Mannatech Inc.Q4 2007 Earnings Call Transcript

| About: Mannatech, Incorporated (MTEX)
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Mannatech Inc. (NASDAQ:MTEX) Q4 2007 Earnings Call March 17, 2008 10:00 AM ET


Terry L. Persinger, President - Chief Executive Officer, and Board Member

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

Robert A. Sinnott, MNS, PhD - Chief Science Officer and Senior Vice President

Gary Spinell - Vice President Investor Relations


Dan Mendoza-Agincourt Capital

Peter Park-Park West Asset Management


Greetings and welcome to the Mannatech Inc. Fourth Quarter 2007 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. Terry Persinger, President and Chief Executive Officer, for Mannatech Inc. Thank you Mr. Persinger, you may now begin.

Terry Persinger

Good morning, this is Terry Persinger, President and CEO of Mannatech and I welcome you to our fourth quarter 2007 earnings conference call. With me today are Steve Fenstermacher, Chief Financial Officer, Gary Spinell, Vice President of Finance and Investor Relations, also joining me today is Dr. Robert Sinnott, our Senior Vice President and Chief Science Officer.

Before we discuss the quarter, I’ll turn the microphone over to Gary Spinell to read the Safe Harbor Statement. Gary.

Gary Spinell

Thank you, Terry. 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 and plan, or other similar words with a 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 SCC’s submission. Thanks and I’ll now turn the call back over to Terry.

Terry Persinger

Thanks, Gary. Truly this last quarter has been the most challenging we have faced in the last six years. The declining sales trend began mid-year shortly after the Texas Attorney General’s announcement. Our US sales and recruiting experienced the biggest impact and the decline was not fully offset by an increase from our international business.

As we announced in our Friday press release, sales in the fourth quarter of 2007 were $99.9 million, 6.5% below the fourth quarter 2006. Our domestic sales, which include the US and Canada, were down 20% versus fourth quarter 2006, primarily due to lower pack sales, which reflects lower recruiting numbers. In the same period international sales grew 27% over prior year, reflecting growth primarily in our Asian markets. Sales in the Republic of South Korea close to tripled in the quarter compared to the fourth quarter 2006, reaching $44 million for the full year. It is now our second largest market after the US; both Germany and Taiwan, which represent a smaller percentage of sales, showed over 20% growth compared to the fourth quarter of 2006.At the time, we incurred significant increased expenses also. In this fourth quarter we invested more heavily in global business development and research and development. At the same time we also had increase appreciation expense and significant increases in label related expenses. The net effect was a fourth quarter loss of $0.13 per diluted share versus earnings of $0.30 per diluted share in the fourth quarter 2006. We are continuing to focus on reducing unnecessary expenses, yet we remain committed to making critical investments in the key areas that will contribute to growth. Stephen Fenstermacher and Robert Sinnott will discuss this in greater detail later.

For the fourth quarter 2007 we reported a loss of $3.6 million versus a fourth quarter 2006 net income of $8.2 million. On a pre-tax basis, for the fourth quarter of 2007, we reported a loss of $4.7 million, compared to a pre-tax income of $12.2 million for the same quarter in 2006.

Total independent associates and members at the end of the fourth quarter 2007 were 575,000 based on a trailing 12 month period. This was 5.7% growth or 31,000 independent associates and members versus fourth quarter 2006; continuing associates and members were up 12.6% or 43,000, new recruits were down 5.9%.

Full year sales for 2007 were $413 million, up almost 1% compared to full year 2006. Net income for the full year 2007 was $6.6 million, a decline of 79.6% compared to 2006 full year net income of $32.4 million.

Diluted earnings per share were $0.29, down 79% from $1.19 for the full year 2006.

As the year ended we continued to address the ongoing litigation. Since our third quarter earnings call we have been actively engaged with discussions with the representative of the Texas Attorney General’s office, which we believe have been very productive. We expect these discussions to continue and to ultimately provide the framework for a resolution of this matter. We remain committed to working with the Texas Attorney Generals’ office to resolve this matter. Of course, we are still in litigation with them and there are no assurances in litigation.

As we leave 2007 behind we are continuing to address the challenges to sales and profit growth. Our business approach is to provide our associates with a new consistent business system to create momentum in recruiting and sales.

On an industry level, regulatory oversight in the dietary supplement industry and competitiveness in the wellness sector are driving aggressive changes to our business approach. We are making comprehensive and company wide modifications to our business model. This requires investment and change through out our organization.

The list of key initiatives for 2008 includes the following: redesign of our global sales system, cost reduction, new product development and research, geographic expansion and continuing to strengthen our management team. Now I’ll to into each of these areas in more detail.

To the part of the overall focus of reenergizing the global sales force with particular emphasis on the domestic group, we are readying the Phase III launch of our global sale platform called Ready, Set, go Give! We have also redesigned our associate business development materials. The culmination of all our efforts will occur at MannaFest our annual convention here in Dallas/ Fort Worth at the end of this month with the roll out of the global sales platform combined with extensive sales training. This convention creates associate momentum and this year will include over 1,300 people from non-US markets. There will be over 600 from South Korea alone.

Following Manifest, we will be focusing on profit improvement through reduction in costs related to finalizing the development of sales materials and optimizing the computer system. At this time we will be positioned to focus on cost structure, not only expenses, but also improving our gross profit margin.

New product development will remain a top priority in 2008, which is a requirement to successfully compete in today’s wellness market.

I would like to introduce Dr. Rob Sinnott, our Senior Vice President and Chief Science Officer to highlight what the company is doing in this area. By way of introduction, Dr. Sinnott joined Mannatech 2.5 years ago with over 17 years of experience in the biotechnology field. He is a graduate of Arizona State University and holds both a Master of Science and PhD degree. During graduate school Dr.Sinnott’s primary focus was plant medicinal chemistry and plant biotechnology and his 1995 research dissertation focused on agricultural biotechnology of plants, including the Aloe Vera plant. So please now welcome Dr. Rob Sinnott.

Robert Sinnott

Thank you, Terry. Good morning. Mannatech continues to invest in evidence based research and development. We feel strongly that this provides us with a clear point of differentiation in the dietary supplement and wellness fields, which continue to evolve to higher required levels of product substantiation. This trend is being led by countries such as Canada, Australia and the European Union. Although it will require more investment in R&D and regulatory affairs to meet these escalating standards, Mannatech feels that this evidence based approach is a positive trend that is already strengthening the reputation of the dietary supplement industry in the minds of consumers.

We continue to expand and strengthen our network of global scientific collaborators at academic institutions and clinical research organizations. We currently have pre-clinical research and human clinical studies underway in North America, Australia and Europe. The focus of these studies is to support structure function claims for our new and existing products. Structured function claims detail the means by which a nutrient or dietary ingredient can be beneficial for normal human metabolism. These types of studies are very different than drug studies that examine disease end points; rather the structure function studies look at changes in wellness outcomes or biomarkers of wellness. These types of studies, particularly performed in human subjects under controlled conditions have become strongly preferred by regulatory bodies to support claims on nutritional products.

A pre-clinical study detailing a portion of Mannatech’s research was published in late 2007 in a leading international journal. Additionally, studies covering Mannatech’s Ambrotose products and new product technologies are scheduled to be presented at phytic conferences and published in peer review journals in 2008.

Part of the investment in R&D is directed at reducing the cycle time of product development process. We currently have 28 projects in the product pipeline ranging from discovery, to refinement to commercialization. We have consistently released new products annually to keep our global markets fresh and supplied with products to support business, but while avoiding the down side of rampant SKU proliferation. We are now looking to expand globally at a faster pace and our science and regulatory resources are ramping up to support that effort. Thank you, Terry.

Terry Persinger

Thank you, Rob, for an informative update. Now speaking of global expansion, with the global view system fully operational, we are now focused on the next phase of geographic expansion. We look to open South Africa in the second quarter. South Africa has a rich tradition of using nature’s biodiversity to help address quality of life and optimal health. This tradition allies well with Mannatech’s products and our emphasis on natural ingredients.

In addition to South Africa, we are actively evaluating other new market entries. Alfredo Bala, Senior Vice President of Global Business Development, who joined us just last November, has extensive experience in opening new and emerging markets. He has already visited each country, except for Korea and has now started to focus on new and emerging markets as well as his primary focus on domestic markets.

We continue to strengthen our management team and just recently announced the addition of Marika Berkley, our new Vice President of Quality Assurance and Regulatory Affairs. Her extensive experience in regulatory health care and consumer products will be a valuable asset as we expand our international presence and our product portfolio. As a matter of fact, in the last 2.5 years we have added Al Bala, Senior Vice President of Global Business Development, Terri O'Day, Executive Vice President and Chief Operating Officer, who has extensive experience in global operation in the food industry and Dr. Rob Sinnott, who you just heard from, as well as Keith Clark our Chief Legal Counsel. Steve Fenstermacher, our Chief Financial Officer, holds the key to continuity with almost 10 years of experience with Mannatech. This management team has the experience and the leadership to manage to us to the next level. That brings me to the CEO search.

The board is continuing the search and continues to interview candidates.

In summary, I believe that our independent associates and members are not only resilient, but continue to have a high level of commitment to the company as indicated by the high retention rate through a challenging year. The demand for our high-quality products continues as evidenced by the auto-ship rate on finished product in North America, which remains well above 70%. This is a testimony to the strength of our company and the loyalty of our associates to our products. I have every confidence that the Mannatech team will successfully deal with our current issues and overcome any challenges that impede our growth and our ability to return value to our shareholders.

We also just announced our 12th consecutive quarterly dividend, evidencing the confidence management and the board have in our cash flow and future potential.

Now I will turn the call over to Stephen Fenstermacher, our Chief Financial Officer.

Stephen Fenstermacher

Thanks, Terry and good morning to everyone on the call.

Our fourth quarter results were below expectations for both sales and operating earnings. In addition, our expenses included reserves of $4.7 million in the fourth quarter for potential losses related to three major items of litigation. The realization of these reserves moved Mannatech from a modest quarterly profit to the reported loss of $0.13 per share. Despite the reduced operating earnings in the quarter, our financial condition remains strong. Our balance sheet shows essentially no long-term debt and at year end 2007 we showed almost $60 million in cash and investments. Despite the continuing sluggish sales pattern in North America, we saw our supply chain cost rate return to a more normal level in the fourth quarter. Our cost of goods sold rate was lowered to 14.2% of sales for the quarter, compared to 15.3% in the 2007 prior three month period.

Our product cost rates earlier this year were elevated due to customer satisfaction product giveaway’s in Q2 and the reserve taken in Q3 related to unusable skin care inventories. The rate in the fourth quarter saw a return to a more normal level.

If you listened to our call in the third quarter you may remember that we encountered a number of problems with the manufacturer of our North American skin care products, which led to an actual product recall during the summer, along with the litigation reserves taken in the fourth quarter, which is related to the situation with this manufacturer. We are now bringing in skin care products manufactured in Japan for sale here in North America and we’re pleased with the initial sales reaction of our associates since the reintroduction of the skin care line in late January.

Commission and incentives expense was 46.7% in the quarter up 2.8 percentage points, compared to 2006. The increase was, again, largely due to higher incentive program activity as direct paid commissions were only slightly higher than last year.

Incentive costs rose to 4.3% of sales in Q4, which was up 2.6 points against 2006 and more than doubled in rate to sales. The incentives were increased to counter the effect of the skin care manufacturing problems, as well as negative publicity involving the company. Each operating region around the world ran separate incentives in the second half of the year tailored to their sales situation. Every year we run a global travel prize incentive in the first half and these second half programs are more tactical and different in nature. We don’t intend, currently, to continue the increased level of second half incentives in 2008, instead we believe that the new Go, Give strategy, which Terry described, will be a much more powerful vehicle for our associates around the world.

Total operating costs of $44.9 million accounted for 44.9% of sales. This rate in total was 14 percentage points above last year, or $11.8 million, including litigation reserves. Depreciation from the new global view system increased by about $1.6 million and was 3.0 percentage points in rate.

Compared to last year staff costs were up due to the unfavorable variance from internal salaries, which in 2006 were capitalized, due to configuration work on the global view system and in 2007 were treated as expense, as capital configuration work ended in early April with the go lag. Contract work, mainly on the system and several consulting projects, also resulted in cost increases from last year as well.

A major expense increase was the reserve of $4.7 million taken for anticipated litigation losses. We cannot give assurance that these reserves will be entirely sufficient. However, the level of reserves taken represents our best estimate of probable loss potential at this time. These accounted for 4.7 percentage points in rate variance compared to 2006. Excluding these reserves total operating cost would have increased 9.4 percentage points in rate or about 22% compared to the overall actual increase of 36%.

In addition we had increased professional costs in several categories. Higher audit expense was due to the late engagement of BDO Seedman as our independent external auditors in the fall of 2007 and costs also increased related to a higher activity level in our patents protection program.

Our pre-tax loss of $4.7 million was related directly to the litigation reserve, it was 4.7% of sales and fell from the $12.2 million profit of a year ago. EPS was a deficit of $0.13 per share, based on the net loss after tax figure of 3.6 million, which again reflected the impact of litigation reserves.

Turning to our annual results for 2007 our cost of goods sold rate of 14.5% was only slightly up from the prior year by 2/10 of 1 percentage point. Our commissions and incentives expense of 45.8% increased over 2006 by 1.4 percentage point due to the higher use of incentives during the year, particularly in the second half.

Depreciation more than doubled due to the global view system Go line in the second quarter and the rate doubles as well adding 1.3 percentage points for the year.

Our operating expenses, excluding depreciation, came to 35.4%, up 6.0 percentage points in rate.

Personnel costs rose as we were no longer capitalizing internal salaries on the system project, while legal costs, professional services such as audit and consulting, all contributed to the increase as well.

2007’s annual pre-tax profit came to 10.5 million or 2.5 percentage points of sales a decline of 78%, compared to 2006. Net income of 6.6 million declined 80%. Earnings per share came to $0.25 per share, down 80% from the year before. However, our balance sheet in December was still strong with almost $60 million in cash and investment and essentially no long-term debt.

Our financial position remains strong with equity comprising the bulk of our capital structure.

Our ending inventory stayed roughly even with December 2006 at 23.7 million as our supply chain staff was successful in limiting our inventory investment through reduction of product lead times and good low estimation processes. We will continue this work and we intend to contain inventories as we begin market growth again in 2008.

We paid a dividend of $0.09 in the quarter, which was about $2.5 million in cash usage and last month our board declared our 12th consecutive quarterly dividend, again for $0.09 per share. Mannatech believes it is important to encourage long-term ownership of its’ stock and to continue dividend distribution.

We did not repurchase shares during the fourth quarter. We do have an open-to-buy allotment of $20 million from the board, so under certain market conditions we may engage in additional re-purchases. Recent events have constrained us from going into the market for stock buybacks.

In summary, we acknowledge that we have challenges in the North American market related to sales ownership and also that we have additional work to do related to our operating cost structure. However, we feel that significant progress was made in the fourth quarter concerning our legal issues and we are anxious to begin the fresh “go Give” marketing approach, which Terry mentioned, to stimulate sales in al our markets around the world. This will be kicked off in a few days during the upcoming MannaFest event, here in Dallas/Fort Worth, which will be held in late March and we are excited about the possibilities it brings to our associates in building their businesses around the globe.

Thanks for listening to our call and now Terry has some wrap up comments.

Terry Persinger

Thank you, Steve. I just want to close by saying that our strategy for returning to growth and profitability is around resolving all litigation issues, reenergizing the associates with global sales materials, which we talked about, focusing on science and substantiation of our products as well as new products and returning to global expansion and also strengthening our management position to lead us to new levels of growth and success.

So, I want to thank you for your continued support and for participating in this call. And now I’ll open it up to any questions you might have.

Question-and-Answer Session


Thank you. We will now conduct a question/answer session. Please limit questions to only two per analyst. (Operator Instructions) Our first question comes from Dan Mendoza from Agincourt Capital. Please proceed with your question.

Dan Mendoza-Agincourt Capital

Hi. Can you tell me what R&D spend was in the fourth quarter and what you expect it to be in 2008 please?

Stephen Fenstermacher

We don’t break those questions down, Dan per quarter. However, we’re looking for a modest increase in our R&D spends in 2008.

Dan Mendoza-Agincourt Capital

Okay. What was it in 2007 for the full year?

Stephen Fenstermacher

You’ll have to give me a moment to check it for you.

Dan Mendoza-Agincourt Capital


Stephen Fenstermacher

In the meantime, if you have an additional question we’d like to go ahead and take that.

Dan Mendoza-Agincourt Capital

Okay, I do. On the human studies and testing that you’re doing, are you using an independent third party for those and if so who are you partnering with?

Robert Sinnott

For the third part, we do use third parties for most of the studies. We use contract research organizations, which are established third-party institutes for running human clinical studies. We also work with various academic institutions and medical universities. I am not at liberty to disclose the names of those, those are subject to confidentiality agreements that we have for all ongoing research.

Dan Mendoza-Agincourt Capital

Okay. Are any of them public companies or household names?

Robert Sinnott

Most of the universities are quite, they would be widely recognized. The contract research organization, again our third-party established entity, but I’m not privy right now to knowing whether, I don’t have information about which ones are public and which are privately held. But they are established third-party institutes.

Dan Mendoza-Agincourt Capital

Okay, great. Thanks. And my other question had to do with litigation reserves. Can you talk; you mentioned I think that there are reserves taken for three different instances. Can you tell us which, what they are and does that include your conversations with the Texas AG or is that not included in that reserve? Thanks.

Stephen Fenstermacher

This is Steve, Dan. Yes it does include our situation with the Texas Attorney General. In addition, I’d invite you to review the 10-K which will be filed a little bit later on today, which describes the legal proceedings in a bit more detail. But, as you’re aware, we do have several major pieces of litigation and we don’t want to go into great detail about those, but the 4.7 million is directly related to our major pieces of litigation.

Dan Mendoza-Agincourt Capital

Okay great and then just the R&D number for ’07 and than that’s it for me. Thanks.

Stephen Fenstermacher

Well at this point, we’re madly going through our 10-K draft.

Dan Mendoza-Agincourt Capital

All that’s great, otherwise I’ll pull off, offline.

Stephen Fenstermacher

Great, thanks a lot Dan.


(Operator Instructions) Our next question is from Peter Park with Park West Asset Management. Please proceed with your question. Mr. Park, your line is live.

Peter Park-Park West Asset Management

Hi, sorry about that. Did you break out legal expense in the quarter? And can you give us a sense of what legal expense might look like on a go-forward basis? Thank you.

Stephen Fenstermacher

We don’t break those numbers out specifically and in this quarter. Simply because of the material nature of the reserves, we wanted to call attention to those on a specific basis. But, we don’t disclose, specifically, the legal overall costs or our specific litigation costs under general circumstances.

Peter Park-Park West Asset Management

Why not? I mean it’s a pretty big number, isn’t it?

Stephen Fenstermacher

It is in this particular quarter and that’s why we broke it out specifically, so that we could talk to it. Under normal circ…

Peter Park-Park West Asset Management

That’s just reserve right?

Stephen Fenstermacher

I’m sorry?

Peter Park-Park West Asset Management

The 4.7 million is just a reserve for or an accrual for expected losses. But, how much is the on going legal expense that you accrued in the quarter?

Stephen Fenstermacher

Well, we reserved 4.7 million of anticipated losses in our major costs.

Peter Park-Park West Asset Management

Right, but that’s anticipated losses. How about the on going legal expense that you might incur over the next year, two years, I’m just trying to understand that.

Stephen Fenstermacher

As I mentioned, we don’t disclose, specifically, our on going legal costs, as these may change drastically from quarter to quarter depending on what situations are actually being handled in the legal department. You may be aware that we have a patents protection program underway, which I mentioned there are costs that may appear in certain quarters and other quarters these kinds of costs may be relatively low. That’s why we don’t have anything material under most operating situations in most quarters.


(Operator Instructions) There are no further questions in queue at this time. I would like to turn it back over to management for closing comments.

Stephen Fenstermacher

Well, I have one last comment. This is Steve. Our research and development cost in 2007, we’re at 6.6 million. So while it took us a couple minutes to find this specific figure, I wanted to make that comment before we signed off here. Gary, any closing comments?

Gary Spinell

Okay, we just want to thank you all for your participation today and look forward to the future. Thank you.


This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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