Medifast, Inc. — Q1 2015 Form 10-Q
Business context and period. The company sells weight-management products and services, primarily through Take Shape For Life (TSFL), Medifast Direct, franchise centers and wholesale accounts. This unaudited report covers the three months ended March 31, 2015, compared with Q1 2014. The company had exited its corporate Weight Control Center model in 2014; those results are reported as discontinued operations.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $73.4 million | $79.2 million | -7.3% |
| Gross profit / margin | $53.8 million / 73.3% | $57.9 million / 73.1% | Profit -7.2%; margin +0.2 pts |
| Operating income / margin | $6.5 million / 8.9% | $9.6 million / 12.1% | -32% |
| Continuing-operations income | $4.4 million | $6.5 million | -33% |
| Net income | $4.4 million | $6.0 million | -26% |
| Diluted EPS | $0.36 | $0.45 | Down $0.09 |
| Cash from operating activities | $10.1 million total; $12.6 million continuing operations | $10.6 million total | Total down $0.5 million |
Gross margin improved modestly on a price increase and supply-chain efficiencies. SG&A declined 2% to $47.3 million, but rose to 64.4% of revenue from 61.0%, reflecting lower sales and $1.8 million of extraordinary legal expense related to 13D filings. Excluding that expense, SG&A was $45.5 million, or 61.9% of revenue; management estimated continuing-operations income of $5.6 million, or $0.46 per diluted share, on the same exclusionary basis.
Liquidity, balance sheet and cash flow
- At March 31, cash and cash equivalents were $33.4 million and investment securities were $28.0 million, together about $61.4 million. Cash increased from $24.5 million at year-end 2014.
- Current assets were $87.6 million and current liabilities $28.1 million. Management reported working capital of $59.5 million, up from $55.0 million at December 31, 2014.
- Total liabilities were $35.4 million, including $0.4 million of capital leases. The filing reports no borrowings; the $5 million unsecured revolving credit line was undrawn and scheduled to expire August 1, 2015.
- Continuing-operations operating cash flow was $12.6 million, offset by $2.5 million used by discontinued operations. Investing activities used $0.4 million and financing activities used $0.7 million; net cash increased $9.0 million.
- Cash-flow statement ending cash is reported as $33.424 million, while the balance sheet reports $33.423 million.
Material changes and management commentary
- TSFL revenue fell 9% to $52.1 million; Medifast Direct revenue fell 16% to $14.4 million. Management cited fewer Health Coaches and lower revenue per coach in TSFL, and difficulty acquiring new customers in Medifast Direct.
- Under the newly reported TSFL metrics, active Health Coaches were 12,100, down 5% year over year but up 400 from Q4 2014. Quarterly revenue per coach was $4,316, down 4% year over year.
- Franchise center revenue rose 31% to $4.7 million, supported by conversion of corporate centers; 70 franchise centers were operating versus 49 a year earlier. Closures and lower sales at centers open more than a year partly offset growth. Wholesale revenue increased to $2.2 million from $1.5 million.
- Advertising spend was $5.5 million versus $5.8 million; management reported revenue-to-advertising-spend of 13.4-to-1 versus 13.6-to-1.
- Q1 discontinued operations produced $28,000 of income, compared with a $578,000 loss in Q1 2014. The company recorded $549,000 of favorable adjustments to clinic exit obligations, primarily from landlord termination agreements, and paid $2.0 million of exit obligations during the quarter.
Outlook, risks and contingencies
- Management expects a 2015 full-year effective tax rate of approximately 34%–35%. No revenue or earnings guidance is provided in the filing.
- Management said the Q1 Engaged Capital settlement meant it did not anticipate additional expenses related to the 13D filings. Actual results remain subject to forward-looking statement risks and are not assured by Q1 performance.
- A franchisee defaulted on obligations covered by a company guarantee; Medifast paid off the associated loans in April 2015 and is pursuing personal recourse. A separate $1.4 million guaranteed loan was paid off in March 2015.
- Litigation includes the company’s long-running claims against several parties, with a $270 million damages demand described in the filing; Medifast reported settlements with Minkow and FitzPatrick and an April 21, 2015 judgment for Coenen. Separately, Medifast sued Team Wellness and its guarantor over franchise and loan-related matters. The company said it did not expect proceedings and claims to materially adversely affect its results, financial position or liquidity.
- The stockholders’ rights plan was set to expire August 28, 2015 unless earlier terminated, redeemed, exchanged or exercised. Management reported disclosure controls effective at the reasonable-assurance level and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether the TSFL coach network and revenue per coach stabilize, and whether Medifast Direct customer acquisition improves.
- Whether franchise revenue growth persists after center closures and weaker sales at mature centers.
- The recurring cost and earnings impact of legal matters, including the Team Wellness case and any remaining obligations from the Coenen judgment.
- Cash requirements to settle discontinued-center lease and other exit obligations, and the outcome of recourse efforts on the franchisee guarantee.
- Renewal or replacement of the $5 million credit line before its August 2015 expiration, and the investment portfolio’s value and liquidity.
- The reported cash-flow/balance-sheet cash difference and the effect of adopting the new revenue-recognition standard when applicable.