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. 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. 29 Table of Contents 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 customers, 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 customers at a point in time accounted for substantially all of our revenue for the years ended December 31, 2022, 2021 and 2020. 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 customers. 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 customers. We estimate expected returns based on historical levels and project this experience into the future. Our sales contracts may give customers 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 customers 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 customers 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 customers 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. 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 30 Table of Contents 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 long-term. 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 customers through independent OPTA VIA Coaches, the majority of whom were customers first. Our product sales accounted for approximately 97.2%, 98.0% and 98.0% of our revenues in each of 2022, 2021, and 2020, respectively. 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 100%, 99.9%, and 98% of our revenues in 2022, 2021 and 2020, respectively. We have operated and reported as a single sales segment, OPTA VIA, since 2018. The Company completed the sunset of the Medifast Direct channel and Medifast-branded product line in 2021. By maintaining our commitment to building capabilities in the areas that matter most to our OPTA VIA Coaches and customers 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 Contents CONSOLIDATED RESULTS OF OPERATIONS - 2022 COMPARED TO 2021 The following table reflects our consolidated statements of income for the years ended December 31, 2022 and 2022 (in thousands, except percentages): 2022 2021 $ Change % Change Revenue $ 1,598,577 $ 1,526,087 $ 72,490 4.8% Cost of sales 458,163 398,490 (59,673) (15.0)% Gross Profit 1,140,414 1,127,597 12,817 1.1% Selling, general, and administrative 955,608 911,356 (44,252) (4.9)% Income from operations 184,806 216,241 (31,435) (14.5)% Other (expense) income Interest (expense) income (701) (231) (470) (203.7)% Other (expense) income (46) 119 (165) (139.0)% (747) (112) (635) (566.7)% Income before provision for income taxes 184,059 216,129 (32,070) (14.8)% Provision for income taxes 40,491 52,098 11,607 22.3% Net income $ 143,568 $ 164,031 $ (20,463) (12.5)% % of revenue Gross Profit 71.3% 73.9% Selling, general, and administrative 59.8% 59.7% Income from Operations 11.6% 14.2% Revenue: Revenue increased $72.5 million, or 4.8%, to $1.599 billion in 2022 from $1.526 billion in 2021. The year-over-year growth in revenue was primarily driven by an increase in the number of active earning OPTA VIA Coach count and higher productivity per active earning OPTA VIA Coach through the first two quarters of the year, as well as a pricing adjustment in December 2021 in which the Company increased prices for most of its products by an average of 3.5%. The average revenue per active earning OPTA VIA Coach decreased 12.4% to $5,538 for the three months ended December 31, 2022 from $6,321 for the three months ended December 31, 2021. Decrease in the revenue per active earning OPTA VIA Coach for the quarter was driven by headwinds in customer acquisition rates through the fourth quarter. This is partially a result of the changing economic environment as customers continue to recalibrate spending in the current inflationary environment. Costs of Sales: Cost of sales increased $59.7 million, or 15.0%, to $458.2 million in 2022 from $398.5 million in 2021. 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 materials, freight and labor costs, and the restructuring of certain external manufacturing agreements to optimize our supply chain for 2023. Non-GAAP adjusted cost of sales were $446.0 million for 2022, an increase of $47.5 million, or 11.9%, as compared to $398.5 million for 2021. Non-GAAP adjusted cost of sales excludes expenses in connection with the restructuring of certain external manufacturing agreements of $12.2 million for 2022. Refer to the section titled “Non-GAAP Financial Measures” below for a reconciliation of each of Non-GAAP financial measures to its most comparable GAAP financial measure. Gross Profit: In 2022, gross profit increased $12.8 million, or 1.1%, to $1.140 billion from $1.128 billion in 2021. 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 2.6% to 71.3% for 2022 from 73.9% for 2021. The decrease in gross margin percentage was primarily due to expenses in connection with the restructuring of certain external manufacturing agreements, a customer 32 Table of Contents acquisition program, which ran from late March to early May in 2022, and the result of higher product and shipping costs resulting from inflation in raw ingredient, freight and labor costs outpacing pricing adjustments. Non-GAAP adjusted gross profit was $1.153 billion for 2022, an increase of $25.0 million, or 2.2%, as compared to $1.128 billion for 2021. Selling, General and Administrative: Selling, general and administrative (“SG&A”) expenses were $955.6 million in 2022, an increase of $44.2 million, or 4.9%, as compared to $911.4 million in 2021. As a percentage of sales, SG&A expenses were 59.8% for 2022 as compared to 59.7% for 2021. SG&A expenses included research and development costs of $4.5 million and $4.4 million for 2022 and 2021, respectively, in connection with the development of new products and programs and clinical research activities. The increase in cost also included donations made to support the Ukraine relief effort, incremental costs related to OPTA VIA Coach compensation expense and credit card fees resulting from higher sales, and continued investment in information technology. Non-GAAP adjusted SG&A expenses were $936.6 million for 2022, an increase of $25.2 million, or 2.8%, as compared to $911.4 million for 2021. Non-GAAP adjusted SG&A expenses exclude expenses in connection with donations made to support to Ukrainian relief effort of $19.0 million for 2022. Refer to the section titled “Non-GAAP Financial Measures” below for a reconciliation of each of Non-GAAP financial measures to its most comparable GAAP financial measure. The total number of active earning OPTA VIA Coaches for the three months ended December 31, 2022 increased to 60,900 from 59,800 for the corresponding period in 2021, an increase of 1.8%. Income from operations: Income from operations in 2022 decreased $31.4 million to $184.8 million from $216.2 million in 2021 primarily as a result of increased SG&A expenses partially offset by increased gross profit. Income from operations as a percentage of sales decreased to 11.6% for 2022 as compared to 14.2% for 2021 due to the factors described above in the explanations from gross profit and SG&A expenses. Non-GAAP adjusted income from operations in 2022 decreased to $216.0 million from $216.2 million in 2021. Refer to the section titled “Non-GAAP Financial Measures” below for a reconciliation of each of Non-GAAP financial measures to its most comparable GAAP financial measure. Provision for income taxes: For 2022, the Company recorded $40.5 million in income tax expense, an effective tax rate of 22.0%, as compared to $52.1 million in income tax expense and an effective tax rate of 24.1%, for 2021. The decrease in the effective tax rate for 2022 as compared to 2021 was primarily driven by an increase in the charitable contribution benefit of 2.3% and a reduction in the limitation for executive compensation of 0.4%, partially offset by a decrease in the stock compensation benefit of 0.8%. Non-GAAP adjusted income tax provision was $51.8 million for 2022, an effective tax rate of 24.1% for both 2022 and 2021. Refer to the section titled “Non-GAAP Financial Measures” below for a reconciliation of each of Non-GAAP financial measures to its most comparable GAAP financial measure. Net income: Net income was $143.6 million, or $12.73 per diluted share, in 2022 as compared to $164.0 million, or $13.89 per diluted share, in 2021. The period-over-period changes were driven by the factors described above in the explanations from operations. Non-GAAP adjusted net income was $163.4 million or $14.49 per diluted share for 2022 as compared to $13.89 per diluted share for 2021. Refer to the section titled “Non-GAAP Financial Measures” below for a reconciliation of each of Non-GAAP financial measures to its most comparable GAAP financial measure. 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, 2021 for management’s discussion and analysis of financial condition and results of operations for the fiscal year 2021 compared to fiscal year 2020. Non-GAAP Financial Measures In an effort to provide investors with additional information regarding our results as determined by GAAP, we disclose various non-GAAP financial measures in this quarterly report, our quarterly earnings press release and other public disclosures. The following GAAP financial measures have been presented on an as-adjusted basis: cost of sales, gross profit, SG&A expenses, income from operations, other expense, provision for income taxes, net income and diluted earnings per share. Each of these as- 33 Table of Contents adjusted financial measures excludes the impact of certain amounts related to our donations to support the Ukrainian relief effort and costs of restructuring of certain external manufacturing agreements, as further identified below and have not been calculated in accordance with GAAP. A reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure is included below. These non-GAAP financial measures are not intended to replace GAAP financial measures. We use these non-GAAP financial measures internally to evaluate and manage the Company’s operations because we believe they provide useful supplemental information regarding the Company’s on-going economic performance. We have chosen to provide this information to investors to enable them to perform more meaningful comparisons of operating results and as a means to emphasize the results of on-going operations. The following tables reconcile the non-GAAP financial measures included in this report (in thousands, except per share amounts): Year Ended December 31, 2022 GAAP Donation Adjustments Restructuring of External Manufacturing Agreements Non-GAAP Cost of sales $ 458,163 $ — $ (12,195) $ 445,968 Gross profit 1,140,414 — 12,195 1,152,609 Selling, general, and administrative 955,608 (18,986) — 936,622 Income from operations 184,806 18,986 12,195 215,987 Other expense (747) — — (747) Provision for income taxes 40,491 8,544 2,744 51,779 Net income 143,568 10,442 9,451 163,461 Diluted earnings per share (1) 12.73 0.93 0.84 14.50 Year Ended December 31, 2021 GAAP Donation Adjustments Restructuring of External Manufacturing Agreements Non-GAAP Cost of sales $ 398,490 $ — $ — $ 398,490 Gross profit 1,127,597 — — 1,127,597 Selling, general, and administrative 911,356 — — 911,356 Income from operations 216,241 — — 216,241 Other expense (112) — — (112) Provision for income taxes 52,098 — — 52,098 Net income 164,031 — — 164,031 Diluted earnings per share (1) 13.89 — — 13.89 (1) The weighted-average diluted shares outstanding used in the calculation of these non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts. Liquidity and Capital Resources The Company had stockholders’ equity of $155.0 million and working capital of $81.9 million at December 31, 2022 compared with $202.5 million and $137.0 million at December 31, 2021. The $47.4 million net decrease in stockholders’ equity reflects $143.6 million in net income for 2022 offset by $126.4 million spent on repurchases of common stock and $74.0 million for dividends paid to holders of our common stock 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 $1.64 per share on December 8, 2022, to stockholders of record as of December 20, 2022 that was paid on February 7, 2023. While we intend to continue the dividend program and believe we will have sufficient liquidity 34 Table of Contents 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 to $87.7 million at December 31, 2022 from $109.5 million at December 31, 2021. Net cash provided by operating activities increased $100.0 million to $194.6 million for 2022 from $94.5 million for 2021 primarily as a result of a net $109.3 million of changes in operating assets and liabilities partially offset by a $9.3 million decrease in net income and adjustment to reconcile net income to cash provided by operating activities. The increase from changes in operating assets and liabilities was primarily due to a $187.8 increase in the change in inventories partially offset by a $91.9 million decrease in the change in accounts payable and accrued expenses. We decreased our inventory purchases in 2022 to align with sales demand in the latter part of 2022. Accounts payable and accrued expenses decreased due to the timing of payments. Net cash used in investing activities was $11.4 million for 2022 as compared to $29.1 million for 2021. This year-over-year change resulted primarily from a $17.5 million decrease in cash used in capital expenditures for 2022 as compared to 2021. Cash used in capital expenditures for 2022 expanded our technology and supply chain capabilities to support our planned growth. Net cash used in financing activities increased $74.4 million to $199.6 million for 2022 from $125.1 million for 2021. This increase was primarily due to a $70.4 million increase in stock repurchases and a $7.8 million increase in cash dividends paid to stockholders, partially offset by a $4.6 million decrease in net shares repurchased for taxes. 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. On April 13, 2021, the Company and certain of its subsidiaries (collectively, the “Guarantors”) entered into a credit agreement among the Company, the Guarantors, the lenders party thereto and Citibank, N.A., in its capacity as administrative agent. On May 31, 2022, the Credit Agreement was amended to increase the borrowing capacity and convert the interest rate to be based on SOFR, from LIBOR (the “Amended Credit Agreement”). The Amended Credit Agreement provides for a $225.0 million senior secured revolving credit facility with a $20.0 million letter of credit sublimit. The Amended Credit Agreement 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 Amended Credit Agreement contains affirmative and negative covenants customarily applicable to credit facilities. As of December 31, 2022, the Company had no borrowings under the credit facility and was in compliance with all of its debt covenants. Contractual Obligations and Commercial Commitments The Company had the following contractual obligations as of December 31, 2022 (in thousands): 2023 2024 - 2025 2026 - 2027 Thereafter Total Operating leases (a) $ 6,243 $ 11,518 $ 6,713 $ 2,858 $ 27,332 Unconditional purchase obligations (b) 121,710 91,670 2,141 129 215,650 Total contractual obligations 127,953 103,188 8,854 2,987 242,982 ____________________ (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 2022, 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 prices for most of its products by an average of approximately 4.5% in November 2022. The Company previously increased sales prices in December 2021 by an average of approximately 3.5%. 35 Table of Contents