Description

Overview

FitLife Brands is a nutritional supplements company that has made significant strides since near bankruptcy in 2017.  FitLife’s management team (led by CEO Dayton Judd) orchestrated an impressive turnaround through significant cost reductions, focus on core high-margin products, and development of a high-growth, high-margin ecommerce channel. FitLife was recently able to find an accretive acquisition candidate, Mimi’s Rock, which will significantly increase earnings power, reduce customer concentration with GNC, and leverage FitLife’s substantial cash balance.  Annual adjusted EBITDA of the combined business will likely exceed $12M, placing FitLife shares around an attractive 7x EBITDA multiple.  I believe there is a strong likelihood FitLife is able to deliver better than expected EBITDA through significant cost reductions and other synergies.  I think the market has not adequately priced FitLife’s post-acquisition earnings power nor do I think enough credit is given to the quality of management and their excellent capital allocation.

After taking control of the business in 2018, FitLife’s new management team began developing their ecommerce capabilities with an eye towards material increases in sales over the long-term.  Management realized the long-term potential for their e-commerce channel in terms of sales but also the superior gross margins (50-60%+) versus their wholesale channel (35-40%).  Although immaterial at first, the growth in e-commerce sales very quickly gained traction and grew at eye-popping rates.  After growing at 21% YoY for the first half of 2022, online sales grew 20% YoY in the third quarter and 31% during October 2022.  While growth in online sales has slowed due to the larger base, this channel continues to grow well into the double digits and should continue to grow in 2023.  The rapid growth in their high-margin e-commerce channel since 2018 has been the biggest driving force behind their financial turnaround and has plenty more runway, as online sales (~$8-9M annualized) represent less than 15% of total sale of FitLife products to end customers (~75M/yr).

Once the business was in a good financial position in 2019, FitLife began looking at potential acquisitions and closed on its first acquisition, Nutrology, in April 2021.  While the acquisition was very small ($500k cash purchase price, ~$900k LTM Revs, $300k est. GP), it was immediately accretive as they essentially paid only 2-3x EBIT and very little if any SG&A was absorbed.  Nutrology’s product line mainly consists of grass-fed, Non-GMO, and other more vegetarian/vegan friendly supplement options.  Vegan-friendly and grass-fed products are faster growing segments of the nutritional supplement industry, giving FitLife more exposure, albeit small, to this attractive segment and widening their product offering. The company also believes it can significantly enhance distribution of the Nutrology products within their GNC and online channels, as well as expand the product line over time.  The company has entered into many NDAs to evaluate potential acquisition candidates since 2019 and are taking a strategic, disciplined approach as laid out below in their most recent investor presentation:

• Acquire brands that compete in complementary product categories, target new demographics, or bring incremental e-commerce skillset

• Where possible, deploy cash for acquisitions as opposed to equity

• Prioritize acquisitions that will be immediately accretive to earnings

• Reduce dependence on the company’s largest customer, GNC

FitLife’s recent acquisition of Mimi’s Rock meets all management’s stated objectives above.  I believe FitLife’s management team is uniquely positioned to take full advantage of Mimi’s weaknesses (bloated cost structure, weak balance sheet, high management comp.) given their proven experience in operational efficiency.  FitLife financed their acquisition of Mimi’s Rock with a combination of debt ($12.5M) and cash, presumably about $8M, which they expect to pay off within a year.  I believe they preserved a large portion of their cash balance to be able to act in case they find another accretive acquisition candidate.

I believe FTLF is an attractive investment opportunity run by a proven management team committed to building shareholder value trading at only 7x EBITDA. I believe it is likely FitLife continues to deploy capital selectively with accretive acquisitions and eventually the market will correctly assign a more appropriate multiple considering the long-term commitment and track-record to building shareholder value. 

Business

FitLife develops and markets nutritional supplements under nine different brands, primarily within the sports nutrition and diet categories. All production is outsourced to contract manufacturers in the US. A short description of each brand and their sales channels are listed below.

Historically, FitLife was a wholesaler of its products with little e-commerce presence.  Products were primarily sold through GNC and generated gross margins of roughly 35-40%.  Like legacy FitLife, iSatori (merged with in 2015) also sold primarily through wholesalers, albeit through more than just GNC (Walmart, Walgreens, CVS, etc.) and did have a small e-commerce footprint.  Leading up to 2018, the combined company experienced significant sales declines and the company was in default on its debt and behind on payables to suppliers.

  In 2018 when new management took over, they significantly reduced costs, recapitalized the company and reduced debt, and most importantly developed a new e-commerce business along with refreshing product branding/packaging. This strategy has proven very successful as their fast-growing e-commerce channel now makes up 25-30% of total sales and has much higher gross margins than their wholesale channel.  

GNC

A key misunderstanding of FTLF to-date has been a misinterpretation of their customer concentration with GNC, which was 65-70% of sales prior to the Mimi’s Rock acquisition.  Almost all of FitLife’s sales to GNC are to GNC franchisees, with whom they have a very strong, 20 year relationship.  Most brands who sell through GNC and their franchisees (and most nutritional supplement companies in general for that matter) spend a large percentage of their revenue on sales and marketing expenses to generate customer demand, often 10-20% of sales or more.  Rather than try and generate demand via this typical model, FitLife focuses on developing high-quality products at a low-cost coupled with a lean cost structure and provides their products to GNC franchisees at a more attractive price, allowing the franchisees to capture a larger portion of the margin and improving their profitability.  Looking at it another way, FitLife is incentivizing the franchisees themselves to act as their “outsourced” salesforce.  According to FitLife’s CEO, GNC franchisees generate higher profit margins from sales of FitLife’s brands than any other vendor.  

The value in this strategy was put to the test during GNC’s recent bankruptcy.  GNC sharply reduced its corporate owned store count from roughly 2,900 to fewer than 2,000 and also gave underperforming franchisees the option to close down, which ended up reducing franchise store count from 1,000 to fewer than 800.  Despite having a 20% reduction in franchise store count, FitLife product sales to GNC franchisees delivered single digit YoY growth for the 2nd half of 2020, and strong double-digit YoY growth YTD for 2021.  FitLife wrote-off $354,000 of GNC receivables in Q2 2020, but other than that emerged relatively unscathed from GNC’s bankruptcy. The key aspect of any franchise business is how well the franchisees are performing and FitLife’s results in light of the GNC bankruptcy speak to how much value they add to GNC franchisees.  This competitive advantage doesn’t eliminate the reality that GNC is the gorilla in the room and can exert leverage over FitLife and franchisees, but GNC’s franchise business is likely their most valuable segment and it’s in their best interest for franchisees to succeed.  I think this reality greatly reduces the likelihood of GNC taking extreme measures (removing FitLife products from GNC, forcibly capturing more margin by squeezing FitLife’s wholesale margins, etc.). 

Competition

The nutritional supplement industry is competitive with many players and low barriers to entry, although not many are publicly traded.  The industry is always changing due to consumer preferences and trends, so new entrants come and go and new product development is key to keep up with customer demand.  Although competitive, margins can be quite attractive once a product line or brand has garnered a loyal customer base.  FitLife’s differentiated strategy through the GNC franchisee channel, supplemented by their strong and growing e-commerce channel has allowed them to carve out a defensible and profitable niche in this competitive space. 

Management

• Dayton Judd (Chairman and CEO) - Prior to launching his own investment fund (Sudbury Capital) in 2012, Mr. Judd was a portfolio manager at Q Investments from 2007-2011, and prior to that worked for McKinsey & Co. for 9 years.

• Jakob York (CFO) - hired in Sept. 2022, experienced as controller and financial reporting manager at numerous other public companies, CPA. Hired as an upgrade from prior CFO and likely more capable to handle larger financial organization (integrating acquisitions, managing quarterly reporting, etc.)

Mr. Judd was already a significant shareholder before becoming CEO in early 2018 but purchased a large portion of his stake through the open market after becoming CEO, culminating in majority ownership and granting him effective control.  Mr. Judd has also been a large shareholder and/or board member in OTEL, MTEX, and RLJE.  It seems his preferred strategy is to work with management and sometimes take board seats but he’s willing to take a more aggressive approach if warranted, e.g., FitLife. In RLJE and OTEL, where Mr. Judd had a board seat, the company was ultimately sold.  The most likely way to monetize his controlling stake in FTLF is a sale of the company, although the timing of such a move is uncertain. 

As a fund manager and board member of a number of different public companies, I believe Mr. Judd values his own reputation and realizes any shareholder unfriendly actions at FitLife could jeopardize that. His majority ownership is a risk to minority shareholders, but given his actions to date and approach towards minority shareholders I believe the risk of him taking advantage of minority shareholders is low.  More specifically, after helping recapitalize the company through preferred stock issuance in 2018, he subsequently voluntarily converted 12% coupon preferred into common and in 2019, he provided debt financing to the company on more favorable terms than any willing third parties.

Share Structure

FitLife has only 4,988,271 common shares outstanding as of 9/30/22 of which less than half are in the public float.   The illiquid nature of the stock likely limits potential investors to small funds and individuals.  An uplisting to NASDAQ and/or a potential stock split could help improve volume, but FitLife will likely remain tightly held and relatively illiquid.

Financials

As discussed previously, the two driving forces behind FitLife’s turnaround have been a reduction in SG&A and the rapid growth of their e-commerce business.  FitLife doesn’t disclose margins for the online segment, only revenues, but knowing the wholesale channel is roughly 38% margin allows us to back into margins for online sales.  Wholesale channel gross margins of ~38% for 2018-2021 imply online gross margins of 66%.  FitLife is in an excellent position to continue growing earnings given the growing and very profitable e-commerce channel and the integration of Mimi’s Rock.  There is also the potential they continue to find suitable acquisition candidates at accretive prices given the strong BS and strong FCF generation.  I’m projecting 20-30% YoY growth in online sales for 2023.  FitLife also has roughly $10M of NOLs which should shield the company from cash taxes for the next year or so.

Valuation

~7x EV/EBITDA is a very attractive valuation for a business with this track record and a clear path of strong double digit earnings and FCF growth for the next couple years.  There are not many great comparables due to the lack of well-run (and profitable) small, publicly-traded nutritional supplement companies, but many larger comparables are valued at 11-13x EV/EBITDA.  Despite the customer concentration with GNC, I believe FitLife’s strong operating margins, growth prospects, and proven management team warrant at least a 9-10x EV/EBITDA multiple on an absolute basis, with further upside if they are able to capitalize on attractive acquisition candidates.  FitLife’s large cash balance and strong FCF put it in a great position to build value through accretive acquisitions which could lead to a sharp multiple re-rating once NASDAQ listed.

Summary

FitLife is a growing, highly cash-generative company trading at only 7x EV/EBITDA with a proven management team deploying excess capital to build shareholder value through accretive acquisitions, buybacks, or reinvesting in the business.  Although there aren’t many public comparables, 9-10x EBITDA would put FitLife on the low end vs. comps. I believe FitLife is trading at a very attractive valuation on an absolute basis as well.  I think the key catalysts which could cause the stock to re-rate closer to FV are the likely uplisting to NASDAQ, successful integration and synergies realized from Mimi’s Rock acquisition and continued business strength, and evidence of excellent capital allocation through additional accretive acquisitions.

Risks

• Largest shareholder has a majority stake and could take advantage of minority SHs

• Customer concentration through GNC is a key risk and margins via their wholesale channel could be compressed further

• The nutritional supplement industry has low barriers to entry and is continually subject to changing consumer tastes, necessitating innovation and responsive operations

• This is a low-float micro-cap security with limited liquidity and is likely only suitable for individuals or small funds

• Mimi’s Rock acquisition could fall through

Catalyst

-Market recognition of management track record of operational and capital allocation excellence

-further accretive acquisitions

-uplisting

-integration of Mimi's Rock acquisition