Medifast, Inc.
Q3 2014 Earnings Call Transcript

Published: 6 Nov 2014

[Operator:]

Greetings, and welcome to the Medifast Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Katie Turner of ICR. Thank you. You may begin.

[Katie M. Turner:]

Good afternoon. Welcome to Medifast's Third Quarter 2014 Earnings Conference Call. On the call with me today are Michael MacDonald, Chairman and Chief Executive Officer; Meg Sheetz, President and Chief Operating Officer; and Timothy Robinson, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ending September 30, 2014, that went out this afternoon at approximately 4

[Michael C. MacDonald:]

Thank you, Katie. Good afternoon, everyone, and thank you for joining us. On today's call, I will provide you with a brief overview of our third quarter performance and an update on our strategic initiatives. Tim will review the financial results for the third quarter in more detail and discuss the fourth quarter and full year 2014 revenue and EPS outlook. I will then provide closing remarks, and we will open up the call to take your questions. I am pleased with our ability to deliver earnings per diluted share of $0.39, ahead of our guidance, which ranged from $0.35 to $0.37. Excluding extraordinary expenses of $1.6 million, or $0.08 per diluted share, which Tim will discuss in more detail, third quarter net income would've been $5.9 million, or $0.47 per diluted share. This reflects our team's continued efforts to optimize profits through careful management of the controllable aspects of our business. We were able to accomplish these results despite continued pressure on revenue in the quarter. Net revenue for the third quarter decreased approximately 14% to $74 million from $86.5 million in the prior year. This was slightly below our guidance expectations for revenue of $75 million to $78 million. As we mentioned in the last call, we continue to experience challenges, with new customer acquisition in what continues to be a softer consumer spending environment and a challenging weight loss environment. On last quarter's call, I discussed a number of exciting initiatives designed to drive revenue. And now I would like to provide you with an update of each of these key strategies. New product innovation is an important part of our 2014 business plan. As many of you know, at this year's Take Shape for Life National Convention in Anaheim, California, we introduced a number of new products in incremental categories to drive revenue. While initial adoption of these new products began in the third quarter, we expect adoption and implementation to continue in the fourth quarter and into the 2015 diet season. So far this year, we have introduced a line of delicious snack products, the newly expanded Flavors of Home product line, several varieties of mashed potatoes and our Habits of Healthy Sleep kit. At the end of the third quarter, we introduced a new gingerbread soft bake, a warm, soft cookie flavored with molasses and ginger, which we made available in time for the holiday season. Just last week, we launched our new digital tracking platforms

[Timothy G. Robinson:]

Thank you, Mike. I'll now review our financial results for the third quarter ended September 30, 2014, in more detail. For the third quarter, net revenue decreased 14% to $74 million from net revenue of $86.5 million in the third quarter of the prior year. The Take Shape For Life sales channel accounted for 68% of total revenue, Medifast Direct accounted for 18% and Medifast Weight Control Centers and Wholesale Physicians accounted for 14% of total revenue. I'll focus in on our sales channels in more detail. Revenue in the direct sales channel, Take Shape For Life, decreased approximately 11% to $49.9 million compared to the same period last year. The decrease in revenue for this channel was primarily driven by a decrease in the number of health coaches, along with a decline in the revenue per health coach. We ended the third quarter with approximately 10,200 active health coaches, and the average revenue per health coach per month during the quarter was $1,504. Take Shape For Life commissions expense, which is variable based upon product sales, decreased by approximately $4.5 million compared to the third quarter of 2013. We're now 3 quarters into our new compensation plan, which was strategically designed to reward those who are currently coaching clients and growing their businesses. We expect our new product launches will contribute to an increase in revenue per health coaches as they roll out. Our Medifast Direct segment revenue decreased 22% to $13.4 million as compared to $17.2 million in the third quarter of 2013. Overall advertising expense decreased $1.2 million or 22% versus the prior year third quarter. Our team continued to focus on efficiency improvements and balancing sales and marketing spends in an effort to drive profitability. In the third quarter, the Medifast Weight Control Centers and Wholesale Physicians channel revenue decreased 20% to $10.6 million. As many of you know, we made the strategic decision to increase the profitability of the Weight Control Centers and, as a result, we have closed 11 centers since the first quarter of 2013. We also completed the sale of 24 centers to new franchise partners in the second quarter of 2014 as part of the company's long-term plan to transition corporate-owned centers to franchise locations. As of September 30, 2014, we have 51 corporate-owned centers and 69 franchise centers. Going forward, we will work to transition more of our corporate centers to the franchise model, while we evaluate the viability of our weakest-performing locations. Gross profit for the third quarter of 2014 decreased 15% to $54.9 million compared to $64.9 million in the third quarter of the prior year. Our gross profit margin decreased 80 basis points to 74.2% versus 75% in the third quarter of 2013. The decreases in gross profit margin was primarily due to 3 factors

[Michael C. MacDonald:]

Thanks, Tim. At Medifast, we believe that being the best place to work is imperative in attracting talent our organization and retaining employees who excel at their jobs. Early this year, we conducted an employee engagement survey and we'll continue to focus on both the things we are doing very well and those areas where we can continue to improve as we aspire to the highest level of employee enablement, engagement. In the third quarter, we also gave $100,000 grant to The V Foundation for Cancer Research, one of the nation's leading cancer research funding organizations. Cancer, in one way or another, has affected us all. And at Medifast, we recognize the importance of research to learn more about cancer prevention and treatment. This grant is a product of a multifaceted partnership between Medifast and The V Foundation to explore links between obesity and cancer, and the impact of healthy living on preventing cancer. The focus on disrupted sleep, which is often associated with obesity, is the first step in looking at some of the factors that may contribute to cancer. As you may know, we recently launched a series of sleep products in Take Shape For Life to help address this important habit of health. In closing, we believe our strategic initiatives will help fuel future growth across our multiple sales channels and improve our ability to attract new clients and retain our existing customers. Our team remains focused on prudently managing the controllable aspects of our business to increase profitability and strengthen our balance sheet, while delivering consistent shareholder value. We would now be open to any questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Scott Van Winkle with Canaccord Genuity.

[Scott Van Winkle:]

A couple of questions. First, the 11 franchise stores that are -- have closed, the 4 that closed, and 7 more announced in late October, where are they located? These aren't the 11 stores you sold to Medex or...

[Michael C. MacDonald:]

No. These were located in the state of Washington and also down in the Southeast in the U.S.

[Timothy G. Robinson:]

Just for clarity, so the 11 -- there's 2 references to 11. So in 2013, we closed 11 of our own stores. So on a year-over-year comparison, that is mentioned. The stores that -- if you look at our current franchise number of stores, we mentioned 69. That 69 reflects 4 store closures in the franchise world that opened on the West Coast earlier this year. We also referenced, not included in our number as of September 30, we referenced the closure we just learned about of 7 stores down south, which is -- are in process right now. They're franchise stores.

[Scott Van Winkle:]

Is that a recent 7 stores that you had refranchised? Or have these been open for a while?

[Michael C. MacDonald:]

These were new locations, Scott. They weren't Medifast transfers.

[Margaret E. MacDonald-Sheetz:]

Yes, these are -- one of our franchisees is expanding, and these are some of his expansions that did not work out appropriately or effectively.

[Scott Van Winkle:]

Okay, okay. And -- all right, I just figured, if you were the guarantor on his debt, I would've assumed that it was -- you sold the stores to him or her or what have you.

[Margaret E. MacDonald-Sheetz:]

He's had -- he's been one of our operators for many, many years. And so this was just his expansion agreement with us.

[Scott Van Winkle:]

Okay, great. And then on ad spending, obviously, you pulled back relative to where you thought you'd be in Q3, given the environment. Now going into Q4, what's the plan? Is it to kind of tiptoe in and see if the market's open for acquiring customers?

[Michael C. MacDonald:]

Well, let me tell you what happened in Q3, Scott. One of the things we saw was even with these new people trying to open more of the franchise locations, they spend extremely heavily in advertising and did not see the appropriate returns. So we did adjust somewhat ourselves, seeing what was going on in the marketplace. But our intent is to spend up year-over-year in the fourth quarter significantly. So we do want to spend up in the fourth quarter significantly, and then go into the diet season with our whole new ad approach with our new agency with a major program. We feel good that we have a new person doing Med Direct, the new agency working with Brian Kagen to drive a whole new program. So that's our strategy. So we're not going to be reducing the spending year-over-year in the fourth quarter.

[Scott Van Winkle:]

Okay. So even if the returns are unfavorable, this is really spinning ahead and getting ready to go in Q1, right?

[Margaret E. MacDonald-Sheetz:]

Yes, this is us getting ready for the first quarter. So whatever we spend in the fourth quarter, we're acknowledging, may trickle into benefiting the first.

[Scott Van Winkle:]

Okay, okay. And then the further declines in health coach count, can you expand on that, and kind of the thoughts there? I know you're working on plans to try and reverse it, but what's the field telling you?

[Margaret E. MacDonald-Sheetz:]

Yes, I mean, the field right now is just heads down and focused on continuing growth. And then, we had an event -- a leadership event in Sundance in October. A lot of the communication there was what we worked on together, both field leadership and corporate, was how do we create and simplified system that includes more of the support infrastructure in the company. So we've done a lot of -- you've heard me talk about simplification for a couple of years now. We've done a lot of simplification from a training and development aspect. We need to do some on the infrastructure side. So that was a big topic, which will be part of a huge strategy for Take Shape For Life in 2015. And we feel that our job is to make being a coach as easy as possible for a part-time person. For any of you who have tried to sign up as a coach, it can be a little cumbersome in that regard. So we continue to work at how to re-create that experience for a client to move into a coach.

[Scott Van Winkle:]

Okay, great. And then last question's for you, Mike, calling out the expenses, the legal and advisory expenses on the shareholders, the active shareholders that are not involved. I'm kind of wondering what's the plan there. Or is something in process? I'm just wondering, spending $1 million on legal and advisory, is there a negotiation that's going on? Can you give us any further detail?

[Michael C. MacDonald:]

Well, basically, we're committed to improving shareholder value as a company. We've had an M&A committee in place since January, and we're really just making sure we're doing the right things to improve shareholder value. And as far as the 13D filers, we've had a constructive discussion with all of our large shareholders, like we always do, and it's been nothing but positive discussion. So that's basically all I can give you on that, Scott.

[Operator:]

Our next question comes from Alec Jaslow with Midtown Partners.

[Alec I. Jaslow:]

Just was curious to hear how some of the products you rolled out early in the third quarter are doing so far. And also, if you could talk a little bit about how the Flavors of Home have done versus your expectations?

[Margaret E. MacDonald-Sheetz:]

Yes, I would say right now that all of our product launches this year, the Flavors of Home, the snacks have all exceeded our expectations. We had initially put an attachment rate on those products and we would say that we're exceeding it. I think we're comfortable with saying that about 3.6% of revenue was the incremental revenue we're getting from the new categories that we've launched. So it's very exciting for us.

[Michael C. MacDonald:]

I think the other thing, I think, Alec, that's going to be a big positive is on November 18, we're going to launch our whole Healthy Living program for Medifast, which gives us a new 3, 2 & 1 plan, which would be called Thrive by Medifast, and we see this as really going into a maintenance area and more the Healthy Living, healthy alternatives. And we see that as a big positive to help us in the fourth quarter.

[Margaret E. MacDonald-Sheetz:]

And I think what's exciting about the launch in November that we really wanted to get ready for diet season in January, is, one, the products are absent of [ph] negatives. Two, we have special packaging. So this new special packaging for Take Shape For Life has its own packaging. Medifast Direct has its own packaging. So one is called Thrive; one is called Optimal Health. It's very exciting for both of those divisions.

[Alec I. Jaslow:]

Okay. There's also -- maybe it'll be helpful to hear about some of the feedback you got from the new franchise -- franchises that were closed, maybe some of the issues, and things you're going to try to do to fix that going forward.

[Michael C. MacDonald:]

I think one of the issues that we've seen is where we've had established locations, whether they be company-owned or franchise locations, those locations are performing well in a difficult environment. Where we're seeing openings into new locations and trying to do that in this environment, it's been extremely difficult. And by the way, I'm talking about very heavy advertising spending, with people who are very good operators. These are not people who don't know how to run their business. They've been in this business a long time. So we've seen that it's been extremely difficult. And obviously, costs are going up in the advertising space and it's been difficult. And I think we made the appropriate decision trying to help a key franchisee expand and lending them the money to try to help them get there, because they'd been with us for years and years. And we've been attempting to really drive revenue. I mean, we've -- we were doing that. We were also putting a very aggressive BeSlim program to improve our order ship and our retention. So even though we cut a little bit back in advertising, we've been aggressive in other areas to try and get revenue. And that's really been sort of the approach, Alec. And these operators, they tried and they reached a point where they just said that it wasn't worth proceeding. And that's the -- I think that's the difficulty right now. And I think some of our competitors are seeing the same thing.

[Alec I. Jaslow:]

Okay. And then just the last question was I'd be curious if your conversations with Ken, the new Vice President at Med Direct, if -- what he thought should be done going forward? Or is he planning on making drastic changes overall? Or does he want to optimize advertising better? Any color you can give on that would be helpful.

[Margaret E. MacDonald-Sheetz:]

Yes, so he's on his third day. So from a third-day perspective he has some very great ideas coming to fruition. Right now, it's about let's look at what we're currently doing and then what can we do by January for diet season to impact it. I think the team here has put together a great strategy to move us into the first quarter and help take part in that as well. But he certainly -- he definitely has -- he is a direct response expert, and so it's been a lot of -- the last 3 days have been exciting around here to change the way we think and really challenge ourselves to do some different things. So we're looking forward to it.

[Michael C. MacDonald:]

Yes, we're determined -- we're determined to bring in people who have the expertise, Alec, that we need to move forward. He's also very focused on measurements and some measurements that we're not doing today that he feels could be brought in. So I think our team has made progress internally, but now we've got to try to take this to the next level. And I think with Brian and Ken, we're in a good position now to move forward at both the advertising agency that we've hired and the direct response.

[Operator:]

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Michael C. MacDonald:]

We appreciate your participation today, and we look forward to speaking with many of you in the coming months. We thank you very much for your support of Medifast.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.