MANNATECH INC quarterly report, Q2 FY2015

Mannatech, Inc. — Form 10-Q Summary

Reporting period: Quarter and six months ended June 30, 2015; filed August 4, 2015. Mannatech develops and sells nutritional supplements, skin-care and weight-management products through independent associates and members in 24 countries. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Financial performance and position

• Q2 sales rose 0.9%; first-half sales rose 2.1%. The loyalty program added $3.2 million to Q2 and $5.5 million to first-half sales versus 2014. Excluding that effect, reported sales would have declined 6.0% and 4.1%, respectively. At constant currency, sales increased 7.6% for Q2 and 7.5% for the first half; these are non-GAAP comparisons.
• Q2 gross margin improved primarily as cost of sales fell, including a smaller obsolete-inventory charge. Operating results also benefited from lower operating expenses. First-half selling and administrative expense increased, partly offsetting lower other operating costs.
• Other expense was $0.5 million in Q2 and $1.4 million for the first half, primarily due to foreign-exchange losses. Effective tax rates were 25.0% for Q2 and 26.8% for the first half, compared with 183.7% and 124.8% in 2014; the prior-year rates were unusually high due to valuation-allowance and foreign-jurisdiction effects, including a deemed intercompany dividend expense.
• At June 30, cash and cash equivalents were $30.7 million, restricted cash was $8.8 million, working capital was $19.8 million, and total assets were $74.4 million. Total liabilities were $38.5 million and shareholders’ equity was $35.9 million. Capital-lease liabilities totaled approximately $2.0 million; the company reported no issued debt instruments.
• First-half cash flow: operations provided $4.5 million, investing used $1.2 million, and financing used $0.9 million. Operating cash flow was lower year over year, mainly from inventory purchases and decreases in deferred revenue and customer deposits. Capital expenditures included $0.9 million for back-office software.

Material changes and operating trends

• Regional Q2 sales were $18.8 million in North America, down 10.0%; $23.6 million in Asia/Pacific, up 10.3%; and $4.3 million in EMEA, up 7.5%. North America’s first-half sales fell 10.4%, while Asia/Pacific rose 14.6% and EMEA rose 2.6%.
• Product sales declined 2.4% in Q2 and 1.7% in the first half. Pack sales increased 21.9% and 27.1%, respectively, with growth concentrated in continuing-associate packs. Q2 average product order value fell to $156 from $165.
• Recruitment weakened: new associates and members in Q2 were approximately 25,600 versus 31,500 a year earlier, an 18.7% decline. Active associates and members over the trailing 12 months totaled approximately 228,000 versus 239,000.
• Cash increased $2.7 million from December 31, 2014, and working capital rose $3.4 million. Inventory increased to $14.2 million from $10.6 million. The company suspended its quarterly dividend in 2009.

Outlook, risks and contingencies

• No specific earnings or sales guidance was provided. Management said existing liquidity and operating cash flows should fund normal operations and possible international expansion for the next 12 months and longer, subject to maintaining or increasing revenue and/or reducing costs. Colombia was planned as a new market by the end of Q3 2015.
• Key risks include foreign-exchange volatility, recruiting and retaining associates and members, product demand and competition, regulation, adverse publicity, and the ability to sustain revenue and control costs. The company does not hedge currency exposure.
• Legal matters include a breach-of-contract suit seeking more than $1 million, which the company disputes; an arbitration in which Mannatech seeks estimated damages of $0.5 million to $3.5 million; and ongoing patent and trademark matters. No liability range could be estimated for certain claims. A proposed RBC patent-case judgment and injunction was submitted in July 2015 but remained subject to court entry; a separate patent case remained open.
• The company disclosed ongoing tax audits and disputes, including a Korean customs assessment of $1.0 million already paid in January 2014 and being challenged. It stated that other international audits were not expected to materially affect the financial statements. Adverse outcomes in litigation or audits could affect cash flows and results.
• Management reported disclosure controls were effective and no material changes to internal control over financial reporting during the quarter. Revenue-recognition estimates, inventory obsolescence, tax valuation allowances and legal contingencies remain judgment-sensitive.

Important facts for investors to verify

1. Whether sales and earnings improvement can persist after accounting for the loyalty-program benefit, currency translation and the unusually favorable year-over-year cost comparisons.
2. Whether North American sales declines and weaker new-recruit counts stabilize, and whether Asia/Pacific growth continues.
3. Whether increased inventory converts to sales and operating cash flow; first-half operating cash flow fell to $4.5 million from $7.4 million.
4. Subsequent status and potential financial effects of the patent, contract, arbitration, trademark and tax matters; several outcomes and possible liabilities were not estimable.
5. Management’s planned Colombia launch, and the assumptions supporting its view that operating cash flows and liquidity are adequate.