Medifast, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The unaudited filing covers Medifast’s weight-management products and services, reported in two segments: Medifast (Take Shape For Life and Medifast Direct) and MWCC and Wholesale.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $74.0 million | $86.5 million | $241.4 million | $279.6 million |
| Gross profit / margin | $54.9 million / 74.2% | $64.9 million / 75.0% | $179.2 million / 74.2% | $210.2 million / 75.2% |
| Operating income / margin | $5.9 million / 8.0% | $7.3 million / 8.5% | $22.0 million / 9.1% | $26.6 million / 9.5% |
| Net income | $4.9 million | $5.7 million | $16.5 million | $18.7 million |
| Diluted EPS | $0.39 | $0.41 | $1.27 | $1.34 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $24.6 million | $34.1 million |
For the nine months, cash from investing was $0.7 million, while financing used $34.0 million, primarily for $33.9 million of share repurchases. Cash and cash equivalents were $27.6 million at September 30, 2014, down from $36.4 million at year-end 2013; investment securities were $28.0 million. Working capital was $51.7 million, compared with $64.9 million at year-end. Total assets were $115.3 million and stockholders’ equity was $82.6 million.
The company reported $0.5 million of capital lease obligations and no outstanding debt; it said prior borrowings had been repaid in 2013. An unsecured $5 million revolving credit line was undrawn and due to expire August 1, 2015. The filing states the company expects to extend it or pursue other financing.
Changes versus the prior comparable period
- Revenue fell $12.5 million in Q3 and $38.2 million year to date. The filing reports a 13.7% nine-month decline; its Q3 narrative cites 14.7%, while the reported figures imply a decline of about 14.4%.
- Nine-month revenue declined across channels. Take Shape For Life sales fell 9% to $160.9 million; Medifast Direct fell 26% to $45.8 million; and MWCC and Wholesale fell 15% to $34.7 million.
- Take Shape For Life had 10,200 active Health Coaches at quarter-end, down 13% year over year. Average monthly revenue per coach for the nine-month period declined to $1,565 from $1,650.
- Gross margin declined, which management attributed to lower manufacturing volume, product and channel mix, lower-margin new products, and loyalty-program costs. SG&A decreased in dollars, but operating margin also narrowed.
- Operating cash flow declined from $34.1 million to $24.6 million. Cash declined partly because the company spent $33.9 million repurchasing shares; it also sold $23.4 million and purchased $19.7 million of investment securities.
- The company closed 11 corporate centers and transferred 24 to franchisees. At September 30, it operated 51 corporate and 69 franchise centers, versus 86 and 36, respectively, a year earlier. Same-store sales for centers open more than one year declined 13% year to date.
Outlook, commentary, and risks
- Management gave no specific revenue or earnings guidance. It anticipated a 2014 full-year effective tax rate of approximately 33%–34% and said it expected to increase Medifast Direct marketing spending relative to Q4 2013 while managing returns and efficiency.
- Management attributed improved cost control to lower compensation, marketing, and other expenses. However, Q3 general expense included $1.6 million of extraordinary legal and advisory costs related to recent Schedule 13D filings; approximately $0.5 million of additional related legal fees was anticipated in Q4.
- Gross-margin pressure, declining channel sales, fewer Health Coaches, lower center same-store sales, and marketing effectiveness remain important operating risks. Management said there were no material changes to the risk factors in its 2013 Form 10-K.
- A long-running company lawsuit seeks $270 million in damages for alleged defamation, market manipulation, and unfair business practices. The Ninth Circuit’s June 2014 decision remanded certain claims for further proceedings; claims against some parties were dismissed. The filing does not report a damages recovery.
- After quarter-end, a franchisee announced the closure of seven centers. Medifast is a secondary guarantor on associated financing and could face a charge of up to $2.0 million if the franchisee defaults. The company also disclosed a second franchisee guarantee covering a $1.0 million loan and a $0.5 million line of credit.
- The company adopted a stockholders’ rights plan on August 28, 2014, expiring August 28, 2015 unless earlier terminated or otherwise resolved. It also repurchased 676,092 shares in August and authorized an additional 1 million shares for repurchase in September.
- Management stated that disclosure controls were effective as of September 30, 2014, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the revenue and Health Coach declines stabilize, and whether planned marketing investment improves customer acquisition efficiently.
- Whether gross margins recover as manufacturing volume, product mix, and loyalty-program costs change.
- The sustainability of operating cash flow after substantial repurchases, and the company’s liquidity and financing plans when its credit line expires.
- The status and potential financial exposure of the franchisee guarantees, particularly the possible $2.0 million exposure following the seven-center closure.
- Developments in the litigation and related legal costs, as well as the rights plan and remaining share-repurchase authorization.