Medifast Inc Q3 FY2022 Earnings Call

Good day, and welcome to the Medifast Third Quarter 2022 Earnings Conference Call. I would now like to turn the conference over to Reed Anderson with ICR. Please go ahead. Good afternoon, and welcome to Medifast's Third Quarter 2022 Earnings Conference Call. On the call with me today are Dan Chard, Chairman and Chief Executive Officer; and Jim Maloney, Chief Financial Officer. By now, everyone should have access to the earnings release for the quarter ended September 30, 2022, which went out this afternoon at approximately 4:05 p.m. Eastern Time. If you have not received the release, it is available on the Investor Relations portion of Medifast's website at www.medifastinc.com. This call is being webcast, and a replay will 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 upon them. Actual results could differ materially from those projected in any forward-looking statements. All of the forward-looking statements contained herein speak only as of the date of this call. Medifast assumes no obligation to update any forward-looking projections that may be made in today's release or call. And with that, I would like to turn the call over to Medifast's Chairman and Chief Executive Officer, Dan Chard.

Thank you, Reed, and good afternoon, everyone. Thank you for taking time to be with us today. On the call with me is Jim Maloney, our Chief Financial Officer. I'll start with an overview of the third quarter and the continued evolution of our business. Then Jim will run through our financial results in more detail. The third quarter has been one of calibration and adjustment. We are pleased to see a faster-than-expected recovery in customer retention, which is now back to historical norms following the disruption in Q2 due to consumer spending pressure from higher inflation and interest rates. Customer satisfaction numbers remain at historical highs as our operating infrastructure continues to enable us to deliver a high-quality customer experience that drives retention and brand ambassadorship. Customer experience is one of the key differentiators that allows us to maintain our leadership position, which was recently underscored when Euromonitor, an independent market research firm, named OPTAVIA as the top weight loss program in the U.S. by revenue for last year. Revenue of $390 million in the third quarter was down less than 6% versus the prior year period, representing an improvement on the outlook we provided earlier in the year of a mid-teen double-digit decline. The number of OPTAVIA Coaches increased 8.5% year-over-year to 66,200, while revenue per active earning coach declined 12.9% to $5,897. Gross margin of 72.5% was down year-over-year but improved 150 basis points sequentially. Additionally, we proactively managed our SG&A expenses, taking meaningful steps to bring costs in line with how our business is operating, and we delivered a 110 basis point reduction on an adjusted basis versus last year despite lower revenue. We achieved earnings per share of $3.27, a decrease of 8.1% compared to the prior year and earnings per share of $3.32 on an adjusted basis compared to $3.56 in the prior year period. As we move forward, we will continue to execute a disciplined capital allocation strategy and prioritize investments that will drive meaningful growth. As we look back over the last few months, there are several important learnings that will help us inform the way we plan and manage our business going forward in this new environment. The programming we implemented in early 2022 proved successful in attracting new customers, confirming the continued demand for the OPTAVIA offer. The program attracted the largest new customer cohort in company history, but repeat rates were negatively impacted by the most price-sensitive customers across all customer cohorts. Repeat purchase rates among our remaining customer base across all cohorts returned to their historical ranges in the third quarter, but there is a lingering overall impact on coach productivity as measured by new customer acquisition for coaches. With this in mind, we made several changes to our programming and operations to help put the business back on a growth track and improve profitability as we finish 2022 and be in 2023. First, using the learning from the successful new coach accelerator program that we put in place during Q3 to accelerate building our base of active earning coaches and acquiring new customers, we expanded the program to include all coaches and extended the program period through the end of the year. This means that all of our coaches have an incremental financial incentive to drive customer acquisition. Second, in partnership with our coach leaders, we identified a set of programming adjustments that reflect learnings from early 2022 to help drive customer acquisition in the new business environment through 2023 and beyond. This programming change will be implemented in the first quarter of 2023 and will focus on accelerating new customer acquisition. Third, we will implement a price increase across the entire product assortment that will be effective in November. The increase is tied to a set of margin assurance and productivity initiatives that will have a positive impact on the P&L in Q4 and provide further profitability support in 2023. The price increase will be an average of 4.5% on our consumable products. Concurrent with this price increase, we will increase shipping prices as well as adjust purchasing thresholds within our premier loyalty program to further support productivity. Fourth, we have made minor changes to optimize the compensation plan and our G&A operating structure that will improve results and better align with our long-term strategy. And finally, leveraging our investment in technology and digital capabilities remains a key area of focus to drive deeper engagement and seamless connectivity across the OPTAVIA community of coaches and customers. Consumer focus and awareness around health and wellness has not dissipated. In a recent Medifast survey, while the majority of U.S. adults said they have cut their spending in the last 6 months, 70% of U.S. adults say they don't plan on letting their health and well-being falter and plan on implementing better lifestyle changes in the coming year. Our unique positioning of a personalized transformation experience remains a critical point of differentiation in this important sector, and our programs and initiatives will help us drive further growth and energy in our business as we continue to scale. Clearly, there are near-term challenges for consumer-facing businesses as they adjust to the changing environment. At Medifast, we remain confident in our ability to navigate this shift and in the strength of our long-term growth strategy. Our coaches and customers remain deeply engaged, and satisfaction levels continue to be near all-time highs. We have a dominant position in a $7 billion weight loss industry with a model that is clearly differentiated and a plan that is clinically proven and consistently delivers positive outcomes for coaches and customers. Over the years, the OPTAVIA community has grown to millions of individuals working in partnership with OPTAVIA Coaches, who provide customized support and teach customers healthy habits that can lead to lifelong transformation. We continue to be well positioned for the long-term growth and remain committed to our target of 15% average annual revenue growth and 15% operating margin. Our investments in technology and infrastructure provide an efficient pathway and significant capacity for growth, as we continue to expand our international footprint as well as move into the broader $230 billion health and wellness market in the future. Medifast has a bold mission to transform lives one healthy habit at a time. We are achieving that in the field with coaches and customers, who are achieving change that they previously thought impossible. We are also helping drive change in the classroom with the healthy habits for all curriculum that is helping school children make healthy choices regardless of socioeconomic background. And we are doing it through our partnership with No Kid Hungry, which has provided up to 10 million nutritious meals to children facing hunger. Our mission motivates us to continue the work we're doing every day. From profit-generating activities to corporate social responsibility initiatives, it's important work that drives us to be better every day to overcome obstacles and to work as a team to drive better outcomes for everybody, from clients to coaches, to employees, to investors. With that, let me now turn the call over to Jim Maloney, who will walk you through the financial results. Jim?

Thank you, Dan. Good afternoon, everyone. Revenue in the third quarter of 2022 decreased 5.6% to $390.4 million from $413.4 million in the third quarter of 2021. We ended the quarter with approximately 66,200 active earning OPTAVIA Coaches, an increase of 8.5% from the third quarter of 2021. Average revenue per active earning OPTAVIA Coach from the third quarter was $5,897, a decline of 12.9% driven by a decrease in the number of customers supported by each coach. Gross profit for the third quarter of 2022 decreased 7.9% to $282.8 million compared to $307.1 million in the prior year period, reflecting lower coach productivity. Gross profit was 72.5% in the third quarter of 2022 versus 74.3% in the comparable prior year period. The 180 basis point decline in gross profit margin was mainly due to inflationary economic conditions that are driving higher raw ingredients, shipping, and labor costs. SG&A expenses for the third quarter of 2022 decreased 6.8% to $234.7 million compared to $251.9 million for the third quarter of 2021. SG&A as a percentage of revenue decreased 80 basis points year-over-year to 60.1% versus 60.9% in the third quarter of 2021. Non-GAAP adjusted SG&A decreased 7.3% to $233.6 million, and non-GAAP adjusted SG&A as a percentage of revenue decreased 110 basis points year-over-year to 59.8%. The decrease in non-GAAP SG&A was primarily due to lower OPTAVIA Coach compensation expense. Non-GAAP adjusted SG&A excludes expenses related to donations made to support the Ukrainian relief effort. Income from operations decreased 12.7% compared to the prior year period or $7 million to $48.2 million primarily as a result of decreased gross profit partially offset by decreased SG&A. Income from operations as a percentage of revenue was 12.3% for the third quarter of 2022 compared to 13.3% in the same period in 2021. Non-GAAP adjusted income from operations, which excludes the Ukrainian donation, decreased $5.9 million to $49.2 million. Non-GAAP adjusted income from operations as a percentage of revenue was 12.6%, a decrease of 70 basis points from the year-ago period. The effective tax rate was 24.5% from the third quarter of 2022 compared to 23.9% in the prior year's third quarter. The increase in the effective tax rate was primarily driven by an increase in state income taxes partially offset by increased tax benefits for donations made in the quarter and research and development tax credits. The non-GAAP effective tax rate was 24.9% as compared to 23.9% in the prior year period. Net income in the third quarter of 2022 was $36.2 million or $3.27 per diluted share, compared to net income of $42 million or $3.56 per diluted share in the prior year's third quarter. The non-GAAP adjusted net income was $36.8 million or $3.32 per diluted share. Additionally, on September 8, the company's Board of Directors declared a quarterly cash dividend of $18.2 million or $1.64 per share, which is payable on November 8, 2022, to the stockholders of record as of September 20, 2022. This represents a 15.5% per share increase compared to the third quarter of the prior year. Turning to the balance sheet and cash flows. We believe our financial position remains strong with $69.7 million in cash, cash equivalents, and no interest-bearing debt as of September 30, 2022. During the 9 months ended September 30, 2022, our net cash flow from operating activities was $142.8 million, an increase of 40% from the year-ago period. As cash flows have improved over the past 5 years, we have returned excess cash to stockholders in the form of dividends and stock buybacks. We've increased our dividend since 2017 by more than 240%, and the dividend yield is 5.6% as of October 31, 2022. We have additionally increased the rate of stock buybacks over the last several years, including the $100 million accelerated stock repurchase program that was completed in Q3 2022. We have continually increased the return to stockholders in the form of dividends and stock buybacks because we are confident in our long-term growth strategy. I will now turn to our guidance for the full year 2022. As Dan discussed, the macroeconomic environment has remained challenging over the past several months. And while our retention rates have returned to historical norms, there is a residual impact on new customer acquisition. We expect full year revenue in the range of $1.51 billion to $1.59 billion and diluted non-GAAP EPS to be in the range of $11.61 to $13.05. Our guidance assumes a 24% to 25% effective tax rate. Finally, we believe that along with our 66,000 coaches, we'll be able to navigate the new business environment in the coming quarters. So we are confident in our long-term 15% growth and 15% operating income targets.

Thanks, Jim. In closing, we are confident in the power of our coach-based model and the habits of health transformation system to change lives for the better. It is our unique model backed by an incredible coach community that is highly adept at engaging and nurturing relationships. We have a strong management team with a proven track record of running and scaling businesses and talented, nimble groups of employees with a passion for what we do. More than that, we have a unique, powerful business model that is scientifically proven to be effective and that is changing lives every single day. The core of this business is strong, and we have invested appropriately over the recent years to create a foundation that we can build on for many years to come. There's more work to be done, and we must always fine-tune our operations, processes, and initiatives to reflect market conditions. The reality is that the environment today is one of constant change, and that means developing a resilient and strong business capable of succeeding regardless of the circumstances. We feel confident that our initiatives and long-term strategy set us up well to deliver our growth and financial objectives for 2023 and beyond. With that, let me turn the call over to the operator for questions.

Our first question comes from Christina Xue with D.A. Davidson.

This is Christina Xue on for Linda from D.A. Davidson. So firstly, we are really happy to hear that the retention rate is now back on track. A couple of questions. Firstly, do you mind commenting a little about do you expect the coaches to be up or down sequentially in the fourth quarter? I think for the third quarter, we were up quarter-over-quarter, we were down a little sequentially. So just want to get some opinions on the fourth quarter.

Yes, Christina, this is Dan. I'll provide some insight on that and let Jim address the specific details you mentioned regarding coaches. It's important to reflect on our past to give context for our future. We ended 2021 strongly, with a 60% growth, completed our supply chain initiatives, and implemented a 3.5% price increase to deal with inflation. As we began 2022, we started well, focusing on acquiring new clients and executing a strategy similar to what we did in 2020. Notably, we brought in nearly 250,000 new customers, the highest in our history, alongside record coach productivity. However, in the latter half of Q2, we faced some challenges as client retention and repeat rates declined, resulting in a loss of about 15% of our active clients across all cohorts, primarily due to inflation and economic uncertainty. As we moved into Q3, we introduced new programs to support our coaches and attract a new set of clients. Fortunately, client retention and repeat rates have quickly returned to pre-Q2 levels. However, acquisition rates are still under pressure, sitting at about 85% of historical norms in Q3. Looking ahead to Q4, we have adjusted our outlook based on this new environment. While we won’t provide specific forecasts during this call, we have learned how to navigate our current landscape for growth. We are implementing a 4.5% price increase to offset inflation and adjusting our compensation plan to keep our coaches focused on acquiring clients. For Q4, we are taking a conservative approach, considering ongoing macroeconomic challenges and the challenges related to coach and client tenure. As we usually bring in a large cohort of newer clients and coaches, that’s not happening now, which affects productivity per coach. Notably, our productivity per coach revenue has increased by over 50% since 2016. The last two months of the year tend to be our slowest seasonally, as many people are focused on the holidays and often defer joining the OPTAVIA program until the new year. Therefore, we will continue to prioritize client acquisition, with significant progress expected in the first quarter of 2023.

Yes. So Christina, as Dan mentioned, the guidance we provided assumes the macro headwinds. And as Dan mentioned, we believe it's conservative guidance. The good news is retention has recovered in Q3, which is really good news. However, the carryforward impact from Q2 of the retention issues left us with suboptimal coaching customer tenure that will put pressure on Q4. So in Q3 and beginning in Q4, what we're seeing is lower-than-anticipated customer acquisition, which we expect will impact the productivity in Q4. We expect productivity to be lower, and we'll have a more modest headwind in coach count in Q4. As Dan mentioned, the good news is we'll be heading into January, which is the best time for customer acquisition for our company, that will help with the tenure mix with coaches and customers.

Okay. That makes sense. So with regard to the retention rate, I think you mentioned there is going to be another round of price increase roughly starting in November, if I remember correctly. So I wonder what your thoughts on how do you expect your clients to react to the latest price increase; will it be an issue for the retention rate again?

Yes. We approached pricing very thoughtfully and took some extra time to contemplate and actually learn from what we had seen versus last year and also through the year as we've looked at how we can optimize our acquisition offer. So the 4.5% reflects what I'd describe as a modest increase that we believe will be easily absorbed by new clients. It's being coupled with some initiatives to make our acquisition kits more affordably accessible for new clients. A good way to think about this is the client acquisition kit and the pricing and price point are the most important base. What we have seen is once a client sees success on the program, enjoys the food, and appreciates the coach, that's what ultimately drives the repeat rates or the retention rates. So we feel confident that we can execute the 4.5% increase across all of our consumable products without creating a significant headwind from a pricing standpoint that will cause any further impact on client acquisition.

And I'll add, Christina, that when you look at 2023, we have in the long term to get to our objective of a 15% operating income margin. So looking at the long term, we have more than enough margin assurance initiatives. Dan mentioned the price increase, but we also have increased our capabilities over the last 12 months in our procurement organization, which offer significant cost savings opportunities that we'll start seeing in 2023 and this will continue into 2024. We also have value engineering initiatives that will reduce overall costs while also increasing customer satisfaction. Finally, we're looking at optimizing our coach compensation and G&A costs to support our growth and help us adjust in these new business norms.

Okay. So a follow-up on the price increase. Is it applicable to all customers? Or is it only applied to new customers?

To all customers.

What do you expect your clients to react? Also, do you have an estimate of which quarter of 2023 we might see positive year-over-year sales growth? Would you be able to comment on that?

Yes. Go ahead.

We are not providing guidance for 2023, making it challenging to address that question. However, we remain committed to our long-term goal of achieving 15% annual growth consistently. Our company is focused on expanding our capacity and technology capabilities, and we are continuing to invest in these areas because we recognize that our offerings are essential. Despite changes in consumer spending, we believe health and wellness will remain a priority for them.

Great. Thank you for your questions and for taking time to join us today. The last 3 years have been interesting for businesses of all shapes and sizes to navigate. First, the global COVID pandemic upended many of the practices we held to be true. And now we're in a period of sustained inflation, interest rate rises, and possibly a recession. I can say that at Medifast, we're committed to delivering shareholder value for the long term, regardless of the macro conditions. This means driving for consistent growth, not just today, but in years to come. It's our job to adjust, learn, and continue to build, and that's exactly what we plan to do. Thank you, as always, for your interest in Medifast, and we look forward to speaking with you again next quarter.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.