Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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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.
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. Prior to a change in our Customer Terms & Conditions (Customer T&Cs) in the first quarter of 2023, revenue was recognized upon receipt by the customer and net of discounts, rebates, promotional adjustments, price adjustments, allocated consideration to loyalty programs, and estimated returns. Upon the change of our Customer T&Cs, revenue is now recognized upon delivery to the shipping carrier and net of discounts, rebates, promotional adjustments, price adjustments, allocated consideration to loyalty programs, and estimated returns. The impact of this change to the quarter ended March 31, 2023 was an increase of approximately $9.1 million in revenue and $2.8 million of income from operations.
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, 2023, 2022, and 2021. Revenue on these contracts is recognized when the obligations under the terms of the contract with our customer are satisfied.
Our return policy allows for customer returns of consumable products from the time of order until 30 days following the date of receipt, 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 customer reward programs and certain 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 as 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 recorded in selling, general and administrative expense in our Consolidated Statements of Income.
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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 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.
BACKGROUND
Medifast is the health and wellness company known for its habit-based and coach-guided lifestyle solution OPTA VIA, which provides people with a simple, yet comprehensive approach to help them achieve lasting optimal health and wellbeing. OPTA VIA's lifestyle plans deliver clinically proven health benefits, and our program includes evidence-based tools, including scientifically developed products and a framework for habit creation reinforced by independent Coaches and Community support. As a physician-founded company with a 40+ year history, Medifast is a leader in the U.S. weight management industry. In early January 2024, through a collaboration with the national virtual primary care provider LifeMD, OPTA VIA customers will have access to board-certified affiliated clinicians and medications, such as GLP-1s, that support treatment plans for obesity and other health conditions. The Company is entering into the medically supported weight loss area and continues to innovate and build upon its scientific and clinical heritage to fulfill its mission of offering the world Lifelong Transformation, One Healthy Habit at a Time. Medifast was recognized in 2023 by Financial Times as one of The Americas' Fastest Growing Companies and in 2022 as one of America's Best Mid-Sized Companies by Forbes. Our product sales accounted for approximately 97.5%, 97.2% and 98.0% of our revenues in each of 2023, 2022, and 2021, 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. The number of active earning OPTA VIA Coaches decreased by approximately 32.5% to 41,100 as of December 31, 2023 from December 31, 2022, and the average revenue per active earning OPTA VIA Coach was $4,648 for the quarter ended December 31, 2023.
Our OPTA VIA business unit accounted for approximately 100%, 100%, and 99.9% of our revenues in 2023, 2022 and 2021, respectively. We have operated and reported as a single sales segment, OPTA VIA, since 2018. 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 our strong financial foundation, flexible model and variable cost structure coupled with disciplined growth initiatives position Medifast for the current environment and the future.
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CONSOLIDATED RESULTS OF OPERATIONS - 2023 COMPARED TO 2022
The following table reflects our consolidated statements of income for the years ended December 31, 2023 and 2022 (in thousands, except percentages):
2023 2022 $ Change % Change
Revenue $ 1,072,054 $ 1,598,577 $ (526,523) (32.9)%
Cost of sales 296,204 458,163 (161,959) (35.3)%
Gross Profit 775,850 1,140,414 (364,564) (32.0)%
Selling, general, and administrative 649,448 955,608 (306,160) (32.0)%
Income from operations 126,402 184,806 (58,404) (31.6)%
Other income (expense)
Interest income (expense) 2,490 (701) 3,191 455.2 %
Other (expense) income (95) (46) (49) 106.5%
2,395 (747) 3,142 420.6 %
Income before provision for income taxes 128,797 184,059 (55,262) (30.0)%
Provision for income taxes 29,382 40,491 (11,109) (27.4)%
Net income $ 99,415 $ 143,568 $ (44,153) (30.8)%
% of revenue
Gross Profit 72.4% 71.3%
Selling, general, and administrative 60.6% 59.8%
Income from Operations 11.8% 11.6%
Revenue: Revenue decreased $526.5 million, or 32.9%, to $1.072 billion in 2023 from $1.599 billion in 2022. The year-over-year decline in revenue was primarily driven by a decrease in the number of active earning OPTA VIA Coaches and lower productivity per active earning OPTA VIA Coach, partially offset by a pricing adjustment in the fourth quarter of 2022 and a $9.1 million impact from a timing difference related to changes in the Company’s sales order terms and conditions with its customers in the first quarter. The total number of active earning OPTA VIA Coaches for the three months ended December 31, 2023 decreased to 41,100 from 60,900 for the corresponding period in 2022, a decrease of 32.5%. The average revenue per active earning OPTA VIA Coach decreased 16.1% to $4,648 for the three months ended December 31, 2023 from $5,538 for the three months ended December 31, 2022. Decrease in the revenue per active earning OPTA VIA Coach for the quarter was driven by continued pressure on customer acquisition rates through the fourth quarter.
Costs of Sales: Cost of sales decreased $162.0 million, or 35.3%, to $296.2 million in 2023 from $458.2 million in 2022. This decrease in cost of sales was primarily driven by decreased volumes and the restructuring of certain external manufacturing agreements in 2022, partially offset by higher product costs resulting from inflationary pressures on raw ingredient costs, shipping costs, and labor costs.
Non-GAAP adjusted cost of sales were $296.2 million for 2023, a decrease of $149.8 million, or 33.6%, as compared to $446.0 million for 2022. 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 2023, gross profit decreased $364.6 million, or 32.0%, to $775.9 million from $1.140 billion in 2022. The decrease in gross profit was primarily attributable to lower revenue as well as cost inflation from raw ingredient costs, shipping
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costs, and labor costs, partially offset by restructuring costs of certain manufacturing agreements in 2022. As a percentage of sales, gross profit increased 110 basis points to 72.4% for 2023 from 71.3% for 2022. The increase in gross margin percentage was primarily due to cost savings from the Company's Fuel for the Future program and restructuring costs of certain manufacturing agreements 2022.
Non-GAAP adjusted gross profit was $775.9 million for 2023, a decrease of $376.8 million, or 32.7%, as compared to $1.153 billion for 2022.
Selling, General and Administrative: Selling, general and administrative (“SG&A”) expenses were $649.4 million in 2023, a decrease of $306.2 million, or 32.0%, as compared to $955.6 million in 2022, primarily due to decreased Coach compensation on lower volumes and fewer active earning Coaches, progress on several cost reduction and optimization initiatives, and charitable donations in 2022, partially offset by market research and investment costs related to medically supported weight loss activities. As a percentage of sales, SG&A expenses were 60.6% for 2023 as compared to 59.8% for 2022, primarily due to the loss of leverage on fixed costs due to lower sales volumes when compared to 2022 and market research and investment costs related to medically supported weight loss activities, partially offset by progress on several cost reduction and optimization initiatives and charitable donations in 2022. SG&A expenses included research and development costs of $4.6 million and $4.5 million for 2023 and 2022, respectively, in connection with the development of new products and programs and clinical research activities.
Non-GAAP adjusted SG&A expenses were $641.9 million for 2023, a decrease of $294.7 million, or 31.5%, as compared to $936.6 million for 2022. Non-GAAP adjusted SG&A expenses for 2023 exclude expenses in connection with the Company's IT and supply chain optimization and costs for the Collaboration. Non-GAAP adjusted SG&A expenses for 2022 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.
Income from operations: Income from operations in 2023 decreased $58.4 million to $126.4 million from $184.8 million in 2022 primarily as a result of decreased gross profit, partially offset by decreased SG&A expenses. Income from operations as a percentage of sales increased to 11.8% for 2023 as compared to 11.6% for 2022 due to the factors described above in the explanations from gross profit and SG&A expenses.
Non-GAAP adjusted income from operations in 2023 decreased to $134.0 million from $216.0 million in 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.
Provision for income taxes: For 2023, the Company recorded $29.4 million in income tax expense, an effective tax rate of 22.8%, as compared to $40.5 million in income tax expense and an effective tax rate of 22.0%, for 2022. The increase in the effective tax rate for 2023 as compared to 2022 was primarily driven by a decrease in the charitable contribution benefit and an increase in the limitation for executive compensation, partially offset by an increase in the research and development benefit and a decrease in state taxes.
Non-GAAP adjusted income tax provision was $31.1 million for 2023, an effective tax rate of 22.8%, compared to $51.8 million in 2022, an effective tax rate of 24.1%, primarily due to the decrease in state taxes and the impact of charitable donations. 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 $99.4 million, or $9.10 per diluted share, in 2023 as compared to $143.6 million, or $12.73 per diluted share, in 2022. The period-over-period changes were driven by the factors described above in the explanations from operations.
Non-GAAP adjusted net income was $105.2 million or $9.64 per diluted share for 2023 as compared to $163.5 million or $14.50 per diluted share for 2022. The period-over-period changes were driven by the factors described above in the Non-GAAP explanations from operations. 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, 2022 for management’s discussion and analysis of financial condition and results of operations for the fiscal year 2022 compared to fiscal year 2021.
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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 our quarterly reports, our quarterly earnings press releases and other public disclosures. The following GAAP financial measures have been presented for 2023 on an as-adjusted basis: cost of sales, gross profit, SG&A expenses, income from operations, other income (expense), provision for income taxes, net income and diluted earnings per share. Each of these as-adjusted financial measures for 2023 excludes the impact of certain amounts related to the Company IT and supply chain optimization efforts and collaboration costs to stand up the LifeMD relationship, 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, 2023
GAAP IT and Supply Chain Optimization
LifeMD Collaboration Costs (2)
Non-GAAP
Cost of sales $ 296,204 $ — $ — $ 296,204
Gross profit 775,850 — — 775,850
Selling, general, and administrative 649,448 (2,555) (5,000) 641,893
Income from operations 126,402 2,555 5,000 133,957
Other income
2,395 — — 2,395
Provision for income taxes 29,382 583 1,141 31,106
Net income 99,415 1,972 3,859 105,246
Diluted earnings per share (1)
9.10 0.18 0.35 9.64
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
(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.
(2) We expect the remaining $5.0 million of LifeMD Collaboration Costs to be recorded in 2024.
Liquidity and Capital Resources
The Company had stockholders’ equity of $201.5 million and working capital of $131.7 million at December 31, 2023 compared with $155.0 million and $81.9 million at December 31, 2022. The $46.4 million net increase in stockholders’ equity
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reflects $99.4 million in net income for 2023 offset by $3.6 million spent on repurchases of common stock and $54.6 million for dividends paid to holders of the Company’s 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’s cash, cash equivalents and investment securities increased to $150.0 million at December 31, 2023 from $87.7 million at December 31, 2022. In December 2023, the Company’s board of directors determined to change the Company’s capital allocation priorities and discontinued the Company’s quarterly cash dividend to support investments in technology and future growth. The decision to declare and pay dividends in the future will depend on general business conditions, the effect of such payments on our financial condition and other factors the Company’s board of directors consider relevant.
Net cash provided by operating activities decreased $46.9 million to $147.7 million for 2023 from $194.6 million for 2022 primarily as a result of a $44.2 million decrease in net income and adjustments to reconcile net income to cash provided by operating activities.
Net cash used in investing activities was $61.0 million for 2023 as compared to $11.4 million for 2022. This year-over-year change resulted primarily from a $54.6 million increase in cash used in the purchase of investment securities for 2023 as compared to 2022. Cash used in capital expenditures for 2023 expanded our technology and supply chain capabilities to support our planned growth.
Net cash used in financing activities decreased $119.8 million to $79.8 million for 2023 from $199.6 million for 2022. This decrease was primarily due to a $122.8 million decrease in stock repurchases, partially offset by a $1.8 million increase in net shares repurchased for employee taxes and a $1.4 million increase in cash dividends paid to stockholders.
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, 2023, 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 with a remaining term in excess of one year as of December 31, 2023 (in thousands):
2024 2025 - 2026 2027 - 2028 Thereafter Total
Operating leases (a)
$ 6,312 $ 11,245 $ 5,171 $ 240 $ 22,968
Unconditional purchase obligations (b)
47,041 22,186 2,955 — 72,182
Total contractual obligations 53,353 33,431 8,126 240 95,150
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(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 2023, the Company's business experienced a certain amount of inflation impact on raw ingredient, freight and supply chain labor. The Company previously increased sales prices for most of its products in November 2022 by an average of approximately 4.5%.
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