UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-23016
MEDIFAST, INC.
(Exact name of registrant as specified in its charter)
Delaware | | 13-3714405 |
(State or other jurisdiction of organization) | | (I.R.S. employer Identification no.) |
11445 Cronhill Drive
Owings Mills, MD 21117
Telephone Number (410) 581-8042
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | | Outstanding at May 9,
2008 |
| Common stock, $.001 par value per share | | 13,814,098 shares |
Index
Part I | |
Financial Information: | |
| | |
| Condensed Consolidated Balance Sheets – | |
| March 31, 2008 (unaudited) and December 31, 2007 (audited) | 3 |
| | |
| Condensed Consolidated Statements of Income – | |
| Three Months Ended March 31, 2008 and 2007 (unaudited) | 4 |
| | |
| Condensed Consolidated Statements of Cash Flows – | |
| Three Months Ended March 31, 2008 and 2007 (unaudited) | 5 |
| | |
| Notes to Condensed Consolidated Financial Statements (unaudited) | 6 |
| | |
| Management Discussion and Analysis of Financial Condition | |
| And Results of Operations | 12 |
| | |
Part II | |
| | |
| Exhibits | 17 |
| EX 31.1 | |
| |
| EX 32.1 | |
MEDIFAST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| | | March 31, 2008 | | December 31, 2007 | |
| | | (Unaudited) | | (Audited) | |
ASSETS | | | | | |
Current assets: | | | | | |
| Cash and cash equivalents | | $ | 1,407,000 | | $ | 2,195,000 | |
| Accounts receivable-net of allowance for doubtful accounts of $100,000 | | | 475,000 | | | 493,000 | |
| Inventory | | | 9,973,000 | | | 9,181,000 | |
| Investment securities | | | 1,405,000 | | | 1,439,000 | |
| Deferred compensation | | | 723,000 | | | 814,000 | |
| Prepaid expenses and other current assets | | | 3,245,000 | | | 2,727,000 | |
| Prepaid income tax | | | 143,000 | | | - | |
| Note receivable - current | | | 180,000 | | | 180,000 | |
| Deferred tax asset | | | 82,000 | | | 100,000 | |
Total Current Assets | | | 17,633,000 | | | 17,129,000 | |
| | | | | | | | |
| Property, plant and equipment - net | | | 19,150,000 | | | 17,031,000 | |
| Trademarks and intangibles - net | | | 6,897,000 | | | 7,356,000 | |
| Deferred tax asset, net of current portion | | | 897,000 | | | 897,000 | |
| Note receivable, net of current portion | | | 1,180,000 | | | 1,212,000 | |
| Other assets | | | 301,000 | | | 99,000 | |
TOTAL ASSETS | | $ | 46,058,000 | | $ | 43,724,000 | |
| | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | |
Current liabilities: | | | | | | | |
| Accounts payable and accrued expenses | | $ | 5,382,000 | | $ | 4,279,000 | |
| Income taxes payable | | | - | | | 592,000 | |
| Line of credit | | | 2,176,000 | | | 1,599,000 | |
| Current maturities of long-term debt | | | 257,000 | | | 264,000 | |
Total Current Liabilities | | | 7,815,000 | | | 6,734,000 | |
| | | | | | | | |
| Long-term debt, net of current portion | | | 4,505,000 | | | 4,570,000 | |
Total Liabilities | | | 12,320,000 | | | 11,304,000 | |
| | | | | | | | |
Stockholders' Equity: | | | | | | | |
| | | | | | | | |
| Common stock; par value $.001 per share; 20,000,000 authorized; 13,814,098 and 13,709,098 shares issued and outstanding, respectively | | | 14,000 | | | 14,000 | |
| Additional paid-in capital | | | 27,225,000 | | | 26,953,000 | |
| Accumulated other comprehensive income | | | 154,000 | | | 321,000 | |
| Retained Earnings | | | 11,183,000 | | | 9,818,000 | |
| | | | 38,576,000 | | | 37,106,000 | |
| | | | | | | | |
| Less: cost of 270,534 and 270,534 shares of common stock in treasury | | | (1,971,000 | ) | | (1,971,000 | ) |
| Less: unearned compensation | | | (2,867,000 | ) | | (2,715,000 | ) |
Total Stockholders' Equity | | | 33,738,000 | | | 32,420,000 | |
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY | | $ | 46,058,000 | | $ | 43,724,000 | |
See accompanying notes to condensed consolidated financial statements.
MEDIFAST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
| | | Three Months Ended March 31, | |
| | | | | (Restated) | |
| | | 2008 | | 2007 | |
| | | (Unaudited) | | (Unaudited) | |
| | | | | | |
| Revenue, net | | $ | 25,169,000 | | $ | 20,089,000 | |
| Cost of sales | | | 6,100,000 | | | 5,058,000 | |
Gross Profit | | | 19,069,000 | | | 15,031,000 | |
| | | | | | | | |
| Selling, general, and administration | | | 17,007,000 | | | 13,117,000 | |
| | | | | | | | |
Income from operations | | | 2,062,000 | | | 1,914,000 | |
| | | | | | | | |
| Other income/(expense) | | | | | | | |
| Interest expense | | | (103,000 | ) | | (95,000 | ) |
| Interest income | | | 38,000 | | | 33,000 | |
| Other expense | | | 36,000 | | | 51,000 | |
| | | | (29,000 | ) | | (11,000 | ) |
| | | | | | | | |
Net income before provision for income taxes | | | 2,033,000 | | | 1,903,000 | |
| Provision for income tax (expense) | | | (668,000 | ) | | (530,000 | ) |
| | | | | | | | |
Net income | | $ | 1,365,000 | | $ | 1,373,000 | |
| | | | | | | | |
| Basic earnings per share | | $ | 0.10 | | $ | 0.11 | |
| Diluted earnings per share | | $ | 0.10 | | $ | 0.10 | |
| | | | | | | | |
| Weighted average shares outstanding - | | | | | | | |
| Basic | | | 13,101,157 | | | 12,899,543 | |
| Diluted | | | 13,799,293 | | | 13,690,788 | |
See accompanying notes to condensed consolidated financial statements.
MEDIFAST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | Three Months Ended March 31, | |
| | | | | (Restated) | |
| | | 2008 | | 2007 | |
| | | (Unaudited) | | (Unaudited) | |
| Cash flows from operating activities: | | | | | |
| Net income | | $ | 1,365,000 | | $ | 1,373,000 | |
Adjustments to reconcile net income to net cash provided by operating activities from continuing operations: | | | | | | | |
| Depreciation and amortization | | | 1,079,000 | | | 786,000 | |
| Realized loss on investment securities | | | 36,000 | | | 32,000 | |
| Common stock issued for services | | | 35,000 | | | 21,000 | |
| Stock options vested during period | | | - | | | 77,000 | |
| Stock options cancelled during period | | | (77,000 | ) | | - | |
| Excess tax benefits from share-based payment arrangements | | | - | | | 30,000 | |
| Vesting of unearned compensation | | | 148,000 | | | 164,000 | |
| Net change in other comprehensive (loss) income | | | (167,000 | ) | | 14,000 | |
| Deferred income taxes | | | 18,000 | | | (88,000 | ) |
| | | | | | | | |
| Changes in assets and liabilities: | | | | | | | |
| (Increase) decrease in accounts receivable | | | 18,000 | | | (76,000 | ) |
| (Increase) in inventory | | | (792,000 | ) | | (452,000 | ) |
| (Increase) in prepaid expenses & other current assets | | | (518,000 | ) | | (885,000 | ) |
| (Increase) decrease in deferred compensation | | | 91,000 | | | (125,000 | ) |
| (Increase) in prepaid taxes | | | (143,000 | ) | | - | |
| (Increase) in other assets | | | (202,000 | ) | | (6,000 | ) |
| Increase in accounts payable and accrued expenses | | | 1,103,000 | | | 701,000 | |
| Increase (decrease) in income taxes payable | | | (592,000 | ) | | 154,000 | |
| Net cash provided by operating activities | | | 1,402,000 | | | 1,720,000 | |
| | | | | | | | |
| Cash Flow from Investing Activities: | | | | | | | |
| (Purchase) sale of investment securities, net | | | (4,000 | ) | | 97,000 | |
| (Purchase) of property and equipment | | | (2,735,000 | ) | | (1,044,000 | ) |
| (Purchase) of intangible assets | | | (2,000 | ) | | (240,000 | ) |
| Net cash (used in) investing activities | | | (2,741,000 | ) | | (1,187,000 | ) |
| | | | | | | | |
| Cash Flow from Financing Activities: | | | | | | | |
| Issuance of common stock, options and warrants | | | 12,000 | | | 24,000 | |
| (Repayment) of long-term debt, net | | | (71,000 | ) | | (137,000 | ) |
| Increase in line of credit | | | 577,000 | | | 650,000 | |
| Decrease in note receivable | | | 33,000 | | | 41,000 | |
| Excess tax benefits from share-based payment arrangements | | | - | | | (30,000 | ) |
| (Purchase) of treasury stock | | | - | | | (309,000 | ) |
| Net cash provided by financing activities | | | 551,000 | | | 239,000 | |
| | | | | | | | |
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | (788,000 | ) | | 772,000 | |
| | | | | | | | |
| Cash and cash equivalents - beginning of the period | | | 2,195,000 | | | 1,085,000 | |
| Cash and cash equivalents - end of period | | $ | 1,407,000 | | $ | 1,857,000 | |
| | | | | | | | |
| Supplemental disclosure of cash flow information: | | | | | | | |
| Interest paid | | $ | 103,000 | | $ | 95,000 | |
| Income taxes | | $ | 1,489,000 | | $ | 464,000 | |
| | | | | | | | |
| Supplemental disclosure of non cash activity: | | | | | | | |
| Common stock issued to Directors over 3-year vesting period | | $ | 195,000 | | $ | - | |
| Options vested during period | | $ | - | | $ | 77,000 | |
| Options cancelled during period | | $ | (77,000 | ) | $ | - | |
| Common stock issued for services | | $ | 35,000 | | $ | 21,000 | |
See accompanying notes to condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements
General
The condensed unaudited interim consolidated financial statements included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The condensed consolidated financial statements and notes are presented as permitted on Form 10-Q and do not contain information included in the Company’s annual statements and notes. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the December 31, 2007 audited consolidated financial statements and the accompanying notes thereto. While management believes the procedures followed in preparing these condensed consolidated financial statements are reasonable, the accuracy of the amounts are in some respects dependent upon the facts that will exist, and procedures that will be accomplished by the Company later in the year.
These condensed unaudited consolidated financial statements reflect all adjustments, including normal recurring adjustments, which, in the opinion of management, are necessary to present fairly the operations and cash flows for the period presented.
2. Presentation of Financial Statements
The Company’s condensed consolidated financial statements include the accounts of Medifast, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
3. Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"), which clarifies the definition of fair value whenever another standard requires or permits assets or liabilities to be measured at fair value. Specifically, the standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability, and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS No. 157 does not expand the use of fair value to any new circumstances, and must be applied on a prospective basis except in certain cases. The standard also requires expanded financial statement disclosures about fair value measurements, including disclosure of the methods used and the effect on earnings.
In February 2008, FASB Staff Position ("FSP") FAS No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP No. 157-2") was issued. FSP No. 157-2 defers the effective date of SFAS No. 157 to fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Examples of items within the scope of FSP No. 157-2 are nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods), and long-lived assets, such as property, plant and equipment and intangible assets measured at fair value for an impairment assessment under SFAS No. 144.
The partial adoption of SFAS No. 157 on January 1, 2008 with respect to financial assets and financial liabilities recognized or disclosed at fair value in the financial statements on a recurring basis did not have a material impact on the Company's consolidated financial statements. See Note 12 for the fair value measurement disclosures for these assets and liabilities. The Company is in the process of analyzing the potential impact of SFAS No. 157 relating to its planned January 1, 2009 adoption of the remainder of the standard.
On January 1, 2008 (the first day of fiscal 2008), the Company adopted SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115" ("SFAS No. 159"). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value, which are not otherwise currently required to be measured at fair value. Under SFAS No. 159, the decision to measure items at fair value is made at specified election dates on an instrument-by-instrument basis and is irrevocable. Entities electing the fair value option are required to recognize changes in fair value in earnings and to expense upfront costs and fees associated with the item for which the fair value option is elected. The new standard did not impact the Company's Condensed Consolidated Financial Statements as the Company did not elect the fair value option for any instruments existing as of the adoption date. However, the Company will evaluate the fair value measurement election with respect to financial instruments the Company enters into in the future.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS No. 141(R)"). SFAS No. 141(R) changes how an entity accounts for the acquisition of a business. While it retains the requirement to account for all business combinations using the acquisition method, the new rule will apply to a wider range of transactions or events and requires, in general, acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed and non-controlling ownership interests held in the acquire, among other items. The Company is beginning to review the provisions of SFAS No. 141(R), which applies prospectively to business combinations with an acquisition date on or after the beginning of its 2009 fiscal year.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements: an amendment of ARB No. 51" ("SFAS No. 160"). SFAS No. 160 replaces the term minority interests with the newly-defined term of non-controlling interests and establishes this line item as an element of stockholders' equity, separate from the parent's equity. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. The Company is continuing to review the provisions of SFAS No. 160, which is effective the first quarter of fiscal 2009, and currently does not expect this new accounting standard to have a significant impact on the Consolidated Financial Statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities: an amendment of FASB Statement No. 133" ("SFAS No. 161"). SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. The Company is reviewing the provisions of SFAS No. 161, which is effective the first quarter of fiscal 2009, and currently does not anticipate that this new accounting standard will have a significant impact on the Consolidated Financial Statements.
Revenue is recognized net of discounts, rebates, promotional adjustments, price adjustments, returns and other potential adjustments upon shipment and passing of risk to the customer and when estimates of are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations.
Inventories consist principally of finished packaged foods, packaging and raw materials held in either the Company’s manufacturing facility or distribution warehouse. Inventories are valued at cost determined using the first-in, first-out (FIFO) method.
6. Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 142 “Goodwill and Other Intangible Assets”. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, “Intangible Assets”. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.
In addition, the Company has acquired other intangible assets, which include: customer lists, non-compete agreements, trademarks, patents, and copyrights. The non-compete agreements are fully amortized as of December 31, 2007. The customer lists are being amortized over a period ranging between 5 and 7 years based on management’s best estimate of the expected benefits to be consumed or otherwise used up. The costs of patents and copyrights are amortized over 5 and 7 years based on their estimated useful life, while trademarks representing brands with an infinite life, and are carried at cost and tested annually for impairment as outlined below. Goodwill and other intangible assets are tested annually for impairment in the fourth quarter, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. The Company assesses the recoverability of its goodwill and other intangible assets by comparing the projected undiscounted net cash flows associated with the related asset, over their remaining lives, in comparison to their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.
| | | As of March 31, 2008 | | As of December 31, 2007 | |
| | | | | | | | | | |
| | | Gross Carrying | | Accumulated | | Gross Carrying | | Accumulated | |
| | | Amount | | Amortization | | Amount | | Amortization | |
| | | | | | | | | | |
| | | | | | | | | | |
| Customer lists | | $ | 8,332,000 | | $ | 3,467,000 | | $ | 8,332,000 | | $ | 3,065,000 | |
| Trademarks, patents, and copyrights | | | | | | | | | | | | | |
| finite life | | | 1,628,000 | | | 505,000 | | | 1,626,000 | | | 446,000 | |
| infinite life | | | 909,000 | | | - | | | 909,000 | | | - | |
| Total | | $ | 10,869,000 | | $ | 3,972,000 | | $ | 10,867,000 | | $ | 3,511,000 | |
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Amortization expense for the three months ended March 31, 2008 and 2007 was as follows: |
| | | | | | | | | | | | (Restated) | |
| | | | | | | | | 2008 | | 2007 | |
| Customer lists | | | | | | | | $ | 402,000 | | $ | 239,000 | |
| Trademarks and patents | | | | | | | | | 59,000 | | | 58,000 | |
| | | | | | | | | | | | | | |
| Total Trademarks and Intangibles | | | | | | | | $ | 461,000 | | $ | 297,000 | |
| | | | | | | | | | | | | | |
| Amortization expense is included in selling, general and administrative expenses. | | | | | | |
7. Fixed Assets
Fixed assets are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets, which are generally three to seven years. Leasehold improvements and equipment under capital leases are amortized on a straight-line basis over the lesser of the estimated useful life of the asset or the related lease terms. Expenditures for repairs and maintenance are charged to expense as incurred, while major renewals and improvements are capitalized.
8. Note Receivable
Medifast realized a $1,503,000 note receivable as a result of the sale of Consumer Choice Systems on January 17, 2006 to a former board member. The note has a 10-year term with imputed interest of 4% collateralized by 50,000 shares of Medifast stock and all the assets of Consumer Choice Systems. The amount of principal to be collected over each of the next 5 years is $183,000 per year with the remaining amount collectible thereafter of $495,000.
9. Income Per Common Share
Basic income per share is calculated by dividing net income by the weighted average number of outstanding common shares during the year. Basic income per share excludes any dilutive effects of options, warrants and other stock-based compensation.
10. Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
11. Deferred Compensation Plans
We maintain a non-qualified deferred compensation plan for Senior Executive management. Currently, Bradley MacDonald is the only participant in the plan. Under the deferred compensation plan that became effective in 2003, executive officers of the Company may defer a portion of their salary and bonus (performance-based compensation) annually. A participant may elect to receive distributions of the accrued deferred compensation in a lump sum or in installments upon retirement
Each participating officer may request that the deferred amounts be allocated among several available investment options established and offered by the Company. These investment options provide market rates of return and are not subsidized by the Company. The benefit payable under the plan at any time to a participant following termination of employment is equal to the applicable deferred amounts, plus or minus any earnings or losses attributable to the investment of such deferred amounts. The Company has established a trust for the benefit of participants in the deferred compensation plan. Pursuant to the terms of the trust, as soon as possible after any deferred amounts have been withheld from a plan participant, the Company will contribute such deferred amounts to the trust to be held for the benefit of the participant in accordance with the terms of the plan and the trust.
Retirement payouts under the plan upon an executive officer’s retirement from the Company are payable either in a lump-sum payment or in annual installments over a period of up to ten years. Upon death, disability or termination of employment, all amounts shall be paid in a lump-sum payment as soon as administratively feasible.
12. Fair Value Measurements
On January 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, provides a consistent framework for measuring fair value under Generally Accepted Accounting Principles and expands fair value financial statement disclosure requirements. SFAS 157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. SFAS 157 classifies these inputs into the following hierarchy:
Level 1 Inputs– Quoted prices for identical instruments in active markets.
Level 2 Inputs– Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs– Instruments with primarily unobservable value drivers.
The following table represents the fair value hierarchy for those financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2008.
Fair Value Measurements on a Recurring Basis as of March 31, 2008
| Assets | | Level I | | Level II | | Level III | | Total | |
| | | | | | | | | | |
| Investment securities | | $ | 1,405,000 | | | - | | | - | | $ | 1,405,000 | |
| Cash equivalents | | | 1,407,000 | | | - | | | - | | | 1,407,000 | |
| Total Assets | | $ | 2,812,000 | | $ | - | | $ | - | | $ | 2,812,000 | |
| Liabilities | | | - | | | - | | | - | | | - | |
| Total Liabilities | | $ | - | | $ | - | | $ | - | | $ | - | |
Stock-Based Compensation
Effective December 31, 2005, the Company adopted the provisions of Financial Accounting Standards Board Statement of Financial Accounting Standard (“SFAS”) No. 123(R), “Share-Based Payments,” which establishes the accounting for employee stock-based awards. Under the provisions of SFAS No.123(R), stock-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The Company adopted SFAS No. 123(R) using the modified prospective method and, as a result, periods prior to December 31, 2005 have not been restated. The Company recognized stock-based compensation for awards issued under the Company’s stock option plans in other income/expenses included in the Condensed Consolidated Statement of Operations. Additionally, no modifications were made to outstanding stock options prior to the adoption of SFAS No. 123(R), and no cumulative adjustments were recorded in the Company’s financial statements.
Unearned compensation represents shares issued to executives that will be vested over a 5-6 year period. These shares will be amortized over the vesting period in accordance with FASB 123(R). The expense related to the vesting of unearned compensation was $148,000 and $164,000 at March 31, 2008 and March 31, 2007, respectively. Expense related to vesting of options under FASB 123R was $0 and $20,000 at March 31, 2008 and March 31, 2007, respectively.
The following summarizes the stock option activity for the Three Months ended March 31, 2008:
| | | Shares | | Weighted Average Exercise Price | | Weighted Average Contractual Term (Years) | |
| | | | | | | | |
| Outstanding, December 31, 2007 | | | 291,300 | | | 4.19 | | | | |
| Options granted | | | | | | | | | | |
| Options reinstated | | | | | | | | | | |
| Options exercised | | | (25,000 | ) | | 0.50 | | | | |
| Options forfeited or expired | | | (100,000 | ) | | 6.25 | | | | |
| | | | | | | | | | | |
| Outstanding March 31, 2008 | | | 166,300 | | | 3.50 | | | 1.90 | |
| Options exercisable, March 31, 2008 | | | 166,300 | | | 3.50 | | | 1.90 | |
| | | | | | | | | | | |
| Options available for grant at March 31, 2008 | | | 1,056,200 | | | | | | | |
The March 31, 2007 financial statements have been restated to increase amortization expense on customer lists by $84,000. Pre-tax income decreased by $84,000 for the quarter-ended March 31, 2007 from $1,987,000 to $1,903,000. Net income for the quarter-ended March 31, 2007 decreased by $49,000 from $1,422,000 to $1,373,000 and retained earnings decreased from $7,403,000 to $7,354,000.
15. Reclassifications
Certain amounts for the quarter ended March 31, 2007 have been reclassified to conform to the presentation of the March 31, 2008 amounts. The reclassifications have no effect on net income for the quarters ended March 31, 2008 and 2007.
16. Business Segments
Operating segments are components of an enterprise about which separate financial information is available that is regularly reviewed by the chief operating decision maker about how to allocate resources and in assessing performance. The Company has two reportable operating segments: Medifast and All Other. The Medifast reporting segment consists of the following distribution channels: Medifast Direct, Take Shape for Life, and Doctors. The All Other reporting segments consist of Hi-Energy and Medifast Weight Control Centers and the Company’s parent company operations.
The accounting policies of the segments are the same as those of the Company. The presentation and allocation of assets, liabilities and results of operations may not reflect the actual economic costs of the segments as stand-alone businesses. If a different basis of allocation were utilized, the relative contributions of the segments might differ, but management believes that the relative trends in segments would likely not be impacted.
The following table’s present segment information for the three months ended March 31, 2008 and 2007:
| | | Three Month Ended March 31, 2008 | |
| | | Medifast | | All Other | | Eliminations | | Consolidated | |
| | | | | | | | | | |
| Revenues, net | | | 23,480,000 | | | 1,689,000 | | | | | | 25,169,000 | |
| Cost of Sales | | | 5,727,000 | | | 373,000 | | | | | | 6,100,000 | |
| Other Selling, General and Adminstrative Expenses | | | 14,415,000 | | | 1,607,000 | | | | | | 16,022,000 | |
| Depreciation and Amortization | | | 842,000 | | | 237,000 | | | | | | 1,079,000 | |
| Interest (net) | | | (10,000 | ) | | (55,000 | ) | | | | | (65,000 | ) |
| Provision for income taxes | | | 668,000 | | | | | | | | | 668,000 | |
| Net income (loss) | | | 1,838,000 | | | ($473,000 | ) | | | | | 1,365,000 | |
| | | | | | | | | | | | | | |
| Segment Assets | | | 27,083,000 | | | 18,973,000 | | | | | | 46,056,000 | |
| | | Three Month Ended March 31, 2007 (Restated) | |
| | | Medifast | | All Other | | Eliminations | | Consolidated | |
| | | | | | | | | | |
| Revenues, net | | | 19,037,000 | | | 1,052,000 | | | | | | 20,089,000 | |
| Cost of Sales | | | 4,827,000 | | | 231,000 | | | | | | 5,058,000 | |
| Other Selling, General and Adminstrative Expenses | | | 11,082,000 | | | 1,198,000 | | | | | | 12,280,000 | |
| Depreciation and Amortization | | | 657,000 | | | 129,000 | | | | | | 786,000 | |
| Interest (net) | | | (8,000 | ) | | 70,000 | | | | | | 62,000 | |
| Provision for income taxes | | | 530,000 | | | | | | | | | 530,000 | |
| Net income (loss) | | | 1,949,000 | | | ($576,000 | ) | | | | | 1,373,000 | |
| | | | | | | | | | | | | | |
| Segment Assets | | | 23,831,000 | | | 15,581,000 | | | | | | 39,412,000 | |
Management Discussion and Analysis of
Financial Condition and Results of Operations
Except for the historical information contained herein, this Report on Form 10-Q contains certain forward-looking statements that involve substantial risks and uncertainties. When used in this Report, the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions, as they relate to Medifast, Inc. or its management, are intended to identify such forward-looking statements. The Company’s actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Accordingly, there is no assurance that the results in the forward-looking statements will be achieved.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in Note 2 of the consolidated financial statements.
The preparation of these 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 estimates to be the most critical in preparing our consolidated financial statements. These critical accounting estimates have been discussed with our audit committee.
Revenue Recognition. Revenue is recognized net of discounts, rebates, promotional adjustments, price adjustments, returns and other potential adjustments upon shipment and passing of risk to the customer and when estimates of are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations.
Impairment of Fixed Assets and Intangible Assets. We continually assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Judgments regarding the existence of impairment indicators are based on legal factors, market conditions and our operating performance. Future events could cause us to conclude that impairment indicators exist and the carrying values of fixed and intangible assets may be impaired. Any resulting impairment loss would be limited to the value of net fixed and intangible assets.
Income Taxes. In the preparation of consolidated financial statements, the Company estimates income taxes based on diverse legislative and regulatory structures that exist in jurisdictions where the company conducts business. Deferred income tax assets and liabilities represent tax benefits or obligations that arise from temporary differences due to differing treatment of certain items for accounting and income tax purposes. The Company evaluates deferred tax assets each period to ensure that estimated future taxable income will be sufficient in character amount and timing to result in their recovery. A valuation allowance is established when management determines that it is more likely than not that a deferred tax asset will not be realized to reduce the assets to their realizable value. Considerable judgments are required in establishing deferred tax valuation allowances and in assessing probable exposures related to tax matters. The Company’s tax returns are subject to audit and local taxing authorities that could challenge the company’s tax positions. The Company believes it records and/or discloses such potential tax liabilities as appropriate and has reasonably estimated its income tax liabilities and recoverable tax assets.
Allowance for doubtful accounts. In determining the adequacy of the allowance for doubtful accounts, we consider a number of factors including the aging of the receivable portfolio, customer payment trends, and financial condition of the customer, industry conditions and overall credibility of the customer. Actual amounts could differ significantly from our estimates.
General
Three Months Ended March 31, 2008 and March 31, 2007
Revenue: Revenue increased to $25.2 million for the first three months of 2008 compared to $20.1 million for the first three months of 2007, an increase of $5.1 million or 25%. The direct marketing sales channel accounted for 51% of total revenue, Take Shape for Life 39%, doctors 3%, and brick and mortar clinics 7%. As compared to the first three months of 2007, the direct marketing sales channel, which is fueled primarily by consumer advertising, increased revenues by approximately 6% year-over year. Take Shape for Life sales, which are fueled by person-to-person recruiting and support increased by 63% compared to the first quarter of 2007. The Company’s doctor’s sales decreased by 25% and The Medifast Weight Control Centers increased sales by 75% as compared to the first quarter of 2007.
The Take Shape for Life division grew 63% year-over-year. This growth can largely be attributed to the tools and training that led to an increase in the ability of the division to both promote growth in recruiting of health coaches, as well as better supporting this growth as it occurs. This continued investment proved to be a large part of the current growth trends in Take Shape for Life sales, as well as the number of active health coaches. The number of active health coaches grew to 2,200 at the end of the first quarter of 2008 as compared to 1,350 for the same time period in 2007, an increase of 63%. The Company believes that the growth in health coach activity is a positive trend that should continue, and will lead to significant revenue growth in the near future.
The Medifast Weight Control Centers, which represent approximately 7% of the Company’s overall revenues, are currently operating in 14 locations in Dallas, Houston, and Orlando. In the first three months of 2008, the Company experienced revenue growth of 62% versus the same time period last year. The average monthly revenue per clinic also witnessed significant growth of 35%, averaging $39,000 per clinic in the first quarter of 2008 as compared to $29,000 in the first quarter of 2007. In the expanding Dallas, TX market, the average monthly revenue per clinic is approximately $50,000. In the estimated $40 billion weight loss and health living industry, the brick and mortar clinic model has always made up a significant portion of overall sales. The recent growth in the Medifast Weight Control Centers has proven that the model is in high demand from a select portion of the weight loss consumers. Throughout 2007, the Company invested in the infrastructure of its clinic model. The major aspects of the investment in this division included an expanded executive team, the creation of a point of sale system, a robust customer data tracking system, and finalizing the franchise opportunity documentation. During the first quarter of 2008, the Company opened four additional corporately owned clinics in the Houston, TX market. The Company plans on opening four additional corporately owned clinics in the Houston market by the end of the second quarter of 2008 as well as two additional clinics in the already established Dallas, TX market.
On February 18, 2008, the Company announced that it has sold its first franchise of Medifast Weight Control Centers. The Company sold the rights to open four clinics in the Greater Baltimore Metropolitan Area. The franchisee also has the rights to open four additional Medifast Weight Control Centers in the Baltimore area over the next two years, bringing the total to eight locations.
Overall, selling, general and administrative expenses increased by $3.9 million as compared to the first three months of 2007. Advertising expense for the first three months of 2008 was approximately $5.2 million compared to approximately $4.3 million for the same period last year, an increase of $900,000. Salaries and benefits increased by approximately $300,000 in the first 3 months of 2008. The increase includes the hiring of additional expertise in critical areas such as Take Shape for Life and the Medifast Weight Control Centers in the second half of 2007 which have greatly impacted the revenue growth in the first quarter of 2008. Additional personnel were hired in the call center during the first quarter of 2008 as the Company brought the outsourced Take Shape for Life call center in-house early in the second quarter of 2008. Going forward, savings will be realized on call center expense however in the first quarter in-house call center reps had to be hired and trained in preparation for the transition. The opening of four new corporately owned clinics in the Houston, TX market also required the hiring of additional center managers and support staff. Take Shape for Life commission expense, which is completely variable based upon revenue, increased by approximately $1,900,000 as the Company showed sales growth of 63% as compared to the first three months of 2007. Communication expense, which includes the Take Shape for Life outsourced call center increased by $50,000 based on additional sales order volume. The reduction in outsourced call center expenses will continue in stages throughout 2008 as the call center is brought in-house. Other expenses increased by $550,000 which included items such as depreciation, amortization, credit card processing fees, charitable contributions, and property taxes. Operating expenses increased by $200,000 which primarily resulted from additional printing expense for our direct to consumer postcard mailings as well as maintenance, repairs, and supplies for our manufacturing and distribution facilities.
Costs and Expenses: Cost of revenue increased $1 million to $6.1 million in the first three months of 2008 from $5.1 million for the first three months of 2007. As a percentage of sales, gross margin increased to 75.8% from 74.8% for the first 3 months of 2008. The margin improved due to efficiencies gained from new machinery purchases in prior year as well as new shipping rules that resulted in additional shipping revenue from customers netting against shipping expense.
Income taxes: For the first three months of 2008 the Company recorded $668,000 in income tax expense, which represents an annual effective rate of 32.9%. For the first three months of 2007, we recorded income tax expense of $530,000 which reflected an estimated annual effective tax rate of 27.9%. The Company anticipates a tax rate of approximately 32-34% in 2008.
Net income: Net income was $1.4 million for the first three months of 2008 as compared to $1.4 million for the first three months of 2007. Net income remained the same despite sales growth of 25% in the first quarter of 2008 due to the increases in selling, general and administrative expenses described above.
SEGMENT RESULTS OF OPERATIONS
| | | Net Sales by Segment as of March 31, | |
| | | | | | | | | | |
| | | 2008 | | 2007 | |
Segments | | Sales | | % of Total | | Sales | | % of Total | |
| | | | | | | | | | |
| Medifast | | | 23,480,000 | | | 93 | % | | 19,037,000 | | | 95 | % |
| All Other | | | 1,689,000 | | | 7 | % | | 1,052,000 | | | 5 | % |
| Total Sales | | | 25,169,000 | | | 100 | % | | 20,089,000 | | | 100 | % |
Three Months Ended March 31, 2008 and March 31, 2007
Medifast Segment: The Medifast reporting segment consists of the sales of Medifast Direct, Take Shape for Life, and Doctors. As this represents the majority of our business this is referenced to the “Condensed Consolidated Results of Operations” management discussion for the three months ended March 31, 2008 and 2007 above.
All Other Segment: The All Other reporting segment consists of the sales of Hi-Energy and Medifast Weight Control Centers. Sales increased by $637,000 year-over year as a result of an increase in Hi-Energy and Medifast Weight Control Centers sales to $1,689,000. The increase in the Hi-Energy and Medifast Weight Control Centers sales was due to opening new centers in the Houston market in the first quarter, spending increases for advertising, increased advertising effectiveness, improved closing rates on walk-in sales, as well as the hiring of more experienced clinic operators to manage the clinics. During the first quarter of 2008, four additional corporate clinics were opened in the Houston, TX market. The Company had 14 clinics operating at the end of the first quarter of 2008 compared to 11 clinics in operation at the end of the first quarter of 2007.
| | | Net Profit by Segment as of March 31, | |
| | | | | | | | | | |
| | | 2008 | | 2007 | |
Segments | | Profit | | % of Total | | Profit | | % of Total | |
| | | | | | | | | | |
| Medifast | | | 1,838,000 | | | 135 | % | | 1,949,000 | | | 142 | % |
| All Other | | | (473,000 | ) | | -35 | % | | (576,000 | ) | | -42 | % |
| Total Net Profit | | | 1,365,000 | | | 100 | % | | 1,373,000 | | | 100 | % |
Three Months Ended March 31, 2008 and March 31, 2007
Medifast Segment: The Medifast reporting segment consists of the profits of Medifast Direct, Take Shape for Life, and Doctors. As this represents the majority of our business this is referenced to the “Condensed Consolidated Results of Operations” management discussion for the three months ended March 31, 2008 and 2007 above. See footnote 16, “Business Segments” for a detailed breakout of expenses
All Other Segment: The All Other reporting segment consists of the profit or loss of Hi-Energy and Medifast Weight Control Centers, and corporate expenses related to the parent company operations. Year-over-year, the loss in the All Other segment improved by $103,000. The Hi-Energy and Medifast Weight Control Centers showed an increase in net profitability year-over-year of $30,000. The increase for the Medifast Weight control centers was due to management fine tuning clinic operations in order to improve profitability. This was offset by the opening of four new clinics in the Houston, TX market during the quarter which led to additional salaries, rent, and advertising expense during the start-up phase with minimal sales volume. Corporate expenses increased by $133,000 year-over-year. Corporate expenses include items such as auditors’ fees, attorney’s fees, Board of Director expenses, investor relations, corporate consulting, corporate outings, as well as depreciation and property taxes on corporately owned buildings. See footnote 16, “Business Segments” for a detailed breakout of expenses.
Seasonality
The Company's weight management products and programs have historically been subject to seasonality. Traditionally the holiday season in November/December of each year is considered poor for diet control products and services. January and February generally show increases in sales, as these months are considered the commencement of the “diet season.” In 2008, seasonality has not been a significant factor. This is largely due to the increase in the consumer’s awareness of the overall health and nutritional benefits accompanied with the use of the Company’s product line. As consumers continue to increase their association of nutritional weight loss programs with overall health, seasonality will continue to decrease.
Inflation
Inflation generally affects us by increasing the costs of labor, overhead and equipment. The impact of inflation on our financial position and results of operations was minimal during the first quarter of both 2008 and 2007. However, we continue to be negatively impacted by increasing raw material costs.
Item 5. Other Information
Litigation:
Leonard Z. Sotomeyer on December 30, 2003 filed an action in the Supreme Court of the State of New York, County of New York, against his former business partner, David Scheffler, and T-1 Holdings, LLC, and included Medifast, Inc., formerly Heathrite, Inc., as a Defendant, Case 604076-03, seeking monetary damages for failure of his former business partner to compensate him under several consulting agreements with Medifast, Inc. made with H-T Capital, Inc. and derivatively on behalf of T-1 Holdings, LLC. The Court dismissed on Defendants’ motions Sotomeyer’s complaint in its entirety by Order of September 30, 2004. Following an appeal, the Appellate Division, First Department, reinstated the first and second causes of action while affirming the dismissal of Plaintiff’s remaining derivative claims by its decision April 13, 2006. The matter is now, again, before the New York Supreme Court for the specific purpose of litigating plaintiff’s first and second causes of action only. Medifast has denied any wrongdoing and discovery is ongoing. Medifast believes it continues to have a meritorious defense to the two remaining counts and that any decision rendered would not materially impact the ongoing operations of Medifast, Inc.
Earnings per Share: The Company follows the provisions of Statement of Financial Accounting Standards No. 128, “Earnings per Share.” The calculation of basic and diluted earnings per share (“EPS”) is reflected on the accompanying Consolidated Statement of Operations.
Code of Ethics: In August of 2006, the Company updated its Code of Ethics by which directors, officers and employees commit and undertake to personal and corporate growth, dedicate themselves to excellence, integrity and responsiveness to the marketplace, and work together to enhance the value of the Company for the shareholders, vendors, and customers.
Trading Policy: In March 2003, the Company implemented a Trading Policy whereby if a director, officer or employee has material non-public information relating to the Company, neither that person nor any related person may buy or sell securities of the Company or engage in any other action to take advantage of, or pass on to others, that information. Additionally, on October 16, 2006 the Board of Directors approved an updated trading policy in which insiders may purchase or sell MED securities if such purchase or sale is made 7 days after or 14 days before an earnings announcement to include the 10-K or 10-Q in order to insure that investors have available the same information necessary to make investment decisions as insiders.
Evaluation of Disclosure Controls and Procedures:
The Securities and Exchange Commission defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based on the evaluation of the effectiveness of our disclosure controls and procedures by our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, as of the end of the period covered by this report, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures at the end of the period covered by this report were effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
Changes in Internal Control over Financial Reporting:
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Forward Looking Statements: Some of the information presented in this quarterly report constitutes forward-looking statements within the meaning of the private Securities Litigation Reform Act of 1995. Statements that are not historical facts, including statements about management’s expectations for fiscal year 2003 and beyond, are forward-looking statements and involve various risks and uncertainties. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge, there can be no assurance that actual results will not differ materially from the Company’s expectations. The Company cautions investors not to place undue reliance on forward-looking statements which speak only to management’s experience on this data.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Medifast, Inc.
| BY: | /S/ MICHAEL S. MCDEVITT | May 12, 2008 |
| | Michael S. McDevitt | |
| | Chief Executive Officer and Chief Financial Officer | |
| | (principal executive officer and principal financial officer) | |
| | |
Index to Exhibits
| Exhibit Number | Description of Exhibit |
| | |
| 31.1 | | Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 31.2 | | Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| | | |
| 32.1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
