XNAS:MTEX Mannatech Inc Quarterly Report 10-Q Filing - 8/9/2012

Effective Date 8/9/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________

FORM 10-Q
(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended:  June 30, 2012
 
OR
[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________.

Commission File No. 000-24657

MANNATECH, INCORPORATED
(Exact Name of Registrant as Specified in its Charter)


Texas
(State or other Jurisdiction of Incorporation or Organization)
75-2508900
(I.R.S. Employer Identification No.)
600 S. Royal Lane, Suite 200, Coppell, Texas
(Address of Principal Executive Offices)
75019
(Zip Code)


Registrant’s Telephone Number, including Area Code:  (972) 471-7400
____________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  [X]  No  [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [  ]
Accelerated filer [  ]
Non-accelerated filer [  ]
Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ] No [X]

As of August 6, 2012, the number of shares outstanding of the registrant’s sole class of common stock, par value $0.0001 per share, was 2,647,735.


 
 

 

MANNATECH, INCORPORATED
TABLE OF CONTENTS

Part I – FINANCIAL INFORMATION
 
   
   
   
   
Part II – OTHER INFORMATION
 
   
   
   
   
Item 4. Mine Safety Disclosures
   
   
   



 
 

 

Special Note Regarding Forward-Looking Statements

Certain disclosures and analyses in this Form 10-Q, including information incorporated by reference, may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the Private Securities Litigation Reform Act of 1995 that are subject to various risks and uncertainties. Opinions, forecasts, projections, guidance, or other statements other than statements of historical fact are considered forward-looking statements and reflect only current views about future events and financial performance. Some of these forward-looking statements include statements regarding:

 
§
management’s plans and objectives for future operations;
 
 
§
existing cash flows being adequate to fund future operational needs;
 
 
§
future plans related to budgets, future capital requirements, market share growth, and anticipated capital projects and obligations;
 
 
§
the realization of net deferred tax assets;
 
 
§
the ability to curtail operating expenditures;
 
 
§
global statutory tax rates remaining unchanged;
 
 
§
the impact of future market changes due to exposure to foreign currency translations;
 
 
§
the possibility of certain policies, procedures, and internal processes minimizing exposure to market risk;
 
 
§
the impact of new accounting pronouncements on financial condition, results of operations, or cash flows;
 
 
§
the outcome of new or existing litigation matters;
 
 
§
the outcome of new or existing regulatory inquiries or investigations; and
 
 
§
other assumptions described in this report underlying such forward-looking statements.
 

 
Although we believe that the expectations included in these forward-looking statements are reasonable, these forward-looking statements are subject to certain events, risks, assumptions, and uncertainties, including those discussed below, the “Risk Factors” section in Part I, Item 1A of our Form 10-K for the year ended December 31, 2011, and the “Risk Factors” section in Part II, Item 1A of this Form 10-Q, and elsewhere in this Form 10-Q and the documents incorporated by reference herein. If one or more of these risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results and developments could materially differ from those expressed in or implied by such forward-looking statements. For example, any of the following factors could cause actual results to vary materially from our projections:

 
§
overall growth or lack of growth in the nutritional supplements industry;
 
 
§
plans for expected future product development;
 
 
§
changes in manufacturing costs;
 
 
§
shifts in the mix of packs and products;
 
 
§
the future impact of any changes to global associate career and compensation plans or incentives;
 
 
§
the ability to attract and retain independent associates and members;
 
 
§
new regulatory changes that may affect operations or products;
 
 
§
the competitive nature of our business with respect to products and pricing;
 
 
§
publicity related to our products or network-marketing; and
 
 
§
the political, social, and economic climate.
 

Forward-looking statements generally can be identified by use of phrases or terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “approximates,” “predicts,” “projects,” “potential,” and “continues” or other similar words or the negative of such terms and other comparable terminology. Similarly, descriptions of Mannatech’s objectives, strategies, plans, goals, or targets contained herein are also considered forward-looking statements. Readers are cautioned when considering these forward-looking statements to keep in mind these risks, assumptions, and uncertainties and any other cautionary statements in this report, as all of the forward-looking statements contained herein speak only as of the date of this report.

Unless stated otherwise, all financial information throughout this report and in the Consolidated Financial Statements and related Notes include Mannatech, Incorporated and all of its subsidiaries on a consolidated basis and may be referred to herein as “Mannatech,” “the Company,” “its,” “we,” “our,” or “their.”

Our products are not intended to diagnose, cure, treat, or prevent any disease, and any statements about our products contained in this report have not been evaluated by the Food and Drug Administration, also referred to herein as the “FDA”.

 
1

 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements

MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS – (UNAUDITED)
(in thousands, except share and per share amounts)

   
June 30,
2012
 
December 31,
2011
   
ASSETS
 
(unaudited)
     
Cash and cash equivalents
 
$
12,103
 
$
18,057
 
Restricted cash
   
1,512
   
1,263
 
Accounts receivable, net of allowance of $23 and $22 in 2012 and 2011, respectively
   
187
   
304
 
Income tax receivable
   
892
   
888
 
Inventories, net
   
18,185
   
17,786
 
Prepaid expenses and other current assets
   
2,179
   
2,497
 
Deferred tax assets
   
978
   
936
 
Total current assets
   
36,036
   
41,731
 
Property and equipment, net
   
6,374
   
9,566
 
Construction in progress
   
3
   
 
Long-term restricted cash
   
3,459
   
3,386
 
Other assets
   
3,124
   
2,815
 
Long-term deferred tax assets
   
846
   
772
 
Total assets
 
$
49,842
 
$
58,270
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
             
Current portion of capital leases
 
$
714
 
$
852
 
Accounts payable
   
6,733
   
4,825
 
Accrued expenses
   
6,861
   
10,514
 
Commissions and incentives payable
   
5,813
   
8,567
 
Taxes payable
   
3,261
   
3,364
 
Current deferred tax liability
   
209
   
185
 
Deferred revenue
   
1,813
   
1,569
 
Total current liabilities
   
25,404
   
29,876
 
Capital leases, excluding current portion
   
1,112
   
1,358
 
Long-term deferred tax liabilities
   
1
   
1
 
Other long-term liabilities
   
5,767
   
5,382
 
Total liabilities
   
32,284
   
36,617
 
               
Commitments and contingencies
             
               
Shareholders’ equity:
             
Preferred stock, $0.01 par value, 1,000,000 shares authorized, no shares issued or outstanding
   
   
 
Common stock, $0.0001 par value, 99,000,000 shares authorized, 2,768,972 shares issued and 2,647,735 shares outstanding as of June 30, 2012 and 2,769,756 shares issued and 2,648,518 shares outstanding as of December 31, 2011
   
   
 
Additional paid-in capital
   
42,529
   
42,408
 
Accumulated deficit
   
(9,387
)
 
(5,532
)
Accumulated other comprehensive loss
   
(788
)
 
(427
)
Less treasury stock, at cost, 121,237 shares in 2012 and 2011
   
(14,796
)
 
(14,796
)
Total shareholders’ equity
   
17,558
   
21,653
 
Total liabilities and shareholders’ equity
 
$
49,842
 
$
58,270
 

See accompanying notes to unaudited consolidated financial statements.

 
2

 

MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS – (UNAUDITED)
(in thousands, except per share information)


   
Three months ended
June 30,
 
Six months ended
June 30,
 
   
2012
 
2011
 
2012
 
2011
 
Net sales
 
$
43,611
 
$
51,362
 
$
88,113
 
$
102,262
 
Cost of sales
   
6,888
   
7,543
   
13,283
   
14,757
 
Commissions and incentives
   
18,637
   
22,896
   
37,622
   
44,603
 
     
25,525
   
30,439
   
50,905
   
59,360
 
Gross profit
   
18,086
   
20,923
   
37,208
   
42,902
 
                           
Operating expenses:
                         
Selling and administrative
   
11,793
   
14,811
   
23,277
   
30,829
 
Depreciation and amortization
   
921
   
2,687
   
3,379
   
5,488
 
Other operating costs
   
6,778
   
7,746
   
14,014
   
15,812
 
Total operating expenses
   
19,492
   
25,244
   
40,670
   
52,129
 
                           
Loss from operations
   
(1,406
)
 
(4,321
)
 
(3,462
)
 
(9,227
)
Interest income (expense)
   
21
   
21
   
(32
)
 
1
 
Other income (expense), net
   
(805
)
 
196
   
87
   
463
 
Loss before income taxes
   
(2,190
)
 
(4,104
)
 
(3,407
)
 
(8,763
)
                           
Provision for income taxes
   
(265
)
 
(1,146
)
 
(448
)
 
(1,265
)
Net loss
 
$
(2,455
)
$
(5,250
)
$
(3,855
)
$
(10,028
)
                           
Net loss per share:
                         
Basic
 
$
(0.93
)
$
(1.98
)
$
(1.46
)
$
(3.79
)
Diluted
 
$
(0.93
)
$
(1.98
)
$
(1.46
)
$
(3.79
)
                           
Weighted-average common shares outstanding:
                         
Basic
   
2,648
   
2,649
   
2,648
   
2,649
 
Diluted
   
2,648
   
2,649
   
2,648
   
2,649
 


 


CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS – (UNAUDITED)
(in thousands)


   
Three months ended
June 30,
 
Six months ended
June 30,
 
   
2012
 
2011
 
2012
 
2011
 
Net loss
 
$
(2,455
)
$
(5,250
)
$
(3,855
)
$
(10,028
)
Foreign currency translations
   
445
   
20
   
(361
)
 
41
 
Comprehensive loss
 
$
(2,010
)
$
(5,230
)
$
(4,216
)
$
(9,987
)
 

 
See accompanying notes to unaudited consolidated financial statements.

 
3

 

MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(UNAUDITED)
(in thousands)






   
Common stock
Par value
 
Additional
paid in
capital
 
Accumulated
deficit
 
Accumulated
other
comprehensive
loss
 
Treasury stock
 
Total
shareholders’
equity
 
Balance at December 31, 2011
 
$
 
$
42,408
 
$
(5,532
)
$
(427
)
$
(14,796
)
$
21,653
 
Net loss
   
   
   
(3,855
)
 
   
   
(3,855
)
Charge related to stock-based
compensation
   
   
124
   
   
   
   
124
 
Repurchase of fractional shares from reverse stock split
   
   
(3
)
 
   
   
   
(3
)
Foreign currency translations
   
   
   
   
(361
)
 
   
(361
)
Balance at June 30, 2012
 
$
 
$
42,529
 
$
(9,387
)
$
(788
)
$
(14,796
)
$
17,558
 

































See accompanying notes to unaudited consolidated financial statements.

 
4

 

MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS – (UNAUDITED)
(in thousands)

 
Six months ended
 June 30,
 
2012
 
2011
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
$
(3,855
)
$
(10,028
)
Adjustments to reconcile net loss to net cash used in operating activities:
           
Depreciation and amortization
 
3,379
   
5,488
 
Provision for inventory losses
 
680
   
1,744
 
Provision for doubtful accounts
 
20
   
42
 
Loss on disposal of assets
 
54
   
68
 
Accounting charge related to stock-based compensation expense
 
124
   
202
 
Deferred income taxes
 
(116
)
 
(401
)
Changes in operating assets and liabilities:
           
Accounts receivable
 
92
   
244
 
Income tax receivable
 
(4
)
 
24
 
Inventories
 
(1,071
)
 
3,647
 
Prepaid expenses and other current assets
 
532
   
(645
)
Other assets
 
(327
)
 
180
 
Accounts payable
 
1,921
   
(504
)
Accrued expenses and other liabilities
 
(3,228
)
 
(116
)
Taxes payable
 
(111
)
 
(1,738
)
Commissions and incentives payable
 
(2,732
)
 
(1,266
)
Deferred revenue
 
248
   
(11
)
Net cash used in operating activities
 
(4,394
)
 
(3,070
)
CASH FLOWS FROM INVESTING ACTIVITIES:
           
Acquisition of property and equipment
 
(235
)
 
(476
)
Proceeds from sales of assets
 
28
   
2
 
Change in restricted cash
 
(322
)
 
65
 
Net cash used in investing activities
 
(529
)
 
(409
)
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Repurchase of fractional shares from reverse stock split
 
(3
)
 
 
Repayment of capital lease obligations
 
(628
)
 
(642
)
Net cash used in financing activities
 
(631
)
 
(642
)
Effect of currency exchange rate changes on cash and cash equivalents
 
(400
)
 
(142
)
Net decrease in cash and cash equivalents
 
(5,954
)
 
(4,263
)
Cash and cash equivalents at the beginning of the period
 
18,057
   
21,584
 
Cash and cash equivalents at the end of  the period
$
12,103
 
$
17,321
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
           
Income taxes paid, net
$
(566
)
$
(292
)
Interest paid on capital leases
$
80
 
$
96
 
 

 
See accompanying notes to unaudited consolidated financial statements.

 
5

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Mannatech, Incorporated (together with its subsidiaries, the “Company”), located in Coppell, Texas, was incorporated in the state of Texas on November 4, 1993 and is listed on the NASDAQ Global Select Market (“Nasdaq”) under the symbol “MTEX”. The Company develops, markets, and sells high-quality, proprietary nutritional supplements, topical and skin care products, and weight-management products that are primarily sold to independent associates and members located in the United States, Canada, Australia, the United Kingdom, Japan, New Zealand, the Republic of Korea, Taiwan, Denmark, Germany, South Africa, the Republic of Namibia (via South Africa), Singapore, Austria, the Netherlands, Norway, Sweden, Mexico, the Czech Republic, Estonia, Finland and the Republic of Ireland.

Independent associates (“associates”) purchase the Company’s products at published wholesale prices to either sell to retail customers or for personal use. Members purchase the Company’s products at a discount from published retail prices primarily for personal use.  The Company cannot distinguish products sold for personal use from other sales because it is not involved with the products after delivery, other than usual and customary product warranties and returns. Only associates are eligible to earn commissions and incentives.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the Company’s consolidated financial statements and footnotes contained herein do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) to be considered “complete financial statements”. However, in the opinion of the Company’s management, the accompanying unaudited consolidated financial statements and footnotes contain all adjustments, including normal recurring adjustments, considered necessary for a fair presentation of the Company’s consolidated financial information as of, and for, the periods presented. The Company cautions that its consolidated results of operations for an interim period are not necessarily indicative of its consolidated results of operations to be expected for its fiscal year. The December 31, 2011 consolidated balance sheet was included in the audited consolidated financial statements in the Company’s annual report on Form 10-K for the year ended December 31, 2011 and filed with the United States Securities and Exchange Commission (the “SEC”) on March 29, 2012 (the “2011 Annual Report”), which includes all disclosures required by GAAP. Therefore, these unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company included in the 2011 Annual Report.

Principles of Consolidation

The consolidated financial statements and footnotes include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the Company’s consolidated financial statements in accordance with generally accepted accounting principles requires the use of estimates that affect the reported value of assets, liabilities, revenues and expenses. These estimates are based on historical experience and various other factors. The Company continually evaluates the information used to make these estimates as the business and economic environment changes. Historically, actual results have not varied materially from the Company’s estimates, and the Company does not currently anticipate a significant change in its assumptions related to these estimates. However, actual results may differ from these estimates under different assumptions or conditions.

The use of estimates is pervasive throughout the consolidated financial statements, but the accounting policies and estimates considered the most significant are described in this note to the consolidated financial statements, Organization and Summary of Significant Accounting Policies.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company includes in its cash and cash equivalents credit card receivables due from its credit card processor, as the cash proceeds from credit card receivables are received within 24 to 72 hours of submission to the credit card processor. As of June 30, 2012 and December 31, 2011, credit card receivables were $1.4 million and $1.7 million,

 
6

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

respectively, and cash and cash equivalents held in bank accounts in foreign countries totaled $9.4 million and $10.5 million, respectively.  The Company invests cash in liquid instruments, such as money market funds and interest bearing deposits.  The Company also holds cash in high quality financial institutions and does not believe it has an excessive exposure to credit concentration risk.

Restricted Cash

The Company is required to restrict cash for: (i) direct selling insurance premiums and credit card sales in the Republic of Korea; (ii) reserve on credit card sales in the United States and Canada; and (iii) the Australia building lease collateral. As of June 30, 2012 and December 31, 2011, our total restricted cash was $5.0 million and $4.6 million, respectively.

Accounts Receivable

Accounts receivable are carried at their estimated collectible amounts. Receivables are created upon shipment of an order if the credit card payment is rejected or does not match the order total. As of June 30, 2012 and December 31, 2011, receivables consisted primarily of amounts due from members and associates. The Company periodically evaluates its receivables for collectability based on historical experience, recent account activities, and the length of time receivables are past due and writes-off receivables when they become uncollectible. At June 30, 2012 and December 31, 2011, the Company held an allowance for doubtful accounts of less than $0.1 million.

Inventories

Inventories consist of raw materials, finished goods, and promotional materials that are stated at the lower of cost or market (using standard costs that approximate average costs). The Company periodically reviews inventories for obsolescence, and any inventories identified as obsolete are reserved or written off.

Other Assets

As of June 30, 2012 and December 31, 2011, other assets were $3.1 million and $2.8 million, respectively, and primarily consisted of deposits for building leases in various locations and certain intangible assets. Also included in the June 30, 2012 and December 31, 2011 balances was $0.9 million, representing a deposit with Mutual Aid Cooperative and Consumer in the Republic of Korea, an organization established by the Republic of Korea’s Fair Trade Commission to protect consumers who participate in network marketing activities.

Commissions and Incentives

Associates earn commissions and incentives based on their direct and indirect commissionable net sales over 13 business periods each year. Each business period equals 28 days. The Company accrues commissions and incentives when earned by associates and pays commissions on product sales three weeks following the business period end and pays commissions on its pack sales five weeks following the business period end.

Other Long-Term Liabilities

In August 2003, the Company entered into a Long-Term Post-Employment Royalty Agreement with Dr. Bill McAnalley, the Company’s former Chief Science Officer, pursuant to which the Company is required to pay Dr. McAnalley, or his heirs, royalties for ten years beginning September 2005 and continuing through August 2015. Quarterly payments related to this Long-Term Post-Employment Royalty Agreement are based on certain applicable annual global product sales by the Company in excess of $105.4 million. At the time the Company entered into this royalty agreement, it was considered a post-employment benefit and the Company was required to measure and accrue the present value of the estimated future royalty payments related to this benefit, and recognize it over the life of Dr. McAnalley’s employment agreement, which was two years. As of June 30, 2012 and December 31, 2011, the Company’s liability related to this royalty agreement was $1.0 million and $1.2 million, respectively, of which $0.3 million was currently due and included in accrued expenses.

 
7

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Certain operating leases for the Company’s regional office facilities contain a restoration clause that requires the Company to restore the premises to its original condition. As of June 30, 2012 and December 31, 2011, accrued restoration costs related to these leases amounted to $0.4 million. At each of June 30, 2012 and December 31, 2011, the Company also recorded a long-term liability for an estimated deferred benefit obligation related to a deferred benefit plan for its Japan operations of $1.3 million.
 
    Comprehensive Income (loss) and Accumulated Other Comprehensive Income (loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources and includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The Company’s comprehensive income (loss) consists of the Company’s net income (loss), foreign currency translation adjustments from its Japan, Republic of Korea, Taiwan, Norway, Sweden, and Mexico operations, and changes in the pension obligation for its Japanese employees.
 
 
Revenue Recognition

The Company’s revenue is derived from sales of individual products, sales of its starter and renewal packs, and shipping fees. Substantially all of the Company’s product and pack sales are made to associates at published wholesale prices and to members at discounted published retail prices. The Company records revenue net of any sales taxes and records a reserve for expected sales returns based on its historical experience.

The Company recognizes revenue from shipped packs and products upon receipt by the customer. Corporate-sponsored event revenue is recognized when the event is held. The Company defers certain components of its revenue. At June 30, 2012 and December 31, 2011, the Company’s deferred revenue was $1.8 million and $1.6 million, respectively, and consisted primarily of revenue received from: (i) sales of packs and products shipped but not received by the customers by the end of the respective period; and (ii) prepaid registration fees from customers planning to attend a future corporate-sponsored event.

We estimate a sales return reserve for expected sales refunds based on our historical experience over a rolling six- month period. If actual results differ from our estimated sales return reserve due to various factors, the amount of revenue recorded for each period could be materially affected. Historically, our sales returns have not materially changed through the years, as the majority of our customers who return their merchandise do so within the first 90 days after the original sale. Sales returns have historically averaged 1.5% or less of our gross sales. For the six months ended June 30, 2012 our sales return reserve consisted of the following (in thousands):

 
June 30, 2012
 
Sales reserve as of January 1, 2012
$
528
 
Provision related to sales made in current period
 
900
 
Adjustment related to sales made in prior periods
 
(315
)
Actual returns or credits related to current period
 
(695
)
Actual returns or credits related to prior periods
 
(224
)
Sales reserve as of June 30, 2012
$
194
 

Shipping and Handling Costs

The Company records freight and shipping fees collected from its customers as revenue. The Company records inbound freight as a component of inventory and cost of sales and records shipping and handling costs associated with shipping products to customers as selling and administrative expenses. Total shipping and handling costs included in selling and administrative expenses were approximately $2.4 million and $2.7 million for the three months ended June 30, 2012 and 2011, respectively, and $4.8 million and $5.6 million for the six months ended June 30, 2012 and 2011, respectively.


 
8

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Reclassifications

Certain reclassifications have been made to the financial statements for prior periods to conform to the current period presentation.


Reverse Stock Split

On January 13, 2012, the Company effected a 1-for-10 reverse stock split of the Company’s common stock (the “reverse stock split”).  All share numbers in this quarterly report have been adjusted to reflect the reverse stock split unless otherwise indicated.

NOTE 2: INVENTORIES

Inventories consist of raw materials, finished goods, and promotional materials. The Company provides an allowance for any slow-moving or obsolete inventories. Inventories at June 30, 2012 and December 31, 2011, consisted of the following (in thousands):

   
June 30, 2012
 
December 31, 2011
 
Raw materials
 
$
5,959
   
$
6,850
 
Finished goods
   
13,578
     
13,247
 
Inventory reserves for obsolescence
   
(1,352
)
   
(2,311
)
Total
 
$
18,185
   
$
17,786
 


NOTE 3: INCOME TAXES

For the three and six months ended June 30, 2012, the Company’s effective tax rate was (12.1)% and (13.1)%, respectively. For the three and six months ended June 30, 2011, the Company’s effective income tax rate was (27.9)% and (14.4)%, respectively.  For the three and six months ended June 30, 2012 and 2011, the Company’s effective tax rate was determined based on the estimated annual effective tax rate.

The effective tax rates for the three and six months ended June 30, 2012 and 2011 were lower than what would have been expected if the federal statutory rate were applied to income before taxes. Items reducing the effective income tax rate included the change in the valuation allowances associated with certain deferred tax assets, and the change in reserves related to uncertain income tax positions.

Our 2005-2009 tax years remain subject to examination by the Internal Revenue Service (“IRS”) for United States federal tax purposes.  On May 26, 2011 the IRS issued a Revenue Agent’s report (“RAR”) detailing proposed adjustments for the tax years under examination. The net tax deficiency associated with the RAR is $8.5 million plus penalties of $1.5 million. On July 8, 2011, we filed a protest letter challenging the proposed adjustments contained in the RAR and are pursuing resolution of these items with the Appeals Division of the IRS.  On July 26, 2012, the Company participated in a hearing with the Appeals Division of the IRS, and the Company believes the net tax deficiency should approximate amounts previously recorded as uncertain income tax positions. There are other ongoing audits in various international jurisdictions that are not expected to have a material effect on our financial statements.

NOTE 4: LOSS PER SHARE

    The Company calculates basic Earnings Per Share (“EPS”) by dividing net income (loss) by the weighted-average number of common shares outstanding for the period. Diluted EPS also reflects the potential dilution that could occur if common stock were issued for awards outstanding under the 2008 Stock Incentive Plan. The Company reported net losses for the three months ended June 30, 2012 and 2011 and approximately 0.1 million and 0.2 million shares, respectively, of the Company’s common stock subject to options were excluded from the diluted EPS calculation, as the effect would have been antidilutive. In determining the potential dilution effect of outstanding stock options during the three months ended June 30, 2012 and 2011, the Company used the quarter’s average common stock close price of $4.96 and $13.10 per share, respectively. For the six months ended June 30, 2012, approximately 0.1 million shares of the Company’s common stock subject to options were excluded from diluted EPS calculations using an average closing price of $4.57 per share, because their effect was antidilutive. For the six months ended June 30, 2011, approximately 0.1 million shares of the Company’s common stock subject to options were excluded from diluted EPS calculations using an average close price of $15.70 per share, because their effect was antidilutive.

 
9


 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
NOTE 5: STOCK-BASED COMPENSATION

The Company currently has one active stock-based compensation plan, which was approved by shareholders. The Company grants stock options to employees, consultants, and board members at the fair market value of its common stock, on the date of grant, with a term no greater than ten years. The majority of stock options vest over two or three years. Shareholders who own 10% or more of the Company’s outstanding stock are granted incentive stock options at an exercise price that may not be less than 110% of the fair market value of the Company’s common stock on the date of grant and have a term no greater than five years.

In February 2008, the Company’s Board of Directors approved the Mannatech, Incorporated 2008 Stock Incentive Plan, as amended (the “2008 Plan”), which reserves up to 200,000 shares, as adjusted for the reverse stock split, for issuance of stock options and restricted stock to our employees, board members, and consultants, plus any shares reserved under the Company’s then-existing, unexpired stock plans for which options had not yet been issued, and any shares underlying outstanding options under the then-existing stock option plans that terminate without having been exercised in full. The 2008 Plan was approved by the Company’s shareholders at the 2008 Annual Shareholders’ Meeting and was amended at the 2012 Annual Shareholders’ Meeting held May 30, 2012 to increase the number of shares of common stock subject to the plan by 100,000. As of June 30, 2012, the 2008 Plan had 135,041 stock options available for grant before the plan expires on February 20, 2018.

The Company records stock-based compensation expense related to granting stock options in selling and administrative expenses. During the three months ended June 30, 2012 and 2011, the Company granted 15,000 and 34,815 stock options, respectively.  During the six months ended June 30, 2012 and 2011, the Company granted 20,000 and 34,815 stock options, respectively.  The fair value of stock options granted during the three months ended June 30, 2012 was $3.21.  The fair value of stock options granted during the three months ended June 30, 2011 ranged from $6.45 to $9.42.  The fair value of stock options granted during the six months ended June 30, 2012 ranged from $2.64 to $3.21 per share.  The fair value of stock options granted during the six months ended June 30, 2011 ranged from $6.45 to $9.42 per share.  The Company recognized compensation expense as follows for the three and six months ended June 30 (in thousands):

 
Three months
 
Six months
 
2012
 
2011
 
2012
 
2011
Total gross compensation expense
$
75
 
$
105
$
124
$
202
Total tax benefit associated with compensation expense
 
19
   
34
 
30
 
51
Total net compensation expense
$
56
 
$
71
$
94
$
151

During the second quarter of 2012 15,000 stock options were granted to three non-employee directors in connection with their re-election to the Company’s Board of Directors at the 2012 Annual Shareholders’ Meeting held on May 30, 2012.  One-third of these stock options were immediately vested on the date of grant, another one-third vest on the first anniversary of the date of grant, and the remaining one-third vest on the second anniversary of the date of grant.


 
10

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



As of June 30, 2012, the Company expects to record compensation expense in the future as follows (in thousands):
 
   
Six months
ending
December 31,
2012
 
Year ending December 31,
2013
 
2014
 
Total gross unrecognized compensation expense
 
$
80
 
$
86
 
$
17
 
Tax benefit associated with unrecognized compensation expense
   
14
   
17
   
3
 
Total net unrecognized compensation expense
 
$
66
 
$
69
 
$
14
 


NOTE 6: SHAREHOLDERS’ EQUITY

Equity Line

On September 16, 2010, the Company entered into an Investment Agreement (as amended, the “Investment Agreement”) with Dutchess Opportunity Fund, II, LP, a Delaware limited partnership (the “Investor”), whereby the Company may sell up to $10 million of the Company’s common stock to the Investor over a period of 36 months from the first trading day following the effectiveness of a registration statement registering the resale of shares pursuant to the Investment Agreement (the “Equity Line”).

The Company may draw on the Equity Line from time to time, as and when it determines appropriate in accordance with the terms and conditions of the Investment Agreement. The Company is not permitted to draw on the Equity Line unless there is an effective registration statement to cover the resale of the shares. The Company filed a registration statement with the SEC, and on October 28, 2010, the SEC declared effective the Company’s Registration Statement on Form S-3 (File No. 333-169774), which registers up to 5,000,000 shares of common stock that may be resold by the Investor pursuant to the Investment Agreement.  The number of shares registered on Form S-3 are subject to adjustment for the reverse stock split pursuant to Rule 416 of the Securities Act.

Investors should read the Investment Agreement together with the other information concerning the Company that the Company publicly files in reports and statements with the SEC.

As of August 6, 2012, no shares of common stock have been issued pursuant to the Investment Agreement.

Treasury Stock

The Company is authorized to repurchase the lesser of (i) 130,000 shares and (ii) $1.3 million in shares pursuant to a stock repurchase plan adopted by the Company’s Board of Directors on June 30, 2004 (as amended, the “June 2004 Plan”). On August 28, 2006, a second program permitting the Company to purchase, in the open market, up to $20 million of its outstanding shares was approved by our Board of Directors (the “August 2006 Plan”).  The Company has not repurchased any shares of its common stock in 2012.

As of August 6, 2012, the maximum number of shares available for repurchase under the June 2004 Plan was 19,084, and the total number of shares purchased in the open market under the June 2004 Plan was 112,672. No shares have ever been purchased under the August 2006 Plan.  The Company does not have any stock repurchase plans or programs other than the June 2004 Plan and the August 2006 Plan.


 
11

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



NOTE 7: LITIGATION

Bradley E. Bagge vs. Mannatech Incorporated, Craig Hermanson et al., Case 12-80828 DSD/AJB, United States District Court, District of Minnesota

On April 3, 2012, Bradley E. Bagge, an individual, filed suit pro se against Mannatech, Incorporated and certain other individuals in the United States District Court, District of Minnesota, alleging that another associate and an investor group fraudulently usurped his interests in his position as an associate, depriving him of potential commissions and bonuses.  Mr. Bagge asserted claims under the  Racketeer Influenced and Corrupt Organizations Act, as well as various allegations of  identity theft, claiming $2,350,000 in actual damages, $3,000,000 in exemplary damages, and $7,050,000 in statutory treble damages.  Mr. Bagge further asserted the Company was complicit in the conduct of the other defendants.
 
On June 6, 2012, Mr. Bagge filed a Motion to Dismiss the suit.  On June 12, 2012, the Court entered an order dismissing the suit without prejudice to refiling same.
 
The Company considers the matter closed.
 
Administrative Proceedings

Our 2005-2009 tax years remain subject to examination by the IRS for United States federal tax purposes.  On May 26, 2011 the IRS issued a RAR detailing proposed adjustments for the tax years under examination.  The net tax deficiency associated with the RAR is $8.5 million plus penalties of $1.5 million.  On July 8, 2011, we filed a protest letter challenging the proposed adjustments contained in the RAR and are pursuing resolution of these items with the Appeals Division of the IRS.  On July 26, 2012, the Company participated in a hearing with the Appeals Division of the IRS, and the Company believes the net tax deficiency should approximate amounts previously recorded as uncertain income tax positions.  There are other ongoing audits in various international jurisdictions that are not expected to have a material effect on our financial statements.

Litigation in General

The Company has incurred several claims in the normal course of business. The Company believes such claims can be resolved without any material adverse effect on its consolidated financial position, results of operations, or cash flows.

The Company maintains certain liability insurance; however, certain costs of defending lawsuits are not covered by or are only partially covered by its insurance policies, including claims that are below insurance deductibles. Additionally, insurance carriers could refuse to cover certain claims in whole or in part. The Company accrues costs to defend itself from litigation as they are incurred or as they become determinable.

The outcome of litigation is uncertain, and despite management’s views of the merits of any litigation, or the reasonableness of the Company’s estimates and reserves, the Company’s financial statements could nonetheless be materially affected by an adverse judgment. The Company believes it has adequately reserved for the contingencies arising from the above legal matters where an outcome was deemed to be probable, and the loss amount could be reasonably estimated. While it is not possible to predict what liability or damages the Company might incur in connection with any of the above-described lawsuits, based on the advice of counsel and management review of the existing facts and circumstances related to these lawsuits, and related legal fees, the Company has accrued $0.2 million as of June 30, 2012 for these matters, which is included in accrued expenses in its Consolidated Balance Sheet.



 
12

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


NOTE 8: RECENT ACCOUNTING PRONOUNCEMENTS

There have been no recently issued accounting pronouncements that impacted the second quarter of 2012, or which are expected to have a material impact on the Company’s future periods that were not already adopted and disclosed in prior periods.


NOTE 9: FAIR VALUE

The Company utilizes fair value measurements to record fair value adjustments to certain financial assets and to determine fair value disclosures.

Fair Value Measurements and Disclosure Topic 820 of the FASB ASC establishes a fair value hierarchy that requires the use of observable market data, when available, and prioritizes the inputs to valuation techniques used to measure fair value in the following categories:

·      Level 1 – Quoted unadjusted prices for identical instruments in active markets.

·      Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all observable inputs and significant value drivers are observable in active markets.

·      Level 3 – Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable, including assumptions developed by the Company.

The primary objective of the Company’s investment activities is to preserve principal while maximizing yields without significantly increasing risk. The investment instruments held by the Company are money market funds and interest bearing deposits for which quoted market prices are readily available. The Company considers these highly liquid investments to be cash equivalents. These investments are classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets. The Company does not have any material financial liabilities that were required to be measured at fair value on a recurring basis at June 30, 2012. The table below presents the recorded amount of financial assets measured at fair value (in thousands) on a recurring basis as of June 30, 2012.

   
Level 1
 
Level 2
 
Level 3
 
Total
Assets
               
Money Market Funds – Fidelity, US
 
$ $
840
 
$ $
 
$ $
 
$ $
840
Interest bearing deposits – various banks, Korea
 
2,391
 
 
 
2,391
Total assets
 
$
3,231
 
$
 
$
 
$
3,231
Amounts included in:
                       
Cash and cash equivalents
 
$ $
840
 
$ $
 
$ $
 
$ $
840
Long-term restricted cash
   
2,391
   
   
   
2,391
Total
 
$
3,231
 
$
 
$
 
$
3,231


NOTE 10: SEGMENT INFORMATION

The Company conducts its business as a single operating segment, consolidating all of its business units into a single reportable entity, as a seller of proprietary nutritional supplements, topical and skin care products, and weight-management products through its network marketing distribution channels operating in twenty-two countries. Each of the Company’s business units sells similar packs and products and possesses similar economic characteristics, such as selling prices and gross margins. In each country, the Company markets its products and pays commissions and incentives in similar market environments. The Company’s management reviews its financial information by country and focuses its internal reporting and analysis of revenues by packs and product sales. The Company sells its products through its associates and distributes its products through similar distribution channels in each country. No single associate has ever accounted for more than 10% of the Company’s consolidated net sales
 
 
13


 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
 
The Company operates facilities in ten countries and sells product in twenty-two countries around the world. These facilities are located in the United States, Canada, Switzerland, Australia, the United Kingdom, Japan, the Republic of Korea (South Korea), Taiwan, South Africa, and Mexico. Each facility services different geographic areas. The Switzerland office was created to manage certain day-to-day business needs of non-North American markets.

By country of operation, consolidated net sales shipped to customers in these locations, along with pack and product information for the three and six months ended June 30, are as follows (in millions, except percentages):

   
Three months
 
Six months
 
Country
2012
 
2011
 
2012
 
2011
 
United States
$
18.6
 
42.7
%
$
21.3
 
41.4
%
$
37.2
 
42.2
%
$
43.7
 
42.7
%
 
Japan
 
6.8
 
15.6
%
 
7.7
 
15.0
%
 
13.6
 
15.4
%
 
15.2
 
14.9
%
 
Republic of Korea
 
5.3
 
12.2
%
 
6.2
 
12.1
%
 
10.8
 
12.3
%
 
11.4
 
11.1
%
 
Canada
 
4.0
 
9.2
%
 
4.3
 
8.3
%
 
7.7
 
8.7
%
 
8.2
 
8.0
%
 
Australia
 
3.4
 
7.8
%
 
4.5
 
8.8
%
 
7.4
 
8.4
%
 
9.0
 
8.8
%
 
South Africa(1)
 
1.9
 
4.4
%
 
2.2
 
4.3
%
 
3.9
 
4.4
%
 
4.3
 
4.2
%
 
New Zealand
 
0.5
 
1.1
%
 
0.7
 
1.3
%
 
1.0
 
1.2
%
 
1.2
 
1.2
%
 
Singapore
 
0.5
 
1.1
%
 
0.8
 
1.6
%
 
1.1
 
1.3
%
 
1.4
 
1.4
%
 
Taiwan
 
0.5
 
1.1
%
 
1.0
 
1.9
%
 
1.2
 
1.4
%
 
2.3
 
2.2
%
 
Germany
 
0.4
 
0.9
%
 
0.5
 
1.0
%
 
0.9
 
1.0
%
 
1.0
 
1.0
%
 
Norway
 
0.4
 
0.9
%
 
0.4
 
0.8
%
 
0.8
 
0.9
%
 
0.9
 
0.9
%
 
United Kingdom(2)
 
0.3
 
0.7
%
 
0.5
(3)
0.9
%
 
0.7
 
0.8
%
 
0.8
(3)
0.8
%
 
The Netherlands
 
0.3
 
0.7
%
 
0.3
 
0.6
%
 
0.6
 
0.7
%
 
0.6
 
0.6
%
 
Czech Republic(4)
 
0.3
 
0.7
%
 
 
   
0.3
 
0.3
%
 
 
 
 
Mexico
 
0.2
 
0.5
%
 
0.6
 
1.2
%
 
0.4
 
0.5
%
 
1.3
 
1.3
%
 
Austria
 
0.1
 
0.2
%
 
0.2
 
0.4
%
 
0.2
 
0.2
%
 
0.5
 
0.4
%
 
Sweden
 
0.1
 
0.2
%
 
0.1
 
0.2
%
 
0.1
 
0.1
%
 
0.3
 
0.3
%
 
Denmark
 
 
   
0.1
 
0.2
%
 
0.1
 
0.1
%
 
0.2
 
0.2
%
 
Finland(5)
 
 
   
 
   
0.1
 
0.1
%
 
 
 
 
Totals
$
43.6
 
100
%
$
51.4
 
100
%
$
88.1
 
100
%
$
102.3
 
100
%
________________________
(1)  
Includes sales for the Republic of Namibia, which began operations in August 2011.
(2)  
Includes sales for Estonia and the Republic of Ireland, which began operations in June 2011. Their combined consolidated sales for the three and six months ended June 30, 2012 were less than $0.1 million and are included in net sales for the United Kingdom.
(3)  
Includes sales for the Czech Republic, which began operations in June 2011.
(4)  
The Company began operations in the Czech Republic in June 2011; net sales for June 2011 are included in net sales for the United Kingdom.
(5)  
The Company began operations in Finland in June 2011.


 
Three months
 
Six months
 
2012
 
2011
 
2012
 
2011
Consolidated product sales
$
38.9
 
$
43.4
$
78.8
$
86.6
Consolidated pack sales
 
3.0
   
5.9
 
6.1
 
11.4
Consolidated other, including freight
 
1.7
   
2.1
 
3.2
 
4.3
Consolidated total net sales
$
43.6
 
$
51.4
$
88.1
$
102.3



 
14

 

 
MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)



Long-lived assets, which include property, equipment and construction in progress for the Company and its subsidiaries, reside in the following countries (in millions):

Country
June 30, 2012
 
December 31, 2011
Australia
$
0.2
 
$
0.3
Canada
 
   
0.1
Japan
 
0.2
   
0.2
Mexico
 
0.5
   
0.5
Republic of Korea
 
0.5
   
0.6
South Africa
 
0.1
   
0.1
Switzerland
 
0.2
   
0.2
United States
 
4.7
   
7.6
Total
$
6.4
 
$
9.6


Inventory balances by country, which consist of raw materials, work in progress, finished goods, and promotional materials, as offset by obsolete inventories, were as follows (in millions):
 
Country
June 30, 2012
 
December 31, 2011
Australia
$
1.9
 
$
1.5
Canada
 
0.8
   
1.3
Japan
 
1.4
   
1.2
Mexico
 
0.3
   
0.3
Republic of Korea
 
1.6
   
0.8
South Africa
 
0.7
   
0.7
Switzerland
 
   
0.2
Taiwan
 
0.3
   
0.3
United Kingdom
 
0.9
   
0.9
United States
 
10.3
   
10.6
Total
$
18.2
 
$
17.8


NOTE 11: SUBSEQUENT EVENTS

In July 2012, the Company entered into a Services Agreement with Integrated Distribution and Logistics Direct, LLC (doing business as SPExpress) whereby Mannatech began outsourcing its United States warehousing and distribution functions to SPExpress. In connection with this agreement, SPExpress provides the space, labor, materials, facilities, equipment, and personnel necessary to fulfill Mannatech’s warehousing and distribution needs in facilities on both the east and west coasts of the United States, as well as in Texas.  Additionally, in connection with such outsourcing arrangement, the Company sold certain assets related to the distribution and warehousing functions previously performed by Mannatech to SPExpress and is subleasing the majority of the space in the distribution center it leases in Coppell, Texas to SPExpress for the purpose of providing the warehousing and distribution services under the Services Agreement.

On July 26, 2012, the Company participated in a hearing with the Appeals Division of the IRS concerning the examination of the 2005 -2009 tax years. The Company believes the net tax deficiency should approximate amounts previously recorded as uncertain income tax positions.



 
15

 


Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of   Operations

The following discussion is intended to assist in the understanding of our consolidated financial position and results of operations for the six months ended June 30, 2012 as compared to the same period in 2011, and should be read in conjunction with Item I “Financial Statements” in Part I of this quarterly report on Form 10-Q. Unless stated otherwise, all financial information presented below, throughout this report, and in the consolidated financial statements and related notes includes Mannatech and all of our subsidiaries on a consolidated basis.

COMPANY OVERVIEW

Since November 1993, we have continued to develop innovative, high-quality, proprietary nutritional supplements, topical and skin care products, and weight-management products that are sold through a global network marketing system. We operate in the United States, Canada, Australia, the United Kingdom, Japan, New Zealand, the Republic of Korea, Taiwan, Denmark, Germany, South Africa, the Republic of Namibia (via South Africa), Singapore, Austria, the Netherlands, Norway, Sweden, Mexico, the Czech Republic, Estonia, Finland, and the Republic of Ireland. Our Switzerland office was created to manage certain day-to-day business needs of non-North American markets.

We conduct our business as a single operating segment and primarily sell our products through a network of approximately 378,000 associates who have purchased our products and/or packs within the last 12 months, plus members eligible to purchase  products who we refer to as current associates and members. New recruits and pack sales are leading indicators for the long-term success of our business. New recruits include new associates and members purchasing our packs and products for the first time. We operate as a seller of nutritional supplements, topical and skin care products, and weight-management products through our network marketing distribution channels operating in twenty-two countries. We review and analyze net sales by geographical location and by packs and products on a consolidated basis. Each of our subsidiaries sells similar products and exhibits similar economic characteristics, such as selling prices and gross margins.

Because we sell our products through network marketing distribution channels, the opportunities and challenges that affect us most are: recruitment of new and retention of associates and members; entry into new markets and growth of existing markets; niche market development; new product introduction; and investment in our infrastructure.

Current Economic Conditions and Recent Developments

During the second quarter of 2012, we continued building the foundation for future revenue growth.  The recruitment of new associates and members in the second quarter of 2012 increased 9% compared to the first quarter of 2012 and increased 4% compared to second quarter of 2011.  The increase in recruitment is due to an increase in the number of first-time members.  We believe the increase was due to the offering of NutriVerus for sale in the United States and the introduction of the 4Free Discount Program in the United States and Canada.  In tandem, we believe these programs offer a business building opportunity to the associates previously not available to them.  We plan to introduce NutriVerus to our other markets as each market’s regulators approve the product for sale.

We experienced a decline in revenue in the second quarter of 2012 as compared to the first quarter of 2012 and the second quarter of 2011.  Although recruitment of associates and members increased, the sale of products and packs decreased as compared to the first quarter of 2012 and second quarter of 2011.  Although a portion of the revenue reduction was offset by lower operating costs as compared to the second quarter of 2011, we generated a net loss for the second quarter of 2012.

In July 2012, the Company expanded its use of third-party logistic providers into our United States operations.  Our largest warehouse, located in Coppell, Texas, was sublet to a third-party logistics company for operation.  We believe this will decrease shipping times to our associates and members in the United States by taking advantage of distribution capabilities of the third-party logistics company on the west coast and east coast.  Additionally, by subletting our warehouse space to the third-party logistics company, we are monetizing our excess warehouse space, which reduces our costs of operations.  We remain dedicated to our 2012 goal of restoring profitability; therefore, we are continuing to reduce our operating expenses on a global basis.  We expect these targeted expense reductions to have a positive impact on profitability and cash flow.



 
16

 

RESULTS OF OPERATIONS

The table below summarizes our consolidated operating results in dollars and as a percentage of net sales for the three months ended June 30, 2012 and 2011 (in thousands, except percentages):
 
   
2012
 
2011
 
Change from
2012 to 2011
 
   
Total
dollars
 
% of
net sales
 
Total
dollars
 
% of
net sales
 
Dollar
 
Percentage
 
Net sales
 
$
43,611
 
100.0
%
$
51,362
 
100
%
$
(7,751
)
(15.1
)%
Cost of sales
   
6,888
 
15.8
%
 
7,543
 
14.7
%
 
(655
)
(8.7
)%
Commissions and incentives
   
18,637
 
42.7
%
 
22,896
 
44.6
%
 
(4,259
)
(18.6
)%
     
25,525
 
58.5
%
 
30,439
 
59.3
%
 
(4,914
)
(16.3
)%
Gross profit
   
18,086
 
41.5
%
 
20,923
 
40.7
%
 
(2,837
)
(13.6
)%
                                 
Operating expenses:
                               
Selling and administrative expenses
   
11,793
 
27.0
%
 
14,811
 
28.8
%
 
(3,018
)
(20.4
)%
Depreciation and amortization
   
921
 
2.1
%
 
2,687
 
5.2
%
 
(1,766
)
(65.7
)%
Other operating costs
   
6,778
 
15.5
%
 
7,746
 
15.1
%
 
(968
)
(12.5
)%
Total operating expenses
   
19,492
 
44.7
%
 
25,244
 
49.1
%
 
(5,752
)
(22.8
)%
Loss from operations
   
(1,406
)
(3.2
)%
 
(4,321
)
(8.4
)%
 
2,915
 
67.5
%
Interest income (expense)
   
21
 
0.0
%
 
21
 
0.0
%
 
0
 
0.0
%
Other income (expense), net
   
(805
)
(1.8
)%
 
196
 
0.4
%
 
(1,001
)
(510.7
)%
Loss before income taxes
   
(2,190
)
(5.0
)%
 
(4,104
)
(8.0
)%
 
1,914
 
46.6
%
(Provision) benefit for income taxes
   
(265
)
(0.6
)%
 
(1,146
)
(2.2
)%
 
881
 
76.9
%
Net loss
 
$
(2,455
)
(5.6
)%
$
(5,250
)
(10.2
)%
$
2,795
 
53.2
%



The table below summarizes our consolidated operating results in dollars and as a percentage of net sales for the six months ended June 30, 2012 and 2011 (in thousands, except percentages):

   
2012
 
2011
 
Change from
2012 to 2011
 
   
Total
dollars
 
% of
net sales
 
Total
dollars
 
% of
net sales
 
Dollar
 
Percentage
 
Net sales
 
$
88,113
 
100.0
%
$
102,262
 
100
%
$
(14,149
)
(13.8
)%
Cost of sales
   
13,283
 
15.1
%
 
14,757
 
14.4
%
 
(1,474
)
(10.0
)%
Commissions and incentives
   
37,622
 
42.7
%
 
44,603
 
43.6
%
 
(6,981
)
(15.7
)%
     
50,905
 
57.8
%
 
59,360
 
58.0
%
 
(8,455
)
(14.2
)%
Gross profit
   
37,208
 
42.2
%
 
42,902
 
42.0
%
 
(5,694
)
(13.3
)%
                                 
Operating expenses:
                               
Selling and administrative expenses
   
23,277
 
26.4
%
 
30,829
 
30.1
%
 
(7,552
)
(24.5
)%
Depreciation and amortization
   
3,379
 
3.8
%
 
5,488
 
5.4
%
 
(2,109
)
(38.4
)%
Other operating costs
   
14,014
 
15.9
%
 
15,812
 
15.5
%
 
(1,798
)
(11.4
)%
Total operating expenses
   
40,670
 
46.2
%
 
52,129
 
51.0
%
 
(11,459
)
(22.0
)%
Loss from operations
   
(3,462
)
(3.9
)%
 
(9,227
)
(9.0
)%
 
5,765
 
62.5
%
Interest income (expense)
   
(32
)
0.0
%
 
1
 
0.0
%
 
(33
)
(3300.0
)%
Other income (expense), net
   
87
 
0.1
%
 
463
 
0.5
%
 
(376
)
(81.2
)%
Loss before income taxes
   
(3,407
)
(3.9
)%
 
(8,763
)
(8.6
)%
 
5,356
 
61.1
%
(Provision) benefit for income taxes
   
(448
)
(0.5
)%
 
(1,265
)
(1.2
)%
 
817
 
64.6
%
Net loss
 
$
(3,855
)
(4.4
)%
$
(10,028
)
(9.8
)%
$
6,173
 
61.6
%


 
17

 
 
Consolidated net sales by customer location for the three months ended June 30, 2012 and 2011 were as follows (in millions, except percentages):

Net Sales in Dollars and as a Percentage of Consolidated Net Sales

   
2012
 
2011
United States
 
$
18.6
 
42.7
%
 
$
21.3
 
41.4
%
Japan
   
6.8
 
15.6
%
   
7.7
 
15.0
%
Republic of Korea
   
5.3
 
12.2
%
   
6.2
 
12.1
%
Canada
   
4.0
 
9.2
%
   
4.3
 
8.3
%
Australia
   
3.4
 
7.8
%
   
4.5
 
8.8
%
South Africa(1)
   
1.9
 
4.4
%
   
2.2
 
4.3
%
New Zealand
   
0.5
 
1.1
%
   
0.7
 
1.3
%
Singapore
   
0.5
 
1.1
%
   
0.8
 
1.6
%
Taiwan
   
0.5
 
1.1
%
   
1.0
 
1.9
%
Germany
   
0.4
 
0.9
%
   
0.5
 
1.0
%
Norway
   
0.4
 
0.9
%
   
0.4
 
0.8
%
United Kingdom(2)
   
0.3
 
0.7
%
   
0.5
(3)
0.9
%
The Netherlands
   
0.3
 
0.7
%
   
0.3
 
0.6
%
Czech Republic(4)
   
0.3
 
0.7
%
   
 
 
Mexico
   
0.2
 
0.5
%
   
0.6
 
1.2
%
Austria
   
0.1
 
0.2
%
   
0.2
 
0.4
%
Sweden
   
0.1
 
0.2
%
   
0.1
 
0.2
%
Denmark
   
 
     
0.1
 
0.2
%
Finland(5)
   
 
     
 
 
Total
 
$
43.6
 
100
%
 
$
51.4
 
100
%
________________________
(1)  
Includes sales for the Republic of Namibia, which began operations in August 2011.
(2)  
Includes sales for Estonia and the Republic of Ireland, which began operations in June 2011. Their combined consolidated sales for the three months ended June 30, 2012 were less than $0.1 million and are included in net sales for the United Kingdom.
(3)  
Includes sales for the Czech Republic, which began operations in June 2011.
(4)  
The Company began operations in the Czech Republic in June 2011; net sales for June 2011 are included in net sales for the United Kingdom.
(5)  
The Company began operations in Finland in June 2011.



 
18

 


Consolidated net sales by customer location for the six months ended June 30, 2012 and 2011 were as follows (in millions, except percentages):

Net Sales in Dollars and as a Percentage of Consolidated Net Sales

   
2012
 
2011
United States
 
$
37.2
 
42.2
%
 
$
43.7
 
42.7
%
Japan
   
13.6
 
15.4
%
   
15.2
 
14.9
%
Republic of Korea
   
10.8
 
12.3
%
   
11.4
 
11.1
%
Canada
   
7.7
 
8.7
%
   
8.2
 
8.0
%
Australia
   
7.4
 
8.4
%
   
9.0
 
8.8
%
South Africa(1)
   
3.9
 
4.4
%
   
4.3
 
4.2
%
Taiwan
   
1.2
 
1.4
%
   
2.3
 
2.2
%
Singapore
   
1.1
 
1.3
%
   
1.4
 
1.4
%
New Zealand
   
1.0
 
1.2
%
   
1.2
 
1.2
%
Germany
   
0.9
 
1.0
%
   
1.0
 
1.0
%
Norway
   
0.8
 
0.9
%
   
0.9
 
0.9
%
United Kingdom(2)
   
0.7
 
0.8
%
   
0.8
(3)
0.8
%
The Netherlands
   
0.6
 
0.7
%
   
0.6
 
0.6
%
Mexico
   
0.4
 
0.5
%
   
1.3
 
1.3
%
Czech Republic(4)
   
0.3
 
0.3
%
   
 
 
Austria
   
0.2
 
0.2
%
   
0.5
 
0.4
%
Sweden
   
0.1
 
0.1
%
   
0.3
 
0.3
%
Denmark
   
0.1
 
0.1
%
   
0.2
 
0.2
%
Finland(5)
   
0.1
 
0.1
%
   
 
 
Total
 
$
88.1
 
100
%
 
$
102.3
 
100
%
________________________
(1)  
Includes sales for the Republic of Namibia, which began operations in August 2011.
(2)  
Includes sales for Estonia and the Republic of Ireland, which began operations in June 2011. Their combined consolidated sales for the six months ended June 30, 2012 were less than $0.1 million and are included in net sales for the United Kingdom.
(3)  
Includes sales for the Czech Republic, which began operations in June 2011.
(4)  
The Company began operations in the Czech Republic in June 2011; net sales for June 2011 are included in net sales for the United Kingdom.
(5)  
The Company began operations in Finland in June 2011.

Net Sales

For the three and six months ended June 30, 2012, our operations outside of the United States accounted for approximately 57.3% and 57.8%, respectively, of our consolidated net sales, whereas in the same period in 2011, our operations outside of the United States accounted for approximately 58.6% and 57.3%, respectively, of our consolidated net sales.

Consolidated net sales for the three months ended June 30, 2012 decreased by $7.8 million, or 15.1%, to $43.6 million as compared to the same period in 2011. United States sales decreased by $2.7 million, or 12.7%, to $18.6 million, while international sales decreased by $5.1 million, or 16.9%, to $25.0 million for the three months ended June 30, 2012 as compared to the same period in 2011.

Consolidated net sales for the six months ended June 30, 2012 decreased by $14.2 million, or 13.8%, to $88.1 million as compared to the same period in 2011. United States sales decreased by $6.5 million, or 14.9%, to $37.2 million, while international sales decreased by $7.7 million, or 13.1%, to $50.9 million for the six months ended June 30, 2012 as compared to the same period in 2011.


 
19

 


Fluctuation in foreign currency exchange rates for the three and six months ended June 30, 2012, had an overall unfavorable impact of approximately $1.0 million and $0.9 million, respectively, on our net sales. The net sales impact is calculated as the difference between (1) the current period’s net sales in USD and (2) the current period’s net sales in local currencies converted to USD by applying average exchange rates for the same periods ended June 30, 2011.

Net sales by country in transactional currency for the three and six months ended June 30, 2012 and 2011 were as follows (in millions, except percentages):
 
       
Three Months
 
Change
 
Country
 
Transactional
Currency
 
2012
 
2011
 
Transactional
currency
 
Percentage
 
Australia
 
AUD
 
3.3
 
4.2
 
(0.9
)
(21.4
)%
Austria, Germany, the Netherlands, the Czech Republic, Estonia, Finland, the Republic of Ireland(1)
 
EUR
 
0.8
 
0.7
 
0.1
 
14.3
 %
Denmark
 
DKK
 
0.3
 
0.5
 
(0.2
)
(40.0
)%
Japan
 
JPY
 
375.8
 
625.8
 
(250.0
)
(39.9
)%
Mexico
 
MXN
 
2.2
 
7.3
 
(5.1
)
(69.9
)%
New Zealand
 
NZD
 
0.6
 
0.8
 
(0.2
)
(25.0
)%
Norway
 
NOK
 
2.0
 
2.3
 
(0.3
)
(13.0
)%
Republic of Korea
 
KRW
 
5,784.6
 
6,707.9
 
(923.3
)
(13.8
)%
Singapore
 
SGD
 
0.6
 
1.0
 
(0.4
)
(40.0
)%
South Africa
 
ZAR
 
14.5
 
15.0
 
(0.5
)
(3.3
) %
Sweden
 
SEK
 
0.4
 
0.6
 
(0.2
)
(33.3
)%
Taiwan
 
TWD
 
14.7
 
30.1
 
(15.4
)
(51.2
)%
United Kingdom
 
GBP
 
0.3
 
0.3
 
 
 

______________________________________________________
(1)  
We began operations in the Czech Republic, Estonia, Finland and the Republic of Ireland in June 2011.

       
Six Months
 
Change
 
Country
 
Transactional
Currency
 
2012
 
2011
 
Transactional
currency
 
Percentage
 
Australia(1)
 
AUD
 
7.0
 
9.2
 
(2.2
)
(23.9
)%
Austria, Germany, the Netherlands, the Czech Republic, Estonia, Finland, the Republic of Ireland(2)
 
EUR
 
1.5
 
1.4
 
0.1
 
7.1
%
Denmark
 
DKK
 
0.7
 
1.1
 
(0.4
)
(36.4
)%
Japan
 
JPY
 
916.6
 
1,246.0
 
(329.4
)
(26.4
)%
Mexico
 
MXN
 
4.7
 
15.2
 
(10.5
)
(69.1
)%
New Zealand
 
NZD
 
1.3
 
1.6
 
(0.3
)
(18.8
)%
Norway
 
NOK
 
4.2
 
4.9
 
(0.7
)
(14.3
)%
Republic of Korea
 
KRW
 
12,020.2
 
12,525.8
 
(505.6
)
(4.0
) %
Singapore(1)
 
SGD
 
1.4
 
1.1
 
0.3
 
27.3
 %
South Africa
 
ZAR
 
30.1
 
29.6
 
0.5
 
1.7
 %
Sweden
 
SEK
 
1.0
 
1.5
 
(0.5
)
(33.3
)%
Taiwan
 
TWD
 
33.1
 
66.5
 
(33.4
)
(50.2
)%
United Kingdom
 
GBP
 
0.5
 
0.6
 
(0.1
)
(16.7
)%

______________________________________________________
(1)  
In March 2011, we started transacting sales in Singapore dollars (SGD). Prior to March 2011, sales in Singapore were transacted in Australian dollars.
(2)  
We began operations in the Czech Republic, Estonia, Finland and the Republic of Ireland in June 2011.


 
20

 


Our total sales and sales mix could be influenced by any of the following:

 
·  
changes in our sales prices;
 
·  
changes in consumer demand;
 
·  
changes in the number of associates and members;
 
·  
changes in competitors’ products;
 
·  
changes in economic conditions;
 
·  
changes in regulations;
 
·  
announcements of new scientific studies and breakthroughs;
 
·  
introduction of new products;
 
·  
discontinuation of existing products;
 
·  
adverse publicity;
 
·  
changes in our commissions and incentives programs;
 
·  
direct competition; and
 
·  
fluctuations in foreign currency exchange rates.


Our sales mix for the three and six months ended June 30, was as follows (in millions, except percentages):
 

 
Three Months
 
Change
 
2012
 
2011
 
Dollar
 
Percentage
Consolidated product sales
$
38.9
 
$
43.4
 
$
(4.5
)
(10.4
)%
Consolidated pack sales
 
3.0
   
5.9
   
(2.9
)
(49.2
)%
Consolidated other, including freight
 
1.7
   
2.1
   
(0.4
)
(19.0
)%
Total consolidated net sales
$
43.6
 
$
51.4
 
$
(7.8
)
(15.1
)%


 
Six Months
 
Change
 
2012
 
2011
 
Dollar
 
Percentage
Consolidated product sales
$
78.8
 
$
86.6
 
$
(7.8
)
(9.0
)%
Consolidated pack sales
 
6.1
   
11.4
   
(5.3
)
(46.5
)%
Consolidated other, including freight
 
3.2
   
4.3
   
(1.1
)
(25.6
)%
Total consolidated net sales
$
88.1
 
$
102.3
 
$
(14.2
)
(13.8
)%


Pack sales correlate to new associates who purchase starter packs and to continuing associates who purchase upgrade or renewal packs. However, there is no direct correlation between product sales and the number of new and continuing associates and members because associates and members utilize products at different volumes.

Product Sales

Substantially all of our product sales are made to associates at published wholesale prices. We also sell our products to members at discounted published retail prices.


 
21

 


Product sales for the three months ended June 30, 2012 decreased by $4.5 million, or 10.4%, as compared to the same period in 2011. The decrease in product sales was primarily due to the reduction in the number of new associates and the loss of existing associates, which resulted in a decline in the number of orders placed during the period. The average order value for the three months ended June 30, 2012 was $154 as compared to $155 for the same period in 2011. Approximately $0.3 million of the reduction in product sales resulted from the decrease in average order value with the remaining decrease attributable to the decline in the number of packs sold during the period.  The number of orders processed during the three months ended June 30, 2012 decreased by 8.9% as compared to the same period in 2011. This decrease was consistent with the decline in the number of continuing associates and members as described in detail below.

Product sales for the six months ended June 30, 2012 decreased by $7.8 million, or 9.0%, as compared to the same period in 2011. The decrease in product sales was primarily due to the reduction in the number of new associates and the loss of existing associates, which resulted in a decline in the number of orders placed during the period. The average order value for the six months ended June, 2012 was $156 as compared to $154 for the same period in 2011. The 1.3% increase in average order value resulted in approximately $1.1 million in additional revenue which partially offset the overall decline in product sales. The number of orders processed during the six months ended June 30, 2012 decreased by 9.6% as compared to the same period in 2011. This decrease was consistent with the decline in the number of continuing associates and members as described in detail below.

Pack Sales

Packs may be purchased by our associates who wish to build a Mannatech business. These packs are offered to our associates at a discount from published retail prices. There are several pack options available to our associates. In certain markets, pack sales are completed during the final stages of the registration process and can provide new associates with valuable training and promotional materials, as well as products for resale to retail customers, demonstration purposes, and personal consumption. Business-building associates can also purchase an upgrade pack, which provides the associate with additional promotional materials, additional products, and eligibility for additional commissions and incentives. Many of our business-building associates also choose to purchase renewal packs to satisfy annual renewal requirements to continue to earn various commissions.

The dollar amount of pack sales associated with new and continuing associates was as follows, for the three and six months ended June 30 (in millions, except percentages):

   
Three Months
 
Change
 
   
2012
 
2011
 
Dollar
 
Percentage
 
New
 
$
2.1
 
$
4.1
 
$
(2.0
)
(48.8
)%
Continuing
   
0.9
   
1.8
   
(0.9
)
(50.0
)%
Total
 
$
3.0
 
$
5.9
 
$
(2.9
)
(49.2
)%


   
Six Months
 
Change
 
   
2012
 
2011
 
Dollar
 
Percentage
 
New
 
$
4.2
 
$
7.8
 
$
(3.6
)
(46.2
)%
Continuing
   
1.9
   
3.6
   
(1.7
)
(47.2
)%
Total
 
$
6.1
 
$
11.4
 
$
(5.3
)
(46.5
)%



Total pack sales for the three months ended June 30, 2012 decreased by $2.9 million, or 49.2%, to $3.0 million, as compared to $5.9 million for the same period in 2011. Average pack value for the three months ended June 30, 2012 was $168 as compared to $252 for the same period in 2011. The total number of packs sold decreased by 5,400, or 23.0%, to 18,100, and the average pack value decreased by $84, or 33.3%, for the three months ended June 30, 2012, as compared to the same period in 2011. The decrease in the average pack value is due to a change in the sales mix of the type of packs purchased. Approximately $1.5 million of the reduction in pack sales resulted from the decrease in average pack value with the remaining decrease attributable to the decline in the number of packs sold during the period.

 
22

 
 
 
Total pack sales for the six months ended June 30, 2012 decreased by $5.3 million, or 46.5%, to $6.1 million, as compared to $11.4 million for the same period in 2011. Average pack value for the six months ended June 30, 2012 was $157 as compared to $247 for the same period in 2011. The total number of packs sold decreased by 7,700, or 16.6%, to 38,600, and the average pack value decreased by $90, or 36.4%, for the six months ended June 30, 2012, as compared to the same period in 2011. The decrease in the average pack value is due to a change in the sales mix of the type of packs purchased. Approximately $3.5 million of the reduction in pack sales resulted from the decrease in average pack value with the remaining decrease attributable to the decline in the number of packs sold during the period.

The approximate number of new and continuing associates who purchased our packs or products during the twelve months ended June 30, 2012 and 2011, plus members eligible to purchase our products during the same period were as follows:

   
2012
 
2011
 
New
 
87,000
 
23.1
%
84,000
 
21.9
%
Continuing
 
291,000
 
76.9
%
301,000
 
78.1
%
Total
 
378,000
 
100.0
%
385,000
 
100
%

There was an overall decrease of 7,000, or 1.8%, for the twelve months ended June 30, 2012 in the number of associates who purchased our products and members eligible to purchase our products as compared to the same period in 2011, which was due to a decline in the number of new and continuing associates offset by an increase in the number of members as a result of the 4Free program introduced in May 2012.

During 2011 and 2012, we took the following actions to recruit and retain associates and members:

 
registered our most popular products with the appropriate regulatory agencies in all countries of operations;
 
 
explored new international markets;
 
 
launched marketing and educational campaigns;
 
 
continued to strengthen compliance initiatives;
 
 
initiated additional incentives;
 
 
explored new advertising and educational tools to broaden name recognition; and
 
 
implemented changes to our global associate career and compensation plan.

Other Sales

Other sales consisted of: (i) sales of promotional materials; (ii) training and event registration fees; (iii) monthly fees collected for Success TrackerTM, a customized electronic business-building and educational materials database for our associates that helps stimulate product sales and provide business management; (iv) monthly fees collected for Navig8, a comprehensive global business system that provides tools and resources to help associates build their businesses; (v) freight revenue charged to our associates and members; and (vi) a reserve for estimated sales refunds and returns.

For the three months ended June 30, 2012, other sales decreased by $0.4 million, or 19.0%, to $1.7 million, as compared to $2.1 million for the same period in 2011.  Other sales for the six months ended June 30, 2012 decreased by $1.1 million, or 25.6%, to $3.2 million, as compared to $4.3 million for the same period in 2011. The decrease was primarily due to a decrease in freight fees resulting from the reduction in the number of product and pack shipments.

Gross Profit

For the three months ended June 30, 2012, gross profit decreased by $2.8 million, or 13.6%, to $18.1 million, as compared to $20.9 million for the same period in 2011. For the three months ended June 30, 2012, gross profit as a percentage of net sales increased to 41.5%, as compared to 40.7% for the same period in 2011.  The increase in gross profit as a percentage of net sales is primarily due to the decline in commissions and incentives earned by the Company’s associates as compared to the same period in 2011.


 
23

 


For the six months ended June 30, 2012, gross profit decreased by $5.7 million, or 13.3%, to $37.2 million, as compared to $42.9 million for the same period in 2011. For the six months ended June 30, 2012, gross profit as a percentage of net sales increased to 42.2%, as compared to 42.0% for the same period in 2011.  The increase in gross profit as a percentage of net sales is primarily due to the decline in commissions and incentives earned by the Company’s associates as compared to the same period in 2011.

Cost of sales during the three months ended June 30, 2012 decreased by 8.7%, or $0.7 million, to $6.9 million, as compared to $7.5 million for the same period in 2011. The reduction in cost of sales was primarily due to the decline in sales for the quarter and a reduction in inventory adjustments related to obsolete inventory, which was partially offset by an increase in inbound freight costs. Cost of sales as a percentage of net sales for the three months ended June 30, 2012 was 15.8%, as compared to 14.7% for the same period in 2011.

Cost of sales during the six months ended June 30, 2012 decreased by 10.0%, or $1.5 million, to $13.3 million, as compared to $14.8 million for the same period in 2011. The reduction in cost of sales was primarily due to the decline in sales for the year and a reduction in inventory adjustments related to obsolete inventory, which was partially offset by an increase in inbound freight costs. Cost of sales as a percentage of net sales for the six months ended June 30, 2012 was 15.1%, as compared to 14.4% for the same period in 2011.

Commission costs for the three months ended June 30, 2012 decreased by 18.8%, or $4.1 million, to $17.7 million, as compared to $21.8 million for the same period in 2011.  The decrease in commissions was due to the decrease in commissionable net sales.  For the three months ended June 30, 2012, commissions as a percentage of net sales decreased to 40.6% from 42.4% for the same period in 2011.

Commission costs for the six months ended June 30, 2012 decreased by 15.6%, or $6.6 million, to $35.8 million, as compared to $42.4 million for the same period in 2011.  The decrease in commissions was due to the decrease in commissionable net sales.  For the six months ended June 30, 2012, commissions as a percentage of net sales decreased to 40.6% from 41.4% for the same period in 2011.

Incentive costs for the three months ended June 30, 2012 decreased by 18.2%, or $0.2 million, to $0.9 million, as compared to $1.1 million for the same period in 2011. The costs of incentives as a percentage of net sales remained the same at 2.1% as compared to the same period in 2011.

Incentive costs for the six months ended June 30, 2012 decreased by 18.2%, or $0.4 million, to $1.8 million, as compared to $2.2 million for the same period in 2011. The costs of incentives as a percentage of net sales, decreased to 2.0%, as compared to 2.2% for the same period in 2011.

The decrease in commission and incentive costs for the six months ended June 30, 2012 compared to the same period in 2011 was largely due to the decrease in the number of new and continuing associates and members who purchased our packs or products, as well as the change in the mix of the type of packs purchased. As a result, there was a decrease in the number of associates who qualified for the 2012 annual incentive trip.

Selling and Administrative Expenses

Selling and administrative expenses include a combination of both fixed and variable expenses. These expenses consist of compensation and benefits for employees, temporary and contract labor, outbound shipping and freight, and marketing-related expenses, such as monthly magazine development costs and costs related to hosting our corporate-sponsored events.

For the three months ended June 30, 2012, selling and administrative expenses decreased by $3.0 million, or 20.4%, to $11.8 million, as compared to $14.8 million for the same period in 2011. The decrease in selling and administrative expenses consisted primarily of a $2.7 million decrease in payroll and payroll-related costs in connection with the restructuring of our U.S. operations and the elimination of 98 workforce positions in June 2011, a $0.4 million decrease in contract labor costs and a $0.3 million decrease in freight costs offset by an increase of $0.4 million in marketing costs. Selling and administrative expenses, as a percentage of net sales, for the three months ended June 30, 2012 decreased to 27.0% from 28.8% for the same period in 2011.


 
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For the six months ended June 30, 2012, selling and administrative expenses decreased by $7.6 million, or 24.5%, to $23.3 million, as compared to $30.8 million for the same period in 2011. The decrease in selling and administrative expenses consisted primarily of a $5.1 million decrease in payroll and payroll-related costs in connection with the restructuring of our U.S. operations and the elimination of 98 workforce