Description

Overview:

We recommend MED as a long.

Medifast, Inc. (the “Company” or “MED”) produces, distributes, and sells weight loss and weight management products and other health and diet products.  The Company has one manufacturing facility in Owings Mills, Maryland.

Medifast has two segments – Medifast and MWCC & Wholesale.  Medifast consists of Medifast Direct Marketing and Take Shape for Life (“TSFL”).  MWCC & Wholesale consists of Medifast Weight Control Centers (“MWCC”) and Wholesale Physicians. 

Investment Thesis:

Increased Market Penetration/Profitable Growth – MWCC has locations in 12 states and has the ability to become a national brand

• Obesity in the US has increased over the past 30 years and shows no sign of slowing down
  • Obesity is defined as a Body Mass Index (BMI) of 30 kg/m² or greater, whereas overweight is defined as a BMI ranging between 25 and 29.9 kg/m².
  • The formula is ; BMI =
    • mass (kg)/height (m)^² or
    • (mass (lb)/height (in)^²) x 703
  • US Center for Disease Control and Prevention reports that over 78 million US adults are obese
• By 2030, half of US adults will be categorized as obese
• Currently has a 2% market share and is growing faster than competitors, WTW, NTRI and Jenny Craig (privately held), due to “medical” credibility through Doctor and healthcare practitioner referral channel.
  • Industry growing at 4-5% and MED growing at 18-20%
• Future growth will come from opening franchised stores with a smaller footprint (not company owned stores) and opening new TSFL geographies.
• Company expects to open 5-7 franchise locations in 2013.  One location opened in Q1 13 and the remaining locations will open in the second half of 2013.
  • Plan to open 40 franchised locations in next 3 to 4 years
    • $400K of franchise revenue per unit is sent to parent company
    • Breakeven timeframe for each new location is 20 months
• TSFL program has recently been revamped with new leadership and extensive new training materials.  The impact is starting to show up in the numbers.  TSFL Health Coaches year over year growth has increased for the past 3 quarters and Monthly Revenue Per Health Coach year over year growth has increased for the past 5 quarters.  The fourth quarter has traditionally been weaker due to the holidays in November and December, but has improved year over year.

• The Company restructured TSFL and Health Centers and will realize increased profits and better margins going forward
  • SG&A increased during the restructuring due to clinic openings and clinic refurbishments.  Costs have come down over the past 4 quarters as restructuring is completed and product prices were increased in the beginning of 2013 for the first time in two years. The total amount of FCF has increased from $30.2mm (Q1 12 LTM) to $36.3mm (Q1 13 LTM)
  • Instituted Six Sigma principles that will deliver cost reductions; we believe there is an incremental 200 bps of manufacturing efficiencies over the next 24 months.
• International Expansion         
  • On June 13, 2012, the Company announced a strategic partnership with Productos Medix S.A. de C.V. ("Medix"), a leader in pharmaceutical obesity products in Mexico.  The agreement grants Medix an exclusive license for the distribution of Medifast meal replacement products and programs through physicians and Weight Control Centers in Mexico under the Medifast Brand.  Medix plans to work with its extensive physician network while it also opens approximately 30 Weight Control Centers over the next two years in Central and South American countries.  In Mexico, ~70% of the adult population is overweight or obese (21mm are clinically obese).  The rate of obesity growth in Mexico has grown the fastest in the entire world.  Mexico also ranks 6^th in the world for diabetes cases.
• Company/Management Changes:  Aside from Michael McDonald, CEO and Margaret Sheetz, COO (and niece of the CEO), the entire management team has been replaced during last 30 months
  • CEO’s family has a 10% ownership and is continuing to upgrade the people below senior management in order to improve organization
• CEO – Michael MacDonald – Became Executive Chairman in November 2011 and was promoted to CEO in February 2012.  Prior to this role, Mr. MacDonald was Executive Vice President of OfficeMax, overseeing the Contract Division – a $3.6 billion division of the OfficeMax Company. Mr. MacDonald has spent an additional 33 years in sales, marketing, and general management at Xerox Corporation.  The former CEO is Michael MacDonald’s brother and Michael took over the role of CEO after his brother’s death. 
• CFO – Timothy Robinson, CPA – Became CFO in February 2013.  Prior to joining Medifast he worked at Canon Business Solutions from 1995-2013 and held several positions including Vice President, Business and Operations.
• VP of Marketing – Brian Kagen – Became Executive Vice President and Chief Marketing Officer in September 2012 and overlooks all marketing of the business including brand, channel and product marketing as well as customer service and nutrition support.  He joined the company June 2011 prior to working at Black & Decker for 14 years in consumer product marketing.

Clean Balance Sheet and Strong Free Cash Flow Generation

• Debt is under $1mm and cash on the balance sheet is $68.9mm ($4.90 of cash per diluted share outstanding). 
• Management indicated on the first quarter call that they will review “strategic moves” and will have a share repurchase in the second half of the year. 
• LTM free cash flow generation was $36.3mm.

Valuation Not In-Line with Peers

• Direct selling peer group (comprised of AVP, NUS and TUP) trades for 12.0x median LTM EBITDA
• Weight management peer group (comprised of HLF, NTRI and WTW) trades for 9.0x median LTM EBITDA.  
• MED currently trades at 6.9x LTM EBITDA.  Applying a weight management peer group multiple of 9.0x LTM EBITDA implies a 25.3% increase in price.

Business Overview:

Medifast has two segments – Medifast and MWCC & Wholesale.  Medifast consists of Medifast Direct Marketing and Take Shape for Life (“TSFL”).  MWCC & Wholesale consists of Medifast Weight Control Systems (“MWCC”) and Wholesale Physicians. 

Medifast Direct is the direct-to-consumer channel and customers can order product from the website or by contacting the Company call center.  The products are shipped directly to the customer’s home and the business provides nutrition support through its team of registered dieticians. 

Take Shape for Life is the personal coaching division of the Company.  Health Coaches provide coaching and support to clients on Medifast weight-loss programs.  Health Coaches, who have knowledge of all Medifast programs and products, give clients the mentoring and assistance needed to help them achieve weight loss.  Health Coaches are independent contractors and are compensated through commissions and bonuses. 

Health Coaches earn commissions by referring product sales to clients.  The clients order and pay for products, and the order is shipped directly from the Company to the client’s home. Health Coaches do not handle payments and are not required to purchase or store products in order to receive a commission. Furthermore, Health Coaches do not receive a commission on their own personal product orders and Health Coaches pay the same price for products as their clients. The Company pays retail commissions to Health Coaches on a weekly basis.

Health Coaches have several bonus opportunities, including growth bonuses, generation bonuses, elite leadership bonuses, rolling consistency bonuses, client acquisition bonuses, and new Health Coach assist bonuses.  Health Coaches are not compensated for recruitment of new Coaches.  

• 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 bonuses that enable Health Coaches to earn income on product orders placed by clients or Health Coaches within their network.
• 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.
• 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.
• 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.
• 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.
• The assist bonuses are paid to Health Coaches who assist a newly sponsored Health Coach attain the Client acquisition bonus

The Company pays bonuses on a monthly basis to qualified Health Coaches.  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.

Medifast Weight Control Centers are the brick and mortar clinics with locations in Pennsylvania, New Jersey, Delaware, Texas, Florida, Maryland, North Carolina and Virginia.  The Centers offer all Medifast weight loss programs and patient counseling and monitoring.  There are 50 company owned locations, 36 franchised locations and 86 total locations. The Company has been franchising locations since 2008 and franchisees receive no products or equipment at a discounted purchase price.  Also, the Company does not offer direct or indirect financing. 

Wholesale Physicians are physicians across the United States who carry an inventory of Medifast products and resell them to patients.  Medifast physicians have been using the Medifast Program within their practices since 1980.  They also provide appropriate medical monitoring, testing, and support for patients on the Medifast Program.

For the LTM period, Medifast Direct accounted for 23.3%, Take Shape for Life accounted for 61.1% and MWCC and Wholesale Physicians accounted for 15.5% of sales, respectively.

Risks:

1)      Direct selling model under scrutiny:  There are concerns that the business is a Ponzi scheme – it is not.   The primary way a Health Coach is compensated is through earning commissions on product sold and through bonus opportunities.  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 cost and no commissions are paid thereafter. 

2)      Owned Control Centers undergoing turnaround and will likely be franchised over the next 24 months: Q1 MWCC comparable store sales decline of 15% - due to transition from owned centers to       franchised centers and impact from economy on discretionary spending.  Management has committed to achieving a healthy return on its existing centers and opening no new owned centers.  The           move toward a franchised model is already begun to show up in the P&L as year over year profit increased $2.8mm for MWCC segment

3)      Modified marketing strategy: The Company is shifting some dollars from its traditional direct marketing and “call to action campaign” to its new national adverting brand campaign.  The Company is also focusing on optimizing e-commerce performance by producing better online content in order to build the brand.  A lot of MED’s growth comes from its advertising efforts and future advertising may not result in sales increases.   However, brand awareness is 24% in the United States and management believes there is ample opportunity to grow their brand as they enter new regions with TSL and the franchised MWCCs.

4)      Channel Conflict:  The Company sees its unique multi-channel approach to market as an advantage over its competitors.  The downside is the risk of channel conflict which may be further acerbated by the shift in marketing strategy

5)      New weight loss drug:  The FDA has not approved a weight loss drug in 13 years until recently approving Belviq and Qsymia in June of 2012.  While the potential impact of these drugs is an               indeterminate risk, the size of the market and its memory of the serious side effects of older weight loss drugs like Fen Phen should mitigate this risk.

6)      Family business: The former CEO is Michael MacDonald’s brother and Michael took over the role of CEO after his brother’s death.  Also, Margaret Sheetz, COO, is the niece of Michael McDonald.           However, the family owns 10% of the shares outstanding so their interests are aligned with shareholders.

Summary:

The company added a new management team, has improved operating metrics, is increasing market share, and generates lots of free cash with likely share buy-backs in the latter half of the year

Catalyst