Medifast Inc (MED) 2018 Q3 法說會逐字稿

Good afternoon, everyone, and welcome to the Medifast Third Quarter 2018 Earnings Conference Call. (Operator Instructions) Please also note that today's event is being recorded.

At this time, I'd like to turn the conference call over to Ms. Katie Turner. Ma'am, please go ahead.

Good afternoon. Welcome to Medifast's Third Quarter 2018 Earnings Conference Call. On the call with me today are Dan Chard, Chief Executive Officer; and Tim Robinson, Chief Financial Officer.

By now, everyone should have access to the earnings release for the period ended September 30, 2018, that went out this afternoon at approximately 4:05 p.m. Eastern Time. If you have not received the release, it's available on the Investor Relations portion of Medifast 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 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 in any forward-looking statements. Medifast assumes no obligation to update any forward-looking projections that may be made in today's release or on today's call. All forward-looking 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, Katie. Good afternoon, everyone. We are pleased to discuss our third quarter 2018 results with you today. I will provide a brief overview of our financial and operational business performance. Tim will then review our financial results in more detail and share our 2018 fourth quarter and full year guidance. We will then be available to answer any questions.

For the third quarter, we continued to successfully align our corporate and field leader activities behind a repeatable business rhythm focused on our long-term purpose and mission to offer the world lifelong transformation one healthy habit at a time. To do this, we continue to invest in and develop our integrated coach model, which leverages nearly 40 years of insights focused on how to deliver the best service and product experience for customers who are engaged in their health and wellness journey. These efforts from our entire organization continue to generate an accelerated quarterly growth rate in 2018. As a result, third quarter revenue and profitability exceeded our expectations, and we're pleased to raise our full year guidance, which Tim will review.

As we move forward with our strategic initiatives both domestically and internationally, we believe we remain well positioned to deliver long-term sustainable growth and value for our shareholders, meaningful improvements to the lives of our customers as they learn new healthy habits and a strong business opportunity for OPTAVIA coaches and business leaders as they focus on our purpose and mission.

We ended the third quarter with a record 22,600 active earning coaches who actively support their clients in achieving their health and wellness goals. The growth of our coach base, along with improved revenue per active coach, drove our strong third quarter financial results. Quarterly year-over-year revenue growth accelerated from 40% in the first quarter and nearly 55% in the second quarter to more than 80% in the third quarter of 2018. This marks the sixth consecutive quarter of year-over-year revenue growth and the seventh consecutive quarter of sequential revenue improvement.

The third quarter was also the largest revenue quarter in the history of the company, resulting in third quarter diluted earnings per share of $1.14, ahead of our third quarter guidance of $1.05 to $1.10. Importantly, we achieved these strong results while accelerating a level of strategic investment during the quarter to support our brand platform and operations as we continue to improve the scalability of our business based on strong growth in the U.S. in the pursuit of international expansion next year.

Our integrated coach model, along with the continued development of our OPTAVIA brand platform, creates a strong foundation for business growth. We now have 71 OPTAVIA brand SKUs to help our coaches build personalized plans to support their clients on their health and wellness journeys.

Today, I will review a few recent highlights that demonstrate our ongoing efforts to align with OPTAVIA coaches as we work together to achieve our strategic growth initiatives. During the third quarter, we build upon the momentum and excitement created at our Annual OPTAVIA National Convention, which took place in July in St. Louis. As we mentioned to you on our last call, this was the largest national convention in the history of the company, with record-breaking attendance of nearly 6,000 coaches and clients, representing a 46% increase from last year's convention. The majority of attendees were OPTAVIA coaches and OPTAVIA business leaders, who were there to receive training, to be recognized for their individual successes and to align around the initiatives that support our purpose and mission. At convention, we also introduced a new product system that promotes the healthy habit of hydration and is branded Purposeful Hydration.

As I mentioned previously, these products complement our existing OPTAVIA Fuelings and became available to coaches and their clients on August 13. This marks our first OPTAVIA product launch that is not one of our OPTAVIA Fuelings and is designed to build on the healthy habits platform we have established for our coaches. We are enthusiastic about the opportunity to provide a complementary product for our coaches and their clients and believe Purposeful Hydration product usage will continue to gain traction over the coming years.

Our product development marketing teams remain focused on the development of future products to support healthy habit creation for our coaches and their clients. In addition, our product and manufacturing teams continue to increase efficiency. We have added shifts and expanded our supplier base as well as taken advantage of key areas where we can utilize co-manufacturers to attain greater capacity and speed to market with new and existing products. We are in a strong position to support the growth of our OPTAVIA coaches domestically and very soon, internationally.

We are also pleased to have many of our OPTAVIA coaches advancing to success, growth and development through our compensation program as well as through specialized leadership training. Most recently, we hosted our Sundance XIII Advanced Leadership Retreat in October. It was an opportunity for nearly 300 of our OPTAVIA leaders to be trained by successful business leaders in our OPTAVIA community.

During this leadership event, we shared transformational stories from the field, aligned behind common goals and business objectives and discussed as well as tasted new OPTAVIA products. During the event, participants also went on a team hike to Stewart Falls, raising over $11,000 for No Kid Hungry, a nonprofit organization working to solve problems of hunger and poverty in the United States and around the world. This was truly a memorable experience that aligns with our recently launched Healthy Habits For All initiative, which was launched earlier this year. Healthy Habits For All is a new platform designed to provide our employees and coaches with a way to further our purpose and mission by giving back to local communities. The program focuses on making healthy habit second nature for our underserved communities through education and access as we advance our mission by providing individuals with the resources they need to live healthier lives in their -- our local communities and ultimately, around the world.

Our third quarter also represented an opportunity for us to further communicate our plans for international expansion with our OPTAVIA Coach community, including presentations and workshops at convention and subsequently, at Sundance. We are on track to launch in Hong Kong and Singapore in the first half of 2019. While we have not yet announced the actual launch date, the response from our OPTAVIA coaches at the prelaunch activities has been overwhelmingly positive and we -- as we continue to grow in the U.S. and take the necessary steps to start growth internationally.

Our Global Health Ambassador Club, which was introduced at convention, is a success-sharing opportunity for U.S.-based coaches who initiate and support business development in Hong Kong and Singapore. We already have a strong group involved, and it continues to build.

In addition, the International Leadership Advancement Trip, our new incentive trip for 2019, is designed to reward business leaders, qualifiers with exclusive training and development opportunities. This will be the largest event of its kind in our company's history, scheduled to take place in March of 2019. The qualification process for OPTAVIA business leaders began in the third quarter. This represents another strategic investment we are making in the second half of this year to support ongoing growth through the end of the year and into 2019.

We're taking the right steps, both domestically and internationally, ahead of our growth to best position the company for future success. We continue to invest in building our corporate leadership as well, including adding key executives to our existing leadership team. Just last week, we announced the appointment of a Chief Marketing Officer and a Chief Human Resources Officer. These appointments follow additions earlier this year, including our President of OPTAVIA U.S.A. and our Vice President of Business Development, Asia Pacific. With each of these new leaders, we gain valuable experience, perspective and insights, we believe in their future contributions, combined with the strength of our existing management team, will be instrumental in scaling the company's growth in new and existing markets for many years to come.

Operationally, we remained focused on making advancements in our technology platforms to further improve our coach and client experience. These investments are a very important part of supporting both the rate of growth we are experiencing domestically and to prepare for our upcoming launch in Hong Kong and Singapore. These initiatives include upcoming launches of a new scalable mobile and e-commerce platform to improve the client shopping experience and to support our expanding OPTAVIA Coach community's ability to train and communicate in multiple languages.

As we mentioned last quarter, we have collaborated with a leading global logistics provider to open a scalable operation designed to support our growing business here in the United States as well as our upcoming shipments to our new Asian markets. This partnership, including the new scalable Nevada distribution center we opened in the second quarter, which will help us better serve our West Coast coach and client base, serves as a key distribution point for our launch in Asian market next year. In addition, we recently began preparations to partner with a global, best-in-class client contact center, which will increase our capacity, improve scalability and advance our technological capabilities to support a growing client base in multiple languages. Combined, these new important partnerships will allow us to internally place more focus on coach support and prepare us to support the growing needs of the company.

In summary, we are incredibly pleased with the results we have achieved year-to-date in 2018. Our entire management team remains focused on delivering strong returns to our shareholders. We expect to achieve this through continuing to build on our U.S. business opportunities and by expanding our mission into the Asia Pacific region as we open these 2 key gateway markets of Hong Kong and Singapore in the first half of 2019. We're excited about our future opportunities and the team we have in place to execute our growth potential.

With that, I would like to turn the call over to our CFO, Tim Robinson.

Thank you, Dan, and good afternoon, everyone. I'll review our financial results for the third quarter ended September 30, 2018, then I'll provide our fourth quarter guidance and discuss our raised annual outlook.

Revenue in the third quarter of 2018 exceeded our expectations, increasing 80.3% to a record $139.2 million from $77.2 million in the prior year period. As Dan mentioned, we ended the quarter with a record 22,600 active earning coaches compared to 14,200 in the same period last year and 19,700 in the second quarter of 2018.

Average revenue per active earning coach for the quarter increased 23.2% to $5,781 compared to $4,693 for the third quarter last year.

The growth in productivity is very encouraging and resulted in part from business initiatives accelerating new coach conversion and new client acquisition rate. This, of course, is aided by a continuing transition to higher-priced OPTAVIA [platform]. OPTAVIA-branded products represented 70% of our total company consumable units sold in the third quarter compared to just 43% in the prior year period.

Gross profit for the third quarter of 2018 increased 84.2% to $107.2 million compared to $58.2 million in the prior year period. Gross profit as a percentage of net revenue increased 160 basis point to 77% versus 75.4% in the third quarter of 2017. The increase in gross margin percentage was driven by higher production volume, yielding favorable manufacturing absorption as we increased inventory to meet expected consumer demand. We expect this absorption benefit to be temporary, and gross margins are expected to return to normalized levels as inventory levels normalize. In addition, the increase in the gross profit margin percentage resulted in part from reduced inventory obsolescence and lower shipping expense.

Selling, general and administrative expenses for the third quarter of 2018 increased $41.7 million to $89.7 million compared to $48 million for the third quarter of 2017, primarily as a result of higher OPTAVIA commission [expense]. SG&A as a percentage of sales increased 230 basis point to 64.4% of total revenue compared to 62.1% in the third quarter of 2017. As OPTAVIA revenue becomes an even larger portion of our overall sales mix, the commission rate as a percentage of total company revenue has increased 470 basis points to 40.5% of total revenue in the third quarter of 2018 compared to 35.8% in the third quarter of last year. This is an outcome of success we've been experiencing with our OPTAVIA integrated coach model.

Additionally, we are investing in an upcoming International Leadership Advancement Trip, which is designed to reward qualifying business leaders with exclusive training and development opportunity. The trip is expensed in the third and fourth quarter of 2018 and expected to drive strong growth in the back half of this year and into next year. These strategic investments are partially offset by the operating leverage we have in other SG&A areas such as labor and advertising.

Our effective tax rate was 22.7% compared to 35.5% in the third quarter of 2017. This decrease in the rate is primarily the result of decrease in the federal statutory rate pursuant to the Tax Cuts and Jobs Act and a decrease in the state rate of 1.7%. The decrease in the effective rate was partially offset by a 2.1% increase in the effective tax rate due to the elimination of the domestic manufacturer [deduction].

Net income in the third quarter of 2018 was $13.8 million or $1.14 per diluted share based on approximately 12.1 million shares outstanding. Third quarter 2017 net income was $6.7 million or $0.55 per diluted share based on approximately 12.1 million shares outstanding.

Our balance sheet remains very strong, with stockholders' equity of $111.6 million and working capital of $89.1 million as of September 30, 2018. Cash, cash equivalents and investment securities as of September 30, 2018, increased $4.4 million to $103.2 million compared to $98.8 million at December 31, 2017. The company remains free of interest-bearing debt.

Inventory increased $24.6 million to $43.9 million as of September 30, 2018, compared to $19.3 million in the prior year period due to an intentional effort to grow inventory levels to meet current and future demand.

Our Board of Directors declared a quarterly cash dividend in the third quarter of $6 million or $0.48 per share, payable on November 8. Our management team and Board of Directors remain committed to enhancing value for our shareholders.

Turning to our guidance. We expect fourth quarter revenue to be in the range of $137.3 million to $142.3 million and earnings per diluted share to be in the range of $1.15 to $1.20 per diluted share. We are raising our previous guidance for the full year of 2018 and now expect revenue in the range of $492.5 million to $497.5 million and earnings per diluted share to be in the range of $4.45 to $4.50 per diluted share. Our fiscal year 2018 guidance assumes a 21% to 23% effective tax rate.

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

(Operator Instructions) And our first question today comes from Doug Lane from Lane Research.

I just want to talk about the disconnect, at least with my numbers, between the top line upside, which was impressive, versus the EPS upside, which was less so. In other words, based on your guidance, you showed $14 million of upside to sales from the high end of your range, which, with your contribution margins and tax rate, according to my math, should be something like -- translated into something more like $0.25 of upside. But you only really showed $0.04 upside versus your previous guidance. And I wondered if there was a component of that SG&A discretionary spending that came down the pipe, whether it was the upcoming leadership advancement trip or if there was something else on the discretionary side in SG&A that wasn't in your original outlook a quarter ago.

It's Tim. So we made a decision to kind of invest some of the growth that we're seeing. The growth started coming in stronger than we expect it to be. So in the third quarter, as you know, we always have some pressure on convention expense. Convention expense was a little bit higher than what we expect because of the size of the attendants. The ILAT trip investment is larger than what we originally intended to do, so there's some learnings we've got out of convention and our Sundance event. The ILAT trip is -- the International Leadership Advancement Trip is really designed to drive more momentum but include more people than what we originally intended. We think that's the right thing for the long term to get us off to, really, our good start next year. So they're the big things. That's fairly substantial costs associated with that event. So from an expectations perspective, I think going in with our guidance, we knew we were a little tighter on EPS than we were on revenue. And we took the opportunity to make an investment going forward when we saw the revenue coming in higher than what we expected.

Well, I mean, those investments sound like they make a lot of sense. And obviously, you're not -- it's very early days. You're not really seeing a return on the ILAT that you talked about. And really, will we even see anything in the fourth quarter? Won't that mostly be a 2019 benefit?

It'll be both, so you're right in that the expense is hitting now in the third quarter, I would say, virtually, is little or no benefit in the third quarter. The benefit should start happening in the fourth quarter as people qualify towards the end of the year. Qualification ends at the end of the year. But what it does is it builds up your energy for the first quarter and second quarter of next year. So the true benefit would be expected next year. There's a little mismatch in expense and revenue benefit, but there is some benefit this year. But I would agree, the majority that you expect would be improved coach productivity going into next year.

No, I mean, that makes sense. You've got, obviously, higher hopes to anniversary next year, and you've got a lot of momentum, and then you've got the international openings. So certainly, the investment you talked about makes sense. I think it just was a little bit -- caught me a little bit by surprise. But obviously, you need to do what you need to do to grow the business. And it sounds like the business has got every bit as much trash as you expected going into this quarter. So I get that.

And you'll see that pressure in SG&A. You're just going to see that in the third and fourth quarter. That expense happens -- it's just on those 2 quarters, and as you go into next year in January, in the first quarter and second quarter, that expense is not there.

And you should see some top line benefit, right?

Absolutely, yes. So also inside of that, we -- and I mentioned, we are getting leverage on our fixed costs. So these -- the net you see there is a -- about a 2.3% increase in operating expenses. Part of that is just the sheer revenue size of OPTAVIA now, which is commissionable revenue is growing as a percentage of business. So it's a good growth, but it does make the percentage level up a little bit. And then that's offset by some of the efficiency we're getting, just with the sheer revenue growth we're getting from leverage off of our fixed costs.

(Operator Instructions) Our next question comes from Linda Bolton-Weiser from D.A. Davidson.

So can I just drill down a little bit more on this SD&A (sic) [SG&A] expense? I've got -- or can you give the commission dollar figure for the quarter? I -- You usually put it in your 10-Q, I believe.

Yes, it's 40.5% of the revenue. So the revenue was $139 million times 0.405, so $56.3 million.

Well, okay, but all of your revenue is not, even at this point, direct selling revenue, right? The vast majority is.

Yes. The reason why we quoted that number, Linda, is historically, what we said is that OPTAVIA commissions is about 42.5% of sales, and that is still true today. But because OPTAVIA is a larger percentage of total sales, it's important to understand why the commission expense in relation to total consolidated sales is going up, the mix is changing. So we quoted that rate of 40.5% to total sales because we no longer disclose the different channel revenues. We wanted to give you that number so you could see how that's grown from approximately 36% last year to 40.5%. It's not that the rate is growing fast, it's that the mix is changing, the more of our revenues are commissionable [total] than they used to be. That's a good thing. It just distorts the percentage.

Okay. So if it was $56 million, and you subtract that from the SG&A of $90 million, I mean, the rest of the SG&A, like, double from like $19 million to $34 million. So I guess that's the fixed portion of your SG&A doubled. So what is that expense? Is that the trip expense that's in there? Or...

It's a combination of things. There are semi-variable expenses, whether that is call center distribution costs, shifting costs, all those things go up as revenues come up -- go up with that. We continue to invest international. So the international expense on a year-over-year basis is clearly incremental. That spend was about $1.2 million in the quarter. And then we're investing in technology, as we mentioned. So on a year-over-year basis, we continue to implement new technology initiatives that will benefit us now and in the future. The rest of our SG&A, we're getting leverage on. So it is not going up proportionally to sales, but it's not rising at the same rate of sales. So there's a real big difference, the incentive program for ILAT, convention hitting in the quarter, biggest convention in our history and commissions rising as the rate of total sales because of the sales mix.

Okay. And then can you just clarify, this trip related to international, is that part of the original $3 million to $5 million investment that you said would be related to international? Or is it something above and beyond that?

No. When we quoted the amount we were going to spend between $3 million and $5 million for international, that is discrete spending in those market or in preparation for those market. It does not include other spending that we may be doing in the U.S. to attract Asian American. It does not include technology spending that's going to be benefited in the U.S. as well so like new technology platforms that we're putting in place. It's just discrete spending in those markets. Clearly, we're making other investments to our platforms to make them multilingual and multi-currency. It's not a discrete benefit just for that sole market. It's not captured in that international, and I mentioned the $1.2 million in the third quarter. That's just very specific spending in market. So this international leadership trip is not part of the international spending that we quoted.

Okay. Got that. And then just in terms of the number of coaches in the quarter, I mean, it was up very, very strong, and it was higher than we expected. But the sequential growth of health coaches did decelerate a little bit. Would you view this sequential growth rate of about 15% as a steady-state type of situation? Or do you think it can fluctuate in terms of how many you add each quarter?

Linda, this is Dan. I think what we see is there are going to be some small variations from quarter-to-quarter, but I think there are going to be a few things that are -- will impact this longer term. Just to go back on the question of this -- the International Leadership Advancement Trip. This trip is a -- we combined what used to be called the Go Global trip with this International -- this advancement trip, and it's tied to building the leadership base, which, in turn, will drive the active earning coach number up. So that's one thing that we think will continue to spur continued growth in the future. The other thing that we continue to focus on is the international expansion. So as we grow internationally, we will essentially have a broader organization structure that will build, and we anticipate that number will start to accelerate as we develop those market. So it's -- I mean, the active earning coach number is a function of how we build leadership beyond just the active coach rings, so those who just support clients as well as our expansion initiatives, which is -- are tied to the international expansion into Asia Pacific.

Okay. And then the coach productivity was very, very strong. I mean, it was very, very good. So what -- I mean, did the sales of Purposeful Hydration affect that? Or what is exactly going on with the very high productivity?

A number of things. I think as we've discussed in previous calls, what -- how productivity would react to the strong growth initiatives was a question last year, and -- which is what prompted us to put in place and work with our leaderships -- leadership in the markets -- or in the U.S., to put in place both training initiatives, also product initiatives, which include Purposeful Hydration as well as other kind of flavor launches and then also dramatically simplify our message. So while it's tempting to try to say this one thing is what pushed it over or what's pushing it ahead, the reality is our coach leaders are getting better at training, where they're getting better at leveraging social media. We're getting better at being consistent with our message and alignment with them as well as the reduction overall in any channel conflict. So it's a combination of multiple things that's making them more efficient and more effective in what they do.

And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back to management for any closing remarks.

We'd like to thank all of you for your interest in Medifast and appreciate your participation in today's call. Tim and I look forward to speaking with you again as we report our fourth quarter 2018 financial results. And have a good evening.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for joining today's presentation. You may now disconnect your line.