MEDIFAST INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are described in Note 2 to the consolidated financial statements. The preparation of our consolidated 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. 29 Table of Conte n t s Management considers the following accounting policies to be the most critical in preparing our consolidated financial statements. These critical accounting policies have been discussed with our Audit Committee, as appropriate. Revenue Recognition: Our revenue is derived primarily from point of sale transactions executed over an e-commerce platform for weight loss, weight management, and other healthy living products. Revenue is recognized upon receipt by customer and net of discounts, rebates, promotional adjustments, price adjustments, allocated consideration to loyalty programs, and estimated returns. Revenue is recognized when control of the promised products is transferred to our clients, in an amount that reflects the consideration we expect to be entitled to in exchange for transferring those products. When determining whether the customer has obtained control of the products, we consider any future performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers . A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, each performance obligation is satisfied. Our contracts have performance obligations to fulfill and deliver products from the point of sale transaction along with the related customer reward programs. Our performance obligations are satisfied at a point in time. Revenue from products transferred to clients at a point in time accounted for substantially all of our revenue for the years ended December 31, 2021, 2020 and 2019. Revenue on these contracts is recognized when the obligations under the terms of the contract with our customer are satisfied. Generally, this occurs with the transfer of control upon receipt of products by our clients. Any consideration received prior to the fulfillment of the Company’s performance obligation is deferred and recognized as a liability. Our return policy allows for customer returns of consumable products within 30 days of purchase and upon our authorization. We adjust revenues for the products expected to be returned and a liability is recognized for expected refunds to clients. We estimate expected returns based on historical levels and project this experience into the future. Our sales contracts may give clients the option to purchase additional products priced at a discount. Options to acquire additional products at a discount can come in many forms, such as customer reward programs and incentive offerings including pricing arrangements, and promotions. We reduce the transaction price for certain customer reward programs and incentive offerings including pricing arrangements, promotions, and incentives that represent variable consideration and separate performance obligations. The Company accounts for sales rewards that provide the customer with a material right as a separate performance obligation of the transactions, and therefore allocates consideration between the initial sale of products and the customer reward program and incentive offering. Amounts billed to clients for shipping and handling activities are treated as a promised service performance obligation and are recorded in revenue in our Consolidated Statements of Income upon fulfillment of the performance obligation. Shipping and handling costs incurred by the Company for the delivery of products to clients are considered a cost to fulfill the contract and are included in cost of sales in our Consolidated Statements of Income. We expense OPTA VIA Coach compensation and credit card fees during the period in which the corresponding revenue is earned. These costs are deferred along with the revenues for goods that are in transit and not received by clients by period end. These costs are recorded in selling, general and administrative expense in our Consolidated Statements of Income. Long-lived Asset Impairment: Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Income Taxes: Deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 30 Table of Conte n t s The benefit of a tax position is recognized in the consolidated 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% 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 our Consolidated Balance Sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Our policy is to recognize interest and penalties accrued on uncertain tax positions as part of income tax expense. We evaluated our tax positions and determined that we did not have any material uncertain tax positions. BACKGROUND Medifast is the global company behind one of the fastest-growing health and wellness communities, OPTA VIA, which offers Lifelong Transformation, One Healthy Habit at a Time. Reflecting the success of our holistic approach to health and wellness, we have consistently grown revenue over the past five years. Of equal importance, we expect our differentiated direct-to-consumer business model to continue to deliver growth in the foreseeable future. Medifast has redefined direct selling by combining the best aspects of the model, while eliminating those dimensions that have typically challenged other companies. Medifast is often compared to diet and weight loss-only companies or to multi-level marketing companies, but our model is very different. The Company supports clients through independent OPTA VIA Coaches, the majority of whom were clients first. Our product sales accounted for approximately 98.0% of our revenues in each of 2021, 2020, and 2019. We review and analyze a number of key operating and financial metrics to manage our business, including the number of active earning OPTA VIA Coaches and average quarterly revenue generated per active earning OPTA VIA Coach. As we previously disclosed, global expansion is an important component of our long-term growth strategy. In July 2019, we commenced our international operations, entering into the Asia Pacific markets of Hong Kong and Singapore. We outsource a distribution center in Hong Kong to provide adequate product distribution capacity for the foreseeable future. Our decision to enter these markets was based on industry market research that reflects a dynamic shift in how health care is being prioritized and consumed in those countries. Our OPTA VIA business unit accounted for approximately 99.9%, 98.0%, and 96.4% of our revenues in 2021, 2020 and 2019, respectively. We have operated and reported as a single sales segment, OPTA VIA, since 2018. Consistent with business and brand strategy, the Company has completed the sunset of the Medifast Direct channel and Medifast-branded product line during the second quarter of 2021. By maintaining our commitment to building capabilities in the areas that matter most to our OPTA VIA Coaches and clients within the OPTA VIA channel, we believe we will enhance our ability to further grow our business over the next several years, enabling robust revenue growth while also maintaining our profitability in the long-term. 31 Table of Conte n t s CONSOLIDATED RESULTS OF OPERATIONS - 2021 COMPARED TO 2020 The following table reflects our consolidated statements of income for the years ended December 31, 2021 and 2020 (in thousands, except percentages): 2021 2020 $ Change % Change Revenue $ 1,526,087 $ 934,842 $ 591,245 63.2% Cost of sales 398,490 237,027 (161,463) (68.1)% Gross Profit 1,127,597 697,815 429,782 61.6% Selling, general, and administrative 911,356 563,656 (347,700) (61.7)% Income from operations 216,241 134,159 82,082 61.2% Other (expense) income Interest (expense) income (231) 246 (477) (193.9)% Other income (expense) 119 (140) 259 (185.0)% (112) 106 (218) (205.7)% Income from operations before income taxes 216,129 134,265 81,864 61.0% Provision for income taxes 52,098 31,406 (20,692) (65.9)% Net income $ 164,031 $ 102,859 $ 61,172 59.5% % of revenue Gross Profit 73.9% 74.6% Selling, general, and administrative 59.7% 60.3% Income from Operations 14.2% 14.4% Revenue: Revenue increased $591.2 million, or 63.2%, to $1.526 billion in 2021 from $934.8 million in 2020. The average revenue per active earning OPTA VIA Coach increased 6.6% to $6,321 for the three months ended December 31, 2021 from $5,932 for the three months ended December 31, 2020. Increase in the productivity per active earning OPTA VIA Coach for the quarter continued to be driven by an increase in both the number of clients supported by each Coach as well as an increase in average client spend. The year-over-year growth in revenue was primarily driven by the continued growth in active earning OPTA VIA Coach count and increase in the productivity per active earning OPTA VIA Coach. Costs of Sales: Cost of sales increased $161.5 million, or 68.1%, to $398.5 million in 2021 from $237.0 million in 2020. This increase in cost of sales was primarily driven by an increase in OPTA VIA product sales, higher product costs and shipping costs resulting from inflation in raw ingredient, freight and labor costs. In addition, acceleration of demand in OPTA VIA-branded products led to the increase in the Company’s use of co-manufacturers, which further increased cost of sales. Gross Profit: In 2021, gross profit increased $429.8 million, or 61.6%, to $1.128 billion from $697.8 million in 2020. The increase in gross profit was primarily attributable to higher revenue partially offset by increased cost of sales. As a percentage of sales, gross profit decreased 70 basis points to 73.9% for 2021 from 74.6% for 2020. The decrease in gross margin percentage was primarily the result of higher product and shipping costs resulting from inflation in raw ingredient, freight and labor costs. Selling, General and Administrative: Selling, general and administrative (“SG&A”) expenses were $911.4 million in 2021, an increase of $347.7 million, or 61.7%, as compared to $563.7 million in 2020. As a percentage of sales, SG&A expenses were 59.7% for 2021 as compared to 60.3% for 2020. The increase in SG&A was primarily due to higher OPTA VIA Coach compensation expense, increased salaries and benefits related expenses for employees, incremental costs related to continued investment in information technology and distribution, increased credit card fees resulting from higher sales, as well as costs for 32 Table of Conte n t s the Company’s hybrid annual convention held in July 2021. As the OPTA VIA convention in July 2020 was a virtual event in response to the COVID-19 pandemic, the costs were significantly lower. SG&A expenses included research and development costs of $4.4 million and $2.8 million for 2021 and 2020, respectively, in connection with the development of new products and programs and clinical research activities. OPTA VIA Coach compensation expense, which is a variable expense, increased $272.1 million, or 68.9%, to $667.2 million in 2021 from $395.1 million in 2020. The increase was primarily the result of increased OPTA VIA product sales. This trend is the result of the success we are experiencing with our growing OPTA VIA Integrated Coach Model. The total number of active earning OPTA VIA Coaches for the three months ended December 31, 2021 increased to 59,800 from 44,200 for the corresponding period in 2020, an increase of 35.3%. Income from operations: Income from operations in 2021 increased $82.0 million to $216.2 million from $134.2 million in 2020 primarily as a result of increased gross profits partially offset by increased SG&A expenses. Income from operations as a percentage of sales decreased to 14.2% for 2021 as compared to 14.4% for 2020 due to the factors described above in the explanations from gross profit and SG&A expenses. Provision for income taxes: For 2021, the Company recorded $52.1 million in income tax expense, an effective tax rate of 24.1%, as compared to $31.4 million in income tax expense and an effective tax rate of 23.4%, for 2020. The increase in the effective tax rate for 2021 as compared to 2020 was primarily driven by an increase in the state tax expenses of 1.2% and an increase in the limitation for executive compensation of 0.5%, partially offset by a decrease in the current year impact of the valuation allowance of 0.8% and an increase in the stock compensation benefit of 0.5% as well as other permanent differences. Net income: Net income was $164.0 million, or $13.89 per diluted share, in 2021 as compared to $102.9 million, or $8.68 per diluted share, in 2020. The period-over-period changes were driven by the factors described above in the explanations from operations. Additionally, refer to Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 for management’s discussion and analysis of financial condition and results of operations for the fiscal year 2020 compared to fiscal year 2019. Liquidity and Capital Resources The Company had stockholders’ equity of $202.5 million and working capital of $137.0 million at December 31, 2021 compared with $157.2 million and $123.0 million at December 31, 2020. The $45.3 million net increase in stockholders’ equity reflects $164.0 million in net income for 2021 offset by $56.0 million spent on repurchases of common stock and $67.2 million for declared dividends paid to our common stockholders as well as the other equity transactions described in the Consolidated Statements of Changes in Stockholders’ Equity included in our consolidated financial statements included in this report. The Company declared a quarterly dividend of $1.42 per share on December 8, 2021, to stockholders of record as of December 21, 2021 that was paid on February 8, 2022. While we intend to continue the dividend program and believe we will have sufficient liquidity to do so, we can provide no assurance we will be able to continue the declaration and payment of dividends. The Company’s cash, cash equivalents and investment securities decreased from $174.5 million at December 31, 2020 to $109.5 million at December 31, 2021. Net cash provided by operating activities decreased $50.7 million to $94.5 million for 2021 from $145.2 million for 2020 primarily as a result of a $114.5 million decrease in operating assets and liabilities partially offset by a $61.2 million increase in net income. Decrease in operating assets and liabilities was primarily due to a $122.0 decrease in the change in inventories. We increased our inventory purchases significantly in 2021 to meet our sales growth demand. Net cash used in investing activities was $29.0 million for 2021 as compared to $1.3 million for 2020. This year-over-year change resulted primarily from a $28.3 million increase in cash used in capital expenditures for 2021 as compared to 2020. Cash used in capital expenditures for 2021 expanded our technology and supply chain capabilities to support our planned growth. Net cash used in financing activities increased $68.0 million to $125.1 million for 2021 from $57.1 million for 2020. This increase was primarily due to a $51.0 million increase in stock repurchases, a $10.7 million increase in cash dividends paid to stockholders and a $5.5 million increase in net shares repurchased for taxes. 33 Table of Conte n t s In pursuing its business strategy, the Company may require additional cash for operating and investing activities. The Company expects future cash requirements, if any, to be funded from operating cash flow and financing activities. From time to time the Company evaluates potential acquisitions that complement our business. If consummated, any such transactions may use a portion of our working capital or require the issuance of equity or debt. We have no present understandings, commitments or agreements with respect to any material acquisitions. As of December 31, 2021, the Company maintained a credit facility, which provides for a $125.0 million senior secured revolving credit facility with a $20.0 million letter of credit sublimit and also provides for an uncommitted incremental facility that permits the Company, subject to certain conditions, to increase the senior secured revolving credit facility by up to $100.0 million. The credit facility contains affirmative and negative covenants customarily applicable to credit facilities. As of December 31, 2021, the Company was in compliance with all of its debt covenants and there were no borrowings outstanding under the credit facility. Contractual Obligations and Commercial Commitments The Company had the following contractual obligations as of December 31, 2021 (in thousands): 2022 2023 - 2024 2025 - 2026 Thereafter Total Operating leases (a) $ 7,130 $ 11,900 $ 9,985 $ 5,412 $ 34,427 Unconditional purchase obligations (b) 94,618 99,886 3,621 756 198,881 Total contractual obligations $ 101,748 $ 111,786 $ 13,606 $ 6,168 $ 233,308 ____________________ (a) The Company has operating leases in place for leased corporate offices, warehouses, and certain equipment. (b) The Company has unconditional purchase obligations primarily for inventories, outsourced information technology and Coach events. INFLATION During 2021, the Company's business experienced a certain amount of inflation impact on raw ingredient, freight and supply chain labor. As a result, the Company increased its product sales prices by 3.5% in December 2021.