MEDIFAST INC

Good day and welcome to the Medifast third quarter 2022 earnings conference call. All participants will be in 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 star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Reed Anderson with ICR. Please go ahead.

Good afternoon and welcome to MediFast's third quarter 2022 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 30th, 2022. It went out this afternoon at approximately 4 or 5 p.m. Eastern Time. If you have not received the release, is 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 the 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 statements. All of the forward-looking statements contained herein speak only as of the date of this call. METAFAST assumes no obligation to update any forward-looking projections that may be made in today's release or call. And with that, I would like to turn the call over to METAFAST's Chairman and Chief Executive Officer, Dan Chard.

Thank you, Reid, and good afternoon, everyone. Thank you for taking time to be with us today. On the call with me is Jim Maloney, our Chief Financial Officer. I'll start with an overview of the third quarter and continued evolution of our business, then Jim will run through our financial results in more detail. Third quarter has been one of calibration and adjustment. We are pleased to see a faster than expected recovery in customer retention, which is now back to historical norms following the disruption in Q2 due to consumer spending pressure from higher inflation and interest rates. Customer satisfaction numbers remain at historical highs as our operating infrastructure continue to enable us to deliver a high-quality customer experience that drives retention and brand ambassadorship. Customer experience is one of the key differentiators that allows us to maintain our leadership position, which was recently underscored when Euromonitor, an independent market research firm named Optivia, hit the top weight loss program in the U.S. by revenue for last year. Revenue of $390 million in the third quarter was down less than 6% versus the prior year period, representing an improvement on the outlook we provided earlier in the year of a mid-teen double-digit decline. The number of Octavia coaches increased 8.5% year-over-year to 66,200, while revenue per active earning coach declined 12.9% to $5,897. First margin of 72.5% was down year over year, but improved 150 basis points sequentially. Additionally, we proactively manage our SG&A expenses, taking meaningful steps to bring costs in line with how our business is operating. And we delivered 110 basis point reduction on an adjusted basis versus last year, despite lower revenue. We achieved earnings per share of $3.27, a decrease of 8.1% compared to the prior year. and earnings per share of $3.32 on an adjusted basis compared to $3.56 in the prior year period. As we move forward, we will continue to execute a disciplined capital allocation strategy and prioritize investments that will drive meaningful growth. As we look back over the last few months, there are several important learnings that will help us inform the way we plan and manage our business going forward in this new environment. The programming we implemented in early 2022 proved successful in attracting new customers, confirming the continued demand for the OPTAVIA offer. The program attracted the largest new customer cohort in company history, but repeat rates were negatively impacted in the most price sensitive customers across all customer cohorts. Repeat purchase rates among our remaining customer base across all cohorts returned to their historical ranges in the third quarter, but there is a lingering overall impact on coach productivity as measured by new customer acquisition per coach. With this in mind, we made several changes to our programming and operations to help put the business back on a growth track and improve profitability as we finish 2022 and begin 2023. First, using the learning from the successful new coach accelerator program that we put in place during Q3, to accelerate building our base of active earning coaches and acquiring new customers, we expanded the program to include all coaches and extended the program period through the end of the year. This means that all of our coaches have an incremental financial incentive to drive customer acquisition. Second, in partnership with our coach leaders, we identified a set of programming adjustments that reflect learnings from early 2022 to help drive customer acquisition in the new business environment through 2023 and beyond. These programming chains will be implemented in the first quarter of 2023 and will focus on accelerating new customer acquisition. Third, we will implement a price increase across the entire product assortment that will be effective in November. The increase is tied to a set of margin assurance and productivity initiatives that will have a positive impact on the P&L in Q4 and provide further profitability support in 2023. The price increase will be an average of 4.5% on our consumable products. Concurrent with this price increase, we will increase shipping prices as well as adjust purchasing thresholds within our premier loyalty program to further support productivity. Fourth, we have made minor changes to optimize the compensation plan in our GNA operating structure that will improve results and better align with our long-term strategy. And finally, leveraging our investment in technology and digital capabilities remains a key area of focus to drive deeper engagement and seamless connectivity across the OPTAVIA community of coaches and customers. We continue to add capabilities and work closely with coaches to integrate these powerful tools to serve existing customers more efficiently and effectively, as well as grow their businesses. Consumer focus and awareness around health and wellness is not dissipated. In a recent MediFast survey, while the majority of U.S. adults said that they have cut their spending in the last six months, 70% of U.S. adults say they don't plan on letting their health and well-being falter and plan on implementing better lifestyle changes in the coming year. Our unique positioning of a personalized transformation experience remains a critical point of differentiation in this important sector. and our programs and initiatives will help us drive further growth and energy in our business as we continue to scale. Clearly, there are near-term challenges for consumer-facing businesses as they adjust to the changing environment. At Medifast, we remain confident in our ability to navigate this shift and in the strength of our long-term growth strategy. Our coaches and customers remain deeply engaged and satisfaction levels continue to be near all-time highs. We have a dominant position in the $7 billion weight loss industry with a model that is clearly differentiated and a plan that is clinically proven and consistently delivers positive outcomes for coaches and customers. Over the years, the OPTAVIA community has grown to millions of individuals working in partnership with OPTAVIA coaches who provide customized support and teach customers healthy habits that can lead to lifelong transformation. We continue to be well positioned for the long-term growth and remain committed to our target of 15% average annual revenue growth and 15% operating margin. Our investments in technology and infrastructure provide an efficient pathway and significant capacity for growth as we continue to expand our international footprint as well as move into the broader $230 billion health and wellness market in the future. MetaFest has a bold mission to transform lives one healthy habit at a time. We are achieving that in the field with coaches and customers who are achieving change that they previously thought impossible. We are also helping drive change in the classroom with the Healthy Habits for All curriculum that is helping school children make healthy choices regardless of socioeconomic background. And we are doing it through our partnership with No Kid Hungry which has provided up to 10 million nutritious meals to children facing hunger. Our mission motivates us to continue the work we're doing every day from profit generating activities to corporate social responsibility initiatives. It's important work that drives us to be better every day, to overcome obstacles and to work as a team to drive better outcomes for everybody, for clients, to coaches, to employees, to investors. With that, let me now turn the call over to Jim Maloney who will walk you through the financial results.

Jim? Thank you, Dan. Good afternoon, everyone. Revenue in the third quarter of 2022 decreased 5.6% to $390.4 million from $413.4 million in the third quarter of 2021. We ended the quarter with approximately 66,200 active earning OPTAVIA coaches An increase of 8.5% from the third quarter of 2021. Average revenue per active earning Octavia Coach from the third quarter was $5,897, a decline of 12.9%, driven by a decrease in the number of customers supported by each coach. Gross profit for the third quarter of 2022 decreased 7.9%, to $282.8 million compared to $307.1 million in the prior year period reflecting lower coach productivity. Gross profit was 72.5% in the third quarter of 2022 versus 74.3% in the comparable prior year period. 180 basis point decline in gross profit margin was mainly due to inflationary economic conditions that are driving higher raw ingredients, shipping, and labor costs. SG&A expenses for the third quarter of 2022 decreased 6.8% to $234.7 million compared to $251.9 million for the third quarter of 2021. SG&A as a percentage of revenue decreased 80 basis points year-over-year to 60.1% versus 60.9% in the third quarter of 2021. Non-GAAP adjusted SG&A decreased 7.3% to $233.6 million and non-GAAP adjusted SG&A as a percentage of revenue decreased 110 basis points year-over-year to 59.8%. The decrease in non-GAAP SG&A was primarily due to lower OPTAVIA coach compensation expense. Non-GAAP adjusted SG&A excludes expenses related to donations made to support the Ukrainian relief effort. Income from operations decreased 12.7% compared to the prior year period or $7 million to $48.2 million, primarily as a result of decreased gross profit partially offset by decreased SG&A. Income from operations as a percentage of revenue was 12.3% for the third quarter of 2022 compared to 13.3% in the same period in 2021. Non-GAAP adjusted income from operation which excludes the Ukrainian donation decreased $5.9 million to $49.2 million. Non-GAAP adjusted income from operation as a percentage of revenue was 12.6%, a decrease of 70 basis points from the year-ago period. The effective tax rate was 24.5% from the third quarter of 2022 compared to 23.9% in the prior year's third quarter. The increase in the effective tax rate was primarily driven by an increase in state income taxes partially offset by increased tax benefits for donations made in the quarter and research and development tax credits. The non-GAAP effective tax rate was 24.9% as compared to 23.9% in the prior year period. Net income in the third quarter of 2022 was $36.2 million or $3.27 per diluted share compared to net income of $42 million or $3.56 per diluted share in the prior year's third quarter. The non-GAAP adjusted net income was $36.8 million or $3.32 per diluted share. Additionally, on September 8th, the company's board of directors declared a quarterly cash dividend of $18.2 million or $1.64 per share, which is payable on November 8th, 2022 to the stockholders of record as of September 20th, 2022. This represents a 15.5% per share increase compared to the third quarter of the prior year. Turning to the balance sheet and cash flows, we believe our financial position remains strong with $69.7 million in cash, cash equivalents, and no interest-bearing debt as of September 30, 2022. During the nine months ended September 30, 2022, our net cash flow from operating activities was $142.8 million, an increase of 40% from the year-ago period. As cash flows have improved over the past five years, we have returned excess cash to stockholders in the form of dividends and stock buybacks. We've increased our dividend since 2017 by more than 240%, and the dividend yield is 5.6% as of October 31st, 2022. We have additionally increased the rate of stock buybacks over the last several years including the $100 million accelerated stock repurchase program that was completed in Q3 2022. We have continually increased the return to stockholders in the form of dividends and stock buybacks because we are confident in our long-term growth strategy. I will now turn to our guidance for the full year 2022. As Dan discussed, the macroeconomic environment has remained challenging over the past several months. And while our retention rates have returned to historical norms, there is a residual impact on new customer acquisition. We expect full year revenue in the range of $1.51 billion to $1.59 billion and diluted non-GAAP EPS to be in the range of $11.61 to $13.05. Our guidance assumes a 24% to 25% effective tax rate. Finally, we believe that along with our 66,000 coaches, we'll be able to navigate the new business environment in the coming quarters so we are confident in our long-term 15% growth and 15% operating income targets. With that, let me turn the call back to Dan. Thanks, Jim.

In closing, we are confident in the power of our coach-based model and the Habits of Health transformation system to change lives for the better. It is our unique model backed by an incredible coach community that is highly adept at engaging and nurturing relationships. We have a strong management team with a proven track record of running and scaling businesses and talented and nimble groups of employees with a passion for what we do. More than that, we have a unique powerful business model that is scientifically proven to be effective and that is changing lives every single day. The core of this business is strong and we have invested appropriately over the recent years to create a foundation that we can build on for many years to come. There's more work to be done and we must always fine tune our operations, processes and initiatives to reflect market conditions. The reality is that the environment today is one of constant change and that means developing a resilient and strong business capable of succeeding whatever the circumstances. We feel confident that our initiatives and long-term strategy set us up well to deliver our growth and financial objectives for 2023 and beyond. With that, let me turn the call over to the operator for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. And our first question comes from Christina Xu with DA Davidson. Please go ahead.

Hi, everyone. This is Christina Xu. I'm Linda from DA Davidson. So firstly, we are really happy to hear that the retention rate is now back on track. A couple questions. Firstly, do you mind commenting a little about do you expect the coaches to be up or down sequentially in the fourth quarter? I think for the third quarter, we were up quarter over quarter, but we were down a little sequentially. So just want to get some opinions on the fourth quarter.

Yeah, Christina, this is Dan. I'll give you a little bit of color around that and let Jim answer the specific detail that you talked about or that you asked a question about related to coaches. So it's important to kind of go back and understand where we've been to kind of give some context and some grounding for where we're going. As you know, we finished 2021 strong. growing 60%. We finished our supply chain build out initiatives, which allows us to grow into the future. And we initiated a 3.5% price increase to counter some of the inflationary pressures. So that's where we ended last year. As we started 2022, we had a strong start. We focused on bringing in new clients and executed a similar program to what we'd executed in 2022, excuse me, in 2020. And importantly, what we saw was that we were able to bring in the highest number of new customers in the history of the company just under a quarter of a million new customers came in equally important is that our coach productivity was the highest in company history so those coaches who were acquiring this was during an inflationary period were able to do so at a high rate the challenge we ran into in the latter half of q2 as you know was that our client retention were disrupted. Or another way of thinking about that is our repeat rates were disrupted. So we lost approximately 15% of our active clients across all cohorts. That's true regardless of whether they joined in 2020, 2021, or more recently. And what we know is after surveying those customers is that the primary reason for leaving was inflation, as well as and many, many more. So, as we entered the Q3, we executed several new programs, which I described earlier, with the supported active burning coaches of 66,000 for the quarter and also brought in a new cohort of clients. The positive thing, which you just highlighted, is that client retention rates or client repeat repeat rates have rapidly returned to historical norms. So they're back to where they were prior to Q2. What has remained, however, is client acquisition rates that we still feel pressure from those. And they're roughly 85% of historical norms in Q3. So as we think about Q4, the outlook has been adjusted to reflect that new environment. So I think an obvious question around this is what's the plan for the return of growth? So we won't provide outlook on this call. We will, when we report fourth quarter earnings. But we've learned a lot about how to make our new environment our growth environment. We ran through earlier the programs we plan to put in place and the programs that we've executed in Q3 and will carry on through Q4. We are implementing a 4.5% price increase to offset some of the inflationary pressure and we're also making some optimizing adjustments to our compensation plan to help keep our coaches focused on client acquisition. As it relates to how we're guiding for Q4, Q4 is a conservative number. It assumes the macro headwinds remain constant in terms of what we've seen. We also are in a state where our coach and client tenure remains a challenge. In other words, as we would normally bring in a large cohort that would build through the year and have younger clients and younger coaches, that is not the case, which is reflected in the lower productivity per coaches. If you remember, our productivity per coach is measured by revenue per active earning coach is up over 50%. versus what it was in 2016. So we'll continue to see some pressure there. And as we move into the last two months of the year, November to December, this typically is our lowest seasonality as people are thinking about how to enjoy the holidays, which usually involves eating. And many clients choose to hold off or prospective customers or clients choose to hold off joining the Optivea program until the start of the new year. We'll continue to focus on client acquisition, but the real work and progress around client acquisition will be made in the first quarter of 2023. With that, I'll turn it back to Jim and let him answer the question about sequential coach growth and year-over-year coach growth.

So, Christina, as Dan mentioned, the guidance we provided assumed the macro headwinds. And as Dan mentioned, we believe it's conservative guidance. And, you know, the good news is retention has recovered in Q3, which is really good news. However, the carry forward impact from Q2 of the retention issues left us with suboptimal coaching customer tenure. that will put pressure on Q4. In Q3 and beginning in Q4, what we're seeing is lower than anticipated customer acquisition, which we expect will impact the productivity in Q4, so productivity we're expecting to be lower, and we'll have a more modest headwind in coach count in Q4. As Dan mentioned, the good news is we'll be heading right into January, which is the best time for customer acquisition for our company. That will help with the 10-year mix with coaches and customers.

Okay, that makes sense. Thank you for that. So with regard to the retention rate, I think you mentioned there is going to be another round of price increase roughly starting in November, if I remember correctly. So I want to, what are your thoughts on how do you expect your clients to react on the latest price increase? Would it be an issue for retention rate again?

Yeah, we approach pricing very thoughtfully and took some extra time to contemplate and actually learn from what we had seen versus last year and also through the year as we looked at how we can optimize our acquisition offer. So the 4.5% reflects what I'd describe as a modest increase that we believe will be easily absorbed by new clients. and it's being coupled with some initiatives to make our acquisition kits more easily kind of affordable for new clients. So I think a good way to think about this is the client acquisition kit and the pricing and price point is the most important piece. What we have seen is once a client both sees success on the program, likes the food, and likes the coach, that's what ultimately drives the repeat rates or the retention rates. So we feel confident that we can increase the, we can execute the 4.5% across all of our consumable products without creating a significant And I'll add, Christina, that when you look at 2023, we have in the longer term to get to our objective of 15% operating income margin.

So looking at the long term, we have more than enough margin assurance initiatives Dan mentioned the price increase, but we also have increased our capabilities over the last 12 months in our procurement organization, which have a significant amount of cost savings opportunities that we'll start seeing in 2023 and it'll continue into 2024. We also have value engineering initiatives that not only will reduce overall cost, it will also increase customer satisfaction. And then, you know, finally, we are looking at optimizing our coach compensation and G&A costs to support our growth and help us adjust in these new business norms.

Okay, so a follow-up on the price increase. Is it applicable to all customers or is it only applied to the new customers?

To all customers.

Okay, maybe a last question from me. So what do you expect your clients to react? Wait, actually, maybe another one. Do you possibly have a rough idea in which quarter of 2023 we will see a positive year-over-year sales growth? would you be able to comment on that?

Yeah, so we don't really, we're not providing guidance for 2023 and so it's difficult to answer that question. But all we really can say is we haven't gone off our long-term objectives of 15% growth in the long term on an annual basis consistently. So that's our objective as a company and we're building out capacity and technology capabilities and we're not slowing down with those investments because we know that our offering is well needed as Dan mentioned about that consumers still need our offerings. So even though they're adjusting their spend, health and wellness is one of the spends that we believe they're going to continue with.

Okay. I think that's all the questions from me. Thank you.

Great. Thank you for your questions and for taking time to join us today. You know, the last three years, has been interesting for businesses of all shapes and sizes to navigate. First, the global COVID pandemic upended many of the practices we held to be true. And now we're in a period of sustained inflation, interest rate rises, and possibly a recession. I can say that at Medifast, we're committed to delivering shareholder value for the long term, regardless of the macro conditions. This means driving for consistent growth, not just today, but in years to come. It's our job to adjust, learn, and continue to build and that's exactly what we plan to do. Thank you as always for your interest in METAFAST and we look forward to speaking with you again next quarter.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.