Medifast, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; compared with the corresponding 2017 periods. Amounts below are in U.S. dollars. Financial statement figures are in millions unless stated otherwise.
Business context
Medifast sells weight-loss, weight-management, and other health and nutrition products, primarily through its OPTAVIA business and e-commerce platform. Product sales represented 98% of revenue in the first half of 2018. The company changed its revenue reporting in 2018 and no longer reports revenue by sales channel.
Key financial results
| Metric | Q2 2018 | Q2 2017 | H1 2018 | H1 2017 |
|---|---|---|---|---|
| Revenue | $117.3 | $75.7 | $215.9 | $146.4 |
| Gross profit | $88.8 | $57.6 | $163.6 | $110.5 |
| Operating income | $17.1 | $11.3 | $31.8 | $19.9 |
| Net income | $14.1 | $7.6 | $26.4 | $13.7 |
| Diluted EPS | $1.16 | $0.63 | $2.17 | $1.14 |
- Revenue grew 54.9% in Q2 and 47.5% in H1; net income rose 86.4% and 92.0%, respectively.
- Gross margin was 75.7% in Q2 (down 0.4 percentage points year over year) and 75.8% in H1 (up 0.3 points). Operating margin was 14.6% in Q2 versus 14.9%, and 14.7% in H1 versus 13.6%.
- Q2 active earning OPTAVIA Coaches increased 45.9% to 19,700; quarterly revenue per Coach increased 16.1% to $5,474. Management attributed growth partly to Coach conversions, client acquisition, and clients moving to higher-priced OPTAVIA products.
- H1 operating cash flow was $38.5 million, versus $20.7 million in 2017. Investing cash use was $0.7 million; financing cash use was $31.8 million, including $20.0 million of stock repurchases and $11.7 million of dividends paid. Cash increased by $6.0 million to $81.1 million.
- At June 30, cash, cash equivalents, and investment securities totaled $103.3 million; working capital was $81.6 million. The balance sheet reports no debt; current liabilities were $53.4 million.
Material changes and notable items
- SG&A increased 54.8% in Q2 and 45.5% in H1, primarily from higher OPTAVIA commissions tied to sales, as well as increased salaries and benefits, consulting and distribution-center relocation costs, Coach events, and credit-card fees.
- Q2 gross-margin pressure reflected a higher proportion of new clients receiving first-order discounts. H1 margin improvement reflected inventory-management efficiencies, partly offset by discounts.
- ASC 606 was adopted January 1, 2018 using the modified retrospective method. Revenue for product shipments is now generally recognized when customers receive products. Adoption reduced opening retained earnings by $2.0 million after tax; reported Q2 revenue was $2.3 million lower and net income $0.8 million lower than they would have been without adoption. H1 revenue was $0.9 million lower and net income $0.4 million lower.
- Revenue growth was reported without sales-channel breakdowns following a change in internal and external reporting. This limits direct comparison of channel-level performance.
- Income tax rates declined to 19.8% in Q2 and 19.0% in H1, mainly reflecting the lower federal statutory rate under the Tax Cuts and Jobs Act. Management expected a full-year 2018 tax rate of 21%–23%.
- Medifast declared a $0.48-per-share dividend in Q2, payable in Q3. Management intended to continue the dividend program but gave no assurance it would do so. The company repurchased 118,686 shares in June at an average $168.48 per share.
Outlook, risks, and contingencies
No revenue or earnings guidance is provided in the filing; the stated 2018 tax-rate expectation is 21%–23%. Management said future cash needs, if any, are expected to be funded from operating cash flow and financing activities. The filing identifies investment-portfolio interest-rate and market-pricing exposure but estimates a hypothetical 10% adverse move would have an immaterial effect. Management reported no material change to the risk factors in the 2017 Form 10-K and did not expect pending litigation to materially affect results, financial position, or liquidity. The company expects lease accounting adoption to result in material right-of-use assets and lease liabilities; the impact was still under evaluation.
Important facts for investors to verify
- Whether the rapid revenue and Coach growth continued, and how much arose from Coach count versus revenue per Coach or higher-priced products.
- How ASC 606 timing effects and the removal of sales-channel disclosures affect year-over-year and underlying growth comparisons.
- Whether elevated commissions, relocation and consulting costs, and inventory growth affect future margins and working capital.
- Cash requirements and capital allocation after the $20.0 million repurchase, ongoing dividends, and the expected material lease liabilities.
- The assumptions supporting the 2018 tax-rate outlook and the company’s ability to sustain its dividend and repurchase activity.