Greetings and welcome to the Mannatech Incorporated second quarter 2011 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 today, Mr. Mark Nicholls, Vice President, Treasury and Tax. Thank you, Mr. Nicholls, you may begin your conference.
Thank you. Good morning everyone. This is Mark Nicholls, and welcome to Mannatech’s second quarter 2011 earnings call. Today, you will hear from Mannatech's Co-CEO and Chief Financial Officer, Steve 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 terminologies 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 submissions.
Thank you. And now, I will turn the call over to Steve Fenstermacher, Co-CEO and Chief Financial Officer.
Thanks Mark, and good day everyone. The second quarter of 2011 was an important period for Mannatech. In our discussion of the first quarter of 2011, we spoke of the planning effort, which takes place in our January meetings with our independent associate leaders each year. In addition, we started our annual travel incentive qualifying period in January.
This year, we initiated operations in Mexico, with our offices in Guadalajara and Mexico City and product pick-up facilities in those cities as well as a distribution center located in Monterey. In the second quarter, we began working on modifications to our Associate Compensation Plan to strengthen the leadership ranks throughout the world.
In addition, Mannatech opened four additional European countries for business in the final weeks of the quarter. To our group of seven European countries, we added Ireland, The Czech Republic, Finland, and Estonia. These Eastern European countries were added with a specific target in mind, which is the eventual entry of Mannatech into Russia at some point in the future. These new markets bring our European presence to a total of 11 country markets. So, a number of critical projects were kicked off. We have successfully completed some and made very good progress on others in this recently-ended second quarter.
In July 2010, Mannatech chose to take on the Number 1 health risk that children face today, poor nutrition. By providing nutritional supplements, based on Real Food Technology solutions through our Give for Real donations through consumption program, together with our Associates, we believe we can affect the lives of children suffering from inadequate nutrition. One of our goals is to eventually link 5 million consumers worldwide directly to the needs of 5 million undernourished children.
The Give for Real program is how Mannatech makes the idea of social entrepreneurship a reality. We have chosen to incorporate a direct marketing distribution and compensation model into our social, entrepreneurial business strategy. This allows us to financially reward individuals who choose to participate in our world-changing fight against poor nutrition in direct proportion to the level of activity.
In the second quarter, we finished plans for launching the Give for Real program this fall in our international markets. So, by the fourth quarter, Give for Real should be supplying our natural nutrient blend to more than 60,000 needy children every month. Our Associates in our foreign countries have expressed to us their strong desire to participate in this giving program, and we look forward to seeing the impact Give for Real makes in their recruiting and business activities.
We have also put to finishing touches on a few improvements to our global seamless commission plan as well. These changes encourage leadership and we will be monitoring the commission plan to confirm that the desired activities are being rewarded. Perhaps, the most exciting item in the second quarter stemmed from our domestic market through discussion with our North American Associate leadership. Together, management and the leadership had for some time been developing new possibilities to stimulate incremental sales and recruiting volume, this spring, an idea for promoting our Optimal Support Packets product when ordered along with Bulk Ambrotose Powder, was created and implemented to provide a strong value innovation for our loyal consumers.
Our history in Mannatech has revolved around technical innovation in bringing our Real Food Technology to the fore. These days, in this continuingly uncertain and difficult economic environment, when even our government is struggling with wide-ranging economic questions, we feel that exploration of economic and value innovation is absolutely the best direction for Mannatech.
So, an Associate consumer can receive our Optimal Support Packets product at a value price by ordering through our regular Auto Order System in combination with Bulk Ambrotose Powder. The OSP packets are individual convenience packs, which contain our premium phytomatrix natural vitamin and mineral tablets, our Plus tablets and our AO antioxidant capsules. This combo kit carries incremental sales and a strong gross margin rate for the company that provides an economic discount to the consumer and it has given our Associate leaders in the United States and Canada a reason to reconnect with people in their down lines whose regular orders from Mannatech had lapsed whatever the reason.
The combo kit has generated excitement and renewed Associate activity, and we have seen thousands of lapsed customers reinstate their auto orders to take advantage of this offer. In fact, four promotional activities will begin only in several weeks due to the lead time required to build sufficient product inventories. But our Associate leadership is working diligently to fully utilize this combination product. The initial results of the promotion appear quite promising, and other logical product combinations will be developed in the coming months, which could provide profitable incremental sales volumes to us and our field sales associates as well.
To recap our financial results for Q2, total sales of $51.4 million were down 10.8% in 2010 due to lower pack and product volumes. Product revenue was reduced by 7.5%, and pack sales declined considerably reflecting the reduction of pack pricing in our international markets since Q1 of 2010. Foreign currency exchange impact was favorable for Q2, adding about $2.8 million compared to last year.
Our second quarter sales figure of $51.4 million exceeded our first quarter level by $500,000, thus recording a notable quarter-to-quarter increase for the first time in several years. The favorable results compared to Q1 2011 reflected an increase of 15% in native currency sales in Korea, as well as an overall international increase due to favorable currency rates in Q2 versus Q1.
Our Q2 operating deficit of $4.3 million was greater than last year, reflecting the impact of overall lower sales, the costs associated with our still-developing operations in Mexico, along with the reserve of $700,000 related to the recent elimination of approximately 100 employee positions, and our net loss of $5.2 million for Q2 was greater than in 2010 due to these same items.
Once again, our major cost areas remained in general historical ranges and overhead expense control also continued in the quarter. Our cost of goods sold rate was 14.7% for the quarter and was higher than last year’s rate by seven-tenths of 1 percentage point due to adding to our inventory reserves in the quarter. These additional reserves essentially finished the overstock positions of our OsoLean product and PhytoBurst Chews as well. Again, our inventory levels were reduced in Q2, and we will continue to concentrate on deploying our inventory investment in the most efficient way.
Through June, the inventory reserves taken in the two quarters elevated cost of goods sold rate by three-tenths of 1 percentage point compared to last year. Total commission and incentive costs of 44.6% in Q2 were again within our general historic range of 44% to 45%. That was somewhat higher than the 2010 rate of 42.5%. As we have mentioned before, we believe our Associate compensation rates remain among the highest in the industry, and the earnings possibilities carried within our global seamless downline commission program are very attractive to business builders. The overall commissions figure includes accrual for the travel incentive contest as well as paid commissions. Again, most of the variance came from direct paid commissions.
Paid commissions expense of 42.6% increased 1.6 percentage points compared to 2010, reflecting higher activity related to triggering powered bonuses. The incentive cost accrual reached 2.0% for the quarter, up from the comparable 2010 level by five-tenths of 1 percentage point. Year-to-date, both paid commissions expense and incentive cost accrual were exactly even with last year in rate at 41.5% and 2.1% respectively.
We continued to focus on operating expense controls and this resulted in favorable totals compared to last year. Operating expenses were reduced by about $1.9 million, even including costs in the quarter for the reserve taken related to the 100 positions eliminated. Excluding Mexico overheads and the reserve costs from the second quarter, our operating expenses would have been lower by $3.1 million, or 11.4%.
The cost reductions announced in late June represent about $12 million annually and were targeted to return Mannatech to a positive operating cash flow or EBITDA level. We intend to further reduce our overhead structure in the coming months, and while these expense cuts to come will be smaller in comparison, they will further strengthen our cash flow possibilities and form the basis for additional incremental profit from incremental sales.
Our balance sheet was improved in several areas compared to March 2011 and continued to show essentially no long-term debt. The cash balance of $17 million was even with the March Q1 figure, but was down from December 2010 as we have funded the launch of our operations in Mexico. Inventories in June were $18.8 million, down by $3.1 million or 14% from the Q1 balance, and down $5.3 million or 22% from 2010 year-end balances.
Reductions in raw materials and finished products were both achieved, which once again helped in our overall gain in current liabilities. As before, we have continued to concentrate on continual improvements to our balance sheet, reducing inventory investment and managing our payables carefully, both continued to be central to that focus.
We did not pay dividends in Q2, and we did not repurchase shares in the quarter. However, we did buy back a very small number of shares in July. We again did not initiate any equity raise through our agreement with Dutchess Capital in the second quarter. Capital additions of $145,000 consisted of small additions to our computer systems and final completion of our facilities in Mexico. We are now concentrating on continuing to support our Associate leaders in growing and developing their downline organizations through social, entrepreneurial activity and Give for Real and rolling the Give for Real donation program out for our international markets this fall.
Also, we are continuing the development of the Mexican market, which launched in late January 2011. We will focus on these projects to achieve sales and recruiting growth, as well as to again tighten our expense control in order to see earnings and shareholder value increases. The increase seen in our automatic orders related to the new OSP Ambrotose combo kit product is encouraging, and we will be working on other such combinations to generate incremental sales volume and heightened recruiting activity in our domestic market.
The second quarter was the first in many quarters to show a quarter-to-quarter increase, and we will focus on building this increase into a change of trend and hopefully a return to growth. Thank you for listening, and we will now take any questions anyone may have.
(Operator instructions) There are no questions at this time.
Thank you for listening to our call, and we look forward to updating you again next quarter.
This concludes today’s conference call. You may now disconnect.
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