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MED > SEC Filings for MED > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for MEDIFAST INC


15-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

FORWARD LOOKING STATEMENTS

This document contains forward-looking statements which may involve known and unknown risks, uncertainties and other factors that may cause the Company's actual results and performance in future periods to be materially different from any future results or performance suggested by these statements. These factors include, but are not necessarily limited to those risks set forth in Item 1A of this Annual Report on Form 10-K. Words such as "projects", "believe", "plan", "anticipate" and "expect" and similar expressions are intended to qualify as forward-looking statements. Medifast, Inc. cautions investors not to place undue reliance on forward-looking statements, which speak only to management's expectations on this date. We undertake no obligation to update any forward-looking statements even if actual results may differ from projections.

The following discussion should be read in conjunction with the financial information included elsewhere in this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in Note 2 of the consolidated financial statements.

The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Management develops, and changes periodically, these estimates and assumptions based on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management considers the following accounting estimates to be the most critical in preparing our consolidated financial statements. These critical accounting estimates have been discussed with our Audit Committee.

Revenue Recognition: Revenue is recognized net of discounts, rebates, promotional adjustments, price adjustments, and estimated returns and upon transfer of title and risk to the customer which occurs at shipping (F.O.B. terms). Upon shipment, the Company has no further performance obligations and collection is reasonably assured as the majority of sales are paid for prior to shipping. Medifast Weight Control Centers' program fees are recognized over the estimated service period. The balance of deferred revenue on the balance sheet is $1.8 million as of December 31, 2012, an increase of $0.6 million in comparison to December 31, 2011.

Impairment of Fixed Assets and Intangible Assets: We continually assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Judgments regarding the existence of impairment indicators are based on legal factors, market conditions and our operating performance. Future events could cause us to conclude that impairment indicators exist and the carrying values of fixed and intangible assets may be impaired. Any resulting impairment loss would be limited to the value of net fixed and intangible assets.

Income Taxes: The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

We evaluated our tax positions and determined that we did not have any material uncertain tax positions requiring recognition of a liability. Our policy is to recognize interest and penalties accrued on uncertain tax positions as part of income tax expense. For the twelve months ended December 31, 2012 and 2011, no material estimated interest or penalties were recognized for the uncertainty of certain tax positions. We file income tax returns in the United States and various states jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations by tax authorities for the years before 2009.

Reserves for Returns: We review the reserves for customer returns at each reporting period and adjust them to reflect data available at that time. To estimate reserves for returns, we consider actual return rates in preceding periods. To the extent the estimate of returns changes, we will adjust the reserve, which will impact the amount of product sales revenue recognized in the period of the adjustment. Our estimates for returns have not differed materially from our actual returns. The provision for estimated returns as of December 31, 2012 and 2011 were $300,000 and $234,000, respectively.

Operating leases: Medifast leases retail stores, distribution facilities, and office space under operating leases. Many lease agreements contain tenant improvement allowances, rent holidays, rent escalation clauses and contingent rent provisions. The Company recognizes incentives and minimum rental expenses on a straight-line basis over the terms of the leases. We commence recording rent expense on the date of initial possession, which is generally when we enter the space and begin to make improvements to properties for our intended use. For tenant improvement allowances and rent holidays, we record a deferred rent liability on the consolidated balance sheets and amortize the deferred rent over the terms of the leases as reductions to rent expense on the consolidated statements of income.

For scheduled rent escalation clauses during the lease terms or for rental payments commencing at a date other than the date of initial occupancy, we record minimum rental expenses on a straight-line basis over the terms of the leases on the consolidated statements of income. Several leases provide for contingent rents, which are determined as a percentage of gross sales in excess of specified levels. We record a contingent rent liability on the consolidated balance sheets and the corresponding rent expense when we determine achieving specified levels is probable.

Background:

The Company is engaged in the production, distribution, and sale of weight management and disease management products and other consumable health and diet products. The Company's product lines include meal replacements and vitamins. Our products and services are sold to weight loss program participants primarily via the Internet, telephone, and brick and mortar clinics. Our product sales accounted for 95% of our revenues in 2012 and 94% of our revenues in 2011. Program sales in our Medifast Weight Control Center channel accounted for 3% of revenues in 2012 and 2011. Shipping revenue and other accounted for 2% of revenue in 2012 and 3% in 2011.

At December 31, 2012, Medifast Weight Control Centers were operating in eighty-seven corporate locations in Pennsylvania, New Jersey, Delaware, Texas, Florida, Maryland, North Carolina and Virginia, and thirty-five franchise centers were in operation.

We review and analyze a number of key operating and financial metrics to manage our business, including revenue to advertising spend in the Medifast Direct channel, number of active Health Coaches, and average monthly revenue generated per health coach in the Take Shape for Life channel, and average same store sales improvement for the Medifast Weight Control Center channel.

CONSOLIDATED RESULTS OF OPERATIONS

 2012 COMPARISON WITH 2011



Overview of the Twelve Months Ended December 31, 2012 Compared to Twelve Months
Ended December 31, 2011



                                                              Twelve Months Ended December 31,
                                                   2012              2011            $ Change        % Change

Revenue                                        $ 356,706,000     $ 298,189,000     $ 58,517,000             20 %
Cost of sales                                     88,671,000        73,693,000       14,978,000             20 %
Gross Profit                                     268,035,000       224,496,000       43,539,000             19 %

Selling, general, and administrative costs       244,773,000       197,114,000       47,659,000             24 %

Income from operations                            23,262,000        27,382,000       (4,120,000 )          -15 %

Other income
Interest income, net                                 301,000           319,000          (18,000 )           -6 %
Other expense                                        895,000           (21,000 )        916,000          -4362 %
                                                   1,196,000           298,000          898,000            301 %

Income before provision for income taxes          24,458,000        27,680,000       (3,222,000 )          -12 %
Provision for income tax expense                   8,582,000         9,139,000         (557,000 )           -6 %

Net income                                     $  15,876,000     $  18,541,000     $ (2,665,000 )          -14 %




% of revenue

Gross Profit                                   75.1 %     75.3 %
Selling, general, and administrative costs     68.6 %     66.1 %
Income from Operations                          6.5 %      9.2 %

Revenue: Revenue increased to $356.7 million in 2012 compared to $298.2 million in 2011, an increase of $58.5 million or 20%. The Take Shape for Life sales channel accounted for 60.6%, the Medifast Direct channel accounted for 23.7%, and Medifast Weight Control Centers and Medifast Wholesale Physicians accounted for 15.8% of total revenue.

In 2012, we continued to see sales growth and improvement in Take Shape for Life, Medifast Direct and Medifast Weight Control Centers, and Medifast Wholesale Physicians. Take Shape for Life revenue increased 16% to $216.1 million compared with $186.2 million in 2011. Growth in revenues for the segment was driven by increased customer product sales as a result of an increase in active Health Coaches and an increase in net pricing resulting from reductions of various discounts programs. The number of active Health Coaches at the end of 2012 increased to 10,200 compared with 9,600 during the period a year ago, an increase of 6%. Active Health Coaches are defined as Health Coaches receiving income from a product sale in the last month of the quarter. The average revenue per Health Coach per month increased to $1,635 in 2012 from $1,555 in 2011. Take Shape for Life introduced monthly incentives in 2012, increasing its monthly revenue per Health Coach. The increase is also attributable to our Trilogy Training website launched July 2011, which offers easier access to training materials. In today's environment where trust and personal recommendations are becoming a more important component in consumer purchasing decisions, the Take Shape for Life model of one-on-one communication continues to excel. Take Shape for Life customers who have utilized the Medifast products and programs and successfully have addressed their body weight and health issues are increasingly choosing to become active Health Coaches. Becoming a Health Coach is a business opportunity with a low cost of start-up and requires no holding of inventory as orders are shipped to the end consumer. Becoming a health coach allows for supplemental income by supporting customers ordering through Take Shape for Life.

The Medifast Direct Sales division increased 16% to $84.4 million as compared with $73.0 million in 2011, an increase of $11.4 million. Due to an effective and targeted advertising message utilizing extensive analytical analysis and improved call center closing rates, the Company experienced a 3.0-to-1 return on advertising spend during 2012 compared to a 2.8-to-1 return on advertising spend in 2011. The Company spent approximately $27.4 million on direct response advertising in 2012, an increase of 11% from 2011.

Medifast Weight Control Centers and Medifast Wholesale Physicians revenue was $56.2 million for 2012, an increase of 44% compared to 2011. Revenue increased due to the opening of nineteen new centers throughout 2012, a 12% increase in the same store sales for Centers open for greater than one year, and continued success with our franchise centers. The revenue increase was partially offset by the closing of two centers in 2012. The Company is continuing to focus on improved advertising effectiveness, improved closing rates on leads generated through advertising, hiring of more experienced clinic personnel, and reducing the start-up costs of our Centers.

Costs of Sales: Cost of sales increased $15.0 million in 2012 to $88.7 million as compared to $73.7 million in 2011 which is primarily volume driven. As a percentage of sales, gross margin decreased from 75.3% to 75.1% in 2012. The drop in gross margin percentage resulted in a $0.5 million deterioration year over year.

Selling, General and Administrative Costs: Selling, general and administrative expenses increased by $47.7 million compared to 2011. As a percentage of sales, selling, general and administrative expenses increased to 68.6% versus 66.1% in 2011.

Two non-recurring items recorded in 2012 drove $7.0 million of the increase. The Federal Trade Commission ("FTC") settlement recorded in the second quarter of $3.7 million as well as the recording of a sales tax accrual of $3.3 million recorded in the fourth quarter. The focus of sales tax on internet based remote sellers has gained momentum in many states. Because of this, combined with the desire of the Company to create symmetry among all sales channels, we have re-aligned our position to be more consistent with other major internet sellers and will now be collecting and remitting sales tax in all states that impose sales or use taxes. In order to mitigate the financial impact on any prior year activity, the company is taking advantage of voluntary disclosure agreements with various states. The total amount of sales tax liability in 2012 related to such disclosure agreements is approximately $3.3 million before income tax and $2.0 million after income tax.

Take Shape for Life commission expense, which is variable based upon product sales, increased by approximately $15.5 million as TSFL sales grew 16% compared to 2011. Take Shape for Life Health Coaches are independent contractors that are paid commissions on product sales referred to the Company. Health Coaches earn commissions by referring product sales through their own replicated website or through the Company's in-house call center. The clients of Health Coaches are responsible for order and payment of product and their order is shipped directly to their home or designated address. Health Coaches are not required to purchase product in order to receive a commission. In addition, Health Coaches do not receive a commission on their personal product orders.

Salaries and benefits increased by approximately $9.7 million in 2012 as compared to 2011. The increase primarily reflects the hiring of regional trainers, district managers, area managers, mobile managers, dietitians, human resource recruiters, operations, and marketing staff to support the general growth throughout the business, the opening of 19 new Medifast Weight Control Centers in 2012, and the continued focus of improving and investing in key executive hires throughout the Company.

Sales and marketing expense increased by $4.2 million in 2012 as compared to prior year, primarily due to a $3 million increase in Medifast Direct advertising as well as increased advertising spend for the Medifast Weight Control Centers. In addition to the FTC settlement and sales tax accrual, office expenses increased by $3.3 million due to higher rent for administrative offices and Medifast Weight Control Centers, information technology consulting fees, insurance, office expenses primarily at the new centers, and higher accounting fees, and other expenses consisting primarily of depreciation and credit card processing fees, increased by $7.7 million.

In March 2012, the Company recorded restructuring charges of $723,000 to facilitate a workforce reduction in the Medifast Weight Control Centers and its Corporate offices. Approximately seventy positions were either eliminated or re-aligned in order to reduce operating costs of the MWCC and Wholesale segment. Several additional positions were also eliminated during the second quarter, increasing the total restructuring charges by $80,000 to $803,000. As of December 31, 2012, the restructuring charges were fully paid. The workforce reduction and staffing re-alignment resulted in approximately $3.0 million in annualized savings.

The rollforward of the restructuring charges is as follows:

                             Restructuring Charges



                                                                         MWCC &
                                                         Medifast      Wholesales        Total

Accrued restructuring charges as of December 31, 2011   $        -     $         -     $        -

Restructuring charges accrued                           $  335,000     $   388,000     $  723,000
Payments during the quarter                                      -               -              -

Ending balance accrued as of March 31, 2012             $  335,000     $   388,000     $  723,000

Additional restructuring charges accrued                $   37,000     $    43,000     $   80,000
Payments during the quarter                               (269,000 )      (360,000 )     (629,000 )

Ending balance accrued as of June 30, 2012              $  103,000     $    71,000     $  174,000

Additional restructuring charges accrued                $        -     $         -     $        -
Payments during the quarter                                (63,000 )       (71,000 )     (134,000 )

Ending balance accrued as of September 30, 2012         $   40,000     $         -     $   40,000

Additional restructuring charges accrued                $        -     $         -     $        -
Payments during the quarter                                (40,000 )             -        (40,000 )

Ending balance accrued as of December 31, 2012          $        -     $         -     $        -

Income taxes: In 2012, the Company recorded $8.6 million in income tax expense, an effective rate of 35.1%. In 2011, the Company recorded $9.1 million in income tax expense, an effective rate of 33.0%. Excluding the $3.7 million FTC settlement, the effective tax rate would have been 30.5%. The decrease in the effective tax rate was a result of extensive state income tax restructuring to take advantage of apportionment methodology. As a manufacturing entity based in Maryland, the Company adopted the single sales factor apportionment method in addition to claiming new state jobs credits and research & development credits. The Company anticipates a tax rate of approximately 34-35% in 2013.

Net income: Net income was approximately $15.9 million in 2012 as compared to approximately $18.5 million in 2011, a decrease of $2.7 million. Income from operations as a percent of sales decreased to 6.5% in 2012 as compared to 9.2% in 2011. The decrease in profitability in 2012 was primarily a result of the settlement charge of $3.7 million with the FTC as well as the $3.3 million charge to accrue for sales tax exposure. Excluding the impact of these items, income from operations for 2012 would have been $30.2 million, or 8.5% of sales.

Non-GAAP Financial Measures

In addition to providing results that are determined in accordance with generally accepted accounting principles in the United States, referred to as GAAP, the Company has provided certain financial measures that are not in accordance with GAAP. The Company's non-GAAP financial measures of adjusted net income and adjusted diluted earnings per share exclude the charges the Company incurred in relation to the anticipated non-tax deductible FTC settlement as well as the charge taken to accrue for sales tax exposures. Because both charges are unique events, not directly related to the Company's normal operations, the Company believes these non-GAAP financial measures may help investors better understand and compare our operating results and trends by eliminating this component.

The reconciliations of these non-GAAP financial measures are as follows:

                                             Years Ended December 31,
                                      2012             2011             2010

Income from operations            $ 23,262,000     $ 27,382,000     $ 31,640,000
Adjustments
Sales Tax Expense Accrual            3,256,000                -                -
FTC Settlement Expense               3,700,000                -                -
Adjusted Income from operations   $ 30,218,000     $ 27,382,000     $ 31,640,000




                                                 Years Ended December 31,
                                          2012             2011             2010

Net income                            $ 15,876,000     $ 18,541,000     $ 19,611,000
Adjustments
Sales Tax Expense Accrual                2,026,000                -                -
FTC Settlement Expense                   3,700,000                -                -
Adjusted net income                   $ 21,602,000     $ 18,541,000     $ 19,611,000

Diluted earnings per share            $       1.16     $       1.31     $       1.35
Impact for adjustments                        0.41                -                -
Adjusted diluted earnings per share   $       1.57     $       1.31     $       1.35

The weighted-average diluted shares outstanding used in the calculation of theses non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts.

Weighted average shares outstanding -
Basic 13,721,997 13,965,018 14,082,213 Diluted 13,739,824 14,198,495 14,572,921

Excluding the impact of the $3.7 million expense for the FTC settlement and the $3.3 million sales tax charge recognized during 2012, income from operations for the year ended December 31, 2012, increased $2.8 million to $30.2 million from $27.4 million for the year ended December 31, 2011. Adjusted net income for the year ended December 31, 2012 increased to $21.6 million from $18.5 million for the year ended December 31, 2011. The costs associated with the FTC settlement are non-deductible for tax purposes and resulted in an increased effective tax rate for the year ended December 31, 2012. Adjusted diluted earnings per share for the year ended December 31, 2012 increased to $1.57 as compared to diluted earnings per share of $1.31 for same period in 2011.

SEGMENT RESULTS OF OPERATIONS



                                               Net Sales by Segment for the years ended December 31,
                                   2012                                2011                                2010
Segments                  Sales          % of Total           Sales          % of Total           Sales          % of Total

Medifast              $ 300,511,000                84 %   $ 259,191,000                87 %   $ 229,879,000                89 %
MWCC and Wholesale       56,195,000                16 %      38,998,000                13 %      27,673,000                11 %
Total Sales           $ 356,706,000               100 %   $ 298,189,000               100 %   $ 257,552,000               100 %

2012 vs. 2011

Medifast Segment: The Medifast segment consists of the sales from Medifast Direct Marketing and Take Shape for Life. As this represents the majority of our business, this is discussed in the "Consolidated Results of Operations" management discussion for 2012 vs. 2011.

The MWCC and Wholesale segment consists of the sales of Medifast Corporate and Franchise Weight Control Centers as well as Medifast Wholesale Physicians and international sales. Sales increased by $17.2 million, or 44% year-over-year due to the opening of nineteen new corporate-owned and five new franchise centers during 2012. The sales increase is also attributable to a 12% increase in the same store sales for Centers open for greater than one year, increased maturity of centers opened in 2011, increased sales to the Company's franchise centers, and was partially offset by the closure of two corporate-owned centers in 2012.

2011 vs. 2010

Medifast Segment: The Medifast segment consists of the sales from Medifast Direct Marketing and Take Shape for Life. As this represents the majority of our business, this is discussed in the "Consolidated Results of Operations" management discussion for 2011 vs. 2010.

The MWCC and Wholesale segment consists of the sales of Medifast Corporate and Franchise Weight Control Centers as well as Medifast Wholesale Physicians. Sales increased by $11.3 million, or 41% year-over-year due to the opening of thirty-one new corporate-owned centers during 2011. A 13% increase in the same store sales for Centers open for greater than one year and increased sales to the Company's franchise centers, also contributed to the sales increase. Improved advertising effectiveness, the launching of a new operating system to enhance the customer experience and store operations, and the hiring of more experienced clinic personnel contributed to sales growth in the period. At the end of 2011, there were seventy corporate-owned centers as compared to thirty-nine centers at the end of 2010. The Company had thirty franchise centers in operation as of December 31, 2011 as compared to twenty-one franchise centers at the end of the prior year.

                                                    Income Before Income Taxes by Segment for the years ended December 31,
                                              2012                                        2011                                  2010
Segments                          Profit              % of Total               Profit             % of Total          Profit          % of Total

Medifast                     $     32,690,000                   133 %     $     36,210,000                 131 %   $ 30,773,000                 97 %
MWCC and Wholesale                   (576,000 )                  -2 %           (2,738,000 )               -10 %      6,762,000                 21 %
All Other                          (7,656,000 )                 -31 %           (5,792,000 )               -21 %     (5,843,000 )              -18 %
Income before income taxes   $     24,458,000                   100 %     $     27,680,000                 100 %   $ 31,692,000                100 %

See Note 13, "Business Segments" of the financial statements for a detailed breakout of cost of sales, selling, general, and administrative expense, depreciation and amortization, and interest (net) and other.

2012 vs. 2011

Medifast Segment: The Medifast reporting segment consists of the profits of Medifast Direct Marketing and Take Shape for Life. As this represents the majority of our business this is referenced to the "Consolidated Results of Operations" management discussion for 2012 vs. 2011 above.

MWCC and Wholesale Segment: This segment increased net profitability in 2012 as compared to 2011 by $2.2 million. The increase was the result of savings from the staffing re-alignment completed in the first quarter of 2012, increased customer sales, and reduced advertising spend as a percentage of sales for each corporate center.

. . .

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