Note Regarding Forward-Looking Statements
This report contains information that may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "project," "will," and similar expressions, which are not historical in nature, identify forward-looking statements. However, the absence of these words or expressions does not necessarily mean that a statement is not forward-looking. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to future operating results, are forward-looking statements. Management believes that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on any such forward-looking statements because such statements speak only as of the date when made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in our 2019 Form 10-K, the Form 10-Q for the Quarter endedMarch 31, 2020 and the Form 10-Q for the Quarter endedJune 30, 2020 , and those described from time to time in our future reports filed with theSEC .
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes appearing elsewhere herein.
Overview
Medifast is the company behind one of the fastest-growing health and wellness communities called OPTAVIA®, which offers Lifelong Transformation, One Healthy Habit at a Time®. Reflecting the success of its approach to health and wellness for its clients,Medifast has consistently grown revenue for the past three years. Of equal importance, our business model is expected to deliver long-term growth in the foreseeable future.Medifast has redefined direct selling by combining the best aspects of the model, while eliminating those dimensions that have typically challenged other companies.Medifast is often compared to diet and weight loss-only companies or to multi-level marketing companies, but our model is very different. The Company supports clients through independent OPTAVIA Coaches, the majority of whom were clients first. Our operations are conducted through our wholly owned subsidiaries,Jason Pharmaceuticals, Inc. ,OPTAVIA LLC ,Jason Enterprises, Inc. ,Jason Properties, LLC ,Medifast Franchise Systems, Inc. ,Medifast Nutrition, Inc. ,Seven Crondall Associates, LLC ,Corporate Events, Inc. , OPTAVIA (Hong Kong ) Limited, OPTAVIA (Singapore ) PTE. LTD andOPTAVIA Health Consultation (Shanghai) Co., Ltd. We sell a variety of weight loss, weight management and healthy living products all based on our proprietary formulas under the Medifast®, OPTAVIA, Thrive byMedifast ,Optimal Health by Take Shape for Life, and Flavors of Home® brands. Our product line includes more than 145 consumable options, including, but not limited to, bars, bites, pretzels, puffs, cereal crunch, drinks, hearty choices, oatmeal, pancakes, puddings, soft serve, shakes, smoothies, soft bakes, and soups. The Thrive byMedifast andOptimal Health by Take Shape for Life lines include a variety of specially formulated bars, shakes, and smoothies for thosewho are maintaining their weight for long-term healthy living. We identify opportunities to expand our product line by regularly surveying our clients and studying industry and consumer trends. This allows us to introduce new, high quality products that we expect to meet consumer demand. Our nutritional products are formulated with high-quality ingredients. Products include individually portioned, calorie- and carbohydrate-controlled meal replacements that share a similar nutritional footprint and provide a balance of protein and good carbohydrates. Our meal replacements are also fortified to contain vitamins and minerals, as well as other 15
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nutrients essential for good health. We offer our OPTAVIA clients exclusive OPTAVIA-branded nutritional products, or "Fuelings," and also offer a variety of other weight loss, weight management, and healthy living products under other brands. OPTAVIA Fuelings come in a variety of flavors that appeal to a broad variety of tastes. Our products are nutrient-dense, portion-controlled, nutritionally interchangeable and simple to use. OPTAVIA is a highly effective lifestyle solution for people for whom diets alone have failed. Habits of Health®, encompasses our community of OPTAVIA Coaches, our OPTAVIA health and wellness programs, and our proprietary OPTAVIA-branded products. This approach developed by OPTAVIA co-founder and independent OPTAVIA Coach, Dr.Wayne Scott Andersen , combines clinically proven plans with scientifically developed products and the ongoing support of OPTAVIA Coaches. The OPTAVIA integrated coaching model is centered around providing focused, individualized attention to our clients. Our OPTAVIA Coaches provide the support and encouragement for clients to successfully learn and adopt a more healthy lifestyle. This clinically-proven plan translates into better client results when compared to programs that leave individuals to adopt and maintain healthy habits on their own. Our clients receive personalized attention from our OPTAVIA Coacheswho share, educate, motivate and pass along their passion for healthy living. We believe this personal, direct-sales and service strategy is optimal for activating and supporting our clients. In a clinical study published in Obesity Science and Practice in 2018, the OPTAVIA model's effectiveness was validated when its meal plan was combined with education and support from OPTAVIA Coaches. Our OPTAVIA Coaches are independent contractors, not employees,who support our clients and market our products and services primarily through word of mouth, email and via social media channels such as Facebook, Instagram, Twitter and video conferencing platforms. As direct-sales entrepreneurs, OPTAVIA Coaches market our products to friends, family and other acquaintances with whom they have established strong relationships. The entrepreneurial success of our OPTAVIA Coaches is the key to our success. We are focused on scaling our OPTAVIA Integrated Coaching Model by offering economic incentives that are attractive to independent entrepreneurs and reflective of the new "gig economy." Our successful clients frequently become enthusiastic health and wellness advocates themselves and may choose to become OPTAVIA Coaches. This process of clients becoming OPTAVIA Coaches underpins our growth. As we previously disclosed, global expansion is an important component of our long-term growth strategy. InJuly 2019 , we commenced our international operations, entering into theAsia Pacific markets ofHong Kong andSingapore . The Company outsources a distribution center inHong Kong to give the Company adequate product distribution capacity for the foreseeable future. Our decision to enter these markets was based on industry market research that reflects a dynamic shift in how health care is being prioritized and consumed in those
countries. COVID-19 Update
InDecember 2019 , a novel strain of coronavirus ("COVID-19") was identified inAsia . Over the next several months, COVID-19 quickly spread across the world. InMarch 2020 , theWorld Health Organization declared COVID-19 a worldwide pandemic. As ofOctober 2020 , the virus continues to spread, infecting more than 40 million people worldwide, and impacting worldwide economic activity. In response to the pandemic, many governments implemented policies intended to stop or slow the further spread of the disease, such as social distancing and shelter-in-place orders. This has resulted in the temporary closure of schools and non-essential businesses. Because the Company sells products that are essential to the daily lives of consumers, the COVID-19 pandemic has not had a material impact to our consolidated operating results for the nine-month period endedSeptember 30, 2020 .
While the duration and severity of this COVID-19 pandemic is uncertain, the extent to which the pandemic ultimately impacts the Company's business, financial condition, results of operations, cash flows, and liquidity may differ from management's current estimates. The difference is due to inherent uncertainties regarding the duration and further spread of the outbreak, its severity, government actions taken to contain the virus or treat its impact, changes in consumer behavior resulting from the pandemic and how quickly and to what extent normal economic and operating conditions can resume. These uncertainties make it challenging for our management to estimate our future business performance. However, we continue to actively monitor the impact of COVID-19 and related developments on our business. 16
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Although the COVID-19 pandemic has impacted our business operations in multiple ways, our manufacturing facility remains fully operational to date and we have not experienced any meaningful disruption to our worldwide supply chain. Additionally, nutritional supplements and health foods have been designated critical/essential infrastructure in theU.S. and, as such, we have continued to actively manufacture and distribute our products in our markets around the world. We will continue to communicate with our supply chain partners to identify and mitigate risk and to manage inventory levels. While our manufacturing and distribution employees continue to work on site, they are following additional health and safety guidelines. In response to the public health crisis posed by COVID-19, we took numerous actions, including:
? successfully implementing a work-from-home plan for all non-essential employees
to comply with guidelines from government and health officials;
? changing this year's OPTAVIA convention from a live event in July to a virtual
event;
prioritizing production to our highest volume products limiting our stock
? keeping unit ("SKU") assortment to ensure that we are able to meet anticipated
product demand across core items;
employing incentives and promotions to help OPTAVIA Coaches adjust to the
? adverse effect of overall economic conditions and the nationwide actions taken
to control the spread of the virus;
providing additional health and safety precautions in our headquarters,
? manufacturing and distribution centers, including use of personal protective
equipment and frequent sanitization;
? process controls in relation to social distancing, visitors, travel and
quarantine. The Company's priorities during the COVID-19 pandemic continue to be protecting the health and safety of our employees and their families, OPTAVIA Coaches; maximizing the availability of products that help consumers with their needs; and the use of our employees' talents and our resources to help society meet and overcome the current challenges. The senior management team meets regularly to review and assess the status of the Company's operations and health and safety of its various constituencies, and will continue to proactively respond to the situation and may take further actions that alter the Company's business operations as may be required by governmental authorities, or that are determined to be in the best interests of employees, OPTAVIA Coaches and consumers.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements are prepared in accordance with GAAP. Our significant accounting policies are described in Note 1 to the unaudited condensed consolidated financial statements included in this report. We consider all of our significant accounting policies and estimates to be critical.
The preparation of our 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. 17 Table of Contents
Overview of Results of Operations
Our product sales accounted for 98% of our revenues for the three months and
nine months ended
The following tables reflect our income statements (in thousands, except percentages): Three months ended September 30, 2020 2019 $ Change % Change Revenue $ 271,470 $ 190,061$ 81,409 42.8% Cost of sales 67,434 47,128 (20,306) (43.1%) Gross profit 204,036 142,933 61,103 42.7%
Selling, general, and administrative 159,477
122,671 (36,806) (30.0%) Income from operations 44,559 20,262 24,297 119.9% Other income Interest income, net 44 324 (280) (86.4%) Other income (expense) 30 (3) 33 (1100.0%) 74
321 (247) (76.9%)
Income from operations before income taxes 44,633
20,583 24,050 116.8%
Provision for income tax 10,180
4,681 (5,499) (117.5%) Net income $ 34,453 $ 15,902$ 18,551 116.7% % of revenue Gross profit 75.2% 75.2%
Selling, general, and administrative costs 58.7%
64.5%
Income from operations 16.4%
10.7%
Income from operations before income taxes 16.4% 10.8% 18 Table of Contents Nine months ended September 30, 2020 2019 $ Change % Change Revenue$ 669,930 $ 543,040 $ 126,890 23.4% Cost of sales 171,354 134,250 (37,104) (27.6%) Gross Profit 498,576
408,790 89,786 22.0%
Selling, general, and administrative 402,385 336,458 (65,927) (19.6%) Income from operations 96,191 72,332 23,859 33.0% Other income Interest income, net 212 1,061 (849) (80.0%) Other income (expense) 12 (11) 23 (209.1%) 224
1,050 (826) (78.7%)
Income from operations before income taxes 96,415
73,382 23,033 31.4%
Provision for income taxes 21,550 15,347 (6,203) (40.4%) Net income $ 74,865 $ 58,035$ 16,830 29.0% % of revenue Gross Profit 74.4% 75.3%
Selling, general, and administrative costs 60.1%
62.0%
Income from Operations 14.4%
13.3%
Income from operations before income taxes 14.4%
13.5% Revenue: Revenue increased$81.4 million , or 42.8%, to$271.5 million for the three months endedSeptember 30, 2020 from$190.1 million for the three months endedSeptember 30, 2019 . The total number of active earning OPTAVIA Coaches for the three months endedSeptember 30, 2020 increased to 42,100 from 32,200 for the corresponding period in 2019, an increase of 30.7%. The average revenue per active earning OPTAVIA Coach was$6,329 for the three months endedSeptember 30, 2020 compared to$5,715 for the three months endedSeptember 30, 2019 . Increase in the productivity per active earning OPTAVIA Coach for the quarter was driven by an increase in both the number of clients supported by each Coach as well as an increase in average client spend. Revenue increased$126.9 million , or 23.4%, to$669.9 million for the nine months endedSeptember 30, 2020 from$543.0 million for the nine months endedSeptember 30, 2019 . This increase in revenue for the quarter and nine months endedSeptember 30, 2020 resulted from temporary program initiatives which drove more clients to be on our plans, aided by the ongoing transition of clients to higher priced OPTAVIA-branded products. OPTAVIA-branded products represented 83.0% of consumable units sold for the three months endedSeptember 30, 2020 compared to 78.0% for the corresponding period in 2019 and 82.0% of consumable units sold for the nine months endedSeptember 30, 2020 compared to 76.0% for the corresponding period in 2019. Costs of sales: Cost of sales increased$20.3 million , or 43.1%, to$67.4 million for the three months endedSeptember 30, 2020 from the corresponding period in 2019 and increased$37.1 million , or 27.6%, to$171.4 million for the nine months endedSeptember 30, 2020 from the corresponding period in 2019. The increase in cost of sales was primarily driven by an increase in product sales. Gross profit: For the three months endedSeptember 30, 2020 , gross profit increased$61.1 million , or 42.7%, to$204.0 million from the corresponding period in 2019. As a percentage of sales, gross margin remained flat at 75.2% for the three months endedSeptember 30, 2020 as compared to the corresponding period in 2019. For the nine months endedSeptember 30, 2020 , gross profit increased$89.8 million , or 22.0%, to$498.6 million from the corresponding period in 2019. As a percentage of sales, gross margin decreased 90 basis points to 74.4% for the nine months endedSeptember 19
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30, 2020 from 75.3% for the corresponding period in 2019. The decrease in gross margin percentage for the year-to-date periods was primarily the result of promotional activity as well as higher production costs in 2020.
Selling, general and administrative: Selling, general and administrative ("SG&A") expenses were$159.5 million for the three months endedSeptember 30, 2020 , an increase of$36.8 million , or 30.0%, as compared to$122.7 million from the corresponding period in 2019. As a percentage of sales, SG&A expenses were 58.7% as compared to 64.5% for the three months endedSeptember 30, 2020 and 2019, respectively. SG&A expenses included research and development ("R&D") costs of$0.8 million and$0.6 million for the three months endedSeptember 30, 2020 and 2019, respectively. The$36.8 million increase in SG&A for the quarter was primarily due to higher OPTAVIA commission expense as a result of growth in OPTAVIA sales, increased salaries and benefits related expenses partially offset by a decrease in sales and marketing expenses. For the nine months endedSeptember 30, 2020 , SG&A expenses increased$65.9 million , or 19.6%, to$402.4 million from$336.5 million for the corresponding period in 2019. SG&A expenses included$1.9 million and$1.8 million in R&D costs for the nine months endedSeptember 30, 2020 and 2019, respectively. As a percentage of sales, SG&A expenses were 60.1% for the nine months endedSeptember 30, 2020 as compared to 62.0% for the corresponding period in 2019. The$65.9 million increase in SG&A for the nine months endedSeptember 30, 2020 was primarily due to higher OPTAVIA commission expense as a result of growth in OPTAVIA sales, incremental professional service costs in connection with the Schedule 13D filing and increased salaries and benefits related expenses partially offset by sales and marketing expenses. For the nine months endedSeptember 30, 2020 , Non-GAAP adjusted SG&A expenses increased$58.9 million to$395.3 million and Non-GAAP adjusted SG&A as a percentage of revenue decreased 300 basis points year-over-year to 59.0%. Non-GAAP adjusted SG&A excludes expenses in connection with the Schedule 13D filing of$5.8 million and severance related costs of$1.2 million resulting from the departure of the Company's previous Chief Financial Officer. OPTAVIA commission expense, which is a variable expense, increased$37.7 million , or 48.8%, to$114.9 million for the three months endedSeptember 30, 2020 from$77.2 million for the corresponding period in 2019. For the nine months endedSeptember 30, 2020 , OPTAVIA commission expense increased$57.5 million , or 25.7%, to$281.2 million from$223.7 million for the corresponding period in 2019. The increase was primarily the result of increased product sales. As OPTAVIA revenue increased as a portion of the Company's total sales mix, the commission rate as a percentage of revenue increased 170 basis points to 42.3% for the third quarter of 2020 compared to 40.6% for the third quarter last year and increased 80 basis points to 42.0% for the nine months endedSeptember 30, 2020 compared to 41.2% for the corresponding period in 2019. This is an outcome of the success we are experiencing with our OPTAVIA integrated coach model. Income from operations: For the three months endedSeptember 30, 2020 , income from operations increased$24.3 million to$44.6 million from$20.3 million for the corresponding period in 2019 primarily as a result of increased gross profit partially offset by increased SG&A expenses. Income from operations as a percentage of sales was 16.4% and 10.7% for the three months endedSeptember 30, 2020 and 2019, respectively. For the nine months endedSeptember 30, 2020 , income from operations increased$23.9 million to$96.2 million from$72.3 million for the corresponding period in 2019 primarily as a result of increased gross profit partially offset by increased SG&A expenses. Income from operations as a percentage of sales was 14.4% and 13.3% for the nine months endedSeptember 30, 2020 and 2019, respectively. For the nine months endedSeptember 30, 2020 , Non-GAAP adjusted income from operations increased$30.9 million to$103.2 million and Non-GAAP adjusted income from operations as a percentage of revenue increased 210 basis points year-over-year to 15.4%.
Other income: For the three and nine months ended
Income from operations before income taxes: Income from operations before income taxes was$44.6 million for the three months endedSeptember 30, 2020 as compared to$20.6 million for the three months endedSeptember 30, 2019 , an increase of$24.0 million . Income from operations before income taxes as a percentage of sales increased to 16.4% for the three months endedSeptember 30, 2020 from 10.8% for the three months endedSeptember 30, 2019 . Income from operations before income taxes was$96.4 million for the nine months endedSeptember 30, 2020 as compared to$73.4 million for the nine months endedSeptember 30, 2019 . Income from operations before income taxes as a 20
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percentage of sales increased to 14.4% for the nine months ended
Provision for income tax: For the three months endedSeptember 30, 2020 , the Company recorded$10.2 million in income tax expense, an effective tax rate of 22.8%, as compared to$4.7 million in income tax expense, an effective tax rate of 22.7%, for the three months endedSeptember 30, 2019 . The slight increase in the effective tax rate was primarily driven by an increase in state income tax rate and a decrease in tax benefit of stock compensation, partially offset by an increase in R&D tax credit and a decrease in meals and entertainment. For the nine months endedSeptember 30, 2020 , the Company recorded$21.6 million in income tax expense, an effective tax rate of 22.4%, as compared to$15.3 million in income tax expense, an effective tax rate of 20.9%, for the nine months endedSeptember 30, 2019 . The effective tax rate was negatively impacted by an increase in state income tax rate and a decrease in tax benefit of stock compensation and in R&D tax credit, partially offset by a decrease in meals and entertainment. Net income: Net income was$34.5 million and$74.9 million , or$2.91 and$6.32 per diluted share, for the three and nine months endedSeptember 30, 2020 as compared to$15.9 million and$58.0 million , or$1.32 and$4.77 per diluted share, for the three months and nine months endedSeptember 30, 2019 . The period-over-period changes were driven by the factors described above in the explanations from operations. Non-GAAP adjusted net income was$80.3 million or$6.78 per diluted share for the nine months endedSeptember 30, 2020 .
Non-GAAP Financial Measures
In an effort to provide investors with additional information regarding our results, we disclose various Non-GAAP financial measures in this Form 10-Q, our quarterly earnings press release and other public disclosures. The following GAAP financial measures have been presented on an as adjusted basis: SG&A expenses, income from operations, net income and diluted earnings per share. Each of these as Non-GAAP financial measures excludes the impact of certain amounts as further identified below that the Company believes are not indicative of its core ongoing operational performance. 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. 21 Table of Contents The following tables reconcile the Non-GAAP financial measures included in this report (in thousands): Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019
Selling, general, and administrative $ 159,477 $ 122,671 $ 402,385 $ 336,458 Adjustments Professional services for 13D Filing
- - 5,811 - Incremental severance costs - - 1,237 - Non-GAAP Adjusted selling, general, and administrative $ 159,477 $ 122,671 $ 395,337 $ 336,458 Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Income from operations $ 44,559 $ 20,262 $ 96,191 $ 72,332
Adjustments
Professional services for 13D Filing - - 5,811 - Incremental severance costs - - 1,237 - Non-GAAP Adjusted income from operations $ 44,559 $ 20,262 $ 103,239 $ 72,332 Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Net income $ 34,453 $ 15,902 $ 74,865 $ 58,035 Adjustments, net of tax Professional services for 13D Filing - - 4,512 - Incremental severance costs - - 961 - Non-GAAP Adjusted net income $ 34,453 $ 15,902 $ 80,338 $ 58,035 Diluted earnings per share (1) $ 2.91 $ 1.32 $ 6.32 $ 4.77 Impact for adjustments (1) - - 0.46 - Non-GAAP Adjusted diluted earnings per share (1) $ 2.91 $ 1.32 $ 6.78 $ 4.77
(1) The weighted-average diluted shares outstanding used in the calculation of these Non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts.
Liquidity and Capital Resources
The Company had stockholders' equity of$140.0 million and working capital of$105.5 million atSeptember 30, 2020 as compared with$104.8 million and$74.8 million atDecember 31, 2019 , respectively. The$35.2 million net increase in stockholders' equity reflects$74.9 million in net income for the nine months endedSeptember 30, 2020 offset by$5.0 million spent on repurchases of the Company's common stock, and$39.9 million for declared dividends paid to holders of the Company's common stock as well as the other equity transactions described in the "Condensed Consolidated Statements of Changes in Stockholders' Equity" included in our condensed consolidated financial statements included in this report. The Company declared a dividend of$13.4 million , or$1.13 per share, to holders of the Company's common stock as ofSeptember 22, 2020 that will be paid in the fourth quarter of 2020. While we intend to continue the dividend program and believe we will have sufficient liquidity to do so, we can provide no assurance that we will be able to continue to declare and pay dividends. The Company's cash, cash equivalents, and investment securities increased from$92.7 million atDecember 31, 2019 to$169.9 million atSeptember 30, 2020 . 22
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Net cash provided by operating activities increased$60.3 million to$125.4 million for the nine months endedSeptember 30, 2020 from$65.1 million for the nine months endedSeptember 30, 2019 as a result of a$16.8 million increase in net income and$47.0 million increase in operating assets and liabilities. Net cash used in investing activities was$1.9 million for the nine months endedSeptember 30, 2020 as compared to$5.5 million for the nine months endedSeptember 30, 2019 . This change resulted from a$5.4 million decrease in cash used in capital expenditures for the nine months endedSeptember 30, 2020 from the corresponding period in 2019 partially offset by a$1.7 million decrease in sale and maturities of investment securities. Net cash used in financing activities decreased$15.8 million to$44.0 million for the nine months endedSeptember 30, 2020 from$59.8 million for the nine months endedSeptember 30, 2019 . This decrease was due to a$28.1 million decrease in stock repurchases partially offset by a$13.2 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.
The Company evaluates acquisitions from time to time as presented.
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