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MED > SEC Filings for MED > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for MEDIFAST INC


10-May-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD LOOKING STATEMENTS

Some of the information presented in this quarterly report constitutes forward-looking statements within the meaning of the private Securities Litigation Reform Act of 1995. Statements that are not historical facts, including statements about management's expectations for fiscal year 2013 and beyond, are forward-looking statements and involve various risks and uncertainties. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge, there can be no assurance that actual results will not differ materially from the Company's expectations. The Company cautions investors not to place undue reliance on forward-looking statements which speak only to management's experience on this data.

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes appearing elsewhere herein.

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 filed on Form 10-K.

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 primarily 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.

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. Our policy is to recognize interest and penalties accrued on uncertain tax positions as part of income tax expense. For the three months ended March 31, 2013 and 2012, 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 provisions for estimated returns as of March 31, 2013 and December 31, 2012 were $403,000 and $300,000, 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 products and other consumable health and diet products. The Company's product lines include meal replacements and supplements. Our products and services are sold to weight loss program participants primarily via the internet, telephone, and brick and mortar clinics. Customers of our Health Coaches in the Take Shape For Life person-to-person direct sales channel are directed to order our products through either the internet or through the Company's in-house call center. Our meal food items accounted for 96% of our revenues in the first quarter of 2013 and 95% of our revenues in the first quarter of 2012. Program sales in our Medifast Weight Control Center channel accounted for 2% of revenues in the first three months of 2013 and 3% in the first three months of 2012. Shipping revenue and other accounted for 2% in the first three months of 2013 and 2012. Revenue consists primarily of meal replacement food sales. In the first three months of 2013, revenue increased to $96.0 million as compared to $88.9 million in the first three months of 2012, an increase of $7.1 million or 8%. The Take Shape For Life sales channel accounted for 61.9% of total revenue, Medifast Direct 23.9%, and Medifast Weight Control Centers and Medifast Wholesale Physicians 14.2%.

We review and analyze a number of key operating and financial metrics to manage our business, including revenue to advertising spend, 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.

Overview of the Company

Distribution Channels

Medifast Direct - In the direct-to-consumer channel ("Medifast Direct"), customers order Medifast product directly through the Company's website, www.medifast1.com or our in-house call center. The product is shipped directly to the customer's home. This business is driven by an aggressive multi-media customer acquisition strategy that includes both national and regional print, radio, web advertising, direct mail, and television as well as public relations, word of mouth referrals, and social media initiatives. The Medifast Direct division focuses on targeted marketing initiatives and provides customer support through its in-house call center and nutrition support team of registered dietitians to better serve its customers. In addition, Medifast continues to use leading web technology featuring customized meal planning and web community components. MyMedifast is a robust online community which provides a library of support articles, support forums, meal-planning tools, and social media functions. See Note 11, "Business Segments" of the financial statements for a detailed breakout of revenues, profit or loss, and total assets of each of the Company's business segments.

Take Shape For Life™ - Take Shape For Life is the personal coaching division of Medifast. The coaching network consists of independent contractor Health Coaches ("Health Coaches"), who are trained to provide coaching and support to clients on Medifast weight-loss programs and is led by its co-founder, a physician with a background in critical care. The role of the Health Coach is to give clients the encouragement and mentoring to assist them to successfully reach a healthy weight. The Take Shape For Life program provides a road map to empower the individual to take control of their health through adopting better long-term habits. Take Shape For Life offers the exclusive proprietary BeSlim® philosophy, which encourages long-term weight maintenance. Take Shape For Life also moves beyond the scope of weight loss to teach clients how to achieve optimal health through the balance of body, mind, and finances. The program uses the high-quality, medically validated products of Medifast that have been proven safe and effective in clinical studies described in our most recent Annual Report on Form 10-K, under "Clinical Research Overview." Health Coaches and their clients follow the Habits of Health book and companion workbook written by the Take Shape For Life co-founder to create a lifelong health optimization program. In addition to the encouragement and support of a Health Coach, clients of Take Shape For Life are offered a bio-network of support including product and program information on our website, weekly medical and general support calls, and access to our registered dietitians.

Program entrants are encouraged to consult with their primary care physician and a Take Shape For Life Health Coach to determine the Medifast program that is right for them. Health Coaches are required to become qualified based upon testing of their knowledge of Medifast products and programs. Our Health Coaches provide coaching and support to their Clients throughout the weight-loss and weight-maintenance process. Most new Health Coaches are introduced to the opportunity by an existing Health Coach. The vast majority of our new Health Coaches started as weight-loss clients of a Health Coach, had success on the Medifast product and program, and became a Health Coach to help others through the weight-loss process. Approximately 20% of active Health Coaches in the Take Shape For Life network are health care providers.

Take Shape For Life Health Coaches are independent contractors who are compensated on product sales referred to the Company. Health Coaches can earn compensation in two ways:

· Commissions: The primary way a Health Coach is compensated is through earning commissions on product sold. 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 ordering and paying for products, and their order is shipped directly from the Company to the client's home or designated address. Our Health Coaches do not handle payments and are not required to purchase or store products in order to receive a commission. In addition, Health Coaches do not receive a commission on their own personal product orders. Health Coaches pay the same price for products as their clients. The Company pays retail commissions to qualified Health Coaches on a weekly basis.

· Bonuses: Health Coaches are offered several bonus opportunities, including growth bonuses, generation bonuses, elite leadership bonuses, rolling consistency bonuses, client acquisition bonuses, and new Health Coach assist bonuses. The purposes of these bonuses are to reward Health Coaches for successfully referring product sales to the Take Shape For Life network, and to incentivize Health Coaches to further support and develop other Health Coaches within their network. The Company pays bonuses on a monthly basis to qualified Health Coaches.

o Growth bonuses are paid to Health Coaches who have at least five ordering clients per month and who have generated over $1,000 in product sales per month. Monthly growth bonuses are incremental bonuses that enable Health Coaches to earn income on product orders placed by clients or Health Coaches within their network.

o Generation bonuses are paid to Health Coaches who have one or more Health Coaches in their business who have achieved the rank of Executive Director. An Executive Director is a Health Coach who either generates $6,000 a month in frontline product sales to either Clients or personally sponsored Health Coaches or personally sponsors five senior Health Coaches. A senior Health Coach is a Health Coach who generates at least $1,000 a month in group product sales from a combination of at least five personally enrolled, ordering Clients, and/or Health Coaches, Health Coach teams, or a combination of both.

o Elite leadership bonuses are paid to Health Coaches who have three or more Health Coaches in their business who have achieved the rank of Executive Director.

o Rolling consistency bonuses are paid to Health Coaches who display frontline product sales with order consistency month after month. Health Coaches who generate at least $2,000 or more in frontline product sales for three consecutive months are paid a rolling consistency bonus.

o Client acquisition bonuses are paid to new Health Coaches who develop five Clients and generate $1,000 in frontline product sales within their first 30 calendar days in Take Shape For Life program.

o The assist bonuses are paid to Health Coaches who assist a newly sponsored Health Coach attain the Client acquisition bonus.

Health Coaches do not earn a commission or bonus when they recruit a new Health Coach into the Take Shape For Life network. Fees paid by new Health Coaches for start-up materials are at the Company's approximate cost and no commissions are paid thereon.

Take Shape For Life is a member of the Direct Selling Association (the "DSA"), a national trade association representing over 200 direct selling companies doing business in the United States. To become a member of the DSA, Take Shape For Life, like other active DSA member companies, underwent a comprehensive and rigorous one-year company review by DSA legal staff that included a detailed analysis of its company business-plan materials. This review is designed to ensure that a company's business practices do not contravene DSA's Code of Ethics. Compliance with the requirements of the Code of Ethics is paramount to becoming and remaining a member in good standing of DSA. Accordingly, we believe membership in DSA by Take Shape For Life demonstrates its commitment to the highest standards of ethics and a pledge not to engage in any deceptive, unlawful, or unethical business practices. Among those Code of Ethics proscriptions are pyramid schemes or endless chain schemes as defined by federal, state, or local laws. Moreover, Take Shape For Life, like other DSA member companies in good standing, has pledged to provide consumers with accurate and truthful information regarding the price, grade, quality, and performance of the products Take Shape For Life markets. See Note 11, "Business Segments" of the financial statements for a detailed breakout of revenues, profit or loss, and total assets of each of the Company's business segments.

Medifast Weight Control Centers- Medifast Weight Control Centers is the brick and mortar clinic channel of Medifast with affiliate-owned locations in Pennsylvania, New Jersey, Delaware, Texas, Florida, Maryland, North Carolina and Virginia. In the first quarter of 2013, the Company closed one of its existing centers, leaving a total of 86 locations in operation at quarter-end. Medifast Weight Control Centers offer a high-touch model including comprehensive Medifast programs for weight loss and maintenance, customized client counseling, an InbodyTM composition analysis, and monitoring with a BodyGemTM resting metabolic rate measurement device. Medifast Weight Control Centers conduct local advertising including radio, print, television and web initiatives. The Centers also benefit from the enterprise brand advertising which encourages walk-ins and referrals from its customers and other Medifast business channels.

In 2008, Medifast Franchise Systems, Inc. ("MFSI"), a subsidiary of Medifast, began offering the Center model as a franchise opportunity. MFSI currently has franchised centers located in Alabama, Arizona, California, Louisiana, Minnesota, Wisconsin, Maryland and Pennsylvania. As of March 31, 2013, 36 franchise locations were in operation.

MFSI currently offers the Medifast Weight Control Center franchise opportunity in all States except Hawaii, North Dakota, South Dakota, and Wisconsin under a registered (where required) franchise disclosure document (FDD). The MFSI Franchise Agreement requires franchisees to develop a minimum of three Medifast Weight Control Centers within a defined geographic area in the time frame set forth in the Development Agreement between Medifast and the franchisees.

Our MFSI's franchise strategy depends on our franchisees' active involvement in, and management of, Medifast Weight Control Center operations. Candidates are reviewed for appropriate operational experience and financial stability, including specific net worth and liquidity requirements. Upon execution of the Franchise Agreement and Development Agreement, franchisees are required to promptly select sites for the Centers which are subject to MFSI's approval.

A franchisee's initial fee includes the franchise fee for the first Center to be developed and a non-refundable deposit for the second and third Centers to be developed, and covers the cost of MFSI resources provided for, among other things, the training of franchisees and their staff, and approval of the proposed territory for development. If a franchisee desires to open more than three centers in the designated territory, there is an additional fee charged for each additional Center to be developed. MFSI provides initial investment estimates in the FDD and cautions applicants considering the franchise opportunity that their actual expenses may vary from the estimates given. Required legal disclosures are provided and the applicant may not sign the Agreements until the applicant has had 14 days to consider the FDD.

Prior to the opening of each Medifast Weight Control Center franchise established under the Franchise and Development Agreements, MFSI will do the following:

i. designate the Center's Protected Territory.

ii. review for approval the sites selected by the Franchisee for the Center.

iii. review for approval the lease governing the location where the Center is to be located.

iv. provide the franchisee with standard plans and specifications for the build-out of the Center along with a list of equipment and improvements which the franchisee is required to purchase and install.

v. provide an initial training program.

vi. provide the franchisee on-site assistance and guidance for approximately three to five days during or close to the opening of the Center.

vii. provide the franchisee with online access to a password-protected, electronic version of the Medifast Weight Control Centers® Franchise Operations Manuals.

MFSI does not provide products at a discounted price, offer direct or indirect financing, or guarantee a franchisee's notes, leases or other obligations.

While MFSI does not currently have a purchase option included in its franchise agreement, it does have the right of first refusal to acquire a Center if the franchisee wishes to sell a Center.

See Note 11, "Business Segments" of the financial statements for a detailed breakout of revenues, profit or loss, and total assets of each of the Company's business segments.

Medifast Wholesale Physicians- Medifast physicians have been implementing the Medifast Program within their practices since 1980. These physicians carry an inventory of wholesale Medifast products and resell them to patients. They also provide appropriate medical monitoring, testing, and support for patients on the Medifast Program. Medifast products and programs have been recommended by over 20,000 doctors since 1980. Many Medifast physicians take advantage of the Medifast Direct or the Take Shape For Life program to support their patient base.

The Company offers an in-house support program to assist the physicians and their customers/patients. Customers have access to registered dietitians who provide program support and advice via a toll-free telephone help line, by email, and online chats. See Note 11, "Business Segments" of the financial statements for a detailed breakout of revenues, profit or loss, and total assets of each of the Company's business segments.

Overview of the Three Months Ended March 31, 2013 Compared to Three Months Ended
March 31, 2012



                                                    Three Months Ended March 31,
                                       2013             2012          $ Change         % Change

Revenue                            $ 96,043,000     $ 88,924,000     $ 7,119,000                8 %
Cost of sales                        23,634,000       22,169,000       1,465,000                7 %
Gross Profit                         72,409,000       66,755,000       5,654,000                8 %

Selling, general, and
administrative costs                 63,831,000       60,618,000       3,213,000                5 %

Income from operations                8,578,000        6,137,000       2,441,000               40 %

Other income
Interest income, net                     52,000           73,000         (21,000 )            -29 %
Other expense                            80,000          123,000         (43,000 )            -35 %
                                        132,000          196,000         (64,000 )            -33 %

Income before provision for
income taxes                          8,710,000        6,333,000       2,377,000               38 %
Provision for income tax expense      2,777,000        2,343,000         434,000               19 %

Net income                         $  5,933,000     $  3,990,000     $ 1,943,000               49 %

% of revenue

Gross Profit                               75.4 %           75.1 %
Selling, general, and
administrative costs                       66.5 %           68.2 %
Income from Operations                      8.9 %            6.9 %

Revenue: Revenue increased to $96.0 million in the first quarter of 2013 compared to $88.9 million in the first quarter of 2012, an increase of $7.1 million or 8%. The Take Shape For Life sales channel accounted for 61.9% of total revenue, Medifast Direct 23.9%, and Medifast Weight Control Centers and Medifast Wholesale Physicians 14.2%. Take Shape For Life sales, which are fueled by increased customer product sales as a result of an increase in active Health Coaches, increased by 12% compared to the first quarter of 2012. As compared to the first quarter of 2012, the Medifast Direct sales channel, which is fueled primarily by consumer advertising, increased revenues by approximately 2% year-over-year. The Medifast Weight Control Centers and Medifast Wholesale Physicians increased sales by 2% due to the opening of new corporate locations in 2012 and new franchise locations in 2012 and 2013. Beginning in the first quarter of 2013, the Company will now report a revenue to spend ratio based on total revenue and total advertising spend as a measure of overall advertising effectiveness. Medifast's advertising has evolved to become focused on a combination of direct response and call to action marketing along with brand building and awareness creation messaging. In the first quarter of 2013 the Company's revenue to spend ratio was 9.6-to-1 versus 9.0-to-1 in the first quarter of 2012.

In the first three months of 2013, 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 12% to $59.4 million compared with $53.0 million in 2012. Growth in revenues for the segment was driven by increased customer product sales. The number of active Health Coaches at the end of the first quarter of 2013 increased to 11,300 compared with 10,200 during the period a year ago, an increase of 11%. 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 from $1,650 in the first quarter of 2012 to $1,720 in the first quarter 2013. These increases are attributable to the launch of new Health Coach and Client acquisition videos and brochures in Q4 2012.

The Medifast Direct Sales division increased 2% to $23.0 million as compared with $22.5 million in 2012, an increase of $0.5 million. Revenues in this channel were driven primarily by targeted customer advertising on-line, across local radio, via email and direct mail campaigns, and by highlighting customer successes in large national publications and on television. The Company is focused on optimizing e-commerce performance and has invested in both tools and talent to drive website performance and conversion.

The Medifast Weight Control Centers and Medifast Wholesale Physicians experienced revenue growth of 2% in the first quarter of 2013 as compared to 2012. Revenue increased due to the opening of twelve new corporate centers during the second and third quarters of 2012 and the increased success of franchise centers. The increase was partially offset by the closure of one corporate-owned center in 2013 and two corporate-owned centers in 2012. At March 31, 2013, Medifast Weight Control Centers were operating in eighty-six corporate locations and thirty-six franchise centers were in operation. In the first quarter of 2013, same store sales decreased by 16% for corporate centers open greater than one year. The Company's focus to improve profitability by creating operational efficiency, optimizing staffing, and managing expenses including advertising spend contributed to the decrease in same store sales. There were 73 centers in the comparative same-store-sales base at March 31, 2013.

Costs of Sales: Cost of sales increased $1.5 million in the first quarter of 2013 to $23.6 million compared to $22.1 million in the first quarter of 2012. As a percentage of sales, gross margin increased to 75.4% from 75.1% in the first quarter of 2012. The increase in gross margin is the result of offering fewer customer discounts, partially offset by increased commodity and shipping costs.

Selling, General and Administrative Costs: Selling, general and administrative expenses were $63.8 million compared to $60.6 million in the first quarter of 2012, an increase of $3.2 million. As a percentage of sales, selling, general and administrative expenses decreased to 66.5% versus 68.2% in the first quarter of 2012. Take Shape For Life commission expense, which is variable based upon . . .

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