Medifast - Earnings Call - Q2 2020

Transcript

Operator (participant)

Good afternoon, and welcome to the Medifast Second Quarter Fiscal 2020 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press * then 1 on your touch-tone phone. To withdraw your question, please press * then 2. Please note this event is being recorded. I would now like to turn the conference over to Scott Van Winkle. Please go ahead.

Scott Van Winkle (Head of Investor Relations)

Good afternoon, and welcome to Medifast Second Quarter 2020 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 June 30, 2020, that went out this afternoon at approximately 4:05 P.M. Eastern Time. If you've not received the release, it's 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 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 statement. Medifast assumes no obligation to update any forward-looking projections that may be made on today's release or call. All the following statements contained herein speak only as of the date of this call, and with that, I'd like to turn the call over to Medifast Chief Executive Officer, Dan Chard.

Dan Chard (CEO)

Thank you, Scott, and good afternoon to everyone joining us. Thank you for taking the time to be with us today. On the call with me today is Jim Maloney, who recently joined us as Chief Financial Officer. Jim brings to Medifast great experience as a public company CFO, as well as international operating and food industry expertise. With years spent in businesses including L.B. Foster Company, First Insight, H.J. Heinz, and Ernst & Young, Jim will bring important insights and understanding to the business, and I'm very pleased to introduce him today, and we're all excited that he's joined the team. After I've provided some updates on our business performance over the course of the last quarter, Jim will review the Q2 financial results in more detail. We'll then open up the call to take your questions.

I'm pleased to say that Medifast had a strong second quarter as the trends we saw in April accelerated during the period. Revenue increased 18% to $220 million, and Non-GAAP adjusted earnings per diluted share increased 12% to $1.96. This growth was driven by robust year-over-year and sequential improvements in the number of active earning coaches, with 36,500 coaches at the end of the quarter, which was a new record level. Productivity per active earning coach also increased during the quarter to $5,851, a substantial increase quarter over quarter and approaching all-time record high levels. The COVID-19 pandemic has clearly been the dominant issue over the last three months, impacting the working and personal lives of almost every single person across the world. With this in mind, we commissioned a U.S.-focused survey to shine light on behavioral changes as it relates to healthy habits among consumers during the health crisis.

The survey uncovered that 88% of Americans are currently experiencing stress, and 82% are concerned about at least one aspect of their physical or mental health. To reflect our understanding of this unique and broad-based consumer health challenge, we've worked with our coaches to refine how we position and support our business for the balance of the year. In Q2, we introduced a key initiative that combined coach skill development and incentives, as well as product promotions for new clients. This initiative ran from March through May and helped drive significant increases in two of our key growth metrics: new client acquisition and coach sponsorship.

We're encouraged by the early results, as it demonstrates the relevance of OPTAVIA even during this global pandemic, as well as our ability to adapt quickly and successfully to a shifting business environment, both in the context of the pandemic, but also related to the changing environment beyond the pandemic. Our focus, as we move into the third quarter, remains on continuing to drive demand for our products and services while providing an exceptional experience for our coaches and clients. With new learning and insights about the current business environment, we've significantly modified our programs for the back half of the year. The pandemic led to the decision to develop a digital-first approach to the business, with the production of a high-profile virtual event called OPTAVIA Together Live, which was being live across the globe from July 24th through the 26th.

The event replaced our planned in-person convention, which was due to be held in Atlanta at the same time. Instead of our anticipated audience of 10,000 of our OPTAVIA coaches at the Atlanta convention, OPTAVIA Together Live allowed us to attract more than 50,000 unique registrants, including coaches, clients, and prospective clients. Our reach was further magnified with over 140,000 views on Facebook, as coaches hosted watch parties and live events on social media. While we're still analyzing the impact of the event, initial indications are incredibly positive. To build effectiveness further, we have added an incentive to promote leadership development within the ranks of our coaches. This incentive began on August 3rd and will run through the end of the month.

This incentive will partially replace the qualification program we would typically run for the 2021 Leadership Advancement Trip, which has been canceled because of the ongoing uncertainties around the travel environment. As an organization, we continue to successfully manage our business operations in this new dynamic business environment. All employees not engaged in manufacturing and distribution continue working effectively remotely. We are leveraging technology to ensure strong productivity and business operations, and we continue to invest in new technology to support our growing business. Our new ERP system went live on May 1st with the support of Deloitte. We continue to work to optimize this important technology and anticipate driving new capability and enabling significant scalability as a result.

Our investments in supply chain, including the opening of our Hong Kong distribution center early in the quarter, went well, and we continue to invest in the resources to support our growth. We also opened our new call center in the Philippines on June 7th, and we are scheduled to open an additional call center in Colombia on August 24th. The restructuring of our call center operations is designed to improve service levels to our U.S. and Asia-Pacific markets, as well as optimize our overall cost structure. Asia-Pacific continues to be an important part of our mission and showed sequential quarterly growth as we continue to drive our coach and client base in the region through enriched service and support. The opening of our Salt Lake City Technology Center to support our coach and client-facing technologies remains on track for Q3.

This center is another example of the initiatives we have been putting in place over the last year to improve client experience and address the short-term challenges created by our rapid growth in late 2019. We continue to build on the operational improvements we saw earlier this year, and our controls around financial payments are working effectively, maintaining bad debt at historical levels. Each of our business operations has continued operating throughout the pandemic without any significant disruption. Manufacturing and distribution centers have continued to operate without any major delays, while our consumer supply chain continues to provide good service levels to our clients. Beyond supporting our coaches and clients, we continue to support our community by maintaining partnerships with national and local nonprofits, No Kid Hungry, and Living Classrooms Foundation. Both of these organizations are providing vital and increasingly relevant resources as the pandemic continues.

We also recognize that racism and hatred continue to plague our world, and we must do better. As a first step, Medifast pledged $100,000 to nonprofits that address social injustice and racial equity. We are committed to do better, both through monetary donations and through company diversity and inclusion programs. As the impact of COVID-19 continues to be felt, we believe our health and wellness services and products are becoming increasingly important. Our solution for physical health and mental wellness through lifelong transformation, one healthy habit at a time, along with our solution for financial health in the form of business opportunity for clients that choose to pursue coaching, is perhaps more relevant today than ever. With a large addressable market and industry-leading product and service solutions, we are well-positioned to drive long-term sustainable growth.

We remain focused on driving shareholder value, leveraging our strong balance sheet and highly attractive and flexible operating model. We're in an enviable position to weather continued challenges. Our financial strength, resilient cash flow profile, recurring revenue model where 95% of our revenues are generated from subscription orders, and a highly variable cost structure that allows us to quickly adapt to any economic challenges are important drivers to our business. We also remain committed to our dividend and have the capacity to utilize our share repurchase authorization to further drive shareholder value. It is now my pleasure to introduce you to Jim Maloney, who will walk you through the financial results. Jim.

Jim Maloney (CFO)

Thank you, Dan. Good afternoon, everyone. It is my pleasure to speak with you today. I am honored to join this incredible team at Medifast. As Dan mentioned, I am still getting up to speed on the business, but was so inspired by the company's unique business model, collaborative culture, and inspiring communities that they foster through their approach to the growing health and wellness market. Additionally, I look forward to getting to know all of you in the coming weeks and months as I hit the ground running and work to propel this company into its next phase of growth. With that, let me walk you through our financial results for the second quarter ending June 30th, 2020. Revenue in the second quarter of 2020 increased 17.6% to $220 million from $187.1 million in the second quarter of 2019.

As Dan highlighted, we hit another record of active earning coaches ending the quarter with 36,500. This represents 19.3% growth as compared to 30,600 coaches in the same period last year and a 12% increase from the end of the first quarter. Average revenue per active earning coach for the quarter was $5,851 compared to $5,863 for the second quarter last year. We have now achieved two quarters of sequential growth, with the second quarter representing 9.7% improvement compared to $5,333 average revenue per active earning coaches in the first quarter of 2020. Also of note, Optavia branded products grew to 83% of our total company consumable units sold in the second quarter, up from 75% in the prior year period. Gross profit for the second quarter of 2020 increased 13.2% to $159.3 million compared to $140.7 million in the prior year period.

Gross profit margin as a percentage of net revenue decreased 280 basis points to 72.4% versus 75.2% in the second quarter of 2019. The decline in gross margin was anticipated and primarily the result of both increased promotional activity and higher production costs. SG&A for the second quarter of 2020 increased $17.8 million to $131.2 million compared to $113.4 million for the second quarter of 2019. The increase was primarily a result of higher Optavia commissions expense, incremental professional services costs in connection with the Schedule 13D filing, and increased expenses for coach incentive programs. SG&A as a percentage of revenue decreased 100 basis points year over year to 59.6% of revenue versus 60.6% in the second quarter of 2019. Non-GAAP adjusted SG&A increased $16.4 million to $129.8 million in the second quarter of 2020, and as a percentage of revenue decreased 160 basis points year over year to 59%.

Non-GAAP adjusted SG&A excludes expenses in connection with the Schedule 13D filing of $1.2 million and severance-related cost of $0.2 million. Income from operations increased $0.7 million to $28.1 million from $27.4 million in the prior year period, as increased gross profit was partially offset by increased SG&A. Income from operations as a percentage of revenue was 12.8% for the quarter, a decrease of 180 basis points from the year-ago period. Non-GAAP adjusted income from operations, which excluded expenses in connection with the Schedule 13D filing and severance-related cost, increased $2.2 million to $29.5 million. Non-GAAP adjusted income from operations as a percentage of revenue was 13.4%, a decrease of 120 basis points from a year-ago period. Our effective tax rate was 22.1% for the second quarter of 2020 compared to 23% expense in the year-ago period.

Net income in the second quarter of 2020 was $21.9 million, or $1.86 per diluted share, based on approximately 11.8 million shares outstanding. Non-GAAP adjusted net income, which excludes expenses in connection with the Schedule 13D filing and severance-related cost, was $23.1 million, or $1.96 per diluted share. This compares to net income of $21.4 million, or $1.75 per diluted share, based on approximately 12.2 million shares outstanding in the prior year. Our balance sheet remains strong with cash, cash equivalents, and investment securities as of June 30th, 2020, of $145.4 million compared to $92.7 million at December 31st, 2019. The company remains free of interest-bearing debt and is well-positioned in this challenging near-term macroeconomic environment. Our board of directors declared a cash dividend in the second quarter of $13.4 million, or $1.13 per share, which is payable on August 6th, 2020.

This reflected a 50.7% increase in the quarterly dividend over the prior year period and is a direct result of our strong financial position and attractive business model. During the second quarter, the company repurchased 46,075 common shares totaling $5 million, leaving approximately 2,323,000 shares of common stock remaining under our stock repurchase program. Consistent with last quarter and due to the ongoing uncertainties related to the COVID-19 pandemic, we are not providing guidance at this time. We would, however, like to provide you some insight into the first month of the third quarter in that July trends are performing consistent with or better than the trends we experienced in the second quarter. We'll continue our focus on controlling our spending for the remainder of the year, as previously mentioned during our call covering first quarter results.

As Dan mentioned earlier, our in-person convention that was supposed to happen in July was replaced with the very successful Optavia Together Live virtual event. The Optavia Together Live event was less expensive than an in-person convention. Also, as a reminder, we restructured our 2021 programming, which will not require an expense accrual in the second half of 2020 for a 2021 incentive trip. This expense accrual totaled $5.6 million in the back half of 2019 for the 2020 incentive trip. To close, I would like to reiterate that it is my pleasure to have joined the Medifast team. I am excited about the opportunities that lie ahead, and I look forward to speaking with you over the coming weeks and months. With that, let me turn the call over for questions. Operator?

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press * then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Kara Anderson with B. Riley. Please go ahead.

Kara Anderson (Senior Equity Analyst)

Hi, good afternoon, guys.

Dan Chard (CEO)

Hi, Kara. Hi.

Kara Anderson (Senior Equity Analyst)

So I guess to kick it off with kind of a two-part question about trends, just wondering if you can talk a little bit more about business trends within the quarter. You obviously indicated that April saw slight improvement, and you did a lot better than that. So hoping you can give us a little bit more color on what drove that shift past April. And then second, within the quarter, just wondering if you saw any impact from former clients returning to make purchases at the height of sort of the rush to stock by many with the pandemic.

Dan Chard (CEO)

Sure. I think to your first question, as we were finishing April, which is basically the insight that we gave you in the last call, that was reflective of the first month of our promotion. So what we saw as we moved through the rest of the quarter was continued activity related to the promotion, which we ran through May as well. So if you remember, we started out with training and fueling and health incentive in March, added in April both of those together, and then in May had just the Essential Start to kind of continue on. So the positive trends as we moved through the quarter were really related to our coaches getting behind the program that was put in place, which included those three elements.

Related to the second question, yeah, I mean, I think we don't give that kind of level of detail, but those who were kind of coming to make purchases were primarily new clients. The promotion also applied to clients who hadn't made a purchase within the previous 12 months. But the majority of those clients who came back and participated in the program were clients who were new to OPTAVIA.

Kara Anderson (Senior Equity Analyst)

Okay. And just to kind of follow up to the promotions and incentives you ran, is there any impact that rolls forward beyond the second quarter that we should consider when modeling out kind of margins and SG&A?

Dan Chard (CEO)

No, I think the biggest question and thing that we're watching very carefully is to understand how a client who comes in on the promotion acts in month two, month three. What we've seen so far is that the retention rate or repeat rate on the first month, and for those who purchased in April, the second month is very similar, so not much difference to a typical client. So we view that as very positive, but that is something that we're watching very closely. We have not put any of those promotions. We don't have any of them for the third quarter. We don't have any planned promotion that's similar to that.

We do, however, have what I mentioned earlier in the script, a business builder promotion, which essentially focuses on a different part of our leadership structure and the coaches, which is meant to motivate and incentivize training new coaches who were previously clients.

Kara Anderson (Senior Equity Analyst)

Got it. And then just one housekeeping question, and then I'll jump back in the queue. Can you tell us what the commissions paid within SG&A were within the quarter or a percentage of SG&A or revenue?

Dan Chard (CEO)

Yeah, go ahead. I'll let Jim answer that one.

Jim Maloney (CFO)

Yeah. So the commission paid within SG&A is approximately 70% of the SG&A.

Kara Anderson (Senior Equity Analyst)

Thank you very much.

Dan Chard (CEO)

Yeah. And just to be clear, yeah, as a percentage of SG&A, but to be clear that our commission as a percentage of total will be slightly elevated by approximately 1.3%, but still within that kind of 42.5% range.

Kara Anderson (Senior Equity Analyst)

Understood. Thank you very much, guys. Congrats on a great quarter.

Dan Chard (CEO)

Thank you.

Jim Maloney (CFO)

Thanks.

Operator (participant)

Our next question comes from Doug Lane with Lane Research. Please go ahead.

Doug Lane (Analyst)

Yes. Hi, good evening, everybody. And so just to follow up on that, when you say 70% of SG&A, is that the GAAP SG&A or the adjusted SG&A for the one-time items?

Jim Maloney (CFO)

That would be the Non-GAAP piece.

Doug Lane (Analyst)

Okay. Thank you. And then, Dan, at the end of February, you were looking for low- to mid-single-digit growth this year. And here we are through the end of June, and you're up 13%. So what changed between the end of February and the end of June that turned so positive so quickly?

Dan Chard (CEO)

Yeah, I think that's a great question, Doug. I think what we saw early in the year were the challenges of starting the year with a, say, lower percentage of the new clients and new coaches. As we put in place the programming, which was really a result of looking at the business in a very different way as we are all facing the realities of what a global pandemic looks like, we put in place the program that we described and found essentially that, one, our coaches were able to break through in a period that we assumed that they would not be able to, and that new clients were, I'll say, far more ready than we anticipated to take on this health and transformation journey that our coaches talked about.

So stepping back, I'd say that our message was relevant during this period of time despite the challenges. The offer we put together for our coaches to help them break through was relevant for them, and the consumer side of the promotion was motivating to new clients who were coming in. So those three things kind of brought together what turned out to be a very strong quarter for us.

Doug Lane (Analyst)

Thanks. Yeah, no, that's fair. And then shifting gears to your Asia strategy here, any change in thinking given the geopolitics that are underway currently?

Dan Chard (CEO)

No. We see it's hard to kind of pull apart what's having a bigger impact, the geopolitics or the pandemic or the two combined, but we still view our two markets in the Asia-Pacific region as an important part of our future. Each time we add a new element to support those markets, it has a good and positive impact on coach and client experience. So you can hear from my earlier comments that we're making investments in call center as well as continuing to put together programs and enhance our training there as well.

Doug Lane (Analyst)

Okay. That's great. Just one last thing. I realize this was just a couple of weeks ago, but what are the learnings from the virtual convention this year, and how do you envision that event changing in a post-COVID environment?

Dan Chard (CEO)

Yeah. I mean, so certainly the event, OPTAVIA Together Live, was a reaction to the travel restrictions. We fully anticipated being together in Atlanta for what is our traditional in-person convention. What we learned was, one, I mean, huge credit to our team internally who reprogrammed the entire back half of the year. So we found that we were able to quickly pivot, work through a whole new dynamic of event planning. What we saw from our coach community and client community was a very strong uptake. Obviously, having a far greater number of registrants sign up, there were 50,000, and then seeing after a significant number, 140,000 shares. And so what we saw beyond that is a lot of watch parties. So even those numbers that we're talking about were probably larger than the numbers that I just shared.

But in terms of what we've learned, far greater reach, more efficient spend, and we've had nothing but positive comments from all our coaches and clients. So we think it will be very positive and certainly some things that we can learn and continue to leverage on a go-forward basis even beyond the pandemic, which was the catalyst for doing it online in the first place.

Doug Lane (Analyst)

But it doesn't sound like you want to abandon the in-person events. I mean, they're important as well, aren't they?

Dan Chard (CEO)

Yeah. No, absolutely. This certainly replaced our convention, but it doesn't in the long term. It replaced it out of necessity. Conventions are very effective for the in-person training, allowing the different coach teams to get together and have that interaction. This allowed us to address a much larger market more efficiently, and so I'd say that to your question, they would most likely work together in the future.

Doug Lane (Analyst)

Okay. Thanks, Dan.

Operator (participant)

Our next question comes from Stephanie Wissink with Jefferies. Please go ahead.

Seb Barbera (Senior Equity Research Analyst)

Hi. This is Seb Barbera for Stephanie Wissing. I had a few questions. Number one, gross margins were down 280 basis points in the quarter, reflective of products and production costs. With product promos no longer pressing in Q3, should we expect gross margin to normalize towards the 75% plus in the back half of the year?

Jim Maloney (CFO)

Yeah. So we would expect that, without promotions, to get to a more historical level in the next quarter. So a significant portion of the decline in the margin was due to the Essential Start promotion in Q2. So as Dan was mentioning, that we're not going to be promoting in Q3, we should expect that to get back to normal levels.

Seb Barbera (Senior Equity Research Analyst)

Got it. And inventory was down 20%. Payables were up 30%. Any additional colors that you could provide us with here?

Dan Chard (CEO)

Yeah. The inventory being down is really a reflection of the strong uptake on the promotion. So we had historically carried a little bit more inventory than we currently are. And so it's really, again, a reflection of a stronger than anticipated promotion. We would expect those inventories to move up closer to the historic levels. And your second question was around what was it around payroll?

Seb Barbera (Senior Equity Research Analyst)

On payables.

Jim Maloney (CFO)

Yeah. Payables is really just a function of the timing of payments this quarter versus comparable periods. There really isn't anything unusual. It's just that the timing of the payments are occurring a little bit later. Yeah, I guess in August, most of those payments will be made.

Seb Barbera (Senior Equity Research Analyst)

Okay. And lastly, on the buyback front, pretty muted this quarter. Cash balance at $145 million at quarter end. Should we expect a more active stance in the back half of the year?

Dan Chard (CEO)

Yeah. I think we've answered this question pretty consistently the same way, which is that as it relates to capital allocation, we'll continue to review on an active basis how to best return value to our shareholders. And that'll be in a combination of dividends, share buyback, and primarily those two things. And I think Steph will be looking at whether that continues, which of those makes sense. As in the past, we will buy when there are opportunities to do share repurchase, and we remain committed to a strong dividend.

Seb Barbera (Senior Equity Research Analyst)

Thank you.

Operator (participant)

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

Bill Baker (Analyst)

Yes, and by the way, the GARP conference was pretty good. I enjoyed Dr. A's presentation.

Dan Chard (CEO)

Thank you, Bill.

Bill Baker (Analyst)

I guess what the thing that encouraged the team this quarter was the productivity of coaches. And this is happening even before you're starting this drive to increase the coaches in Q3. And the productivity was pretty high. I expect that lockdown people have nothing better to do. It may not happen.

Dan Chard (CEO)

Yeah. Bill, you broke up a little bit, but I think you were asking the question about what drove improved coach productivity. And the answer to that is you're right. I mean, we were back up to the historic high levels that we saw at the end of 2018, beginning of 2019. I think it's a reflection, again, of our coaches being very active, having a highly relevant message, and having a lot of potential prospects out there who, during the lockdown period, have become either more aware or having a greater need for what the Optavia coaches offer. So I think we look at it as a very positive sign of where the business is going, and we'll continue to watch it closely.

Bill Baker (Analyst)

Great. Thanks a lot. I appreciate that.

Operator (participant)

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

Dan Chard (CEO)

Thank you. I think we'd like to, first of all, thank all of you for participating. We appreciate you taking the time. I think in closing, I'll just make a couple of comments. We feel like the second quarter was a reflection of our continued ability to support a fast-growing health and wellness community across our markets. It's supported by a very large, addressable market of both clients and coaches. We remain diligent and focused on leveraging our strong financials. I think as we mentioned earlier, we have 95% of our revenue coming from recurring orders. We remain focused on investing to support our long-term growth by strengthening our operating infrastructure. You heard several examples of that. And with that, we feel like we are ready now to continue to move through the rest of the year, understanding how to make additional adjustments in this continuously changing environment.

But we feel like we're well-positioned to capitalize on the significant opportunities ahead. So thank you for joining.

Operator (participant)

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