MANNATECH INC annual report, FY2009

Mannatech, Inc. — 2009 Form 10-K

Reporting period: Fiscal year ended December 31, 2009. This is an annual report; fourth-quarter figures are included below where disclosed. Amounts are U.S. dollars.

Business context

Mannatech sells nutritional supplements, skin-care and weight-management products through a network-marketing model in 16 countries. It reported approximately 513,000 associates and members who purchased products during the year, down from 531,000 in 2008. The company operates as one reportable segment and uses third parties to manufacture its products.

Financial performance and liquidity

Metric	FY 2009	FY 2008
Net sales	$289.7 million	$332.7 million
Gross profit / margin	$96.5 million / 33.3%	$134.5 million / 40.4%
Operating income (loss)	$(25.6) million	$(14.5) million
Net income (loss)	$(17.4) million	$(12.6) million
Diluted EPS	$(0.66)	$(0.48)
Cash from (used in) operations	$(10.3) million	$(19.9) million

• Sales fell 12.9%; product sales declined 17.9% to $213.9 million, while pack sales increased 7.6% to $62.1 million. New recruits increased 9.2%, but continuing associate/member activity declined.
• Gross margin contracted as cost of sales rose to 16.2% of sales from 14.6%, and commissions and incentives rose to 50.5% from 45.0% of sales. Operating expenses declined 18.1%, primarily reflecting lower staffing, legal and consulting costs, but did not offset the gross-profit decline.
• Fourth-quarter sales were $70.1 million versus $76.4 million a year earlier. The company reported fourth-quarter net income of $2.1 million, or $0.08 per share, compared with $0.6 million, or $0.02 per share. A $3.0 million tax valuation-allowance reversal contributed to the 2009 tax benefit.
• Year-end cash and cash equivalents were $17.4 million, down from $30.9 million; working capital was $21.8 million, down from $32.0 million. Total restricted cash was $8.5 million. The balance sheet reports capital-lease obligations of approximately $1.9 million; the company said it had not issued debt instruments.
• Total assets were $102.3 million, versus $124.1 million. Cash declined in part due to inventory purchases, capital spending, payments of accrued expenses and approximately $8.4 million in litigation settlements.

Material changes and management commentary

• Management attributed lower sales primarily to the difficult economic environment and reduced consumer spending. The U.S. accounted for 48.6% of sales; international markets accounted for 51.4%. Foreign exchange reduced 2009 sales by approximately $4.6 million.
• Core Ambrotose and Advanced Ambrotose products represented 31.4% of sales, down from 35.9% in 2008, but remain a significant product concentration.
• The company launched new products, introduced a lower-priced $499 starter pack in certain markets, and began selling in Austria, the Netherlands, Norway and Sweden. Management said the pack supported recruiting and starter-pack sales.
• Management reported positive operating cash flow in the fourth quarter, but did not provide a quarterly amount. It expects 2010 operating cash flows to fund current operations and says liquidity is adequate for normal operations and potential expansion over the next 12–24 months, subject to economic and cash-flow uncertainty. Planned 2010 capital spending is up to $3.0 million; research and development spending is expected to be approximately $4.7 million.
• The board suspended quarterly dividends in August 2009, citing financial performance, the recession and funding needs for business initiatives. The company paid $0.04 per share in 2009, compared with $0.22 in 2008.

Risks, contingencies and unusual items

• The Texas Attorney General settlement required the company, without admitting wrongdoing, to refund up to $4 million to eligible members and pay $2 million for regulators’ fees and expenses. The filing also describes required compliance and governance measures. Separately, the company agreed to indemnify its founder for a $1 million fine and related expenses under his settlement.
• Supplier Marinova filed an arbitration claim alleging damages exceeding $5 million. Mannatech denies liability, asserts counterclaims and seeks, among other relief, approximately $600,000 for non-conforming product. The dispute was ongoing; the company had accrued $1.5 million for litigation matters overall at year-end.
• Other principal risks include continued decline in sales or associate retention, dependence on core products, regulatory scrutiny of supplements and network marketing, product claims made by associates, foreign-exchange movements, supplier disruption and litigation. A supplier facility closure was disclosed; the company said inventory covered its needs for the next 12 months and alternative sources had been identified.
• The company terminated a supply contract with Marinova for asserted breach and was in arbitration. Reported purchase obligations include $4.7 million, $2.1 million and $1.5 million for 2010–2012, respectively, under that terminated contract.
• Management and the independent auditor reported effective internal control over financial reporting as of year-end. The auditor gave an unqualified opinion on the consolidated financial statements.

Important facts for investors to verify

• Whether revenue, product sales and active associate/member trends stabilized after the 2009 declines, and whether new recruits convert into repeat product purchases.
• Whether margins recover given elevated commissions, incentives and cost of sales as a share of revenue.
• Actual operating cash flow, cash balances and working-capital needs, including whether the stated 2010 liquidity outlook is achieved.
• Final outcomes and financial exposure from the Marinova arbitration, Texas settlement obligations and other litigation, compared with recorded accruals.
• Progress in reducing reliance on Ambrotose-related products and maintaining reliable supply of key ingredients.
• Whether the dividend remains suspended and whether management’s projected capital and research spending is funded from operations.