Greetings and welcome to the Mannatech Incorporated third quarter 2008 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Gary Spinell, Vice President of Finance and Corporate Communications. Thank you, Mr. Spinell, you may begin.
Thank you and good morning everyone. This is Gary Spinell and I want to welcome you to Mannatech’s third quarter 2008 earnings call. Before we begin the call, I will first read the Safe Harbor statement. During this conference call, we may make forward-looking statements, which can involve future events or future financial performance. Forward-looking statements generally can be identified by the use of phrases or terminology such as will continue, may, believe, intend, expects, potential, should, and plan or other similar words or the negative of such terminology. We caution listeners that such forward-looking statements are subject to certain events, risks, uncertainties and other factors and speak only as of today. We also refer our listeners to review our SEC submission.
Thank you and I will now turn the call over to Mr. Wayne Badovinus, Mannatech’s President and CEO.
Thank you, Gary. Hello and good morning to everyone. This is Wayne Badovinus, President and CEO of Mannatech. It is a pleasure to be here to update you on the progress we are making at our company. We have made significant and tangible strides since our last call. I have now been here almost five months and have much to share with you. The excitement continues to build in the field. We launched a key new product to address a new market segment and we are aggressively managing expense levels. There are many additional hurdles ahead, but I believe we are on-track to turn the business around.
Just this week, we received additional great news from the Securities and Exchange Commission regarding the previously-issued Wells notices. The SEC has stated it has completed its investigation of Mannatech and that they will not recommend enforcement action against the company. We are pleased with their decision. Resolution of this issue is one more step in our company moving forward. In my experience with turnarounds, improvement is initially visible on the operating line and subsequently becomes apparent on the net income line. Reversing declining sales will often take longer. In direct selling, this is because it involves re-engaging and re-energizing the independent associates, who are the key to business growth. We are seeing this pattern in our results for the quarter.
As we reported, we generated an operating profit of $1.1 million for the third quarter of 2008. This is the first quarterly operating profit in one year. We reported a net loss in the third quarter of $400,000 or $0.02 per diluted share. This compares to net income of $1.7 million or $0.07 earnings per diluted share for the third quarter of 2007. We recorded a pre-tax loss of $700,000 in the quarter compared to a pre-tax income of $2.1 million for last year’s third quarter. Although net income was negative in this quarter, we have made considerable progress against the much deeper losses of the prior three quarters. We accomplished this through a rigorous review process of all operating expenses, which resulted in a 15% reduction in corporate head count and strict expense controls across the company. We have eliminated all discretionary spending and are establishing a culture of expense accountability throughout the organization.
Third quarter 2008 sales were $78 million, a decrease of 19.5% from the same quarter in 2007. This decrease was smaller than our reported second quarter decline, when compared to prior year. Most of the sales shortfall came from our North American market, which showed a decrease of 25.7% versus the prior year. The significant economic slow down has been an important factor in our continuing sales under-performance. The Texas Attorney General’s litigation has also remained an important factor.
International sales were below prior year, down 8.8%. This was also due to the slowing worldwide economy with some modest fall in currency effect. Geographic expansion continued, as we had our official hard opening of South Africa the first week of October. Often with new country openings, strong sales occur, and South Africa is no exception. Additionally this week, we announced Mannatech products are now being sold in Singapore. Total independent associates and members at the end of the third quarter of 2008 were 540,000 over a trailing 12-month period. This represented a decrease of 6.1% year over year. The decrease was primarily due to a drop in domestic recruiting. The decline in new associates and members of 28.6% was partially offset by higher retention of continuing independent associates and members. Our continuing associates and members count was up 5.5% or 21,000 people.
On our last call in August, I stated we would immediately attack two priorities. First, shore up the bottom line and secondly re-energize our associates and employees. We have made significant progress on both fronts.
Our operating expenses for the third quarter of 2008 were $43.4 million, the lowest level in over a year. This was almost a 10% decrease compared to the third quarter of 2007, down 16.1% compared with the first quarter of 2008 and down 31.6% from the second quarter of 2008. This is a considerable achievement and reflects the renewed sense of accountability and attention to detail across the organization. We are confident we can manage the business effectively at these expense levels for the next several quarters.
My second priority was to re-energize our associate base. Since July, I have attended personally regional meetings on my Whistle-Stop tour, including stops all across Canada. To date, I have met several thousand sales associates at these meetings, including our annual instructional event, MannaQuest, which took place the first weekend in September. Many associates described MannaQuest as the best event Mannatech has held in many years. We held all of these meetings on weekends in order not to disrupt the ongoing business. Consequently, I have been in the field every weekend except three for the past five months. This two-way communication is building excitement and enthusiasm among our associates and momentum is returning to our associate base. At each meeting, associates have eagerly expressed to me how they are motivated to restart their business and their down-lines.
To support this effort, we have launched new sales trading materials, focusing on business building opportunities. Specifically, the materials provide instruction on how an associate can build his or her business to our highest income earner level, Platinum Presidential, in two to five years. I have encouraged our associates to believe they are no different than I am, a CEO. Each of them is CEO of his or her business. Our training class is focused on the key elements of planning and driving forward a business by thinking strategically as a Chief Executive Officer.
Our corporate office is operating more efficiently, with renewed focus on responding to the needs of our associates. I also mentioned on our last call, that in my first days on the job, many associates communicated their need for improved customer service, including upgrading our call center service. During a recent regional meeting, when I mentioned how hard the call center was working to support our associates, the attendees actually gave our call center a standing ovation. At the same time that we continue to manage expenses and engage our associates, we have embarked on a paradigm shift to a new selling approach based on wellness. On our last earnings call, I stated that the transition requires a new skill set, rigorous planning and execution and accountability across the organization. We have made substantial progress in all of these areas.
To strengthen our management skill set, we have hired a new Senior Vice President of Marketing, Terri Maxwell. Terri previously operated her own marketing consulting company, employing nearly 50 people. She has extensive experience providing marketing direction to Fortune 500 companies. Her focus is on further institutionalizing the Mannatech brand and building marketing programs that target growth opportunities. Senior management and I have laid out a five year strategic plan, the first of its kind at Mannatech. It has been vetted and approved by our Board of Directors and we are in the process of implementing it.
As we speak, we are in the midst of our annual budget preparation, which for the first time includes a zero-based budgeting approach. As we reported in the last conference call, we continue to be actively engaged in discussion with representatives from the Texas Attorney General’s offices. We believe these meetings have been productive and we expect these discussions to continue and ultimately provide the framework for a satisfactory resolution of this matter.
In August, I outlined three strategic initiatives to drive business growth, to move aggressively into the weight management market, to establish Mannatech the brand, and to expend consumer segments including the sports fitness category. In September, we made an aggressive move into the weight management market with the launch of our new fat-loss product, Oh So Lean powder. Since many Americans struggle with maintaining their weight, we believe the timing for a fat loss product is ideal. The response to date is ahead of expectations, with sales far exceeding our original estimates. In fact, what we believe was a sufficient supply for five months was sold in 10 days. It is also noteworthy that these results are for North America only. Oh So Lean powder is not available yet in other countries. We are prepared to broaden global distribution in January to coincide with the time when most people focus on dieting.
Our associates are extremely excited about this particular product. They now have a product that is not only in high demand, but also provides an easier approach for new customers. Associates are so enthused with the product that they have taken the fat-loss challenge, initiated by our marketing group, to see how many inches they can lose from their waistlines. Our Mannatech executives have also used the product and have challenged these associates to a fat loss contest. To date, the executives are having some success reducing their waist lines, but the associates are showing even greater results.
Our new Chief Marketing Officer, in tandem with our Chief Science Officer is implementing a new brand strategy that emphasizes Mannatech’s proven science and product strengths. Today’s consumers are insisting on access to high quality products with proven performance. Our new associate training and consumer promotional materials will position the company and its products as synonymous with innovation, science, and build on the power of the brand.
As an example, we have new marketing efforts centered on Bounce Back capsules, a product formulated for anyone with an active lifestyle. Bounce Back capsules have been proven to help relieve the soreness and stiffness that follows exercise. Recently we issued results of a randomized, double-blind, placebo-controlled, cross-over human study that indicates that Mannatech’s Bounce Back capsules significantly reduce muscles soreness after over-exertion. This human clinical study, presented at the 2008 International Society of Sports Nutrition Conference and Expo was published on September 17 in the Journal of the International Society of Sports Nutrition. This is just one of the ways that Mannatech is working to open new frontiers in the area of nutritional science.
We are also developing programs to penetrate new consumer segments in the sports nutrition industry, specifically, the sports fitness category. Today that category represents an $18 billion business. It is expected to continue to grow exponentially over the next decade. As part of this initiative, we continue to bring the achievements of our Team Mannatech member athletes to the front and center. The Team had a significant presence in Beijing from Olympic athletes representing 7 countries to an Olympic torch bearer and a sports announcer. Three additional athletes participated in the Para Olympics.
Another example of the impact of these role models is basketball Hall of Famer, Nancy Lieberman who spoke to a women’s only audience at our MannaQuest event in September. The women that attended felt greatly empowered to succeed in their own business after hearing Nancy speak. Each of these athletes embodies commitment to his or her respective sport and the resilience to reach the highest levels of competition. This discipline to pursue their goals through consistent effort every day is a real example for our associates and for anyone wanting to be successful in life. These Team Mannatech athletes represent numerous sports and millions of people who are sports minded. Almost everyone participates in sports in some form. Who better to use as a role model than our Team Mannatech athletes? You will hear more about these initiatives in the future.
Now, Steve Fenstermacher will discuss our financial performance in more detail.
Thank you ,Wayne, and good morning everyone. The third quarter sales results again lag behind last year by about 19%. Compared to the prior three quarters, in which our operating results came to a cumulative deficit of $26 million, our third quarter results were positive. Although we experienced a net deficit in the quarter, we generated a profit from operations of about $1.1 million. Despite experiencing the lowest sales quarter during that trailing period, we generated the operating profit by bringing our direct sales variable costs in line and by maintaining tight control of our overhead expenses. Due to these actions, our conversion rate of operating profits compared to the sales decline was held to only about 3%. Also, our financial condition once again included a high level of liquidity.
Our balance sheet continued to show essentially no long-term debt and for September 30, we held about $43 million in total cash. The continuing slow sales pattern in North America had little impact on our product cost numbers. Our cost of goods sold rate was reduced to 14.2% for the quarter, below the 2007 prior year three-month period by 1.2 percentage points. Our product cost rate in the second quarter of this year was higher because of some inventory reserves taken in several of our international countries related to some market-specific product formulations made for those markets only and some promotional materials which we replaced. The actual third quarter figure of 14.2% was a return to a more normal cost rate for Mannatech.
Commission and incentives expense was 41.5% of sales in the quarter, which was an improvement of 3.2 percentage points compared to the 2007 third quarter. This category declined more than 6 percentage points against the second quarter of 2008. Both accrued travel incentive costs and paid commissions were lower than the comparison periods. Paid commissions dropped in rate to sales to 40.4%, lower than last year by 2 percentage points. The decrease reflected lower pack sales as well as some recent changes in our associate compensation plan, which took effect on a staggered timing basis due to regulations in several of our international markets. These changes, which are now completely in effect in all markets, are expected to help stimulate new recruiting efforts and also to modify slightly the overall commission rate. Part of the decrease also reflected changes in product mix to proportion of sales generated from each country and the mix of sales as well.
Incentive costs were 1.1% of sales versus last year which was 2.4% in rate. We were investing fairly heavily in incentives last year in the third quarter, while this year we held more incentive funding for the fourth quarter. The fourth quarter incentive contest this year, generally have higher hurdles for qualifications for the prizes, and we added some new parameters to the fourth quarter contest here in North America. In order to qualify, the Q4 qualifiers will have to show growth in their businesses compared to the third quarter actual levels, in addition to satisfying other requirements. We are watching this contest to see how it develops. It is still early, but the changes which are being made will likely be reflected in future contests also. We want to emphasize growth in all phases of our incentives spending to benefit shareholders, the company and our associates as well.
Total operating costs of $33.4 million accounted for 42.8% of sales. This rate in total was above last year by 4.6 percentage points, but the actual expense was reduced by $3.7 million, for a decrease of almost 10%. Depreciation for 4.1% in rate and increased several hundred thousand dollars through the comparison. Compared to last year, selling and administrative costs in total were down by $2.6 million. Last year, these costs were increased due to the high level of contract work required on the computer system and several consulting projects in our sales and marketing area related to consumer satisfaction. In addition, outgoing freight costs declined, due in part to negotiated rate reductions. Compared to the 2008 second quarter, selling and administrative expenses were reduced $3.1 million or 14%. Other operating costs decreased $1.3 million compared to Q3 of 2007. These expenses were reduced $12.5 million or 48% against the second quarter of this year. The second quarter included large accruals related to litigation but even without those accruals, we reduced operating costs by roughly an additional $1.5 million.
All of these cost controls reflected the reduction in force that Mannatech went through in the early summer, when we chose to cut close to 15% of our domestic work force here. Our international offices also reduced head count as well. We also eliminated or reduced spending levels per projects in many areas of the company. We plan to maintain essentially this tight level of corporate support for the short to intermediate term, while a number of sales and recruiting programs are undergoing refinement and implementation. All of these efforts resulted in an operating profit of $1.1 million for the third quarter, even though sales for the quarter were the slowest we have seen in the past year.
Our pre-tax loss of $700,000 reflected unfavorable currency translations related to our international operating markets, which overcame our operating profit. We saw simultaneous negative quarter-to-quarter movements in the Australian dollar of 17%, the Korean Wan of about 14% and roughly 10% in the pound and the euro. These currency fluctuations were related to the global financial credit crisis seen over the past few months. Earlier in the year, currency fluctuations had a favorable impact on our statements. That situation reversed in the third quarter. Net loss for the quarter was $400,000 or 0.6 of 1 percentage point of sales. Our deficit per share was a loss of $0.02 per share for the quarter.
Our balance sheet for September 30 remained a strength, with about $43 million in total cash and essentially no long term debt. Current liabilities were reduced about $10 million or 17% from the prior June 30 levels. Equity continued to comprise the bulk of our capital structure. Our ending inventory grew by about $1.2 million to $29 million versus June 30, reflecting our raw materials balance. Our raw components increased again due to a large delivery of one proprietary item, which ships only several times per year. We paid a dividend of $0.02 cents per share during the quarter, which used about $0.5 million in cash. We did not repurchase shares during the third quarter. We do have an allotment from the Board. So under certain market conditions, we may engage in additional repurchases. Recent events have constrained us from going into the market for stock buybacks. We had roughly $900,000 in capital additions in the quarter, once again mostly system-related enhancements.
In summary, our results for the quarter did not reflect the level of profit which we are trying to attain. While we see some encouraging signals, we can not yet state that our sales trend has completely changed. We do have continuing challenges in the North American market related to sales and associate recruiting, but we also have a number of new and innovative programs that work in our home market to address these needs and our stringent cost control activity since July were sufficient to bring our operating profit results back into a positive position. Our plan is to maintain expense control so that when sales and recruiting do begin an improved trend, Mannatech will be in a position to experience a high flow through rate into incremental earnings.
Thanks for listening to our call. And now, Wayne has some wrap up comments.
Thank you, Steve. Although we are pleased with the progress we have made, we know we have just begun this journey. To accomplish our goals for growth, we need to map out a clear plan with actionable steps, metrics for accountability and to effectively manage each step in the process. With this in mind, we challenged our field leaders to develop their own personal strategic plan that parallels the plan approved by the company’s Board of Directors. I believe that Mannatech has the right products for engaging the emerging wellness market. Therefore, I believe we will continue to meet the market demands for high quality, innovative products.
In summary, we have established our goals, implemented a plan with actionable steps, incorporated metrics and instituted accountability. In short, three months ago, I laid out our first set of goals. Today, you have heard that we achieved those goals. We are moving one step at a time with great confidence in our future and now we will take your questions.
(Operator instructions) Ladies and gentlemen, there are no questions at this time. I will turn the conference back to management for closing comments.
Thank you, everyone; that concludes our call for today.
This concludes today’s teleconference; you may now disconnect your lines at this time. Thank you for your participation.
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