Earnings Call Transcript - MED Q4 2020

Operator, Operator

Good day, and welcome to the Medifast Fourth Quarter and Full Year 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 Reed Anderson. Please go ahead.

Reed Anderson, Moderator

Good afternoon, and welcome to Medifast fourth quarter 2020 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 period ended December 31, 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 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. Medifast assumes no obligation to update any forward-looking projections that may be made in today's release or call. All of 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, Chairman and Chief Executive Officer, Dan Chard.

Dan Chard, CEO

Thank you, Reed, and good afternoon to everyone joining us. Thank you for taking time to be with us today. On the call with me today is Jim Maloney, our Chief Financial Officer. After I've provided some updates on our business performance, Jim will review the Q4 financial results in more detail. We'll then open up the call to take your questions. We closed the year on a strong note, with accelerating top line growth over the third quarter. Revenue increased 55.3% to $264.9 million in the fourth quarter of 2020, and we continued to execute strongly across all areas of the business. Earnings per diluted share were $2.36, up 42.2% compared to the prior year period. However, due to significant differences in tax rates between the periods, we believe income from operations is a better gauge of how we perform from a profitability standpoint. Jim will discuss our tax rates in more detail when he covers our financial results. For the fourth quarter, income from operations was $38 million, an increase of 103% versus the same period last year. Growth was driven by significant year-over-year and sequential improvements in the number of active earning OPTAVIA Coaches, which grew to 44,200 in the fourth quarter, another new record. Additionally, productivity per active earning coach increased 13.4% to $5,932 during the quarter compared to the prior year period. Our client community remains strong, and we finished 2020 even better than expected with successful incentives and coach programs in Q4 that position us well for 2021. The initiatives we've implemented over the past one to two years are delivering consistent, meaningful progress, as evidenced by the results we announced today. The company's focus continues to be supporting our growing community of independent OPTAVIA 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 5&1 Plan, and supporting new coaches and developing coach leaders. There's an ever-growing number of individuals seeking greater health and wellness. We remain resolutely focused on targeting those for whom diets have failed and who desire a holistic approach to optimizing their overall health and wellbeing. The key insights supporting our sustained growth is that clients do better on their health and wellness journey when they have the support of a coach. The coach-led model has been clinically proven to be more effective in this regard. As such, we have combined the most powerful aspects of the direct selling model and direct-to-consumer offerings and created a model that puts the OPTAVIA Coach at the center of helping clients on their health transformation journey, with the company providing the distribution infrastructure to supply products directly to the end consumer. We reach our target audience through the community of OPTAVIA Coaches, who leverage social media channels to relay their success with our proprietary habits of health transformation system and products. Our vision is to achieve long-term sustainable growth in the mid-teens by penetrating the large and growing addressable market in the United States, continuing our expansion into Asia-Pacific markets and developing other large markets throughout the world. As we continue to grow at scale in both coaches and clients, it's essential that we maintain a sharp focus on building an operational foundation through investments related to organization, technology, digital products, manufacturing, and distribution. This will allow us to take full advantage of the long-term growth opportunity. Consistent with the business and brand strategy that we communicated last quarter, we are moving forward with the sunset of our Medifast direct channel and Medifast branded products and anticipate this being complete by the end of the second quarter. By focusing on building capabilities in the areas that matter most to our OPTAVIA Coaches and client-centered model, we will further enhance and solidify our competitive advantage in the health and wellness space in support of our long-term growth and profit vision. Last year, we initiated an important project to rationalize our SKUs, enabling us to place greater focus on the most popular and profitable products in our portfolio, and to place a more consistent emphasis on our OPTAVIA brand. We continue to enhance our supply chain capabilities to meet product demand across core items, while also empowering further operational optimization across all aspects of the manufacturing and distribution network. The strategic value of having a strong supply chain has never been more important, and we continue to prioritize these investments focusing on expanding capacity, as well as driving operational excellence. We remain on track to support a $2 billion revenue business by the end of 2021, creating ample headroom for several years, depending on the trajectory of future growth. We are scaling up new and existing co-manufacturers, which mitigates the risk through diversification while also adding capacity. We're also working closely with our third-party logistics partners to leverage their capacity, as well as adding distribution assets to our facility in the Maryland area. Technology remains another key area of focus for Medifast. We opened a new technology center in Utah roughly a year ago to become our pioneering digital lab for developing tools that create efficiencies for coaches and drive engagement for clients. Our OPTAVIA Coaches continue to refine their use of technology and social media in attracting new clients and broadening their reach. Overall, the new coach-dedicated training regimen and technology support systems are increasingly effective at supporting more clients than has been historically possible. Deeper digital expertise will also allow us to further leverage the competitive advantages of the coach model. During the first half of 2021, we will launch the beta version of the OPTAVIA Coach connect app, a powerful productivity tool aimed at helping coaches manage clients. We will also launch the beta version of the OPTAVIA client app, which focuses on meal planning for the OPTAVIA Weight 5&1 Plan. Our team in Utah continues to work on a range of other tools to drive digital engagement with the field. We're excited about the opportunities that lie ahead in this space. In 2020, our revenue growth rate was roughly two times our long-term growth rate, essentially pulling forward an entire year. While we're clearly pleased with this elevated growth rate, as a management team, we're focused on delivering long-term sustainable value. Our current business remains strong, and I've never been more confident in the direction of the company and our ability to drive consistent and sustainable growth by delivering on our mission of lifelong transformation, one healthy habit at a time. For current stockholders and prospective investors, the Medifast story remains compelling for several reasons. First, our addressable market is large and growing. The U.S. weight loss market that is core to OPTAVIA's business has been growing at about 6% per annum and is worth $20 billion today. Roughly 70% of the U.S. population is overweight or obese, and this segment is growing at 2% per annum, which highlights the importance of a proven health and wellness solution like the one we offer. Earlier this year, we commissioned an independent survey to show that the pandemic has only heightened consumer focus on health and wellness. Now 63% of Americans report that they have adopted new positive health routines since March of 2020, and of those, 96% plan to continue embracing healthy habits this year. COVID-19 is causing people to put their personal health and wellness higher up in their priorities. And this presents a significant opportunity for our company. Second, our holistic coach-centered approach is supported by proprietary tools in a vibrant community that provides a clear competitive advantage in the health and wellness space. Again, it is clinically proven that people who want to lose weight do better when they have the support of a coach and a community, and that principle is at the very heart of the OPTAVIA offer. Third, we have a dynamic and agile organization that adapts quickly to changes in the marketplace, even when those changes come unexpectedly and at a rapid pace such as what we saw last year as a result of COVID-19. That makes us more nimble and a better place to take advantage of tactical opportunities as they emerge. Finally, we have a strong financial position, efficient business, and a disciplined strategy for allocating capital, prioritizing organic growth opportunities while returning a significant amount of value to stockholders through dividends and share repurchases. Before I turn the time over to Jim, let me 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. In this challenging time, our commitment to these groups remains a priority. As an example, in the fourth quarter, Medifast behavioral health specialists and registered dieticians partnered with select OPTAVIA Coaches to lead remote classes and activities for the second and fifth graders of the Living Classrooms foundation in Baltimore. For children, the pandemic has brought about increased feelings of stress and anxiety. These classes were designed to promote the habit of healthy minds and to empower children to better handle stress. I'm proud of the work our 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. With that, let me now turn the time over to Jim Maloney, who will walk you through the financial results. Jim?

Jim Maloney, CFO

Thank you, Dan. Good afternoon, everyone. Revenue in the fourth quarter of 2020 increased 55.3% to $264.9 million from $170.6 million in the fourth quarter of 2019. As Dan highlighted, we achieved another record quarter of active earning coaches, ending the quarter with 44,200. This represents 39% growth compared to 31,800 coaches in the same period last year, and a 5% increase from the end of the third quarter of 2020. Average revenue per active earning coach for the quarter was $5,932 compared to $5,229 for the fourth quarter of 2019 and down from $6,329 in the third quarter of 2020, mainly due to the timing of promotional activity moving from one quarter to another. The fourth quarter 2020 was the second-highest level of revenue per active earning coach in our history, and we are very pleased with this strong result. Programming in the quarter was largely unchanged from last year's December dash, other than timing, indicating the strength of the underlying fundamentals of our model. OPTAVIA branded products grew to 87.2% of our total company consumable units sold in the fourth quarter, up from 79% in the prior year period. Gross profits for the fourth quarter of 2020 increased 55.6% to $199.2 million compared to $128.1 million in the prior year period. Gross profit as a percentage of revenue was 75.2%, a slight increase compared to 75.1% in the fourth quarter of 2019. SG&A for the fourth quarter of 2020 increased by $51.9 million to $161.3 million compared to $109.4 million for the fourth quarter of 2019. The increase was primarily due to higher OPTAVIA commission expenses as a result of growth in OPTAVIA sales, as well as increased salaries and benefits-related expenses, partially offset by a decrease in sales and marketing expenses. SG&A as a percentage of revenue decreased by 320 basis points year-over-year to 60.9% compared to 64.1% in the fourth quarter of 2019. Income from operations increased by $19.3 million to $38 million from $18.7 million in the prior year period, primarily as a result of increased gross profits, partially offset by increased SG&A expenses. Income from operations as a percentage of revenue was 14.3% for the quarter, an increase of 340 basis points from the year ago period. The effective tax rate was 26% for the fourth quarter of 2020 compared to 22.4% for the year-to-date ending September 30, 2020, and compared to a tax benefit of 4.7% in the year-ago period. During the fourth quarter of 2020, the effective tax rate increased by 3.8%, which reduced earnings per diluted share by $0.12 due to a discrete tax reserve recorded during the period. For the full year of 2020, earnings per diluted share were negatively impacted by $0.12 due to this discrete tax reserve. The fourth quarter of 2019 tax benefit reflected the impact of federal tax benefits from share-based compensation, partially offset by increases in the effective state tax rate of 2%. Net income in the fourth quarter of 2020 was $28 million or $2.36 per diluted share, based on approximately 11.9 million shares outstanding. This compares to net income of $19.9 million or $1.66 per diluted share, based on approximately 11.9 million shares outstanding in the prior year. Our balance sheet remains very strong with cash, cash equivalents, and investment securities of $174.5 million as of December 31, 2020, compared to $92.7 million at December 31, 2019. The company remains free of interest-bearing debts and believes it is well-positioned in this challenging near-term macroeconomic environment. Our Board of Directors declared a quarterly cash dividend in the fourth quarter of $13.4 million or $1.13 per share, which was paid on February 5, 2021. There are 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 with some insight into the first month of the first quarter, indicating that January's top-line year-over-year growth trends are performing consistent with or better than the trends we experienced in the fourth quarter. If you were attempting to develop a financial model for 2021, I will remind you that Q2 through Q4 2020 have much harder comparables than Q1 2020 from a top-line basis. As Dan discussed, in 2021 we intend to sunset our Medifast direct channel and Medifast branded products, and further invest in our supply chain and technology. We've also budgeted for a return to in-person conventions if safety measures permit. These decisions and investments will impact our operating margins during 2021, enabling long-term growth in operating income objectives. Again, if you are developing a financial model for 2021, these initiatives will increase costs. In closing, 2020 has been a very robust growth year in the face of a very challenging and uncertain environment. We remain confident in our business model and are well-positioned to capitalize on opportunities that lie ahead. With that, let me turn the call over for questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Doug Lane with Lane Research. Please go ahead.

Doug Lane, Analyst

Yes. Hi. Good evening everybody. Can I start with the operating margin? I know you had a very strong margin in the third quarter, but I was wondering if you could help me understand why the operating margin was down 210 basis points sequentially. What changed in the fourth quarter on the expense line that wasn't there in the third quarter?

Jim Maloney, CFO

Yeah, Doug, this is Jim. I wanted to remind you that during the Q3 call, we indicated our plans to invest more significantly in supply chain and technology, and these investments are the main reason for the decline in operating margins in Q4.

Doug Lane, Analyst

Okay.

Jim Maloney, CFO

We tried to highlight that in the previous call. That is generally the reason behind it.

Doug Lane, Analyst

Okay. And are these the same sort of investments you expect to carry into this year?

Jim Maloney, CFO

Some of them are. Additionally, the supply chain and technology investments will continue. The decision to end the Medifast direct channel will also have some impact on operating income percentage because the direct channel does not incur commissions, and even though it's a smaller portion of our business, discontinuing it will affect margins, not in terms of gross margin but in terms of operating income.

Doug Lane, Analyst

Okay. Got it. And then when you talk about the discrete $0.12 tax item, I take that to mean that there's no real structural change in your expected tax rate going forward, but it was more or less a non-repeatable kind of event?

Jim Maloney, CFO

That is correct. It's a one-time charge. At this point, we are not anticipating any additional tax reserves for 2021.

Doug Lane, Analyst

Okay. That's helpful. And then sitting back here, your top line numbers have been very impressive. Your coach growth has been very impressive and obviously not sustainable with these rates, but still, it feels like the business is very strong. And I was wondering with these kinds of growth rates, have you taken a look at, perhaps changing your capital allocation strategy and maybe take on some leverage and accelerate your stock buyback here?

Jim Maloney, CFO

Yeah. On the capital allocation front, we're prioritizing organic growth by first looking at CapEx spend. At least as of right now, we're not anticipating any acquisitions in 2021. So, with that, the decisions to pay dividends or share repurchases, those discussions are held at the board level. So that's really pretty much all I can really say about that.

Doug Lane, Analyst

Okay. Thank you.

Operator, Operator

The next question comes from Sebastian Barbero with Jefferies. Please go ahead.

Sebastian Barbero, Analyst

Hi, team. Congrats on the quarter. I just wanted to start first, Jim, just hang on until the last question from Doug. Do you have a CapEx guide for the year?

Jim Maloney, CFO

We're not really providing that guidance. All I can really tell you is that there are going to be additional investments in technology and in supply chain. That's also going to be in capital spend, and it's also going to be in operating income. So it'll hit the P&L. So there will be additional projects that will happen in 2021 that'll impact CapEx.

Sebastian Barbero, Analyst

Okay. And then, I was wondering if you could talk a little bit more about your progress on the manufacturing fund. It's been a very limited amount of SKU out of stock last time I checked this morning, which points to improved capacity, considering the momentum of the business in early 2021. What is your manufacturing capacity today in terms of annual sales? And then how should we think about that ramping through the year? Should we expect you to hit that capacity to be able to support $2 billion in sales by the end of 2021 or earlier than that?

Dan Chard, CEO

Yes, this is Dan. We began increasing our capacity in the fourth quarter, starting with adding more co-manufacturing partners, and this has continued into the first quarter. It's not a straightforward progression, but we expect to reach $2 billion by the end of the year. Currently, our focus, as mentioned in the last quarterly earnings call, is on consolidating all our volume under the OPTAVIA brand. This involves phasing out the Medifast brands and directing our capacity towards OPTAVIA. We are providing insights on our path to the $2 billion target, and I'm pleased to confirm that we have sufficient capacity to meet our fueling needs throughout the year.

Sebastian Barbero, Analyst

Got it. Okay. Can you discuss the progress of the international business in relation to your expectations? You mentioned opportunities in larger markets around the world, and I was wondering if you could provide more details about that, such as potential markets like Canada or Europe.

Dan Chard, CEO

We expanded a little over a year ago into Hong Kong and Singapore, which we view as gateway markets into the Asia-Pacific region. We have been enhancing our infrastructure and maintaining the same quality experience we offer in the United States. We established a distribution center in Hong Kong and call centers in the Philippines to provide support specifically for Hong Kong and Singapore. Our growth in the Asia-Pacific region aligns with our expectations, and while we don't disclose the exact volume, it represents about 10% of our overall revenue if it becomes significant. Regarding your second question, we conducted tests in Europe and South America before launching in Asia-Pacific and believe there are long-term opportunities in those markets. We see this as an ongoing opportunity to expand our total addressable market, but that’s all the detail we can provide right now about our expansion plans.

Sebastian Barbero, Analyst

Great. Thank you.

Operator, Operator

The next question comes from Kara Anderson with B. Riley FBR. Please go ahead.

Kara Anderson, Analyst

Hi, guys. Thanks for taking some of my questions. I kind of just wanted to jump back to the first question on operating margins. Can you discuss, I guess, with all the changes that are happening in 2021 investments in the sunsetting of the Medifast brand, how you feel about that 15% operating margin target on the $1 billion revenue target?

Jim Maloney, CFO

Since we're not providing guidance, it's a bit challenging to share our thoughts on that. However, there are a few important points to consider. First, we've budgeted for an in-person convention, which, if safety allows, could account for a 70 basis point investment. Secondly, the transition away from the classic brand and towards Medifast direct is likely to have an additional 70 basis point impact on our operating income margins. Finally, the investments in technology and supply chain are expected to affect the P&L, amounting to roughly a 100 basis point investment. I hope this gives you some directional insight.

Kara Anderson, Analyst

It does. Thank you. And then as you begin to think about promotional plans for the year and kind of what you did in April and May of last year, can you give us a peek at anything that might look similar this year?

Dan Chard, CEO

Sure. What we've observed, as Jim mentioned earlier, is that the trends we noticed in the fourth quarter have continued at a similar or improved pace as we enter the first quarter. With that in mind, we're still in the process of evaluation and have not finalized the promotional structure. We know we can promote, and the response we received in 2020 was very encouraging. We're also concentrating on building a natural business rhythm that enables us to sell our products within the framework we've established.

Kara Anderson, Analyst

Okay. Great. Thank you. That's it for me.

Jim Maloney, CFO

Thanks, Kara.

Dan Chard, CEO

Thanks.

Operator, Operator

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

Dan Chard, CEO

Thank you, and I want to thank everybody who's on the call, including any of our OPTAVIA Coaches who may have joined. As you can hear from our results in the fourth quarter, we remain confident in our business structure and our business concept, as well as our addressable market. We believe that our mission to offer the world lifelong transformation, one healthy habit at a time remains even more relevant as we move throughout this New Year and look forward to reporting our first quarter results in several months. Thank you.

Operator, Operator

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