Medifast, Inc. (NYSE:MED) Q3 2023 Earnings Call Transcript

Medifast, Inc. (NYSE:MED) Q3 2023 Earnings Call Transcript November 6, 2023

Medifast, Inc. beats earnings expectations. Reported EPS is $2.12, expectations were $1.02.

Operator: Greetings. Welcome to the Medifast Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. I’ll now turn the conference over to your host, Steven Zenker, Vice President of Investor Relations. You may begin.

Steven Zenker: Good afternoon, and welcome to Medifast third quarter 2023 earnings conference call. On the call with me today are Dan Chard, Chairman and Chief Executive Officer; and Jim Maloney, Chief Financial Officer. By now, everyone should have access to the earnings release for the quarter ended September 30, 2023, that went out this afternoon at approximately 4:05 PM Eastern Time. If you have not received the release, it is available on the Investor Relations portion of Medifast’s website at www.medifastinc.com. This call is being webcast, and a replay will also be available on the company’s website. Before we begin, we would like to remind everyone that today’s 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. All of the forward-looking statements contained herein speak only as of the date of this call. Metifast assumes no obligation to update any forward-looking statements that may be made in today’s release or call. And with that, I would like to turn the call over to Medifast’s Chairman and Chief Executive Officer, Dan Chard.

Dan Chard: Thanks, Steve, and thanks to all of you for joining us on the call. With me today is Jim Maloney, Medifast’s Chief Financial Officer. I’ll take a few minutes to share some insights from Medifast’s journey over the last 12 months and then provide you with some context for where we’re taking the business. I’ll then turn the call to Jim, who will take you through Q3 financials. There are two key takeaways from our latest results. First, our financial position remains very strong and we continue to deliver solid profitability despite continued top-line headwinds. Second, we are making steady progress on several initiatives to expand our offering into the broader health and wellness market and drive sustainable long-term growth.

Our recent entry into the sports nutrition market with our new OPTAVIA ACTIVE line is one example. Weight loss medications are another major opportunity for us as the surging awareness and popularity of these products has prompted a huge change in the way the consumers think about weight loss and lifestyle modification solutions in general. As a result, earlier this year, we commissioned an extensive independent market research study to understand consumer sentiment in regards to the medications and our coach-based habit-centered lifestyle program within this evolving business environment. What was immediately clear is that our addressable market is split relatively evenly regarding weight loss medications. Around half of those looking for weight loss solutions are accepting of medication-based therapies, and around half of them reject the idea of using GLP-1 medications like Wegovy to support weight loss.

The research clearly demonstrates that most of those who are interested in medical weight loss medications are also looking for support beyond a prescription that includes clarity on how they should incorporate healthy eating and exercise into their lifestyle while using these medical solutions. Additionally, they generally do not see weight loss medications as a lifelong commitment, but rather something that when paired with lifestyle modification can help them to make a long-lasting change. So with this in mind, we’re focused on developing an approach that will enable us to make this new business environment our sustainable growth environment. We recently launched the pilot initiative with three different telehealth companies to explore how we might incorporate weight loss medication into our coach-centered business model.

These pilots have given us some good insights around positioning and approach. What particularly appears to be resonate with customers who are interested in medically-supported weight loss is a compelling three-way partnership between customer, clinician, and coach. Importantly, the efficacy claim of GLP-1 medications for weight loss is based specifically on their incorporation with lifestyle changes that include a reduced calorie diet and increase physical activity. As a result, under Medifast offering, weight loss medications become one important element in an overall tailored lifestyle plan that also includes coaching, community support, healthy habit development, and nutritionally-balanced meals, along with exercise. This holistic approach we are piloting is collaborative between the customer, coach, and clinician, focusing on helping customers achieve lasting health and wellness as they learn to make a healthy lifestyle second nature.

As part of the telehealth pilot program I mentioned, we have been working closely with a set of select coaches to bring them up to speed on the benefits of the OPTAVIA solution for those who are currently using or are considering using GLP-1 or other weight loss medications. Initial feedback suggests that most coaches involved in the pilot are optimistic about having another tool at their disposal for use with customers and that the partnership between clinician and coach is productive for customers who want an approach that fits their own unique needs. This pilot program has provided us with some important data and understanding, and we’ll use this information to inform our thinking now that we have shifted into the second phase of our pilot program.

During the second phase, we are measuring key metrics associated with OPTAVIA customers who are combining prescribed medical weight loss medicines with our OPTAVIA program. We believe there is significant potential to maintain our market share and growth position by tapping into this important new market, whether that’s through a partnership, acquisition, investment or an organically-developed solution. And we expect to provide more details on our approach in the coming months. Of course, for all those people who are not interested in weight loss medications, OPTAVIA continues to offer a compelling lifestyle modification opportunity. With our clinically-proven Coach-led model, that is built on the six macro habits of health, providing the cornerstone of reaching a sustainable, healthy lifestyle.

Customers benefit from the support of an OPTAVIA Coach who understands the challenges one faces when looking to improve their overall health and wellness, with most coaches having started as customers themselves. The active role the coach takes, as well as the support of thousands of like-minded individuals in the OPTAVIA community, who are also on their own health and wellness journeys, is what continues to make our solutions so effective. What is clear to the Medifast leadership team is that medical weight loss solutions have to sit within an overall health and wellness ecosystem. Medications alone are not a long-term solution. And only by helping drive holistic lifestyle shifts can we help customers achieve lifelong transformation. Exercise is one important element of that, which is why we’re excited by our entrance into the sports nutrition market that took place in mid-September with the launch of our new OPTAVIA ACTIVE product line.

The initial products in our new OPTAVIA ACTIVE line consist of essential amino acids, whey protein powders, and a digital exercise program offered through a partnership with Aaptiv. The products are aligned with the habits of healthy motion, one of the six macro habits that underpin our business health model, and can be used by individuals actively looking to move forward along the health spectrum by adding exercise to their health routine, whether as part of a medication-supported or non-medication-supported approach. The products include two flavors of essential amino acids, or EAAs, as well as two flavors of whey protein, and are developed to help support healthy muscle maintenance in conjunction with both exercise and everyday activity.

Aging and weight loss are two common causes of reduced muscle mass, which is why it is important to have a diet that is inclusive of EAAs and quality protein and is nutritionally balanced. The objectives of this launch are threefold. First, we believe these products expand our addressable market, allowing our coaches to attract a new demographic to OPTAVIA. Second, they’re expected to extend the lifetime value of OPTAVIA customers by extending their time with OPTAVIA as they learn to live the habits of healthy motion during and after achieving their healthy weight. And lastly, they extend our offering by adding exercise to the lifestyle program, making it ideal for those who are interested in using lifestyle modifications along with the support of medical weight loss.

All the products are designed to be used in conjunction with our existing OPTAVIA plans. The new OPTAVIA ACTIVE product line expands the breadth of our overall addressable market in an important way. The business opportunity within the sports nutrition market is substantial, with a total addressable market that is over 3 times the size of the structured weight management market in which our products operated exclusively in the past. We expect to add further ACTIVE products to the line next year. The work with weight loss medications and the entry into the sports nutrition market are really just the first steps in Medifast’s work to transform into a total lifestyle company, helping our customers make a healthy lifestyle second nature. Regardless of whether a customer wants to explore weight loss, with or without a medical solution, Medifast has a compelling option for them.

Long-term success is driven by the adoption of a healthier lifestyle built on nutrition, exercise, and other lifestyle habits. Our scientifically-developed products are effective in achieving weight loss when following our clinically-proven plans, including the support of our independent coaches. In a clinical study, it was shown that those on the optimal weight five-in-one program who had the support of a coach lost 10 times more weight than the self-directed group. Our approach is flexible and inclusive, and we’re excited by the opportunities that lie ahead. Turning to the third quarter numbers, our revenues for the quarter were at the high end of our guidance, though down year-over-year by 39.6%, as challenges faced earlier in the year continued as expected.

We continue to believe that the efforts we are taking to expand our product offerings, incorporate medical weight loss into our programs, and diversify our customer base will aid in improving these trends. However, we would not expect to see this improvement until 2024. The operating margin for the quarter of 10.8% was ahead of our expectations, as cost reduction actions taken as part of our Fuel for the Future initiative continue to generate savings ahead of schedule. Operating margin is down approximately 150 basis points compared to last year, as investments in customer acquisition and a loss of leverage of fixed costs due to lower revenues year-over-year had a negative impact on the margin. As a reminder, 70% to 75% of our expenses are typically variable in nature, which speaks to the adaptability and resiliency of our business model.

As we move into the fourth quarter, we continue to focus on a number of growth initiatives using our strong debt-free balance sheet and our Fuel for the Future expense reduction initiatives to help fund them. As mentioned earlier, in addition to our new OPTAVIA ACTIVE product line and the medically-supported weight loss opportunities we are assessing, we are also pursuing the expansion of our customer base by focusing on demographic groups in the U.S. where we are underrepresented. Specifically, we have been taking steps to further penetrate the Hispanic market and we have made great strides in translating our main materials and website into Spanish to better connect with this group. We have now translated more than 70% of our core materials into Spanish and expect to be completed by the end of the year.

In October, in conjunction with the National Hispanic Heritage Month, we executed on our first-ever OPTAVIA Spanish language social and digital pilot targeting the U.S. Hispanic market. It was intended to begin building the OPTAVIA brand awareness and measure the effectiveness of our efforts to learn how to best market our clinically-proven health benefits and scientifically-developed products, plans, coaches, and community to this growing demographic. It also enabled us to test and learn how to most effectively match Spanish-speaking coaches with U.S. Hispanic customers. The goal is to leverage the learning from the social and digital pilot as we anticipate launching a larger, more comprehensive media effort to the U.S. Hispanic market in 2024.

We believe that advancing our business in the U.S. Hispanic demographic will help us set the stage for future expansion into Latin America. Also, we continue to evaluate the effectiveness of our customer acquisition initiatives, including our recent limited testing of company-led digital marketing, which we conducted over a three-month period to generate prospects. We are conducting attribution, analytics, and path to purchase optimization, which should all result in more efficient advertising spend and scalability. As a company that has a history of marketing directly to consumers, we understand the benefits of corporate advertising to generate prospects for our coaches. It allows our coaches to better optimize their time and focus more on their energy on supporting their customers.

We just have to ensure that the return we are getting on these expenditures is commensurate with the costs. We also continue to grow our efforts around our corporate social responsibility initiative Healthy Habits For All. At our OPTAVIA convention in July, our Coach community raised funds for our non-profit partners No Kid Hungry and Living Classroom Foundation. Together with our coaches, we assembled over 6,000 kits for local Metro Atlanta kids. As kids headed back to school, our curriculum reached a new milestone, impacting an estimated 100,000-plus students in thousands of schools across the nation, free of cost since it launched last fall. And in September, we officially opened a new kitchen at the facility of our local partners Living Classroom Foundation.

Medifast provided capital funds to renovate the kitchen. Previously, instructors were teaching healthy cooking classes on hot plates. By welcoming kids into the kitchen and inviting them to experiment with healthy ingredients from a young age, we can cultivate a habit in them that can last a lifetime. So, to summarize, backed by a strong balance sheet with no debt, we are building out a new approach that better reflects the new realities of the weight loss and health and wellness marketplace, and which plays to the competitive strengths of our existing offering. We continue to seek to broaden our offerings to integrate medical weight loss, expand our addressable market, and extend our demographic and geographic reach, along with optimizing our coach compensation and increasing corporate advertising to bring in new customers.

These efforts are expected to aid in turning around the recent decline in new customers and coaches we have experienced over the past year. We do not expect to start seeing a meaningful impact from these efforts until 2024. And our guidance for our fourth quarter, which Jim will cover in just a minute, reflects the continued short-term challenges we face in customer acquisition in what is seasonally a weaker quarter. However, we do expect our highly variable cost structure and expense reduction efforts under our Fuel for the Future initiative to continue to shore up our profit as we mitigate some of the revenue weaknesses in the quarter. With that, I’ll turn it over to Jim to go over the specifics of the quarter.

Jim Maloney: Thank you, Dan. Good afternoon, everyone. Third quarter 2023 results were at or above our guidance. As we continue to execute our cost reduction initiatives with the savings intended to be utilized for key initiatives to stimulate growth. Revenue of $235.9 million was at the upper end of our guidance range of $220 million to $240 million, but decreased 39.6% versus the year-earlier period, primarily driven by a decline in the number of active earning OPTAVIA Coaches and lower productivity per active earning OPTAVIA Coach. Customer acquisition continues to be pressured by the macroeconomic shift impacting inflation and interest rates and the growth in popularity of weight loss medications. We ended the quarter with approximately 47,100 active earning OPTAVIA Coaches, as — a decrease of 28.9% from the third quarter of 2022.

Average revenue per active earning OPTAVIA Coach for the third quarter was $5,008, a year-over-year decline of 15.1%, reflecting the continued headwinds to customer acquisition, partially offset by a price increase we implemented in November of last year. Gross profit decreased 37.3% year-over-year to $177.4 million, driven by lower revenue, while gross profit margin improved 270 basis points to 75.2%, positively impacted by efficiencies in inventory management and lower supply chain costs, including benefits from the optimization of our distribution center footprint. SG&A expense was down 35.3% year-over-year to $151.9 million due to the decreased coach compensation on lower volumes and fewer active earning coaches, as well as progress on several cost reduction and optimization initiatives and the impact of charitable donations in 2022.

SG&A as a percentage of revenue increased 430 basis points, primarily reflecting the loss of leverage on fixed costs due to lower sales volumes compared to 2022 as well as market research and investment costs in this year’s third quarter related to medically-supported weight loss activities. Income from operations was $25.5 million in the third quarter of 2023, down 47% versus the year-earlier period, driven by lower gross profit, partially offset by lower SG&A, and aided by the Fuel for the Future cost reduction efforts. As a percentage of revenue, income from operations was 10.8% in the third quarter, a 150 basis point decline versus the year-earlier level. The effective tax rate of 12.9% was lower than expected and meaningfully lower than the 24.5% recorded in the prior year’s third quarter, due to an increase in the tax benefit for charitable donations of inventory, an increase in research and development tax credits, and a decrease in state income taxes.

During the quarter ended September 30, 2023, the company completed its 2022 Federal income tax return, which included an update to the estimated tax-basis cost of charitable donations of inventory and the estimated research and development tax credits. Net income in the third quarter of 2023 was $23.1 million, or $2.12 per diluted share, compared to $36.2 million, or $3.27 per diluted share, in the year-earlier period. Turning to our balance sheet and cash flows. Our financial position remains strong with $157.8 million in cash, cash equivalents, and investment securities, and no interest bearing debt as of September 30, 2023. Cash flow from operations continued to be strong at $137.1 million from the nine months ended September 30, 2023, relatively in-line with a year-ago period.

Turning to the guidance. While our third quarter results were ahead of our guidance, the operating environment remains challenging, and we continue to expect that future growth initiatives will take time to gain traction and deliver meaningful results. For the full-year 2023, we are estimating revenue in the range of $1.05 billion to $1.07 billion, and diluted EPS to be in the range of $8.65 to $9.55. Our guidance assumes a 20.5% to 21.5% effective tax rate. In summary, we remain confident that our strong financial position, coupled with the progress we are making towards exciting new growth opportunities, discussed by Dan, will enable us to evolve our business like we have successfully done in the past and allow us to continue to generate significant cash flow and strong returns on capital in the years ahead.

With that let me turn the call back to the operator for questions.

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Q&A Session

Operator: Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Linda Bolton Weiser with D.A. Davidson. Please proceed with your question.

Linda Bolton Weiser: Yes, hello. So, your gross margin was very impressive in the quarter, the 75% number. It sounds like those are kind of permanent-type improvements you’ve made along the lines of the supply chain. Is that 75% gross margin level, is that something that’s roughly sustainable going forward, or how should we think about that level?

Jim Maloney: Yeah, the — Linda, this is Jim. So, the gross margin improvement we saw in Q3, at the 75%, we saw that through our Fuel for the Future initiatives. We’re starting to see the benefits of optimizing our distribution centers, which we’ve seen improvement in our inventory controls with less obsolescence compared to the prior year. And we’ve also seen improvement in our procurement practices, which has — have lowered costs. The thing when you’re — we’re not really going to talk to the gross — at a gross margin level since we haven’t provided guidance going forward. But what I can say on that is, there is some fixed costs within our cost of sales. As we see lower revenues that are forecasted, we will lose some leverage on our P&L within the gross margin level. So, that will impact Q4. So, right now, we’re projecting the revenue range in Q4 between $170 million and $190 million in Q4, and that loss on leverage will impact gross margin.

Linda Bolton Weiser: Right, okay. And then, I’m curious about, Dan, you’re talking about the testing or trying out some digital marketing methods. And that’s a little unusual being that you pay a lot of commissions to your coaches to kind of drive demand. Do you think down the road, like if you were to adopt some kind of permanent method of digital marketing, is there any way to quantify what percentage of revenue you might spend on that? Are we talking it’s like just a few percentage points of revenue or could it be higher than that? Thanks.

Dan Chard: Yeah, Linda, we’re at the very beginning stages of doing these tests. As you know from the past, this is not new to us. In the past, we had a direct marketing organization that marketed directly to end users. We, as you pointed out, moved away from that, letting our coaches use their word-of-mouth campaign over social media in — rather than us spending our dollars to do that. The reality is that the environment has changed. And through some of the things that we’ve talked about in the past, including changes in social media algorithms, as well as a more crowded and more, I’ll say, dynamic message that’s going on out there, we think it’s a good time for us to take some of those learnings that we have from the past, some of the learnings that we talked about in the future around medical weight loss and to introduce a new message through the company’s lead advertising.

We’ve been doing small tests. We feel good about what we’ve seen so far. Anything that we do will be done only once we understand the benefits from a financial standpoint of doing it. So, I’d say the important thing is assume that we are going to test right now, which is what we’ve been doing both in the Hispanic market and, more broadly, understand how we improve that client acquisition cost and use it to get a new message out there that ties to our broader offering that includes the things that we’re learning about, the ability to offer medical weight — medically-supported weight loss, our ability to offer a broader offering, which is inclusive of the active program. And we believe all this will help make our coaches more productive and return to some of the productivity levels we’ve been in the past.

Linda Bolton Weiser: Okay. And then, I was just wondering about if you could give any color on what you saw in October, with the return to people paying educational loan payments. Like, are you seeing kind of worsening trends or kind of the same? What are you seeing kind of so far in the most recent couple of weeks?