MED - NYSE

Good afternoon, and welcome to the Medifast Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Steve

Good afternoon, and welcome to Medifast second 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 June 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. Medifast 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.

I want to start by thanking you all for joining today's call. With me today is Jim Maloney, Medifast's Chief Financial Officer. Before I get into the specific dynamics of the second quarter, I want to share how Medifast is evolving to create sustainable success in the changing marketplace. As we have mentioned previously, the market has experienced some significant shifts in the last year, caused in part by changes in the macroeconomic and competitive environments. In both areas, shifts have impacted the nature of the demand and demand creation and caused Medifast and other companies to reassess drivers for long term growth. With that in mind, we have now embarked on an aggressive path to make meaningful investments to evolve our business model for growth in the new environment. Going forward, we will use our Coach-guided lifestyle program and products to extend beyond the $8 billion structured weight loss market, where we are a major player. To be clear, the traditional weight loss management sector will remain important and we will continue to implement plans designed to increase our share of this dynamic segment. Including extending our offer to better integrate with the emerging trends in medically supported weight loss and continuing to broaden our demographic focus to the Hispanic market, which will lay the groundwork for future expansion into Latin America. However, at the same time, we are also moving forward with some exciting new initiatives, which we expect will be drivers for future performance, focused on monetizing multiple Healthy Habits. I'll spend some time talking about those today. What is not changing is our mission to offer the world lifelong transformation one healthy habit at a time, utilizing our six macro habits of health and our more than 53,000 active earning coaches to help people achieve their health and wellness goals. For more than 20 years, these Healthy Habits and our coach-led approach have encouraged millions to achieve a sustained healthier lifestyle. As consumers increase their focus on personal health and wellness, the desire for support in achieving their goals continues to be a trending topic within the space. Science-based solutions that empower transformation change have and will always remain at the heart of our offering, underpinned by coach support, products and tools that help customers achieve their goals. Before I share more on how we intend to act on that principle going forward, I want to turn my attention to the second quarter. Customer acquisition in the second quarter was in line with our projections, but down year-over-year as we continue to execute on the three critical business drivers that will return the business to growth. Those businesses are programming, coach training and our offer. We were down by 35% in revenue in Q2 of 2023 year-over-year. The comparison quarter last year included the acquisition of a record number of new customers driven by our successful Essential STAR program, which made for a difficult comparison. Macro headwinds, including the rapidly shifting economy, inflation, changes in social media algorithms, along with a changing competitive environment, with the growth of medically supported weight loss, all impacted our ability to drive customer acquisition to prior year levels. New coach programs planned for the remainder of 2023 should aid in improving customer acquisition, particularly in conjunction with the new product line that we announced at our recent convention. More on that in just a moment. While we continue to see retention rates in line with our historical averages and conversion rates also in normal ranges, new customer acquisition continues to be our most significant challenge. We believe that the new product line will help energize our coaches and allow our health transformation message to break through a crowded marketplace, driving customer acquisition and revenue going forward. We also continue to place significant focus on broadening our coach and customer bases in the Hispanic community, where we see significant potential to build on our progress over the last few quarters. This fast-growing population segment provides us with significant room to grow as our current estimated Hispanic customer base is well below the 18% of the U.S. population that identifies as Hispanic. Operating margin rose to 13.1% from 10.8% in the year ago quarter, reflecting less promotional activities in this year's second quarter compared to a year ago and continued progress on our Fuel for the Future cost savings initiatives. We do expect to increase investment in our growth initiatives throughout the rest of the year, which should more than offset our savings in 2023, but should help set the stage for a return to growth in the future. During the quarter, we made the decision to exit Singapore and Hong Kong effective July 1, to focus the company's resources and efforts on growth initiatives that we anticipate will have the greatest impact on profitability in the next several years. As we discussed previously, our work in the region was impacted by COVID-19. And with the current dynamics in the Asia Pacific region being less than ideal for expansion, we believe there are more compelling geographic expansion opportunities elsewhere. We developed important insights and learnings from our work in the region, and these will be invaluable in pursuing new geographies in the future. I want to move now to the specifics of our growth investment initiatives. At our annual convention 10 days ago, we announced the launch of our new product line, OPTAVIA ACTIVE that is part of our coach supported healthy motion program and is one of the six habits of health within our proprietary system. OPTAVIA ACTIVE was born out of a desire from our field to offer more comprehensive and effective options than those offered in the marketplace, in order to support an active lifestyle that includes exercise. According to an internal survey, more than 80% of OPTAVIA Coaches see the value of a healthy motion program and products. The new line contains premium exercise supplements and products that are scientifically designed to help people with a habit of healthy motion as part of their optimal health pursuits. The initial products with others expected to be rolled out next year include OPTAVIA essential amino acid blend and OPTAVIA ACTIVE way protein. Both products are also formulated to work within the OPTAVIA nutrition plans to help people achieve their health and wellness goals while incorporating exercise and supplements into their routine. In addition to the new products, we have partnered with Aaptiv, a leading fitness app, to provide on-demand guided workouts for our community of coaches and customers. OPTAVIA ACTIVE products help activate muscle protein synthesis, support healthy muscle and reduce muscle soreness after exercise. And of course, with coaching center for OPTAVIA initiatives, customers interested in OPTAVIA ACTIVE will be guided by coach support. Much like our mill replacement solutions, OPTAVIA ACTIVE is not just about the consumable product but rather about the entire program that provides each customer with an easy, guided way for them to practice the habit of Healthy Motion whether it be walking, running, biking, weightlifting, et cetera. The products are now available exclusively for coaches with the OPTAVIA ACTIVE program and products launch into the public through our coaches in September of 2023. The total addressable market for sports nutrition, which includes exercise supplements, is over three times, the size of our current market opportunity and is expected to grow at a 9% CAGR over the next four years, according to the Nutrition Business Journal, making it a very attractive market for us to pursue. We expect these new products to attract new customers, both in the weight loss and fitness categories as well as those who have already reached a healthy weight with OPTAVIA and are looking for support for the next phase of their health goals. Another initiative we announced at convention and that we are in the initial stages of exploring is medically supported weight loss solutions. GLP-1 and other medications have, of course, been in a hot topic in the media over recent months, and we believe that this could be a potential area for growth. Medifast was founded by doctors and our scientific and clinical heritage gives us the knowledge and credibility to evaluate and develop new products and partnerships that could further help customers in their health and wellness journeys. Our in-house scientific and clinical affairs team as well as our Scientific Advisory Board of external scientific experts guide us in making informed decisions based on the latest scientific developments in health and wellness. It is important to note that the weight loss medications are being prescribed to be used in conjunction, with lifestyle changes, and these are the same lifestyle behaviors that are exemplified in our six habits of health. As such, our science-backed products and coaching model make OPTAVIA, a powerful solution alone or as the cornerstone of a program that, includes weight loss medications. What has been historically true is still true today. Lifestyle change is the cornerstone of long-term healthy living regardless of what solution people are using to effectuate short-term weight loss. We are exploring ways to offer a combination of our habits based coach guided solution together with medically supported weight loss to serve those potential customers who may be in need and are looking for different approaches. We are simultaneously exploring strategic partnership opportunities. We are currently piloting relationships with several telehealth providers and will take action to determine the right path forward for Medifast and OPTAVIA. We will certainly have more to say on this subject, when we have some data, and insights from the pilots that are currently underway. These new initiatives are intended to be funded in part by our Fuel for the Future program, which is expected to result in a 200 to 300 basis point sustainable reduction in annualized cost savings by the end of 2025. We are already ahead of our expectations in these cost reduction efforts and hope to realize a third of the savings in 2023. Although, as I mentioned earlier, all savings this year are expected to be reinvested in our growth initiatives. We expect to start to see the benefit of these actions in 2024 and beyond, which is also where we would expect to see the revenue impact from the new growth initiatives. By the end of 2025, we are targeting a sustainable 15% revenue growth rate, and 15% operating margin. We are continuing to make remarkable headway under the education pillars with our healthy habits for all curriculum which is modeled after the company's habits of health system and has now impacted nearly 90,000 students since it launched in the summer of 2022. Lesson plans will remain available free of cost to millions of educators nationwide, through our partnership with We Are Teachers for the 2023-2024 school year. We are glad to continue supporting teachers and equipping their students with the skills, knowledge and confidence needed to build healthy habits from a young age. We have also increased access to nutritious foods through our continued partnership, with a nonprofit, No Kid Hungry. To date, the company, along with our independent coaches have provided nearly 14 million nutritious meals to kids in need. As we look forward, to the second half of the year, we are continuing our relationship with nonprofit partners to pair health education with greater access to critical resources, so children can make healthy choices a reality regardless of their socioeconomic background. Finally, before I turn it over to Jim, I wanted to give you a few more thoughts from the OPTAVIA Convention I mentioned a few moments ago. The Convention focused on training and building energy as we launch new programs, introduce new products and make other enhancements to our offer. The coach base has enthusiastically embraced our new line of motion products and are very excited about using this new tool to help people on their journeys to a healthier lifestyle. They also understand the critical role that lifestyle solutions play, as a complement to medically supported weight loss. Our coaches realize that health is a continuum and that every single customer is on a journey. They understand that as we think about our continued expansion in pursuit of our mission, we are committed to reaching and activating a wider variety of health solutions to meet our customers' needs, and that wherever they are on their journey, OPTAVIA will be there for them. With that, I'll turn it over to Jim to go over the specifics of the quarter.

Thank you, Dan. Good afternoon, everyone. Second quarter 2023 results were ahead of our guidance, as we continue to advance key initiatives aimed at optimizing profitability and reenergizing growth. Revenue of $296.2 million exceeded the upper end of our guidance range of $250 million to $270 million, but decreased 34.7% versus, the year earlier period, primarily driven by a decline in the number of active earning OPTAVIA Coaches and lower productivity per active earning coach. Customer acquisition continues to be pressured by less prospects being identified by coaches, impacted by competition from GLP-1 drugs, inflationary pressures and social media algorithm changes. We ended the quarter with approximately 53,100 active earning OPTAVIA Coaches, a decrease of 21.9% from the second quarter of 2022. Average revenue per active earning OPTAVIA Coach for the second quarter was $5,578, a year-over-year decline of 16.3%, reflecting the continued headwinds to customer acquisition, partially offset by a price increase we implemented in November last year. Gross profit decreased 34.5% year-over-year to $210.7 million, driven by lower revenue, while gross profit margin improved 10 basis points to 71.1%. SG&A expense was down 36.9% year-over-year to $172 million and decreased 210 basis points as a percent of revenue, primarily reflecting lower compensation expenses due to lower volumes and fewer active earning coaches as well as the absence of charitable donations that we did in the prior year period. Another significant factor that favorably impacted SG&A, this quarter versus second quarter of 2022, was our continued progress on several cost reduction and optimization initiatives. Income from operations was $38.7 million in the second quarter of 2023, down 21% versus the year earlier period, driven by lower gross profit, partially offset by lower SG&A. As a percentage of revenue, income from operations was 13.1% in the second quarter, a 230 basis point improvement versus the year earlier level. While we initially expected the operating margin to be below last year's second quarter level, it actually was significantly above our expectations due to timing benefits from a program that was run earlier in the quarter than forecast and from certain expenses that were pushed out until later in the year as well as greater-than-expected savings from our Fuel for the Future cost reduction initiative. We continue to be very encouraged by the result of our efforts to take 200 to 300 basis points of annualized expenses out of our cost structure by 2025, which is running ahead of our expectations. As Dan said earlier, we expect to use the savings this year to help fund our strategic growth initiatives, and customer acquisition efforts. The effective tax rate of 22.6% was higher than 19.8%, recorded in the prior year second quarter due to a decrease in the tax benefit for inventory donations, when compared to last year.Net income in the second quarter of 2023 was $30.3 million, or $2.77 per diluted share, compared to $39.1 million or $3.42 per diluted share in the year earlier period, aided by a 4.5% decrease in diluted shares outstanding. Turning to our balance sheet and cash flow. Our financial position remains strong, with $147.4 million in cash, cash equivalents and no interest-bearing debt as of June 30, 2023. Cash flow from operations continues to be strong at $43.1 million during the second quarter, relatively in line with the year ago period. Cash flow from operations for the six months ended June 30, 2023, was $107.2 million, outpacing last year's comparable period by 22.6%. Turning to our guidance. While our second quarter results were ahead of our guidance, the operating environment remains challenging, and we continue to expect that programming changes compensation dynamics and future growth initiatives will take time to gain traction and deliver meaningful results. For the third quarter of 2023, we are estimating revenue in the range of $220 million to $240 million and diluted EPS in the range of $0.71 to $1.32. Our guidance assumes a 23% to 25% effective tax rate. In summary, we remain convinced that our strong financial position coupled with the numerous exciting 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 to the operator for questions.

Thank you [Operator Instructions] Our first question comes from Linda Bolton-Weiser with D.A. Davidson. Please go ahead.

Yes. Hello. So I guess I would just like to ask about your coach decline sequentially in the quarter, I think it was about 10%, if I calculate it right. And that was quite a bit bigger than in the first quarter, where the decline was 4%, sequentially. So I'm just curious about like what to expect there. I know you don't want to get into giving guidance, but is this - do you think this is the worst trough point in terms of sequential decline of coaches? Or do you think it's going to get worse? Or is there something you can tell us about the cadence of the progress on the coach front. Thank you.

Sure. Thanks, Linda. The coach - active running coach number is highly influenced, as you know, by clients coming in since over 95% of our clients - excuse me, our coaches were clients previously. So it all comes back to that headwind that we continue to experience around client acquisition. So what we believe is that the three things that we've talked about, specifically the launch of the active line that took place a convention and expands our addressable market and brings in a new type of customer who are looking for exercise as part of their health journey along with moving from exploring or monitoring the medically supported weight loss segment that's creating a lot of noise and then as well as the continued progress we're making in the Hispania segment, all have the potential of increasing that overall client acquisition number. And as our client acquisition number improves, what we know is that our conversion rate, meaning the percentage of those customers who become coaches has remained at historical norms. So at this stage, we continue to focus really on that last metric that has been disrupted and focusing on those three different areas. And I feel confident that as we improve our client acquisition number that the active earning coach number will start to improve as well as the productivity per active earning coach.

Okay. Also, can you comment on the wide range for EPS guidance for the second quarter? It seems unusually wide, whereas the revenue guidance is not kind of typical. So I'm just wondering - what is it that's dictating that wide range? And what would have to happen to get to the bottom end of the range versus the top end in the second quarter? Thanks.

Yes. This is Jim, Linda. So the range of EPS guidance is twofold. One is the - as we see - if we actually hit the bottom end of the range of revenue, we start losing leverage on our fixed cost, which will impact operating income. The second thing is when you look at the tax rate, the difference between 23% and 25% is the other major difference that causes EPS to be at that lower range. So it's really those two factors that caused that. It's the loss of leverage on fixed costs and the tax rate at the higher rate.

Okay. I mean you really don't have any international operations anymore. So I'm just curious what dictates the wide range of tax rates.

Yes. The wide range of tax rate is dictated actually when you - at the lower operating income levels, it doesn't - the way our tax rate works, it will go - it will climb to a higher rate. So typically, our rate over the last several years has been about anywhere between 22% and 24%, but it could climb to 25% at the lower amounts of operating income. And that's what causes that rate decline.

Okay. Got you. And then - it's sort of interesting when you listen to other weight loss companies like, for example, Herbalife is another direct seller of some weight loss products. They say the GLP-1 drugs are really not affecting their business, at least not yet. So I'm curious why you think it would be affecting your business more? Do you think it's the relative cost of the program? You're selling a $400 per month program, whereas Herbalife is selling something that's less expensive or even individual SKUs more. So maybe their client base is different in terms of demographic? Or what do you think accounts for the difference on the business between yourself and Herbalife?

It's hard to comment on Herbalife's business, but it certainly can help clarify what we're seeing. There are three things that have affected us in the last year, and you're very well aware of this. One is the macroeconomic environment, which primarily took place last year, took out a portion of our clients who typically would have added significant value even moving into this year. The second one is change in the social media algorithms. And then the third one is one that we're talking about now, which we didn't see during the - say, until late last year, and at that point, we started looking at to try to understand exactly what the impact was. So here's what we know. We know that roughly across the country over the last several years, 10% of Americans or people in the United States have used the - some kind of medically prescribed drug. And that's inclusive of the ones that are considered the GLP-1 drugs as well as any other prescribed drug, and they currently about 3% are using. The more interesting part for us, and we've done some quantitative research to better understand this is that among our target consumer, 44% don't want medically supported weight loss or the medicines to be part of their health journey or their weight loss journey. However, 41% of our target customers do want medicine as part of their weight loss program or their health journey. So that's a significant portion of our target group. The good news related to that is that we tie back to what we launched a convention as well as the pilots that were only engaged in. We have the - it's a good fit in several areas. First, these medications work in conjunction with lifestyle as specifically called out is, as you - I think you know, both some dietary changes, diet restrictions or work restrictions as well as increased exercise. So our entry into the - with our active line into the habit of healthy motion cause back to increasing our overall addressable market, but it also puts us in a good position to be a solution for those who are on the drugs. The second thing that is positive for us is that individuals who are going on these drugs, and this just comes from our quantitative research as well. They're looking for guidance. And specifically, guidance from someone who understands where they are having gone through something similar in terms of a weight loss journey, and we believe that positions us very well with our coaches having - the majority having been on a weight loss journey or a health journey themselves. So we think all of those elements are helpful for us in terms of reaching the other side of this question of how we participate and how we use what's happening in the medically supported weight loss space, Phase 2 leverage our client acquisition rate and move in the future with a broader offering that's more - that's even more relevant than it has been in years past.

Okay. And then finally, you mentioned in your comments that certain expenses, I think it was the SG&A line, certain expenses were pushed out to later in the year. Can you comment on the nature of those expenses and quantify how much were pushed out to later in the year?

Yes. So - in those expenses, so we're looking at - and we mentioned this also in the prepared remarks about investments that are going to hit the P&L during the third quarter. So we're looking at about - in total, this includes the convention, Linda, but not - which was planned for the third quarter. So - but in total, when you look at our total spend of initiatives that really didn't occur other than the convention in 2022 in Q3. It's about 565 basis points. So there's additional initiatives that - some of it was thought to occurred - that would have occurred more in Q2 that got pushed out into the July, August and September time frame. So the convention, obviously, that was planned for Q3 and was one of the bigger impacts to Q3 which is included in that number.

Okay. All right. Thanks a lot. That's it for me.

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

We'd like to thank everyone for joining today, and we look forward to speaking to you next quarter and hope to see many of you at the Wells Fargo Consumer Conference in Southern California in late September. Have a nice evening.