Medifast, Inc. — Q3 2017 Form 10-Q
Business context and period: Medifast sells weight-management and healthy-living products through Optavia (formerly Take Shape For Life), Medifast Direct, franchise centers and wholesale channels. This filing covers the quarter and nine months ended September 30, 2017; comparisons are to the corresponding 2016 periods. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $77.2 | $68.6 | $223.6 | $212.1 |
| Gross profit / margin | $58.2 / 75.4% | $52.2 / 76.1% | $168.7 / 75.5% | $158.6 / 74.8% |
| Operating income / margin | $10.2 / 13.2% | $9.0 / 13.1% | $30.1 / 13.5% | $20.2 / 9.5% |
| Net income | $6.7 | $6.1 | $20.4 | $13.7 |
| Diluted EPS | $0.55 | $0.51 | $1.69 | $1.15 |
- Growth and mix: Q3 revenue rose 12.6%; nine-month revenue rose 5.4%. Optavia revenue was $66.4 million in Q3, up from $56.5 million, and $187.9 million year to date, up 10.1%. Management attributed growth to volume, customers shifting to higher-priced products and the April 2016 price increase. Optavia represented 84.1% of nine-month revenue.
- Other channels: Nine-month Medifast Direct revenue fell to $25.3 million from $28.4 million; MWCC fell to $9.6 million from $12.0 million; Wholesale fell to $0.7 million from $1.1 million. MWCC had 35 franchise centers and two reseller locations versus 55 centers and one reseller a year earlier.
- Costs and margins: Q3 gross margin declined 0.7 percentage point as manufacturing costs increased after inventory build for the Optavia launch ended. Nine-month gross margin improved 0.7 point, reflecting product mix and pricing. Q3 SG&A rose 11.0% to $48.0 million, mainly from higher Optavia commissions; as a share of revenue it declined to 62.1% from 63.0%. Nine-month SG&A was nearly flat at $138.5 million, while its revenue share improved to 62.0% from 65.2%.
- Cash flow and liquidity: Nine-month operating cash flow was $33.3 million versus $26.1 million in 2016. Investing activities used $3.4 million and financing activities used $11.8 million, primarily reflecting dividends. Cash and cash equivalents were $70.6 million at quarter-end; investment securities were $25.2 million. Working capital was $89.1 million and stockholders’ equity was $108.2 million. The balance sheet reports no debt.
- Dividends and capital: Dividends declared were $0.32 per share in Q3 versus $0.25 a year earlier, and $0.96 per share for the nine months versus $0.75. The company declared $4.1 million payable in Q4. It authorized a separate repurchase plan for up to 850,000 shares through June 30, 2018; no shares had been repurchased under that plan as of September 30.
Changes, outlook and risks
- Management cited Optavia as the principal growth driver: active earning coaches increased 10.9% year over year to 14,200 in Q3, and quarterly revenue per coach increased 6.2% to $4,693. Q3 marked the eighth consecutive quarter of Optavia year-over-year revenue growth. Revenue-to-advertising-spend ratio improved to 46.1-to-1 from 37.2-to-1 in Q3 and to 36.7-to-1 from 27.9-to-1 year to date.
- Management said Medifast Direct customer acquisition remained challenging, though its quarterly revenue decline was in single digits for a second consecutive quarter. MWCC revenue was affected by fewer centers and lower center activity; Wholesale declines reflected lost accounts following enforcement of distribution-compliance requirements.
- Management anticipated a 2017 full-year tax rate of 33%–34%. The filing provides no specific revenue or earnings guidance. Management stated it expected to fund future cash needs from operating cash flow and financing activities and believed liquidity would support the dividend, while giving no assurance dividends would continue.
- Unusual/comparability items: 2016 nine-month results included $6.1 million of asset impairment and $1.2 million of restructuring charges. Excluding these, 2016 adjusted operating income was $27.5 million and adjusted net income was $18.6 million, compared with 2017 reported figures of $30.1 million and $20.4 million. The Take Shape For Life business was rebranded Optavia in July 2017; the Medix licensing agreement was terminated in Q1 2017, and Medix closed its centers in Q2.
- The corporate office relocation involved an operating lease with $8.8 million of future minimum payments from August 2017 through February 2026. The company said it was assessing the upcoming revenue-recognition standard; preliminary assessment indicated shipping-point timing could be affected, but management did not expect a material effect on results, cash flows or financial position. Required revenue disclosures will expand.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It reported no material changes to the risk factors in its 2016 Form 10-K; it did not expect pending litigation to materially affect results, financial position or liquidity.
Important facts for investors to verify
- Whether Optavia’s coach growth, revenue per coach and customer/product mix can sustain growth given its dominant share of revenue.
- Whether higher manufacturing costs and Optavia commissions pressure gross or operating margins as sales expand.
- Whether Medifast Direct customer acquisition and the declining MWCC and Wholesale channels stabilize.
- Cash generation and liquidity after dividends, the declared repurchase authorization and the long-term office lease commitments.
- The final impact of revenue-recognition adoption and the assumptions underlying the 2017 tax-rate outlook.