Medifast, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparative periods ended September 30, 2017. Dollar amounts below are in millions except per-share data. The filing reports unaudited results.
Business context and results
Medifast sells weight-loss, weight-management and other nutrition products, primarily through e-commerce. Product sales were 98% of revenue for the first nine months of 2018. The company said its business focus had shifted toward OPTA VIA and, beginning in 2018, it stopped disclosing revenue by sales channel.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $139.2 | $77.2 | $355.2 | $223.6 |
| Gross profit | $107.2 | $58.2 | $270.8 | $168.7 |
| Operating income | $17.5 | $10.2 | $49.3 | $30.1 |
| Net income | $13.8 | $6.7 | $40.1 | $20.4 |
| Diluted EPS | $1.14 | $0.55 | $3.31 | $1.69 |
| Gross margin | 77.0% | 75.4% | 76.2% | 75.5% |
| Operating margin | 12.5% | 13.2% | 13.9% | 13.5% |
Financial position and cash flow
- For the first nine months, operating cash flow was $45.5 million versus $33.3 million a year earlier; investing cash outflow was $0.8 million versus $3.4 million; financing cash outflow was $37.4 million versus $11.8 million.
- Cash and cash equivalents were $82.3 million at September 30, 2018, and cash, cash equivalents and investment securities totaled $103.2 million. Working capital was $89.1 million; stockholders’ equity was $111.6 million.
- No debt is reported on the balance sheet. Current liabilities were $62.8 million, consisting of accounts payable and accrued expenses.
- Inventory rose to $43.8 million from $19.3 million at December 31, 2017. The filing attributes the increase in part to inventory buildup for expected demand.
- The company paid $17.4 million in dividends and spent $20.0 million on stock repurchases during the first nine months. It declared a further $6.0 million dividend, or $0.48 per share, for payment in Q4.
Material changes and management commentary
- Q3 revenue increased 80.3% year over year; nine-month revenue increased 58.9%. Management cited accelerated Coach conversions, higher client acquisition and a shift toward higher-priced OPTA VIA products. Active earning OPTA VIA Coaches rose 59.2% to 22,600 in Q3; quarterly revenue per Coach increased 23.2% to $5,781.
- Gross margin increased 160 basis points in Q3 and 70 basis points year to date. Management cited higher production volume and favorable manufacturing cost absorption, lower inventory obsolescence and lower shipping expense. It cautioned that the production-absorption benefit may be temporary as inventory normalizes.
- SG&A rose 87.1% in Q3 and 59.9% year to date, reflecting higher OPTA VIA commissions, Coach events and incentives, distribution-center relocation startup costs, IT consulting, credit-card fees and compensation costs. Q3 operating margin declined year over year despite higher operating income.
- Net income growth also benefited from lower effective tax rates: 22.7% in Q3 and 20.3% year to date, versus 35.5% and 33.1%, respectively. Management anticipated a 2018 full-year tax rate of 21%–23%.
- Operating cash flow benefited from higher earnings but was affected by working-capital movements, including the inventory increase and higher accounts payable and accrued expenses.
Outlook, accounting, and risks
- The filing provides no specific revenue or earnings guidance. Management said it expects to fund future cash needs, if any, from operating cash flow and financing activities, and intends to continue dividends while noting it cannot assure future declarations or payments.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. Product revenue is generally recognized upon customer receipt rather than shipment. Adoption reduced opening retained earnings by $2.0 million after tax; reported nine-month revenue was $1.3 million lower and net income $0.6 million lower than under the prior standard.
- The company expected adoption of the new lease standard on January 1, 2019 to result in material right-of-use assets and lease liabilities; its impact was still under evaluation.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. It said there were no material changes to the risk factors in its 2017 Form 10-K. The company is subject to ordinary-course litigation but did not expect it to have a material adverse effect.
- Investment holdings are exposed to interest-rate and market-pricing risk; management estimated an immediate uniform 10% adverse movement would have an immaterial effect on portfolio fair value. It reported no material change in market-risk exposure since year-end.
Important facts for investors to verify
- Whether Coach growth, client acquisition and revenue per Coach can be sustained, and how much growth reflects higher-priced product mix.
- Whether inventory buildup converts to sales without increased obsolescence, and whether temporary manufacturing absorption benefits reverse as inventory normalizes.
- Whether commission, event, relocation and other SG&A growth remains proportionate to revenue and how it affects operating margins.
- How ASC 606 affects period-to-period comparisons and revenue timing; the filing also notes that revenue by prior sales channel is no longer disclosed.
- Future cash requirements, dividend capacity and the impact of repurchases, as well as the material balance-sheet effects expected from lease-accounting adoption.