Feb 26, 2019
Operator
Good afternoon, and welcome to Medifast’s Fourth Quarter and Full Year 2018 Earnings Conference Call. All participants will be in listen-only mode.
[Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note today’s event is being recorded.
I would now like to turn the conference over to Katie Turner with ICR. Please go ahead.
Katie Turner
Good afternoon, and welcome to Medifast Fourth Quarter and Full Year 2018 Earnings Conference Call. On the call with me today are Dan Chard, Chief Executive Officer; and Tim Robinson, Chief Financial Officer.
By now, everyone should have access to the earnings release for the period ended December 31, 2018, that went out this afternoon at approximately 4:05 p.m. Eastern Time.
If you have not received the release, it's available on the Investor Relations portion of Medifast’s website at www.medifastinc.com. This call is being webcast, and a replay will be available on the Company's website.
Before we begin, we’d like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. The words believes, expects, anticipate and other similar expressions generally identify forward-looking statements.
These statements do not guarantee future performance and therefore undue reliance should not be placed on them. Actual results could differ materially from those projected in any forward-looking statements.
Medifast assumes no obligation to update any forward-looking projections that maybe made in today's release or on today's call. All the forward-looking statements contained herein speak only as of the date of this call.
And with that, I would like to turn the call over to Medifast’s CEO, Dan Chard.
Dan Chard
Thank you, Katie. Good afternoon everyone.
We are pleased to discuss our fourth quarter and full year 2018 results with you today. I will provide a brief overview of our business performance.
In addition, I will share the progress our team has made against the objectives that we’ve set out to accomplish two years ago and provide a clear perspective of what we plan to do moving forward as we continue our growth in 2019 and beyond. Tim will then review our financial results in more detail and share our 2019 first quarter and full year guidance.
We will then be available to answer any questions. We are very pleased with our fourth quarter and full year 2018 results to reflect the unified and aligned execution by both our corporate and field leaders against the plan we began to focus on two years ago allowing us to achieve over $500 million in annual revenue, an increase of 66% year-over-year, a tremendous corporate milestone for Medifast.
This success can be attributed to our efforts to align the organization and our field leadership behind a repeatable business rhythm focused on our long-term mission to offer the world lifelong transformation, one healthy habit design. Importantly, we generated these results while elevating a level of strategic investment to support our long-term growth plans to build our brand platform and operations as we continue to improve scalability of our business.
We believe we are building a trusted, transparent and effective direct sales health and wellness community through our integrated coach model. This leverage is nearly 40 years of insights focused on how to deliver the best-in-class service and product experiences for clients who are engaged in their health and wellness journey.
Our success in creating the OPTAVIA Coach community and achieving the desired results for our clients is reflected in the growing number of active earning Coaches and the average revenue each active earning Coach generates. We ended the year with a record 24,100 active earning Coaches who enthusiastically support clients in achieving their health and wellness scores.
Average quarterly revenue per active earning Coach increased 26% to $5,756. Our integrated Coach model, along with the continued development of our OPTAVIA brand platform creates the strong foundation for continued business growth.
We now have 72 OPTAVIA branded consumable products to help our Coaches build personalized plans to support clients on their health and wellness journeys. Our product development and marketing teams remained focused on the development of future products to support healthy habit creation for our Coaches and clients.
The improvement of these key metrics combined with the consistent focus on our mission drove our strong fourth quarter and annual financial results. As a result, revenue and profitability exceeded our expectations both for the quarter and the year.
Our strong business fundamentals helped accelerate revenue growth during 2018 from 40% in the first quarter and nearly 55% in the second quarter and more than 80% in the third quarter and 87% growth in the fourth quarter of 2018. This marks the seventh consecutive quarter of year-over-year revenue growth and the eighth consecutive quarter of sequential revenue improvement.
The fourth quarter was also the largest revenue quarter in the history of the company resulting in fourth quarter diluted earnings per share of $1.30 ahead of our fourth quarter guidance of $1.15 to $1.20. Our strong financial results in 2018 and our confidence in the business enabled us to continue to fulfill our commitments to deliver attractive total shareholder returns.
For the year, we paid $23.2 million in quarterly cash dividends and recently increased our dividend 56% to $0.75. We also repurchased $30 million of Medifast common stock during the year.
In 2016, our Board of Directors sent a strong message of confidence when they challenged our management team with a very aggressive long-term goal to reward shareholders. Our goal is to generate 35% annual compounded total shareholder return by the end of 2019, which we believe would require us to nearly double the size of the business to $500 million in revenue and grow the OPTAVIA Coach network to 30,000 Coaches.
Shortly thereafter, we lined all of our senior executive goals and long-term incentives around the same three year aggressive objectives. I am pleased to report that the team achieved this long-term objective of 35% total shareholder return at the first measurable opportunity in January of 2019.
Additionally, we generated over $500 million in revenues, nearly a year ahead of schedule and are trending towards an excess of 30,000 Coaches by the end of 2019. We are very proud of these achievements and we feel that we are very well positioned for the next chapter in our business transformation.
Through strong revenue growth and disciplined investments, we believe Medifast remains well positioned to deliver a long-term sustainable growth and value to our shareholders as well as meaningful improvements to the lives of OPTAVIA clients across the country as they learned new healthy habits that make their lives better. We believe we will accomplish this in partnership with our growing community of OPTAVIA Coaches who join us in helping clients achieve optimal health and well-being.
With that in mind, I would like to review a few recent highlights to demonstrate our ongoing efforts to align with OPTAVIA Coaches as we work together to continue to execute our strategic growth initiatives. In the fourth quarter, we hosted our Sundance XIII Advanced Leadership Retreat in Sundance Utah.
It was an opportunity for nearly 300 of our OPTAVIA leaders to be trained by successful business leaders in our OPTAVIA community. This has been exciting to experience OPTAVIA Coaches advancing to leader status within the Coach community.
These leaders are the foundation of our domestic and international expansion strategy. We recognize these leaders for their success, growth and development through our compensation program as well as through specialized leadership training.
Our fourth quarter was also an important time to further prepare for the upcoming international expansion into Hong Kong and Singapore. During the quarter we successfully hired additional personnel in the market to support our upcoming launch and refined our final call formulations packaging, content and messaging as well.
Our technology teams have also been hard at work readying our new mobile applications for our launch. Our preparations are nearly final and I am pleased to report that we will be ready to sign up our first clients and Coaches and ship our first orders by June 30 of this year.
This is an exciting milestone for our growing company. I want to emphasize that our expectations for this inaugural year in these new markets is modest as our business model focuses on building a base of clients who are successful in achieving their health goals and then developing a portion of those clients into successful OPTAVIA Coaches.
Over time, we believe these markets will be an important part of our growth story. In the mean time, we believe we can continue to expand significantly in the United States and leverage this market to build our business in Asia.
We are proud of significant progress in technology we are making to support our scalable business model in the U.S. and abroad.
Just this month, we successfully launched our new e-commerce platform. This new state-of-the-art cloud-based platform will improve our Coach and Client experience while enabling both multi-lingual and multi-currency capabilities further preparing us for the expansion – for our expansion plans.
We were also pleased to kick-off our process earlier this month to implement a new enterprise resource planning system, a leading cloud-based ERP platform that will enable our finance and supply chain functions to support our rapidly growing business for the years to come. This important initiative is expected to be completed by year end at an estimated SG&A cost of $5 million in 2019.
These investments are important to support our continued business momentum. We continue to partner with world-class organizations to support our growth.
In mid-2018, we partnered with a global logistics company to open a new distribution center in Nevada. I am pleased to report that this transition went very smoothly and has enabled us to subsequently expand our capabilities further to support our rapid growth.
Similarly, during the fourth quarter, we transitioned our client support contact center functions to a leading global third-party contact center in Nevada to further expand our capacity and gain multi-lingual capabilities to support our Hong Kong and Singapore markets. This will now allow us to place more focus on supporting our rapidly growing Coach community with dedicated internal Coach support resources.
In addition, we are enhancing our supply chain capabilities through key initiatives in 2019 including the expansion of our Maryland manufacturing facility raw materials warehouse and distribution center. These initiatives are already underway and will help us support our growing business.
Last quarter, we introduced our very first International Leadership Advancement Trip which will take place in March. This new qualifying event is designed to reward business leaders who exhibit specific business building skills with exclusive training and development opportunities to further advance their business.
We have approximately 2500 Coaches and guests who qualified to attend this week long event. We strategically invested approximately $7 million in the third and fourth quarters of 2018 for this first ever leadership event to support ongoing growth in 2019 and beyond.
Earlier in my remarks today, I mentioned we recently met two of our three long-term objectives that we established in 2016 ahead of schedule. As a result, we are now setting our sites on our next set of long-term objectives.
In January, we began ensuring our long-term vision with investors to double the size of our business every three to four years while increasing our operating margins for the three to four year targets of at least 15%. With that in mind, we have established specific three year goals for our management team.
They are, to grow top-line revenue and operating margin to $1 billion and 15% respectively by the end of 2021 and to grow the number of active earning Coaches to 50,000 by the end of 2021. Similar to our process in 2016, we are now taking the important step of aligning these expansive goals to our entire management team and the field as we all work together to achieve success.
Our 2019 guidance that Tim will share with you in a moment is reflective of our confidence in our ability to continue to grow the business to reach these long-term objectives. As we go forward, we believe we will generate future growth by focusing on four key areas.
We expect them to enable our ongoing expansion of our OPTAVIA Coach community. The first area is to continue to develop and refine our integrated Coach model; second, leverage technology to optimize business efficiency; third, drive product innovation in support of our mission; and fourth, expand into new demographic segments and geographies.
We are fortunate to operate in a very large addressable market. Over two-thirds of Americans are either overweighed or obese and that number continues to rise 5% a year.
In the U.S. alone, if you think about health and wellness, it’s a $194 billion market and the U.S.
addressable weight loss market is a $17 billion business. We believe our growth goals align with what we have learned over the past two years and we will focus on what has worked well and the insights that we have – that have allowed us to get to this point.
We will continue to work collaboratively with our corporate and field leaders on activities to support OPTAVIA’s repeatable business rhythm focused on our long-term mission to offer the world lifelong transformation one healthy habit at a time. In summary, we are incredibly pleased with the results we have achieved in 2018.
Our entire team remains focused on delivering strong returns to our shareholders and we are excited about our future opportunities and the team we have in place to execute our growth potential. With that, I would like to turn the call over to our CFO, Tim Robinson.
Tim Robinson
Thank you, Dan and good afternoon everyone. I will review our financial results for fourth quarter and full year ended December 31, 2018.
Then I’ll provide our first quarter guidance and discuss our 2019 outlook. As Dan commented, revenue in the fourth quarter of 2018 exceeded our expectations increasing 87% to a record $145.8 million from $78 million in the prior year period.
We ended the quarter with a record 24,100 active earning coaches compared to just 15,000 in the same period last year and 22,600 in the third quarter of 2018. Average revenue per active earnings coach for the quarter increased 26.2% to $5,756 compared to $4,562 for the fourth quarter last year.
The growth and productivity results in part from business initiatives accelerated new coach conversion and new client acquisition rates aided by the ongoing transition to higher price OPTAVIA products. OPTAVIA branded products represented 72% of our total company consumable units sold in the fourth quarter, compared to 51% in the prior year period.
Gross profit for the fourth quarter of 2018 increased 84.5% to $109.1 million, compared to $59.1 million in the prior year period. Gross profit margin as a percentage of net revenue decreased 100 basis points to 74.8% versus 75.8% in the fourth quarter of 2017.
The decrease in gross margin percentage was driven by increased inventory reserves for a select group of products as well as higher freight cost resulting in strong year-end consumer demand. Selling, general, and administrative expenses for the fourth quarter of 2018 increased $39.6 million to $89.3 million compared to $49.6 million in the fourth quarter of 2017, primarily as a result of higher OPTAVIA commission's expense and consulting cost related to IT projects to support our future growth.
SG&A as a percentage of sales decreased 240 basis points to 61.2% of total revenue, compared to 63.6% in the fourth quarter of 2017. As OPTAVIA revenue becomes an even larger portion of our overall sales mix, the commission rate as a percentage of total company revenue has increased 350 basis points to 40.8% of total revenues in the fourth quarter of 2018, compared to 37.3% in the fourth quarter last year.
We have been able to more than offset this increase along with strategic investments Dan mentioned earlier with the operating efficiencies we have in other SG&A areas such as labor and advertising. Our effective tax rate was 22.4%, compared to 25.4% in the fourth quarter of 2017.
This decrease is primarily the result of the decrease in the federal statutory rate pursuant to the Tax Cuts and Job Act rate of 14% offset by 2.1% due to the elimination of domestic manufacturing deduction. 5% due to a decrease in windfalls related to stock compensation and 3% due to a change in temporary differences resulting from the Tax Cuts and Job Act.
Net income in the fourth quarter of 2018 was $15.7 million or $1.30 per diluted share, based on approximately 12 million shares outstanding. Fourth quarter 2017 net income was $7.3 million or $0.60 per diluted share based on approximately 12.1 million shares outstanding.
Our balance sheet remains very strong with stockholders equity of $109.1 million and working capital of $85.2 million as of December 31, 2018. Cash, cash equivalents and investment securities as of December 31, 2018 increased $2.2 million to $101 million compared to $98.8 million at December 31, 2017.
The company remains free of interest-bearing debt. Inventory increased $19.6 million to $38.9 million as of December 31, 2018, compared to $19.3 million in the prior year period due to an intentional effort to grow inventory levels to meet current and future demand.
Our Board of Directors declared a quarterly cash dividend in the fourth quarter of $9.1 million or $0.75 per share payable on February 7 representing a 56% increase in the prior $0.042 quarterly cash dividend. We also repurchased approximately 68,000 shares of Medifast common stock worth $10 million during the fourth quarter.
There are approximately 665,000 shares of common stock available for repurchase under our existing share repurchase program. Our management team and Board of Directors remain committed to enhancing the value for our stockholders.
Now turning to our guidance. We expect first quarter revenue to be in the range of $150 million to $155 million and earnings per diluted share to be the range of $1.50 to $1.55 per diluted share.
For the full year 2019, we expect revenue in the range of $700 million to $720 million and earnings per diluted share to be in the range of $6.45 to $6.65 per diluted share. Our fiscal year 2019 guidance assumes a 22.5% to 23.5% effective tax rate.
We do not expect our international activities to be material in 2019 and we do not anticipate reporting these results separately during the year. We expect that 2019 cadence of spending to be similar to 2018 with our annual convention spending occurring in the third quarter of the year and a cost of 2020 leadership advancement event to be incurred in the third and fourth quarter of the year.
While our business is generally not capital-intensive, as Dan mentioned, we do have plans in 2019 to invest in our growth. As a result, we expect capital expenditures in 2019 to be approximately $15 million or 2% of revenues.
We are in a fortunate position to be able to invest ahead of our future growth to support our business needs. Well, that concludes our operational and financial overview.
We appreciate your interest in Medifast and Dan and I are now available to take your questions. Operator?
Operator
[Operator Instructions] The first question comes from Frank Camma with Sidoti. Please go ahead.
Frank Camma
Good afternoon guys. Thanks for taking the questions.
So, just a question on the guidance. Tim, you said you don’t expect material amount of revenue this year from international.
So, obviously, still domestic and just doing the packing into the math here on the guidance, it looks like you are still forecasting pretty strong growth on the active health Coach count. So, can you talk about sort of the cadence about that?
And how you – what sort of conviction you have given that you are not going into new markets. From my math, it looks like the first quarter growth is somewhat muted relative to the rest of the year, because it looks like you have to get beyond your 30,000 health Coach count by the end of the year to hit those numbers.
Tim Robinson
Yes, so, Frank, I think, on the international front, kind of the rhythm our business starts with gaining customers and those customers – a portion of those customers become health coaches, that’s kind of how our business works. So the expectations early on will be accumulating customers and then as they convert to coaches that will start to grow at a more rapid race.
That’s why we – our expectations are kind of modest for 2019 in the second half. From a coach count perspective, we didn’t really provide any guidance on the number of coaches.
What we said was that our original goals were to reach 30,000 by the end of 2019 and we expect to be able to meet or exceed that number. So we haven’t provided any specific guidance on the number of coaches for the year.
Frank Camma
No, I understand that. But just doing the math and the productivity you would have to, I mean, it seems like you would have to exceed that number to get into your guidance range and you are not…
Tim Robinson
Yes, we would give you that.
Frank Camma
Okay. But – so, then, that leads me to other question on international.
So you are saying that when you launch into these international markets, how coach will actually be based in the U.S. and actually reach the customer in Singapore and Hong Kong?
Tim Robinson
No, we are saying, is that we’ll leverage our leadership of health coaches in the United States to reach out through their contacts into the new markets of Hong Kong and Singapore to both attract new clients and also develop those new clients into coaches. So, there will be both clients and coaches based in Singapore and Hong Kong, but it all starts with our leadership in the United States.
In other words, the company doesn’t play a role in going out and actually bringing in clients other than helping through the messaging and the infrastructure, really is our coaches in the U.S. through their contacts of that mechanism starts to occur.
Frank Camma
And has that already begun?
Tim Robinson
We have – I think, as we have talked about previously, we have two programs that start to create the incentive for our coaches to start communicating. But we are not actively signing up coaches in Hong Kong and Singapore.
But the activity is starting to reach out and build those relationships has begun.
Frank Camma
Okay. My only other question was sort of on the gross profit, you did explain it as increased inventory reserves and some shipping costs.
Can you just give us a level of magnitude of how much was related to essentially writing down expired inventories? Is that what it is and versus the freight cost?
Tim Robinson
Yes, I would say, three quarters it was probably the inventory write-down. It was product either expired or about to expire.
And then the other portion of which is just freight cost kind of year end hurried to get across to customers on a condensed period of time.
Frank Camma
Okay. And was that product mostly Medifast branded products?
Or is it OPTAVIA branded products or mix?
Tim Robinson
It was a mix of products.
Frank Camma
Okay, okay. Okay, great.
Thanks guys.
Operator
Okay. The next question comes from Linda Bolton Weiser with DA Davidson.
Please go ahead.
Linda Bolton Weiser
Yes, hi.
Tim Robinson
Hi, Linda.
Dan Chard
Hi, Linda.
Linda Bolton Weiser
So – hi. So, just another question on the gross margin.
I think in the past, you have talked about when there is very high coach growth and recruitment going on that you have sort of free offer when new clients were signing up. And so, a very high top-line growth can result in some gross margins impacts from those free offers.
Is that something we should kind of expect going forward in 2019 being that your growth is still so high and just wondering some of the puts and takes as we think about gross margin for the whole year of 2019. How should we think about it?
Thanks.
Tim Robinson
Sure. Yes, I think we are very confident in our gross margin.
I think what you saw in the fourth quarter is two very discrete items that we don’t expect to repeat themselves. So, we call those out specifically, but as you are seeing our gross margin, it continues to slightly expand and we would expect that to continue.
To be clear, we don’t expect it to go up from 76% to 80% or something like that. But some small margin improvement we do expect throughout the year.
When we do offer – we have a big influx of new customers in high growth phase as you mentioned, the new customers do get an offer and that offer is a discount on the order. So, you are right.
In high growth period it puts pressure on the margin percentage because a larger percentage of your shipments are going out of the discounted price. But that’s a good thing.
That brings in new customers to continue purchase thereafter.
Linda Bolton Weiser
Thanks. And just in thinking about your high revenue per coach growth, I mean, it continues to be extremely strong, right.
How should we think about that? As some of that’s starting to be the hydration products that’s being sold to your customers as they sign up and that’s boosting productivity?
Or what is exactly driving that high productivity?
Dan Chard
I think, as we’ve talked about in the past, it’s not any one thing. I think it started out by – with the launch of the OPTAVIA brand and creating very simple narrative that resonates.
So that allows our coaches to be more effective at attracting clients. There is an improved partnership with the company and alignments with us.
So love the programs and put together I think drives the right kind of activity. And then, I think the most important part of this is, we’ve started to build the – all of this – some really important insights which are that when coaches involve that the results some of these health drinks are far more effective.
And so, I think, more and more people are recognizing that and I think there is some benefit of social media platforms being part of how that’s shared and communicated. So, the program works extremely well and the coaches with the program are highly effective at helping people know what they are doing to get the results they are looking for.
And I think the other part of this is, we are seeing more and more of the – the people aren’t – people are focused and interested on their health, not just on weight loss. And so our program has been highly effective at hitting that sweet spot of going beyond just helping people lose weight.
But really helping them achieve a healthy way than using now to the catalyst for greater change in their lives. So that’s – the message is really resonating.
So I think it’s all of those things kind of in combination probably with a few other things that are more minor, but it’s all those things together and we anticipate that that should continue on. We don’t know how high it could go.
So, certainly there is a limit to that. But so far we are seeing very positive results from those things.
Linda Bolton Weiser
And then, just in terms of potential in the categories you’ve alluded to, could we expect to potentially hear about another new category entry in the convention time in July?
Dan Chard
What we anticipate and are thinking about are for July is that, we will continue to reinforce the launch of purposeful hydration. So that’s the last healthy habit we introduced.
So we will continue to drive that and we will also begin focusing in creating more emphasis on the second – the part of our health program that the 5&1 which is the lean and green meal. So, we have technology to help create that healthy eating habits and making that move where we talked about is making healthy eating second nature.
So, it’s those two things together that reinforce the overall program that again, tie back into what coaches do as far as teaching those new healthy habits.
Linda Bolton Weiser
Okay. Thank you very much.
Dan Chard
Thanks, Linda.
Operator
Okay. The next question comes from Doug Lane with Lane Research.
Please go ahead.
Doug Lane
Yes, hi. Good afternoon everybody.
I think on the hydration product, so I think the fourth quarter was the first full quarter where you actually had it for sale. Can you give us an idea just generally how it performed versus expectations?
Dan Chard
We – the expectations going in were that, we are doing couple of things. One, introducing the next healthy habit in a product form and then also to bring the OPTAVIA brand into a category.
We have a Medifast segment that includes products. So we just talked about its flavor and fuser.
So, starting to transition in the same way we did with our Fuelings transition over to the new brand. So, it’s been effective at bringing people over the new brand, but it hasn’t been a core driver in what we have seen in terms of revenue per active earning coach.
It’s just part of the overall story of one healthy habit at a time.
Doug Lane
And there will be more news on that front this year and getting back to the question about the convection, will most of the new product activity announcements if you will, be centered around convention or it will be anything between now and then?
Dan Chard
Yes, we have a few other launches. But the other launches are really in those cases, they are either new flavors or flavor improvements to our current line.
So, the new product activity really takes place and is announced at convention and as you pointed out and as I mentioned earlier, it will likely be focused on continued emphasis on the healthy habit of hydration as well as that lean and green component of our 5&1 plan.
Doug Lane
Okay. And just lastly, are you looking to take any just outright price increases?
Or you just going to manage the mix like you’ve been doing lately?
Tim Robinson
No, Doug, we always look at that. We look at our supply chain and we look at any pressures that are coming from costs and we evaluate that few times per year.
So, we will do that evaluation coming up some time this first half and make that determination. But historically, that’s not been an issue for us.
So, I think, from a price elasticity perspective we feel confident that we have an opportunity periodically to take price.
Doug Lane
Okay. Thanks guys.
Operator
Okay. This concludes our question and answer session.
I would like to turn the conference back over to Dan Chard for any closing remarks.
Dan Chard
Thank you very much and thank you for all of those who are able to join us this evening. We appreciate all the participation and Tim and I look forward to speaking with you again when we report our first quarter 2019 results.
Have a great evening.
Operator
The conference is now concluded. Thank you for attending today’s presentation.
You may now disconnect.