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Mannatech, Inc. (NASDAQ:MTEX)

Q4 2006 Earnings Call

March 16, 2007 10:00 am ET

Executives

Samuel L. Caster - Chairman of the Board, Chief Executive Officer

Stephen D. Fenstermacher - Chief Financial Officer, Senior Vice President

Gary M. Spinell - Vice President of Investor Relations

Analysts

Doug Lane - Avondale Partners

Scott Van Winkle - Canaccord Adams

Presentation

Operator

Greetings, ladies and gentlemen, and welcome to the Mannatech Incorporated Fourth Quarter and Year-end 2006 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, Mr. Sam Caster, Chairman and CEO of Mannatech. Thank you Mr. Caster, you may begin.

Samuel L. Caster

Thank you. Well, good morning, everyone. This is Sam Caster, Chairman and CEO of Mannatech and I do welcome you to our fourth quarter 2006 earnings conference call. With me today are Steve Fenstermacher, our Chief Financial Officer and Gary Spinell, our Vice President of Treasury and Investor Relations.

Before we discuss the quarter, I will turn the microphone over to Gary Spinell to read the Safe Harbor statement.

Gary M. Spinell

Thank you, Sam. During this conference call we may make forward-looking statements, which could involve future events or future financial performance. Forward-looking statements generally can be identified by the use of phrases or terminology; such as, may, believe, 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.

Thanks, and now I'll turn the call back over to Sam.

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Samuel L. Caster

Thanks, Gary. Well, let's start with the fact that we are pleased with our record quarter sales and encouraged by strengthening sales trend. On the heels of a soft third quarter sales, the 5.3% growth in the fourth quarter indicates that we are experiencing upward sales momentum. Both our fourth quarter sales of $106.8 million and our annual sales of $410.1 million are new records for Mannatech.

We are seeing results from the various incentive programs and sales initiatives that we've implemented over the previous quarters. These programs in conjunction with the launches of two key new proprietary products have helped to generate incremental sales and higher pack sales. We are retaining an industry high, 74% auto order rate.

On a regional basis, our domestic markets, which include the United States and Canada, saw sales rebound. Just as important, two of our key international markets, Australia and Japan, also demonstrated sales improvement over the third quarter. Japan demonstrated strong growth, up 30% over third quarter results. We are particularly encouraged by our Australia results, which indicate a strengthening trend there also. In addition, Korea, which continues to be a stellar market for growth in the fourth quarter, was 57% higher than in the third quarter.

Our earnings for the quarter were down compared to the prior year as we made a significant investment in new proprietary technologies. The launch of PhytoMatrix and the anticipated rollout of our Optimal Skin Care System at the end of the first quarter in North America demonstrate our continued pursuit of leading edge science and technology in the Wellness Industry. This impacted our earnings per share, which decreased $0.04 from the prior year to $0.30.

Net income declined $1.2 million to $8.2 million compared to $9.4 million in the prior year. Steve Fenstermacher, our CFO will provide more detailed information on the various categories of expenses.

These two new proprietary products, PhytoMatrix and the Optimal Skin Care System are the catalysts that are building excitement and enthusiasm throughout our Associate and Member base. As we stated in our prior earnings calls, regaining momentum can take one to two quarters. We are encouraged by the recent sales and associate recruiting trends continuing in the first two months of 2007.

Mannatech has taken a unique position in the Wellness Industry with three revolutionary product technologies, each addressing distinctive consumer needs. Since inception, Mannatech's goal has been to provide leading edge, science-based products to the growing number of individuals who are seeking natural alternatives and solutions to achieving and maintaining optimal health.

Our newest product, PhytoMatrix, is the nutrition industry's first supplement containing completely standardized levels of all natural vitamin complexes and phytochemicals combined with a 100% plant sourced minerals. It was launched in the U.S. in late November. A survey by Proevity Continuing Education Group found PhytoMatrix to be the only multivitamin product on the market today containing new third generation vitamin mineral technologies.

So far we have found this product to be a strong door opener for our associates, and we're in the process of rolling this product out globally over the next six months. Our Optimal Skin Care System, which was launched in Japan this summer and in Korea in December, is set for its U.S. debut later this month.

There is considerable excitement from our associate base in anticipation of our skin care launch in the United States and Canada, due to the high consumer acceptance of the product in Japan. Our Optimal Skin Care System uses an enhanced water technology that provides a preservative-free environment, not just a paraben free product.

This advanced skin care system translates well into our existing customer base, as well as providing an entree into new consumer markets.

And of course Mannatech's patented Glyconutritional Supplements continues to have an extensive loyalty from our associate base. It remains the core technology in our product portfolio and once again generated more than 50% of our sales in 2006.

These products provide our associates with the opportunity to reach out to more consumers than ever before, whether new potential associates are seeking something to help improve their physical quality of life, looking to maintain their health through the most natural plant source products or seeking water based, preservative free skin care products or healthy skin Mannatech is now their destination.

In addition to our product launches, Mannatech is ready for another unprecedented launch and that of our unique IT system beginning next quarter.

Mannatech is proud to be the first company in the direct selling industry to our knowledge to have a fully integrated single instance global Enterprise Resource Planning System, otherwise known as ERP.

Once fully implemented, this comprehensive system, internally known as GlobalView will better allow to us to track sales more closely starting from our order entry system with automatic posting in accounting and inventory processing.

It's state-of-the-art capability will allow to us enter new markets faster and more efficiently, streamline the associate commission process, and greatly enhance our ability to manage our business on a global scale.

I would now like to turn the call over to Stephen Fenstermacher, our CFO.

Stephen D. Fenstermacher

Thanks Sam, and good morning to everyone on the call. As Sam mentioned, Mannatech is excited about our positive sales performance in the fourth quarter of 2006. As we told you on our third quarter call, we have invested in the business to ensure that we would again show a positive comparison after the small negative in the September quarter and we saw our sales respond.

Our balance sheet is still strong with more than $70 million in cash and investments and essentially no long-term debt. Our financial position is well established with equity, comprising most of the capital structure. The costs associated with spurring our sales volume appeared in all major areas of the P&L in the fourth quarter.

Cost of goods sold, commissions and operating expenses; the cost of goods sold ratio was 14.7% of sales, essentially even with the fourth quarter of 2005, but up somewhat versus our 2006 third quarter. We absorbed some costs related to our new product introductions, which impacted the quarter. Some startup batches, skin care component items, some packaging items, etcetera.

We also saw our inbound freight go up, reflecting the higher petroleum and fuel costs, which we have all seen recently. Most of these impacts were one-time or expected to be temporary in nature outside of the freight costs, so our cost of goods may return to a more normal rate in the future.

Our cost rate in the second quarter of 2006 was 14.1% and the third quarter it was 13.5%. Our cost of goods sold rate for the year of 2006 was 14.3%, favorable to 2005 by 6/10th of one point. We have discussed on past calls our ongoing efforts to obtain higher quality product components with more economical prices, and these efforts are continuing. This improvement in our annual cost rate is reflective of hard work and great results from our supply chain team.

Commission and incentive expense in the fourth quarter was 43.9% of sales, an increase of about 1.6 percentage points compared to a year ago. The commissions paid directly on sales accounted for most of the year-to-year change at 42.2%.

Our pack sales tilted somewhat towards the higher value and higher cost business packs. To sell these packs successfully involves a great deal of time and activity on the part of the sponsoring associates, and thus these packs carry a higher total commission rate. Our fourth quarter All-Star Pack sales reached relative highest level, we've seen in about two years outside of the final weeks of the annual travel incentive contest.

This could indicate a resurgence of interest in new associate business builders, as well as, greater interest from new product consumers due to the discount available on these high value packs. We perceive both of these scenarios as good for the Company, and this trend could continue in the coming months.

Incentives cost was 1.7% of sales in the fourth quarter and was up five-tens of one point in rate to sales compared to 2005. The higher level related to our fourth quarter program in which our international associates can win prizes that pay their travel costs from their home country to Dallas for our annual global event called MannaFest. MannaFest 2007 is coming up here at the end of March, where we will host upwards or perhaps as many as 8,000 of our associates not only from North America, but from around the globe for four days.

We had a very large number of international winners more than 500 this year, as we put greater emphasis on the program. And our independent associates worked diligently to be able to travel here to Dallas and participate in MannaFest. All of these winners will be joining us here shortly. So we are really looking forward to what should be a very exciting and rewarding meeting for the company and our associates as well.

Annual commissions and incentives together came to 44.4%, compared to 44.2% in 2005, due to the higher level of incentives, over the course of the year. Total operating costs for the quarter were $33 million at 30.9% of sales. Operating costs showed a variance of about $4.6 million compared to 2005.

The additional costs fall into three main areas of expense, new products, additional marketing support and fixed costs such as depreciation, options expense, and credit card and bank fees. These areas together accounted for about three-fourths of the year-to-year expense increase.

New product spending obviously included the launch of PhytoMatrix, our new natural vitamin mineral product. We provided a considerable level of support for the PhytoMatrix launch, and as Sam mentioned, so far we are pleased with the performance we have seen.

The upcoming skin care launch in North America has been a focal point for us, and considerable energy has been put into this important product kick-off. A number of projects related to the skin care launch began in the fourth quarter to help ensure that this product line introduction will be the smoothest and best coordinated effort in the history of Mannatech.

We also saw a greater marketing support activity in the fourth quarter. First, our annual training event called MannaQuest was held in Denver in November, whereas in 2005 MannaQuest was held in the third quarter.

This difference in scheduling shifted the costs associated with the event into the fourth quarter from the third quarter in the prior year. Also, more emphasis was placed on associate meeting attendance; speaker travel, and our in-house associate magazines carried more extensive data on PhytoMatrix, as well as the upcoming domestic skin care line launch.

Our fixed and semi-fixed costs complex also rose in the fourth quarter from higher depreciation, stock option expense and credit card and bank fees. Depreciation increased due to the human resources module of our GlobalView ERP, which was put into use earlier in 2006.

Options expense was new for us in 2006 and the credit card costs was up due to the transactional rate pressure, which has been seen by many companies over the last year or so. Total operating costs for 2006 annual was 30.6% of sales, compared to 29.2% in 2005. Depreciation, options expense, travel, new product R&D, and additional staff expenses all drove the increase.

Operating profit of $11.2 million for the quarter was down from over $15 million in 2005, due to the heavier investment spending in our new product launches and upcoming skin care support. We saw a greater interest income and favorable foreign exchange helped our fourth quarter pre-tax profit to $12.2 million or 11.5% of sales.

The income tax rate for the fourth quarter was 33.1%, reflecting continuing R&D tax credit realization, as you saw in the third quarter. The tax rate in 2005 was 37.6% and net income of $8.2 million resulted in earnings per share of $0.30 down from $0.34 last year.

Our full year net income was $32.4 million or 7.9% of sales, up 500 basis points from the 7.4% of 2005 due largely to our favorable tax rate, which was 32.1%. Earnings per share for the year grew to $1.19, up 15.5% from 2005 on the sales gain of 5.3%.

I would like to make several points concerning our balance sheet and cash flow. We continued in the fourth quarter to bring our GlobalView ERP system toward go live, which is scheduled for April 1, just a few weeks from now. Most of the capital spending in the quarter of over $6 million concerning the project, which will total roughly $33 million in capital by go live.

We are anxious to bring the new system up, as it will bring us considerable efficiencies in many phases of the business. The go live activity will cause us to shut down our legacy system for about a week at the end of March. The file conversions, etcetera, associated with bringing up the new system will take time, and we want to ensure that these delicate processes are performed correctly.

This downtime could shift roughly one week of sales, out of the first quarter of 2007, and into the second quarter. But we've planned this very carefully so as to cause the least amount of disruption to our associates and consumers, and we are very confident that the process will go smoothly.

Depreciation will be a large non-cash expense increase for us in 2007, due to the system go live date coming up here in a few weeks. The major portion of the system will then be put into use and depreciation of the capital cost will begin.

Our capital spending should decline with the completion of the system, which could be expected to increase our overall cash flow. And we actually had two $0.08 dividend payments hit the books for the quarter due to timing. One dividend was paid in the month of October.

For the dividend declared in November, we wired the cash to our transfer agent in late December, and then the distribution out to our shareholders occurred a few days later in early January. These together were about $4.2 million with the annual dividend for 2006 coming to $0.32 per share or $8.5 million in cash for the year.

We announced earlier this week that the 2007 quarterly dividend would increase to $0.09 per share, up 12.5% from the 2006 dividend. The increase reflects the earnings growth achieved in 2006 and is also an expression of confidence by our board and management in the trend shaping up for 2007. As always, we encourage long-term ownership of Mannatech stock by our shareholders.

Our ending inventory increased about $4 million compared to 2005. The drivers were new product items, including PhytoMatrix and skin care, and also we added some additional product line extensions, as well as, new international formulations for several products.

We didn't repurchase shares during the fourth quarter. The year of 2006 saw repurchases of almost 541,000 shares using $7 million of cash. We have an open-to-buy allotment of $20 million from the Board, so under certain market conditions we may engage in additional repurchases.

In summary, we're looking forward to the opportunities we see within our improving sales trend, and also by the upcoming go live for our GlobalView ERP. The go live will shift about one week of sales due to system downtime, and those sales will move into the second quarter. It looks like 2007 will be an exciting year, and we are eager to support our associates as they grow their Mannatech businesses around the world.

Thanks for your time. And now, Sam has some closing comments.

Samuel L. Caster

Thanks, Steve. You know, as always, my commitment remains strong to continue to return value to our shareholders. This past year, we have increased earnings per share of 15% and repurchased $14 million worth of stock. We just announced a dividend increase for the third consecutive year.

At the same time, we worked diligently putting the final touches on the products, programs and systems for the next evolutionary step in Mannatech's future. I believe these new products and services are again the catalyst that will move our company into new growth.

In January, company executives and our top sales leaders from every country came together at our annual leadership event. The attitudes were more positive than I have actually seen in several years. And I think this was critical because it’s been said that new sales in our industry are based on 10% skill and 90% attitude. So it appears to me that we may have turned the corner in this regard as the excitement level and activity continues to build.

As we discussed on our last call, momentum is that magic energy that feeds on itself. In other words, success begets success, and I am excited about what I am seeing, and more importantly, what I am feeling from our field force.

So, that concludes our call today, and we will now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Doug Lane with Avondale Partners. Please proceed with your question.

Doug Lane - Avondale Partners

Yes. Hi. Good morning, everybody.

Samuel L. Caster

Hi, Doug.

Doug Lane - Avondale Partners

Question, first one on the associates; you mentioned that the recruiting seems to be picking up and the mood and spirit seems to be heightening as well. Do you think in the March quarter that we will see the trailing 12 months new associate number improve in the December quarter? They have been kicking down lately?

Stephen D. Fenstermacher

Doug, this is Stephen. Good morning. I think it is too early to judge what we may see for the entire quarter. Remember, we also have essentially a week of systems downtime that will impact our results for the first quarter.

What we can say is that we are encouraged by a number of different items, as Sam mentioned, including the movement of the PhytoMatrix product itself, the energy level that we are seeing results from the upcoming skin care launch and the activity and preparations from our associate leadership.

And we are very encouraged, also, as you can tell from the Board level and management by the increase in the dividend rate. I don't think we want to comment specifically on expectations for the first quarter, but we are pleased with what we are seeing.

Doug Lane - Avondale Partners

Okay. Fair enough. And then if you could help us get our arms around the margins here, we've seen margins, operating margins that is down year-over-year for the last two quarters, and you did explain particularly the fourth quarter today fairly thoroughly. How much of this sort of near-term spend behind the new product launch is going to spill over into 2007?

And layering in the added depreciation expense from your systems investment, can you talk about when you think operating margins will start to improve year-over-year and just bigger picture should we be looking for an improvement in operating margins in 2007?

Stephen D. Fenstermacher

We have mentioned a couple of times in the past, Doug, the timing situations that we see impacting results in our first fiscal quarter each year. We have a great deal of incentive accrual in the first quarter for our annual travel incentive contest as the contest begins in the first week of January and continues into May.

So the entire first quarter bears significant amount of incentive accrual as, we're putting that through the books. In addition, MannaFest occurs in March each year, so those costs are contained within the first quarter as well. The items that we spoke about impacting the fourth quarter, many of them were essentially onetime or short-term in nature.

There will be some additional continuing costs for the skin care launch that hit the first quarter, since we are introducing at MannaFest here in a couple of weeks. The depreciation on the bulk of the costs associated with the GlobalView investment, however, will begin on April 1st, and so we'll see that impact in the second quarter.

And that obviously is going to be a sizable amount of non-cash expense on the P&L, but in terms of many other costs contained in the fourth quarter and the first, some of them do tail off in the second.

Doug Lane - Avondale Partners

So I mean, I know that you don't want to get too specific, but just directionally, Steve, here for the full year in '07, do you think operating margins will be the same, an improvement from '06, below '06, until you start to get through all the spending?

Stephen D. Fenstermacher

Well, we are planning on a successful year in 2007, Doug. We are pleased with what we have seen so far on the sales side and the momentum, and our plans are certainly for a successful 2007, so I think we will leave it at that.

Doug Lane - Avondale Partners

Okay. Thank you.

Operator

Our next question comes from the line of Scott Van Winkle with Canaccord Adams. Please proceed with your question.

Scott Van Winkle - Canaccord Adams

Good morning, everyone.

Samuel L. Caster

Hi, Scott.

Scott Van Winkle - Canaccord Adams

A few questions, and I apologize; I missed a portion of the call. Have you continued to work on the relation's efforts you started a couple of quarters ago?

Samuel L. Caster

Say that again, Scott, I don’t read.

Scott Van Winkle - Canaccord Adams

I apologize. Have you continued to work on the public relations efforts that you begun a couple of quarters ago, particularly the ads in the local paper in Dallas?

Samuel L. Caster

Yes, we have. We sponsored an organization called Up with People here in Dallas that we think was very positive, not only for our associates, but also for the community.

So we continue to look for opportunities around not only the United States but around the world to continually build the image of our company and the things that we are actually doing and contributing out there. So, yeah, we are going to continue the efforts.

Scott Van Winkle - Canaccord Adams

I am sure that you saw the issues affecting one of your competitors yesterday on circling the street and something earlier this year around a lawsuit on one of the major multi-level marketers.

Have you heard anything from your distributors, well, this is more just for kind of an indication of the industry itself rather than particularly to you, but I would love to hear your thoughts, about any impact from some recent skepticism around the network marketing industry in retail?

Samuel L. Caster

You know, those types of things can go two ways. One is they can temporarily, whenever there is a negative article, put a glitch out there in overall recruiting I think for the industry.

On the other hand, listen the people in our industry get what we are all about. They understand the significance of our sales effort. They understand the ability to educate consumers on new technologies that are pretty unique to the direct-selling industry.

And so I think they look at a lot of this stuff as manipulation by someone who has an agenda or possibly a profit motive, as was indicated in the response from USANA. And I think our overall basis is, it has very little effect, I think on the industry itself, because we know the facts.

Scott Van Winkle - Canaccord Adams

Great. Well, congratulations on the improved recruiting and keep it up. Thank you.

Samuel L. Caster

Thanks, Scott.

Operator

(Operator Instructions) Thank you. There are no further questions at this time. I would like to turn the call back over to management for closing comments.

Samuel L. Caster

Well, again, we are very excited about what we are seeing. You know, again attitude is 90% of moving an organization like this forward. I think on previous calls we have talked about the fact that we think our new product technologies and rollouts are having a big impact on picking momentum back up again, and I think we are seeing the initial signs of this, so we are very positive. We thank you guys for being on the call, and we will talk to you next quarter.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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