforts allowed us to attract them in a way that we haven’t been able to before. We anticipate repeating a refined version that ties back to our learnings from this year. Our coaches and social leaders now understand how to optimize promotion, and we are very optimistic about these learnings increasing our ability to penetrate and accelerate growth moving forward.

That makes sense, but there's no plan to abandon the in-person events, the global conventions, the leadership trips, what have you.

What we've said previously is that we believe our business will support a 15 percent operating margin as we move forward. We plan to achieve that around the same time we reach a billion dollars in revenue, allowing us to invest back into programs you describe, while also supporting the dividend we pay and the operations of the business.

I remember those goals, and I think they also included fifty thousand active coaches. Have you updated the timetable for that?

No, we decided at the end of last year to focus really on the long-term sustainable growth rate in the mid-teens, and we’re confident enough in our business to project that without tying it to specific goals.

Thanks, Dan.

Thank you, Doug.

There are no more questions in the queue. This concludes our question and answer session. I would like to turn the conference back over to Dan Chard for any closing remarks.

Yes, I would like to say thank you for all of your participation in this conference call. We appreciate your interest in Bedfast and appreciate you joining us this evening. We look forward to providing you an update in our upcoming quarter and appreciate all of your interest. A big shout out to all of our coaches across the world at this stage. Thank you again. Bye bye.

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