Medifast, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. Medifast sells weight-management and related nutrition products through Take Shape for Life, Medifast Direct, Weight Control Centers and wholesale physicians. This unaudited quarterly report covers the three and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $78.3 million | $66.7 million | $152.6 million | $127.2 million |
| Gross profit | $59.0 million | $49.5 million | $115.7 million | $95.2 million |
| Income from operations | $9.0 million | $9.3 million | $19.0 million | $17.5 million |
| Net income | $5.9 million | $5.5 million | $12.3 million | $10.4 million |
| Diluted EPS | $0.41 | $0.38 | $0.85 | $0.71 |
- Revenue increased 17% in Q2 and 20% for the first half. First-half gross margin improved to 75.9% from 74.8%, while operating margin declined to 12.5% from 13.7%. Q2 margins were 75.4% gross and 11.5% operating, compared with 74.2% and 13.9%, respectively.
- Operating cash flow was $30.5 million for the first half, versus $19.8 million in 2010. Capital expenditures were $5.5 million. Cash and cash equivalents rose to $28.3 million from $17.2 million at year-end; investment securities were $18.8 million. Cash plus investment securities totaled $47.1 million.
- Total debt was approximately $5.1 million at June 30, including $0.9 million current and $4.2 million long-term. The company reported $4.8 million of variable-rate loans outstanding. Current assets were $66.5 million and current liabilities $22.1 million.
- Repurchased $12.3 million of stock in the first half. Treasury shares increased to 958,908 from 368,908 at year-end.
Material changes versus prior comparable periods
- First-half revenue growth came from all channels: Take Shape for Life revenue rose 21% to $96.1 million; Medifast Direct rose 15% to $38.9 million; and Weight Control Centers and wholesale physician revenue rose 25% to $17.9 million.
- Active health coaches increased 29% to approximately 10,300, but average monthly revenue per coach fell 9% to $1,610, which management attributed to challenges training a much larger coach network.
- Weight Control Centers and wholesale segment revenue grew, but its reported pre-tax contribution fell to $0.4 million in Q2 from $1.7 million, and to $1.3 million for the first half from $3.3 million. Management cited expansion, start-up costs and staffing for planned openings.
- SG&A grew 24% in both Q2 and the first half, faster than revenue, reflecting commissions, staffing, advertising and infrastructure investment. Q2 operating income declined 3% year over year despite higher sales.
Outlook, commentary, risks and unusual items
- Management planned 30–35 new company-owned centers during 2011, including 17–19 in Q3, and described approximately 50–60 additional corporate locations in 2012. These are expansion plans, not quantified earnings or revenue guidance.
- Management expected an effective tax rate of approximately 36%–37% for 2011. The first-half effective rate was 36.7%, compared with 40.1% in 2010, reflecting tax planning and Maryland’s single-sales-factor apportionment election.
- Management identified growth-related execution risks, including pressure on call-center, website, order-processing, distribution and production capacity; inventory availability; and the potential departure of independent health coaches. It cited investments in distribution, web systems, logistics and call-center capacity as mitigations.
- Disclosure controls and procedures were reported ineffective as of June 30, 2011 because of material weaknesses in expense-period recognition and income-tax provision preparation and review. Remediation steps included finance staffing, expense-control enhancements, internal audit review and tax consultants; the company said additional procedures were performed and management believed the statements were fairly presented.
- Litigation includes securities class actions and shareholder derivative claims consolidated by court order in July 2011, a bankruptcy trustee preference-payment action against a subsidiary, and remaining EEOC charges. The company disputes or intends to defend the claims. Separately, Medifast’s own defamation/market-manipulation suit seeks at least $270 million; that amount is a claim, not a reported recovery.
- After quarter-end, the board authorized up to 500,000 additional repurchases on July 21, 2011. The filing reports 775,000 shares remaining under repurchase authorizations; purchases are discretionary and funded from available cash.
- The filing cautions that interim results are not necessarily indicative of full-year results. Management said seasonality had not been significant in 2011, though the business has historically experienced weaker holiday-season demand.
Most important facts for investors to verify
- Whether revenue growth can continue while operating margins recover from the year-over-year compression.
- Whether coach-network expansion translates into improved revenue per coach and whether the new training and e-commerce tools achieve their intended results.
- Whether planned center openings can generate adequate returns after start-up and staffing costs.
- Progress in remediating the material weaknesses, particularly expense accruals and tax accounting, and whether controls are later determined effective.
- Developments and potential financial exposure from the disclosed litigation, tax contingencies and discretionary share-repurchase program.