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Mannatech, Incorporated (NASDAQ:MTEX)

Q4 2009 Earnings Call

March 11, 2010 10:00 am ET

Executives

Gary Spinell – SVP, Finance & Administration

Rob Sinnott – Co-CEO and Chief Science Officer

Stephen Fenstermacher – Co-CEO and CFO

Analysts

Peter Park – Park West Asset Management

Operator

Greetings, and welcome to the Mannatech Incorporated fourth quarter 2009 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.

Now, I would like to introduce our moderator for the call, Mr Gary Spinell, Senior Vice President of Finance & Administration. Thank you Mr. Spinell, you may begin.

Gary Spinell

Thank you and good morning everyone. This is Gary Spinell and welcome to Mannatech’s fourth quarter 2009 earnings call. Today you will hear from Mannatech’s Co-CEOs Dr Rob Sinnott and Stephen Fenstermacher.

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.

Now, I will turn the call over to Dr Rob Sinnott, Co-CEO and Chief Science Officer.

Rob Sinnott

Hello, and good morning everyone. This is Rob Sinnott, the Co-CEO and Chief Science Officer of Mannatech. I am joined on the call with my Co-CEO Stephen Fenstermacher; and the new President of Global Business Operations and Expansion, Randy Bancino. We appreciate your interest in our company. I will make a few opening comments and then turn the call briefly to our Co-CEO Stephen Fenstermacher.

I have been pleased to take on the Co-CEO role, as I believe Mannatech is positioned right now for a great future, more so than it has been in sometime. Steve and I are working extensively together, expanding the working relationship with our associates, as well as our growing associate base globally. Further, we remain focused on bringing exceptional real food technologies to the marketplace.

In my five years as Mannatech’s Chief Science Officer, our company has launched products that are second to none in the industry. These products combined with our flagship product Ambrotose are a strong foundation on which we believe we can grow our company. We believe that the key to our growth is focusing the great balance and opportunity that Mannatech provides our associates.

Associates today, more than ever, can combine the power of leading-edge products, and outstanding business building system, and commissioned structure. These products and business opportunity are second to none for consumers interested in their health and finances, two key issues for most people.

Before I comment further on the quarter and our future, I would like to turn the call briefly over to my Co-CEO Stephen Fenstermacher.

Stephen Fenstermacher

Thanks Rob and good morning everyone. In some ways, the recent action taken by our Board of Directors to install us as Co-CEOs of Mannatech was an unusual and bold move. However, both Rob and I have been with the company in our respective positions for years, and we are both well known to our many constituencies, our field sales associates, our product to consumers worldwide, our many business partners and vendors, our shareholders, and to the Board of Directors themselves.

This change presented an opportunity to utilize our specific in company experience, which avoids the learning curve that might be required with a new addition from outside. We believe that we have hit the ground running since early December when we accepted the Co-CEO titles, and we are excited to share with you today some of our accomplishments since then.

Rob will now summarize our recent results and speak to some of our global initiatives.

Rob Sinnott

Thanks Steve. 2009 was a year of significant change for Mannatech. Not only did we meet a number of significant challenges, but by the end of 2009 we forged a new direction.

First, early in the year, we reached the settlement with the attorney general that resulted in no penalty or fine for the company. We continued to institute new business practices in addition to a number of which had already been implemented prior to the settlement. More importantly, the efficacy of Mannatech’s products was never questioned. Mannatech has some of the best real food technologies in the industry. Second, we launched a new all All-Star Pack with a greatly reduced price of $499 in our domestic market, providing a much more affordable opportunity for associates interested in business building.

Third, we opened four new countries in Europe and are looking to add additional countries over the next 12 to 18 months. This indicates our revitalization of our international expansion. To further emphasize our significant focus on international growth, Randy Bancino was promoted to President Global Business Operations and Expansion. Fifty, the validity of our patents was upheld as we won three litigation cases as plaintiff against companies attempting to illegally duplicate our products. Sixth, we launched an outstanding Omega-3 product and a family product called Phytoburst, which is based on our proven PhytoMatrix technology. And finally, we ended the year with two new Co-CEOs taking the helm, who have combined over 16 years of experience of direct selling nutritional products here at Mannatech.

Our financial results indicate the impact of all of these accomplishments and initiatives. As we look forward to 2010, we ended 2009 on a positive note posting a net income of $2.1 million or $0.08 per share in the fourth quarter of 2009, this compares to a net income of $620,000 or $0.02 per share for the fourth quarter of 2008.

Fourth quarter 2009 sales were $70.1 million, a decrease of 8.4% from the same quarter in 2008. North American sales declined 19.7% compared to the fourth quarter of 2008 reflecting the ongoing difficult economic conditions. International sales increased 8% in the fourth quarter of 2009 compared to the same quarter for 2008. International sales showed significant gains in South Africa and Australia when compared to the fourth quarter of 2008. We are seeing significant business builder activity in these areas as well as in our Asian markets.

Regarding recruiting activity for 2009, we added 144,631 new associates and members, up 9.2% compared to 132,447 in the full year 2008. I give this brief look back because we are now poised ahead in a new direction. As we move forward, our strategy is to embrace some of our history while developing and delivering new technologies to power the future of the wellness industry. Mannatech has an extensive legacy of producing high quality, proprietary, natural and plant-source products. These products have always demonstrated our leading-edge technology in science and our future is to company that excellence while adhering to our current compliant messaging policies.

Many of the nutritional products today contain predominantly synthetic or chemical ingredients. Mannatech’s strong preference for natural ingredients gives us a clear advantage in the wellness market. Our goal is to continue expanding our global reach to provide our products to people who are interested in maintaining and improving their health through a natural wellness approach. We will continue emphasizing the tremendous value and quality of our products in combination with the great business opportunity for our associates.

In today’s world of uncertain economic conditions and increased concern about health, this approach is the right solution. As I commented earlier, we believe the key for growth is focusing on balance. Traditionally, we are a product-based company and had a product-based philosophy in selling. Over the past two years, we moved towards the other end of the pendulum with a heightened focus on business building. Now, Steve and I believe that the most effective strategy is move to the middle of the pendulum by emphasizing both the outstanding cutting edge real food value of our products in conjunction with an economical entry point for associates to become business builders. As our associates grow their business, they expand their capability to reach more people around the world who can benefit from our products.

Let us talk briefly about the current state of the marketplace. Today consumers are confused. With the proliferation of health products and information available in stores and on the Internet, the result is a consumer that is overwhelmed with information and struggles to sift through this information to make the best choice of nutritional products for themselves and their family. To help the consumer, we are expanding the clinical research on all new products. Behind our most recent products BounceBack capsules and OsoLean fat loss powder are the backing of human clinical studies supporting the benefits of these products.

In addition, we continue to work with key scientific organizations doing research on the benefits of Ambrotose, our polysaccharide product. The latest research in process of being published indicates that Ambrotose technologies appear to have a synergistic effect in the body in conjunction with helpful, probiotic bacteria. In January, we were very proud to announce the results of a randomized, double blind placebo controlled human study on Ambrotose complex. It showed that healthy (inaudible) who took one teaspoon of Ambrotose complex twice daily performed significantly better on memory tasks and were overall more positive in their mood. The 12-week study was published in the January 2010 edition of the Developmental Neuropsychology, which is a peer-reviewed scientific journal.

There is a largest spotlight being shined on the nutritional industry and its products. Most countries have stricter standards than the United States when it comes to product validation and pre-market approval. We are proud to state that Mannatech has been developing and formulating our products around the world to meet the stricter standards imposed by these countries. I personally sit on the Board of the Council of Responsible Nutrition, also I am the Chairman of the Senior Scientific Committee of the Council of Responsible Nutrition. This committee includes chief scientific officers from many nutritional and pharmaceutical companies globally.

Mannatech is a proactive leader in the area of scientific validation of dietary supplements. Therefore Mannatech is well positioned to be among the leaders in offering the highest-quality products as stricter legislation is enacted globally. The stricter requirements will force many other companies to cut back on product offerings or drop out entirely from operating in some countries. We see that as an opportunity for Mannatech to gain market share.

Canada is the great example of where stricter regulations and requirements have been enacted. Canada had some of the highest standards in the world. Mannatech meets those standards and has remained competitive in that market as some other companies have not been able to meet the strict requirements. Since its inception, Mannatech has produced high-quality natural products and this year Mannatech will introduce more products that meet these strict requirements. Further evidence of this is that just recently our OsoLean powder was certified by Orthodox Union as being Kosher. Orthodox Union is the world’s largest and most widely recognized Kosher certification agency.

We are launching more products this year that will meet the stringent requirements we have established. Number one, the products are formulated predominantly using natural plant-derived sources. Number two, these products meet the highest quality requirements from our GMP-compliant manufacturing partners. Number three, we quality control each lot received from the manufacturer before adding the lot to our distribution centre. Number four, our products meet the strictest worldwide standards for purity. Number five, our products are extensively validated including many products with human clinical studies backing them. Number six, Mannatech products are proprietary and give the consumers the highest quality and value.

We continue bringing great products to the marketplace as we grow and work in tandem with our hard marketing [ph] associate base. We have aligned the management to maximize execution of our mission. The top eight senior management executives at Mannatech collectively have over 126 years of experience in the dietary supplement industry, and have been with Mannatech collectively for 47 years.

Before I provide some final thoughts on our business and our future, I will turn the call over to Steve Fenstermacher, Co-CEO and CFO, who will discuss our financial performance as well as share his insight into the future of Mannatech. Steve?

Stephen Fenstermacher

Thanks Rob. For Q4, our total sales were down 8.4% due largely to lower finished product movement. The pack sales revenue was reduced by only 2.8%. Overall, the earnings comparison to Q4 in 2008 is complicated somewhat by a favorable adjustment last year related to litigation cost of about $5 million. Excluding this item from the 2008 prior year quarter makes our operating result essentially even for Q4. Our currency translations in 2009 were better by about $3.1 million. So the pretax number is 2009 is favorable by about $2.5 million on that adjusted basis.

The most important item in the fourth quarter was our recovery to a positive cash flow or EBITDA. Our depreciation in the quarter was almost $3 million, so we posted a positive EBITDA for the first time since the end of 2008 at $2.9 million, about 4.1% of sales. This return to a positive operating cash flow is significant in that it was a reversal of a trend, which dominated our results in the first three quarters of the year. This trend showed elevated commission and cost of sales rates, which resulted from the launch of the very popular $499 All-Star Pack, and we saw a year-to-date operating loss through September of $25.3 million.

Commissions reached very high rates at times approaching 55% and cost of sales also rose due to the discount carried by the All-Star Pack. We made adjustments to the economics of the All-Star Pack in late September and the fourth quarter results reflect the impact of those changes in returning our operating ratios to historical ranges where Mannatech can operate in a consistently profitable manner.

The changes we made in pack commission plans were designed with two purposes in mind, motivation and financial stability. We knew we had to maintain a strong motivational factor regarding new associate recruiting. Many people new to networking are most productive in developing their home-based businesses in the first 90 days after joining a company and our pack bonus structure is designed to reward both new business builders in their first three months, as well as more established associates. We maintained all the prior pack bonuses, but the amount of the various payments were brought more in line with the parameters of a long-term sustainable model.

We believe that the motivational factor for new associates, which is offered by the pack bonus system is very strong and more than competitive within the networking industry, and still offers great rewards to established associates also. The financial aspect of the bonus changes for the company allows for a more equitable spread of commissioned payments between those who recruit new consumers and those who specialize more in recruiting new business builders. This better balance was a major point in designing the modifications to the pack structure and judging from recent results, it appears that we have achieved the balance we had sought.

Our cost of goods sold rate was 15.5% for the quarter compared to 15.1% last year. This cost carrier was also favorably impacted by the modifications made to the All-Star Pack, which helped so much with the commission expense. Previously the All-Star Pack carried a higher discount compared to normal associate pricing so that as the All-Star Pack took up higher proportions of the total sales mix, the discount more heavily influenced the overall product cost rate. The rate of discount was reduced to more reasonable levels in September in our domestic market in Europe and in South Africa also.

Total commission costs of 44.2% in Q4 dropped about 5 percentage points from almost 50% in Q3 and improved by more than 15 percentage points from the highest peak level in Q2. Our target level is in the historic range of 44% to 45%, and the tweaks, which were put into effect in last September had the desired impact, and put us squarely back into that range. The elevated commission costs of the last several quarters were in essence a higher cost of new customer and business builder acquisition, which targeted higher recruiting numbers. In that sense, we were successful as we saw new associate sign ups, which were better than comparison periods. We feel that adding new associates was the primary need to return to more successful sales levels.

Our commission costs have moved back to normal levels and were concentrating on developing renewed sales growth and encouraging many of our recent new associates to focus on building their new Mannatech businesses. In detail, paid commissions were 43.6% in rate to sales for the fourth quarter. Incentive costs were seven tenths of one percent of sales, lower than last year in rate. The third and fourth quarters generally have relatively little incentive activity impacting the financial statements. Our 2010 incentive travel contest began in late February and we are looking forward to the results of this year’s contest. We emphasized growth in our incentive contest rules, so we expect to see impact in the coming months. The contest runs for 20 weeks through late July.

As we have mentioned, Mannatech has focused on controlling our operating expenses very tightly. We noted repeatedly in our recent conference calls that our expense levels have been the lowest in years. Our operating costs in the 2009 fourth quarter were lower than the Q3 2009 prior quarter figure by almost 13%, and our total overhead expense was cut almost 11% from last year’s adjusted figure. Last year, the fourth quarter had a benefit from a favorable adjustment of about $5 million, which was made to a litigation accrual. We are maintaining this level of expense control on a continuing basis, so that as our sales begin to show growth, we will be positioned to produce this strong incremental sales flow-through profit rate.

These components led to our operating results improving and essentially reaching the breakeven point and a positive EBITDA for Q4. We believe that we have enhanced the ability of the business to produce positive EBITDA at our current sales level by returning our operating ratios to their historical ranges. While expense control remains a necessity, increases in finished product sales and continued recruiting success are the vehicles to restoring earnings growth in the future.

Our annual results for 2009 included sales of almost $290 million, down 12.9% from 2008. Cost of goods sold was 16.2% in rate, higher than the previous year by 1.6 percentage points due to the higher sales levels of the All-Star Pack. Commissions in total were 50.5%, also due to the higher All-Star Pack sales and related incremental bonuses. Paid commissions were 47.7%, up 5 percentage points from 2008. Incentive costs were 2.8% of sales, up 0.5 percentage points from 2008. Total operating costs of $122 million were reduced by 18% from the prior year or almost $27 million. Depreciation was $12.3 million, essentially even with 2008. Our annual operating loss was $25.6 million. Lower sales, higher product cost, and increased overall commission expenses together accounted for the deficit for the year.

Other income and expense showed a positive currency translation result. Strengthening in the Australian and New Zealand dollars has occurred and also in the Korean won. Of the Japanese yen, it was largely maintained. Currency deterioration had negatively affected us since the trend changed in Q3 of 2008. Other income in total was favorable $1.5 million for the year compared to a negative in 2008 of $3.7 million. Our net loss was $17.4 million for 2009 with a net loss per share of $0.66.

Our balance sheet at 12/31 continued to show essentially no long-term debt and in December, we held $17.4 million in cash along with $8.5 million in various restricted accounts. The new general manager in South Korea has been very helpful to our Treasury function in freeing up about $1.5 million in previously restricted funds there. Our ending inventory of $31.3 million was even with the 2008 ending balance. We have safety stocks of several of our fairly expensive larger volume product component, and these represent roughly one third of our total inventory balance.

Dividends of $1.1 million were paid in 2009. We again did not repurchase shares during the year. We invested roughly $2.8 million in capital additions mostly Web site and systems related enhancements throughout the year. We have continued development of our new Web site and currently we have a team working on the project, which includes associate leaders as well as internal marketing, and IT department members. Also our 12/31 balance sheet shows an income tax receivable of $8.1 million. We will be filing shortly for a refund for most of that balance sheet amount.

In summary, 2009 was a pivotal year in that we had targeted for an increase in recruiting, which was achieved. The cost of that recruiting increase was significant but temporary. We have now returned to our historical operating ratios and for 2010, our target is to successfully develop and grow many of those new business builders who joined Mannatech last year. We are looking forward to the results of the 2010 travel incentive contest, which we hope will indicate that many of those who have recently joined us have concluded that our combination of proprietary wellness products and our industry leading commission plan gives them the best of both worlds for a home-based business.

Thanks for your attention, and now Rob has some final wrap-up comments.

Rob Sinnott

Okay, thank you Steve. Briefly, I just want to address some of the fundamental trends that we believe will drive growth for Mannatech into the future.

First of all, consumer driven wellness trends strongly indicate that a rapid increasing focus on health and prevention around the world will continue. Dietary supplements and nutritional products are no longer a cottage industry, rather they are a big business. Even established large pharmaceutical companies are embracing nutrition as the next frontier. Everyone is beginning to realize that wellness is a consumer driven trend that will have beneficial impact on human health, stemming on wellness, represent a better long-term value proposition for customers than having their body break down at a relatively young age.

There is increasing attention being focused by sciences on the role and potential benefits that polysaccharides, such as our product Ambrotose, play in consumers’ health and well-being. Steve and I have been strengthened by the challenges that we have successfully navigated during the last few years at Mannatech. We have built a great relationship with our associates and have a clear understanding of our unique business.

Next week, we are holding our annual manifest convention here in Dallas. Steve and I are very excited to meet with many of our friends and associates from all over the world. Manifest activities will include break out training sessions, as well as the new product launch, and recognition of top associate earners worldwide. This convention will highlight the outstanding combination of balance for our associates, to expand their reach through real food technologies, and our significant business building opportunity.

And now, we will take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question is from the line of Peter Park – Park West Asset Management.

Peter Park – Park West Asset Management

Hi. When do you expect to receive the income tax refund that you have applied for, and are there any further income tax refunds that you can apply for given the taxes you pay while the business is doing better a while ago?

Stephen Fenstermacher

Hi Peter, good morning. This is Steve. We will be filing fairly shortly for the bulk of that particular figure on the balance sheet with the US taxing authorities. Making projections about receipt from the government is probably not the best bet in the world, but based on history, we believe that we are probably looking at a 45 to 60-day time period, perhaps 90 days at the outset, but our experience with the IRS over the past several years has been relatively quick response.

Peter Park – Park West Asset Management

Okay, great. What was the amount of legal expense that was accrued for as of the fourth quarter and can you remind us what that was as of the third quarter?

Stephen Fenstermacher

In 2008, we had accrued a fairly significant amount in the second quarter related to various litigation that was ongoing at the time. By the time that we released our annual numbers and the 10-K for 2008, we had total charges related to litigation of about $9.5 million on a direct basis Peter. There were some other specific operating expenses on an ongoing basis, but in terms of items specific to the class action and the AG, that total was in that range.

Operator

(Operator instructions) We have a follow-up question from the line of Peter Park.

Peter Park – Park West Asset Management

Hi. My question was actually regarding the balance sheet accrual as of the fourth quarter for a legal as opposed to the third quarter.

Stephen Fenstermacher

Okay Peter, you are talking about the 2009 fourth quarter?

Peter Park – Park West Asset Management

Right. So as of the third quarter in the 10-Q, it says that the amount is I think, let’s see, the accrued liability is I think $5.5 million related to the Texas Attorney General. Do you have a current number as of the fourth quarter?

Stephen Fenstermacher

Yes, that number has been reduced to about $1.5 million or so Peter.

Peter Park – Park West Asset Management

And how did that happen?

Stephen Fenstermacher

A specific payment was made in November.

Operator

(Operator instructions) There are no further questions at this time.

Rob Sinnott

Okay, thank you very much for being with us today. We will look forward to speaking with you at the end of the next quarter.

Operator

This concludes today’s conference call. You may now disconnect.

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