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

 
FORM 10-Q
(Mark One)
 
⌧ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended:  June 30, 2013
 
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 | | 75-2508900
(State or other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification No.)
600 S. Royal Lane, Suite 200, Coppell, Texas | | 75019
(Address of Principal Executive Offices) | | (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   ⌧   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  ⌧  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 ⌧

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

As of July 31, 2013, 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
Special Note Regarding Forward-Looking Statements | 1
Part I – FINANCIAL INFORMATION |
Item 1.  Financial Statements | 2
Consolidated Balance Sheets - Unaudited | 2
Consolidated Statements of Operations - Unaudited | 3
Consolidated Statement of Comprehensive Loss - Unaudited | 3
Consolidated Statement of Shareholders’ Equity - Unaudited | 4
Consolidated Statements of Cash Flows - Unaudited | 5
Notes to Unaudited Consolidated Financial Statements | 6
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16
Company Overview | 16
Results of Operations | 17
Liquidity and Capital Resources | 25
Critical Accounting Policies and Estimates | 28
Recent Accounting Pronouncements | 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk | 32
Item 4. Controls and Procedures | 33
Part II – OTHER INFORMATION |
Item 1. Legal Proceedings | 34
Item 1A. Risk Factors | 34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 34
Item 3. Defaults Upon Senior Securities | 34
Item 4. Mine Safety Disclosure | 34
Item 5. Other Information | 34
Item 6. Exhibits | 34
Signatures | 35

Table Of Contents
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, 2012, 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”.
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Table Of Contents
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, 2013 | | | December 31, 2012 |
ASSETS | | (unaudited) | | | |
Cash and cash equivalents | | $ | 17,787 | | | $ | 14,377 |
Restricted cash | | | 1,513 | | | | 1,515 |
Accounts receivable, net of allowance of $89 and $20 in 2013 and 2012, respectively | | | 246 | | | | 324 |
Income tax receivable | | | 19 | | | | 884 |
Inventories, net | | | 14,165 | | | | 15,154 |
Prepaid expenses and other current assets | | | 3,045 | | | | 2,487 |
Deferred tax assets | | | 578 | | | | 561 |
Total current assets | | | 37,353 | | | | 35,302 |
Property and equipment, net | | | 3,832 | | | | 4,825 |
Construction in progress | | | — | | | | 8 |
Long-term restricted cash | | | 4,231 | | | | 3,736 |
Other assets | | | 2,942 | | | | 3,187 |
Long-term deferred tax assets | | | 621 | | | | 502 |
Total assets | | $ | 48,979 | | | $ | 47,560 |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | |
Current portion of capital leases | | $ | 906 | | | $ | 780 |
Accounts payable | | | 5,719 | | | | 4,154 |
Accrued expenses | | | 7,411 | | | | 6,348 |
Commissions and incentives payable | | | 6,235 | | | | 7,373 |
Taxes payable | | | 3,684 | | | | 3,901 |
Current deferred tax liability | | | 271 | | | | 179 |
Deferred revenue | | | 1,504 | | | | 1,486 |
Total current liabilities | | | 25,730 | | | | 24,221 |
Capital leases, excluding current portion | | | 700 | | | | 938 |
Long-term deferred tax liabilities | | | 7 | | | | 2 |
Other long-term liabilities | | | 1,679 | | | | 2,178 |
Total liabilities | | | 28,116 | | | | 27,339 |
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 | | | — | | | | — |
Additional paid-in capital | | | 42,626 | | | | 42,614 |
Accumulated deficit | | | (5,492 | ) | | | (6,920 | )
Accumulated other comprehensive loss | | | (1,475 | ) | | | (677 | )
Less treasury stock, at cost, 121,237 shares in 2013 and 2012 | | | (14,796 | ) | | | (14,796 | )
Total shareholders’ equity | | | 20,863 | | | | 20,221 |
Total liabilities and shareholders’ equity | | $ | 48,979 | | | $ | 47,560 |
 
See accompanying notes to unaudited consolidated financial statements.
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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, |
| | 2013 | | | 2012 | | | 2013 | | | 2012 |
Net sales | | $ | 44,801 | | | $ | 43,611 | | | $ | 86,467 | | | $ | 88,113 |
Cost of sales | | | 8,694 | | | | 8,852 | | | | 16,391 | | | | 17,127 |
Gross profit | | | 36,107 | | | | 34,759 | | | | 70,076 | | | | 70,986 |
Operating expenses: | | | | | | | | | | | | | | | |
Commissions and incentives | | | 19,181 | | | | 18,637 | | | | 36,722 | | | | 37,622 |
Selling and administrative | | | 8,541 | | | | 9,945 | | | | 17,172 | | | | 19,600 |
Depreciation and amortization | | | 588 | | | | 921 | | | | 1,225 | | | | 3,379 |
Other operating costs | | | 6,247 | | | | 6,662 | | | | 12,752 | | | | 13,847 |
Total operating expenses | | | 34,557 | | | | 36,165 | | | | 67,871 | | | | 74,448 |
Income (loss) from operations | | | 1,550 | | | | (1,406 | ) | | | 2,205 | | | | (3,462 | )
Interest income (expense) | | | 17 | | | | 21 | | | | 4 | | | | (32 | )
Other income (expense), net | | | (1,420 | ) | | | (805 | ) | | | (1,003 | ) | | | 87 |
Income (loss) before income taxes | | | 147 | | | | (2,190 | ) | | | 1,206 | | | | (3,407 | )
Provision for income taxes | | | 637 | | | | (265 | ) | | | 222 | | | | (448 | )
Net income (loss) | | $ | 784 | | | $ | (2,455 | ) | | $ | 1,428 | | | $ | (3,855 | )
Income (loss) per share: | | | | | | | | | | | | | | | |
Basic | | $ | 0.30 | | | $ | (0.93 | ) | | $ | 0.54 | | | $ | (1.46 | )
Diluted | | $ | 0.30 | | | $ | (0.93 | ) | | $ | 0.54 | | | $ | (1.46 | )
Weighted-average common shares outstanding: | | | | | | | | | | | | | | | |
Basic | | | 2,648 | | | | 2,648 | | | | 2,648 | | | | 2,648 |
Diluted | | | 2,655 | | | | 2,648 | | | | 2,658 | | | | 2,648 |

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) – (UNAUDITED)
(in thousands)
 
| | | Three months ended June 30, | | | | Six months ended June 30, |
| | | 2013 | | | | 2012 | | | | 2013 | | | | 2012 |
Net income (loss) | | $ | 784 | | | $ | (2,455 | ) | | $ | 1,428 | | | $ | (3,855 | )
Foreign currency translations | | | 146 | | | | 445 | | | | (798 | ) | | | (361 | )
Comprehensive income (loss) | | $ | 930 | | | $ | (2,010 | ) | | $ | 630 | | | $ | (4,216 | )
 
See accompanying notes to unaudited consolidated financial statements.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENT 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, 2012 | | $ | — | | | $ | 42,614 | | | $ | (6,920 | ) | | $ | (677 | ) | | $ | (14,796 | ) | | $ | 20,221 |
Net income | | | — | | | | — | | | | 1,428 | | | | — | | | | — | | | | 1,428 |
Charge related to stock-based compensation | | | — | | | | 96 | | | | — | | | | — | | | | — | | | | 96 |
Tax shortfall from expiration of stock options | | | — | | | | (84 | ) | | | — | | | | — | | | | — | | | | (84 | )
Foreign currency translations | | | — | | | | — | | | | — | | | | (798 | ) | | | — | | | | (798 | )
Balance at June 30, 2013 | | $ | — | | | $ | 42,626 | | | $ | (5,492 | ) | | $ | (1,475 | ) | | $ | (14,796 | ) | | $ | 20,863 |

See accompanying notes to unaudited consolidated financial statements.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS – (UNAUDITED)
(in thousands)

Six months ended
June 30,

| | 2013 | | | 2012 |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | |
Net income ( loss) | | $ | 1,428 | | | $ | (3,855 | )
Adjustments to reconcile net income (loss) to net cash used in operating activities: | | | | | | | |
Depreciation and amortization | | | 1,225 | | | | 3,379 |
Provision for inventory losses | | | 207 | | | | 680 |
Provision for doubtful accounts | | | 129 | | | | 20 |
Loss on disposal of assets | | | (1 | ) | | | 54 |
Accounting charge related to stock-based compensation expense | | | 96 | | | | 124 |
Deferred income taxes | | | (134 | ) | | | (116 | )
Changes in operating assets and liabilities: | | | | | | | |
Accounts receivable | | | (62 | ) | | | 92 |
Income tax receivable | | | 865 | | | | (4 | )
Inventories | | | 643 | | | | (1,071 | )
Prepaid expenses and other current assets | | | 88 | | | | 532 |
Other assets | | | 38 | | | | (327 | )
Accounts payable | | | 1,614 | | | | 1,921 |
Accrued expenses and other liabilities | | | 849 | | | | (3,228 | )
Taxes payable | | | (83 | ) | | | (111 | )
Commissions and incentives payable | | | (916 | ) | | | (2,732 | )
Deferred revenue | | | 27 | | | | 248 |
Net cash provided by (used in) operating activities | | | 6,013 | | | | (4,394 | )
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | |
Acquisition of property and equipment | | | (252 | ) | | | (235 | )
Proceeds from sales of assets | | | - | | | | 28 |
Change in restricted cash | | | (746 | ) | | | (322 | )
Net cash used in investing activities | | | (998 | ) | | | (529 | )
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | |
Repurchase of fractional shares from reverse stock split | | | - | | | | (3 | )
Repayment of capital lease obligations | | | (787 | ) | | | (628 | )
Net cash used in financing activities | | | (787 | ) | | | (631 | )
Effect of currency exchange rate changes on cash and cash equivalents | | | (818 | ) | | | (400 | )
Net increase (decrease) in cash and cash equivalents | | | 3,410 | | | | (5,954 | )
Cash and cash equivalents at the beginning of the period | | | 14,377 | | | | 18,057 |
Cash and cash equivalents at the end of  the period | | $ | 17,787 | | | $ | 12,103 |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | | | | | | | |
Income taxes paid, net | | $ | (850 | ) | | $ | (566 | )
Interest paid on capital leases | | $ | (74 | ) | | $ | (80 | )
Summary of non-cash investing and financing activities: | | | | | | | |
Assets acquired through capital leases | | $ | 685 | | | $ | 225 |

See accompanying notes to unaudited consolidated financial statements.
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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.  We currently sell our products in three regions: (i) North America (the United States, Canada, and Mexico); (ii) Europe/the Middle East/Africa (“EMEA”) (Austria, the Czech Republic, Denmark, Estonia, Finland, Germany, the Republic of Ireland, Namibia, the Netherlands, Norway, South Africa, Sweden, Ukraine, and the United Kingdom); (iii) Asia/Pacific (Australia, Hong Kong, Japan, New Zealand, the Republic of Korea, Singapore, and Taiwan).  In December 2012, the Company commenced the shipment of its products to Hong Kong and officially launched Hong Kong operations in April 2013.  In November 2012, the Company commenced the shipment of its products to Ukraine and officially launched Ukrainian operations in July 2013.

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, 2012 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, 2012 and filed with the United States Securities and Exchange Commission (the “SEC”) on March 28, 2013 (the “2012 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 2012 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.

Reclassifications

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

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 .
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
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 each of June 30, 2013 and December 31, 2012, credit card receivables were $1.7 million and cash and cash equivalents held in bank accounts in foreign countries totaled $14.4 million and $10.8 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, 2013 and December 31, 2012, our total restricted cash was $5.7 million and $5.3 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, 2013 and December 31, 2012, 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 each of June 30, 2013 and December 31, 2012, 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, 2013 and December 31, 2012, other assets were $2.9 million and $3.2 million, respectively, and primarily consisted of deposits for building leases in various locations of $1.6 million and $1.8 million, respectively.   Additionally, included in the June 30, 2013 and December 31, 2012 balances was $0.9 million and $1.0 million, respectively, 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.  Also included in the June 30, 2013 and December 31, 2012 balances was $0.2 million of indefinite lived intangible assets relating to the Manapol ® powder trademark.

Other Long-Term Liabilities

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, 2013 and December 31, 2012, accrued restoration costs related to these leases amounted to $0.2 million and $0.5 million, respectively.   Also included in long-term liabilities at June 30, 2013 and December 31, 2012 was an estimated defined benefit obligation related to a non-U.S. defined benefit plan for its Japan operations of $0.6 million and $0.7 million, respectively.

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 Long-Term Post-Employment 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, 2013 and December 31, 2012, the Company’s liability related to this royalty agreement was $0.1 million and $0.2 million, respectively.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
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 each of June 30, 2013 and December 31, 2012, the Company’s deferred revenue was $1.5 million 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, 2013 our sales return reserve consisted of the following  (in thousands) :
| | June 30, 2013 |
Sales reserve as of January 1, 2013 | | $ | 156 |
Provision related to sales made in current period | | | 502 |
Adjustment related to sales made in prior periods | | | 2 |
Actual returns or credits related to current period | | | (357 | )
Actual returns or credits related to prior periods | | | (160 | )
Sales reserve as of June 30, 2013 | | $ | 143 |

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.  To improve the matching of costs associated with the revenue from freight and shipping fees collected, beginning December 31, 2012, freight charges associated with shipping products to our customers were reclassified to cost of sales from selling and administrative expenses with prior periods’ presentations adjusted accordingly. Total revenue from freight and shipping fees were approximately $1.9 million and $1.5 million for the three months ended June 30, 2013 and 2012, respectively, and $3.8 million and $3.0 million for the six months ended June 30, 2013 and 2012, respectively.  Total freight costs for shipping products to our customers included in cost of sales were approximately $1.7 million and $1.9 million for the three months ended June 30, 2013 and 2012, respectively, and $3.3 million and $3.7 million for the six months ended June 30, 2013 and 2012, respectively.

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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
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.

In order to more closely conform to the financial presentation of our competitors, beginning December 31, 2012, commissions and incentive expenses were reclassified to operating expenses from cost of sales with prior periods’ presentations adjusted accordingly.  Total commissions and incentive expenses reclassified to operating expenses were approximately $19.1 million and $18.6 million for the three months ended June 30, 2013 and 2012, respectively, and $36.7 million and $37.6 million for the six months ended June 30, 2013 and 2012, respectively.

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, Mexico, and Ukraine operations, and changes in the pension obligation for its Japanese employees.

NOTE 2: INVENTORIES

Inventories consist of raw materials and finished goods, which also includes promotional materials. The Company provides an allowance for any slow-moving or obsolete inventories. Inventories at June 30, 2013 and December 31, 2012, consisted of the following  (in thousands) :
| | June 30, 2013 | | | December 31, 2012 |
Raw materials | | $ | 5,490 | | | $ | 6,071 |
Finished goods | | | 9,982 | | | | 10,702 |
Inventory reserves for obsolescence | | | (1,307 | ) | | | (1,619 | )
Total | | $ | 14,165 | | | $ | 15,154 |

NOTE 3: INCOME TAXES

For the three and six months ended June 30, 2013, the Company’s effective tax rate was (429.5)% and (18.4)%, respectively. For the three and six months ended June 30, 2012, the Company’s effective income tax rate was (12.1)% and (13.1)%, respectively.  For the three and six months ended June 30, 2013 and 2012, the Company’s effective tax rate was determined based on the estimated annual effective tax rate.

The examination of our 2005-2009 tax years by the IRS for U.S. federal tax purposes was settled during the second quarter of 2013.  In connection with the audit, the IRS and the Company agreed to a net tax deficiency of $0.8 million and the payment of interest accrued through June 30, 2013 of $0.2 million, without any penalties.  In connection with the settlement of the audit, the Company reclassified amounts owed to the IRS and previously recorded as uncertain tax positions as taxes payable, resulting in a $1.0 million tax benefit during the three months ended June 30, 2013.

Excluding the release of uncertain income tax positions in connection with the settlement of the IRS audit, the effective tax rate for the three and six months ended June 30, 2013 would have been 263.2% and 66.7%.  These rates are higher than what would have been expected if the federal statutory income tax rate were applied to income before taxes primarily from the unfavorable differences from foreign operations.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
There are other ongoing income tax audits in various international jurisdictions that are not material to our financial statements.

NOTE 4: EARNINGS (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 income and a net loss for the three months ended June 30, 2013 and 2012, respectively. For each of the periods, approximately 0.1 million shares 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, 2013 and 2012, the Company used the quarter’s average common stock close price of $9.15 and $4.96 per share, respectively. The Company reported net income and net loss for the six months ended June 30, 2013 and 2012, respectively.  For each of the periods, approximately 0.1 million shares 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 six months ended June 30, 2013 and 2012, the Company used the six month  average common stock close price of $7.66 and $4.57 per share, respectively.

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 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 to increase the number of shares of common stock subject to the plan by 100,000. As of June 30, 2013, the 2008 Plan had 74,741 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, 2013 and 2012, the Company granted 5,000 and 15,000 stock options, respectively.  During the six months ended June 30, 2013 and 2012, the Company granted 80,000 and 20,000 stock options, respectively.  The fair value of stock options granted during the three months ended June 30, 2013 was $6.07.  The fair value of stock options granted during the six months ended June 30, 2013 ranged from $3.53 to $6.07 per share.  The Company recognized compensation expense as follows for the three and six months ended June 30  (in thousands) :
| | | Three months | | | | Six months |
| | | 2013 | | | | 2012 | | | | 2013 | | | | 2012 |
Total gross compensation expense | | $ | 59 | | | $ | 75 | | | $ | 96 | | | $ | 124 |
Total tax benefit associated with compensation expense | | | 13 | | | | 19 | | | | 21 | | | | 30 |
Total net compensation expense | | $ | 46 | | | $ | 56 | | | $ | 75 | | | $ | 94 |

During the second quarter of 2013, 5,000 stock options were granted to a non-employee director in connection with his re-election to the Company’s Board of Directors at the 2013 Annual Shareholders’ Meeting held on June 5, 2013.  One-third of these stock options were immediately vested on the date of grant, another one-third vests on the first anniversary of the date of grant, and the remaining one-third vests on the second anniversary of the date of grant.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
As of June 30, 2013, the Company expects to record compensation expense in the future as follows (in thousands):
 
| | | Six months ending December 31, 2013 | | | | | | | | Year ending December 31, | |
| | | | | | | 2014 | | | | 2015 | | | | 2016 | |
Total gross unrecognized compensation expense | | $ | 70 | | | $ | 111 | | | $ | 91 | | | $ | 15 | |
Tax benefit associated with unrecognized compensation expense | | | 12 | | | | 20 | | | | 15 | | | | 2 | |
Total net unrecognized compensation expense | | $ | 58 | | | $ | 91 | | | $ | 76 | | | $ | 13 | |

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 500,000 shares of common stock (as adjusted for a 1-for-10 reverse stock split effected January 13, 2012) that may be resold by the Investor pursuant to the Investment Agreement.

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 July 31, 2013, 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) 131,756 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 2013.

As of July 31, 2013, 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.

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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 7: LITIGATION

Pending Litigation

Natalie Clark v. Mannatech, Incorporated, Case No. DC-13-05038, 192^nd Judicial District Court, Dallas County, Texas
 
On May 10, 2013 the Company was served notice of a lawsuit filed by Ms. Natalie Clark, a former executive with the Company, in the 192 ^nd  Judicial District Court, Dallas County, Texas (the “Court”) alleging discrimination and harassment based on gender. Ms. Clark alleges that she was stripped of her duties and wrongfully discharged as part of an alleged “purge of females in key positions” within the Company. Ms. Clark is seeking damages in excess of $1,000,000. The Company has retained counsel and filed its answer denying Ms. Clark’s allegations.  This case is set for jury trial on June 2, 2014. Additionally, the Court issued a standard mediation order and mediation must be conducted no later than May 2, 2014.
 
The parties are in the initial stages of the discovery process. It is not possible at this time to predict whether the Company will incur any liability, or to estimate the ranges of damages, if any, which may be incurred in connection with this matter.  However, the Company believes it has a valid defense and will vigorously defend this claim.
 
Administrative Proceedings

The examination of our 2005-2009 tax years by the IRS for U.S. federal tax purposes was settled during the second quarter of 2013.  On May 13, 2013, the IRS and the Company concluded the audit and agreed to a net tax deficiency of $0.8 million and the payment of interest accrued through June 30, 2013 of $0.2 million, without any penalties.  In connection with the settlement of the audit, the Company reclassified amounts owed to the IRS and previously recorded as uncertain income tax positions as taxes payable, resulting in a $1.0 million tax benefit during the three months ended June 30, 2013.  There are other ongoing income tax audits in various international jurisdictions that are not expected to have a material effect on our financial statements.

On July 11, 2013 the Company was issued an assessment notice from the Busan Custom Office in Korea in the amount of KRW 2,147,034,680 (approximately $1.9 million) resulting from an audit covering fiscal years 2008 through 2012.  We are pursuing relief through the administrative review processes available in the jurisdiction.  Additionally, we have created a reserve of approximately $0.9 million which reflects our current estimate of the probable outcome of our appeal.  Please see  Note 11, Subsequent Events , for additional information.
 
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 related legal fees and the contingencies arising from the above legal matters where an outcome was deemed to be probable, and the loss amount could be reasonably estimated.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8: RECENT ACCOUNTING PRONOUNCEMENTS

 In February 2013, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under this standard, entities will be required to disclose additional information with respect to changes in accumulated other comprehensive income (“AOCI”) balances by component and significant items reclassified out of AOCI. Expanded disclosures for presentation of changes in AOCI involve disaggregating the total change of each component of other comprehensive income (for example, unrealized gains or losses on available for sale marketable securities) as well as presenting separately for each such component the portion of the change in AOCI related to (1) amounts reclassified into income and (2) current-period other comprehensive income. Additionally, for amounts reclassified into income, disclosure in one location would be required, based upon each specific AOCI component, of the amounts impacting individual income statement line items. Disclosure of the income statement line item impacts will be required only for components of AOCI reclassified into income in their entirety. This ASU is effective beginning January 1, 2013. Because this standard only impacts presentation and disclosure requirements, its adoption did not have a material impact on the Company’s consolidated results of operations or financial condition. No additional disclosures were presented during the quarter as there were no material reclassifications from AOCI during the periods presented.

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, 2013.
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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The table below presents the recorded amount of financial assets measured at fair value (in thousands) on a recurring basis as of June 30, 2013.
| | Level 1 | | | Level 2 | | | Level 3 | | | Total |
Assets | | | | | | | | | | | |
Money Market Funds – Fidelity, US | | $ | 1,141 | | | $ | — | | | $ | — | | | $ | 1,141 |
Interest bearing deposits – various banks, Korea | | | 3,375 | | | | — | | | | — | | | | 3,375 |
Total assets | | $ | 4,516 | | | $ | — | | | $ | — | | | $ | 4,516 |
Amounts included in: | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 1,260 | | | $ | — | | | $ | — | | | $ | 1,260 |
Long-term restricted cash | | | 3,256 | | | | — | | | | — | | | | 3,256 |
Total | | $ | 4,516 | | | $ | — | | | $ | — | | | $ | 4,516 |

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-four 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.

The Company operates facilities in eleven countries and sells product in twenty-four 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, Mexico, and Ukraine. Each facility services different geographic areas.  We currently sell our products in three regions: (i) North America (the United States, Canada, and Mexico); (ii) EMEA (Austria, the Czech Republic, Denmark, Estonia, Finland, Germany, the Republic of Ireland, Namibia, the Netherlands, Norway, South Africa, Sweden, Ukraine, and the United Kingdom); (iii) Asia/Pacific (Australia, Hong Kong, Japan, New Zealand, the Republic of Korea, Singapore, and Taiwan).  In December 2012, the Company commenced the shipment of its products to Hong Kong and officially launched Hong Kong operations in April 2013.  In November 2012, the Company commenced the shipment of its products to Ukraine and officially launched Ukrainian operations in July 2013. The Switzerland office was created to manage certain day-to-day business needs of non-North American markets.

Consolidated net sales shipped to customers in these regions, 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 |
Region | | 2013 | | | 2012 | | | 2013 | | | 2012 |
North America | | $ | 21.3 | | | | 47.6 | % | | $ | 22.8 | | | | 52.3 | % | | $ | 41.8 | | | | 48.3 | % | | $ | 45.3 | | | | 51.4 | %
Asia/Pacific | | | 19.9 | | | | 44.4 | % | | | 17.0 | | | | 39.0 | % | | | 37.7 | | | | 43.6 | % | | | 35.1 | | | | 39.9 | %
EMEA | | | 3.6 | | | | 8.0 | % | | | 3.8 | | | | 8.7 | % | | | 7.0 | | | | 8.1 | % | | | 7.7 | | | | 8.7 | %
Totals | | $ | 44.8 | | | | 100 | % | | $ | 43.6 | | | | 100 | % | | $ | 86.5 | | | | 100 | % | | $ | 88.1 | | | | 100 | %

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MANNATECH, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
| | Three months | | | Six months |
| | 2013 | | | 2012 | | | 2013 | | | 2012 |
Consolidated product sales | | $ | 38.9 | | | $ | 38.9 | | | $ | 76.2 | | | $ | 78.8 |
Consolidated pack sales | | | 3.9 | | | | 3.0 | | | | 6.3 | | | | 6.1 |
Consolidated other, including freight | | | 2.0 | | | | 1.7 | | | | 4.0 | | | | 3.2 |
Consolidated total net sales | | $ | 44.8 | | | $ | 43.6 | | | $ | 86.5 | | | $ | 88.1 |

Long-lived assets, which include property, equipment and construction in progress for the Company and its subsidiaries, reside in the following regions  (in millions) :
Region | | June 30, 2013 | | | December 31, 2012 |
North America | | $ | 3.0 | | | $ | 3.8 |
Asia/Pacific | | | 0.6 | | | | 0.7 |
EMEA | | | 0.2 | | | | 0.3 |
Total | | $ | 3.8 | | | $ | 4.8 |

Inventory balances by region, which consists of raw materials, work in progress, finished goods, and promotional materials, as offset by obsolete inventories, were as follows  (in millions) :
Region | | June 30, 2013 | | | December 31, 2012 |
North America | | $ | 9.1 | | | $ | 9.5 |
Asia/Pacific | | | 3.4 | | | | 4.2 |
EMEA | | | 1.7 | | | | 1.5 |
Total | | $ | 14.2 | | | $ | 15.2 |

NOTE 11: SUBSEQUENT EVENTS

On July 11, 2013 the Company was issued an assessment notice from the Busan Custom Office in Korea in the amount of KRW 2,147,034,680 (approximately $1.9 million) resulting from an audit covering fiscal years 2008 through 2012.  We have recorded $0.9 million in taxes payable on our consolidated balance sheet related to this event with $0.5 million related to customs charges being recorded as cost of sales and $0.4 million related to surtaxes on customs and VAT being recorded as other expense.  An additional approximately $0.7 million is recoverable VAT, which has no effect on the Company’s statement of operations.  The amounts being accrued are based on our current estimate of the possible outcome of our appealing the assessment through the administrative review processes.
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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, 2013 as compared to the same period in 2012, 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 three regions: (i) North America (the United States, Canada, and Mexico); (ii) EMEA (Austria, the Czech Republic, Denmark, Estonia, Finland, Germany, the Republic of Ireland, Namibia, the Netherlands, Norway, South Africa, Sweden, Ukraine, and the United Kingdom); (iii) Asia/Pacific (Australia, Hong Kong, Japan, New Zealand, the Republic of Korea, Singapore, and Taiwan).  In December 2012, the Company announced the shipment of its products to Hong Kong and officially launched Hong Kong operations in April 2013.  In November 2012, the Company commenced the shipment of its products to Ukraine and officially launched Ukrainian operations in July 2013.

We conduct our business as a single operating segment and primarily sell our products through a network of approximately 240,000 active independent associates and members who have purchased our products and/or packs within the last 12 months, who we refer to as  active 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-four 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 2013 we continued to observe the improvements we experienced during the first quarter of 2013.  We increased the number of active associates and members by 4.3% as compared to the same period in 2012.  This increase was due to an increase in the recruitment of both associates and members as the phased introduction of compensation plan changes targeting associates was implemented primarily during the second quarter of 2013.  We implemented enhancements to our sign-up packs globally, except in Korea, which we believe will lead to increases in the recruitment of business- building associates.  This increase led to an overall increase in revenue of $1.2 million, or 2.8%, during the three months ended June 30, 2013 as compared to the same period in 2012.  In July 2013, we launched the final phases of the compensation plan, which enhance the compensation received by associates for the sale of finished products.  These changes, along with Korea’s adoption of the enhancements of the sign-up packs, were fully implemented world-wide in July 2013.

We experienced a $1.2 million unfavorable impact on our net sales due to fluctuations in foreign currency exchange rates for the three months ended June 30, 2013.  For the six months ended June 30, 2013, we experienced a $1.9 million unfavorable impact on our net sales due to fluctuations in foreign currency exchange rates.  The majority of the unfavorable impact on our net sales is in the Asia/Pacific region due to the weakening of the Japanese Yen.

For the three months and six months ended June 30, 2013, our operating expenses (net depreciation, commissions, and incentives) decreased by $1.8 million and $3.5 million, respectively, as compared to the same periods in 2012.  This decrease is due primarily to decreases in payroll and payroll-related costs and a reduction in office and occupancy costs.  These continued improvements in our operational efficiencies, along with increased sales, generated $1.6 million of operating income for the three months ended June 30, 2013, as compared to an operating loss of $1.4 million during the same period in 2012.
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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, 2013 and 2012  (in thousands, except percentages):
 
| | 2013 | | | 2012 | | | Change from 2013 to 2012 |
| | Total dollars | | | % of net sales | | | Total dollars | | | % of net sales | | | Dollar | | | Percentage |
Net sales | | $ | 44,801 | | | | 100.0 | % | | $ | 43,611 | | | | 100 | % | | $ | 1,190 | | | | 2.7 | %
Cost of sales | | | 8,694 | | | | 19.4 | % | | | 8,852 | | | | 20.3 | % | | | (158 | ) | | | (1.8 | )%
Gross profit | | | 36,107 | | | | 80.6 | % | | | 34,759 | | | | 79.7 | % | | | 1,348 | | | | 3.9 | %
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | |
Commissions and incentives | | | 19,181 | | | | 42.8 | % | | | 18,637 | | | | 42.7 | % | | | 544 | | | | 2.9 | %
Selling and administrative expenses | | | 8,541 | | | | 19.1 | % | | | 9,945 | | | | 22.8 | % | | | (1,404 | ) | | | (14.1 | )%
Depreciation and amortization | | | 588 | | | | 1.3 | % | | | 921 | | | | 2.1 | % | | | (333 | ) | | | (36.2 | )%
Other operating costs | | | 6,247 | | | | 13.9 | % | | | 6,662 | | | | 15.3 | % | | | (415 | ) | | | (6.2 | )%
Total operating expenses | | | 34,557 | | | | 77.1 | % | | | 36,165 | | | | 82.9 | % | | | (1,608 | ) | | | (4.4 | )%
Income from operations | | | 1,550 | | | | 3.5 | % | | | (1,406 | ) | | | (3.2 | )% | | | 2,956 | | | | 210.2 | %
Interest income (expense) | | | 17 | | | | 0.0 | % | | | 21 | | | | 0.0 | % | | | (4 | ) | | | (19.0 | )%
Other income (expense), net | | | (1,420 | ) | | | (3.2 | )% | | | (805 | ) | | | (1.8 | )% | | | (615 | ) | | | (76.4 | )%
Income  before income taxes | | | 147 | | | | 0.3 | % | | | (2,190 | ) | | | (5.0 | )% | | | 2,337 | | | | 106.7 | %
(Provision) benefit for income taxes | | | 637 | | | | 1.4 | % | | | (265 | ) | | | (0.6 | )% | | | 902 | | | | 340.4 | %
Net income (loss) | | $ | 784 | | | | 1.7 | % | | $ | (2,455 | ) | | | (5.6 | )% | | $ | 3,239 | | | | 131.9 | %

The table below summarizes our consolidated operating results in dollars and as a percentage of net sales for the six months ended June 30, 2013 and 2012  (in thousands, except percentages):
| | 2013 | | | 2012 | | | Change from 2013 to 2012 |
| | Total dollars | | | % of net sales | | | Total dollars | | | % of net sales | | | Dollar | | | Percentage |
Net sales | | $ | 86,467 | | | | 100.0 | % | | $ | 88,113 | | | | 100 | % | | $ | (1,646 | ) | | | (1.9 | )%
Cost of sales | | | 16,391 | | | | 19.0 | % | | | 17,127 | | | | 19.4 | % | | | (736 | ) | | | (4.3 | )%
Gross profit | | | 70,076 | | | | 81.0 | % | | | 70,986 | | | | 80.6 | % | | | (910 | ) | | | (1.3 | )%
Operating expenses: | | | | | | | | | | | | | | | | | | | | | | | |
Commissions and incentives | | | 36,722 | | | | 42.5 | % | | | 37,622 | | | | 42.7 | % | | | (900 | ) | | | (2.4 | )%
Selling and administrative expenses | | | 17,172 | | | | 19.9 | % | | | 19,600 | | | | 22.2 | % | | | (2,428 | ) | | | (12.4 | )%
Depreciation and amortization | | | 1,225 | | | | 1.4 | % | | | 3,379 | | | | 3.8 | % | | | (2,154 | ) | | | (63.7 | )%
Other operating costs | | | 12,752 | | | | 14.7 | % | | | 13,847 | | | | 15.7 | % | | | (1,095 | ) | | | (7.9 | )%
Total operating expenses | | | 67,871 | | | | 78.5 | % | | | 74,448 | | | | 84.4 | % | | | (6,577 | ) | | | (8.8 | )%
Income (loss) from operations | | | 2,205 | | | | 2.5 | % | | | (3,462 | ) | | | (3.8 | )% | | | 5,667 | | | | 163.7 | %
Interest income (expense) | | | 4 | | | | 0.0 | % | | | (32 | ) | | | 0.0 | % | | | 36 | | | | 112.5 | %
Other income (expense), net | | | (1,003 | ) | | | (1.2 | )% | | | 87 | | | | 0.1 | % | | | (1,090 | ) | | | (1252.9 | )%
Income (loss) before income taxes | | | 1,206 | | | | 1.3 | % | | | (3,407 | ) | | | (3.7 | )% | | | 4,613 | | | | 135.4 | %
(Provision) benefit for income taxes | | | 222 | | | | 0.3 | % | | | (448 | ) | | | (0.5 | )% | | | 670 | | | | 149.6 | %
Net income (loss) | | $ | 1,428 | | | | 1.6 | % | | $ | (3,855 | ) | | | (4.2 | )% | | $ | 5,283 | | | | 137.0 | %

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Consolidated net sales by region for the three months ended June 30, 2013 and 2012 were as follows (in millions, except percentages) :

Net Sales in Dollars and as a Percentage of Consolidated Net Sales
Region | | 2013 | | | 2012 |
North America | | $ | 21.3 | | | | 47.6 | % | | $ | 22.8 | | | | 52.3 | %
Asia/Pacific | | | 19.9 | | | | 44.4 | % | | | 17.0 | | | | 39.0 | %
EMEA | | | 3.6 | | | | 8.0 | % | | | 3.8 | | | | 8.7 | %
Total | | $ | 44.8 | | | | 100 | % | | $ | 43.6 | | | | 100 | %

Consolidated net sales by customer location for the six months ended June 30, 2013 and 2012 were as follows (in millions, except percentages) :

Net Sales in Dollars and as a Percentage of Consolidated Net Sales
Region | | 2013 | | | 2012 |
North America | | $ | 41.8 | | | | 48.3 | % | | $ | 45.3 | | | | 51.4 | %
Asia/Pacific | | | 37.7 | | | | 43.6 | % | | | 35.1 | | | | 39.9 | %
EMEA | | | 7.0 | | | | 8.1 | % | | | 7.7 | | | | 8.7 | %
Total | | $ | 86.5 | | | | 100 | % | | $ | 88.1 | | | | 100 | %
 
Net Sales

Consolidated net sales for the three months ended June 30, 2013 increased by $1.2 million, or 2.8%, to $44.8 million as compared to the same period in 2012.  Consolidated net sales for the six months ended June 30, 2013 decreased by $1.6 million, or 1.8%, to $86.5 million as compared to the same period in 2012.

 North American sales decreased by $1.5 million, or 6.6%, to $21.3 million for the three months ended June 30, 2013 as compared to the same period in 2012.  North American sales decreased by $3.5 million, or 7.7%, to $41.8 million for the six months ended June 30, 2013 as compared to the same period in 2012.  The decline in revenue for both the three and six months ended June 30, 2013 as compared to the same periods in 2012 is primarily due to a decrease in the revenue generated per active associate and member.

For the three and six months ended June 30, 2013, our operations outside of North America accounted for approximately 52.4% and 51.7%, respectively, of our consolidated net sales, whereas in the same period in 2012, our operations outside of North America accounted for approximately 47.7% and 48.6%, respectively, of our consolidated net sales.

Asia/Pacific sales increased by $2.9 million, or 17.1%, to $19.9 million for the three months ended June 30, 2013 as compared to the same period in 2012.  The increase in revenue for the three months ended June 30, 2013 as compared to the same period in 2012 is due to an increase in the number of active associates and members and an increase in the revenue generated per active associate and member.  Asia/Pacific sales increased by $2.6 million, or 7.4%, to $37.7 million for the six months ended June 30, 2013 as compared to the same period in 2012.  The increase in revenue for the six months ended June 30, 2013 as compared to the same period in 2012 is due to an increase in the number of active associates and members.

EMEA sales decreased by $0.2 million, or 5.3%, to $3.6 million for the three months ended June 30, 2013 as compared to the same period in 2012 due to the impact of fluctuations in foreign currency exchange rates.  EMEA sales decreased by $0.7 million, or 9.1%, to $7.0 million for the six months ended June 30, 2013 as compared to the same period in 2012 in part due to fluctuations in foreign currency exchange rates and in part due to a decrease in the revenue generated per active associate and member.
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Fluctuation in foreign currency exchange rates for the three months ended June 30, 2013 had an overall unfavorable impact on our net sales of approximately $1.1 million, of which $0.8 million was attributed to Asia/Pacific and $0.3 million was attributed to EMEA. For the six months ended June 30, 2013, fluctuation in foreign currency exchange had an overall unfavorable impact on our net sales of approximately $1.9 million, of which $1.3 million was attributed to Asia/Pacific and $0.6 million was attributed to EMEA. 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, 2012.

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 |
| | 2013 | | | 2012 | | | Dollar | | | Percentage |
Consolidated product sales | | $ | 38.9 | | | $ | 38.9 | | | $ | (0.0 | ) | | | (0.0 | )%
Consolidated pack sales | | | 3.9 | | | | 3.0 | | | | 0.9 | | | | 30.0 | %
Consolidated other, including freight | | | 2.0 | | | | 1.7 | | | | 0.3 | | | | 17.6 | %
Total consolidated net sales | | $ | 44.8 | | | $ | 43.6 | | | $ | 1.2 | | | | 2.8 | %

| | Six Months | | | Change |
| | 2013 | | | 2012 | | | Dollar | | | Percentage |
Consolidated product sales | | $ | 76.2 | | | $ | 78.8 | | | $ | (2.6 | ) | | | (3.3 | )%
Consolidated pack sales | | | 6.3 | | | | 6.1 | | | | 0.2 | | | | 3.3 | %
Consolidated other, including freight | | | 4.0 | | | | 3.2 | | | | 0.8 | | | | 25.0 | %
Total consolidated net sales | | $ | 86.5 | | | $ | 88.1 | | | $ | (1.6 | ) | | | (1.8 | )%

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.
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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.

Product sales for the three months ended June 30, 2013 were relatively unchanged from the same period in 2012. The average order value for the three months ended June 30, 2013 was $153 as compared to $154 for the same period in 2012.  The number of orders processed during the three months ended June 30, 2013 increased by 1.1%, as compared to the same period in 2012.

Product sales for the six months ended June 30, 2013 decreased by $2.6 million, or 3.3%, as compared to the same period in 2012. The decrease in product sales was primarily due to the reduction in the average order size. The average order value for the six months ended June, 2013 was $153, as compared to $156 for the same period in 2012. The 2.2% decrease in average order value resulted in approximately $1.7 million less revenue. The number of orders processed during the six months ended June 30, 2013 decreased by 0.4%, as compared to the same period in 2012.

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 |
| | | 2013 | | | | 2012 | | | | Dollar | | | | Percentage |
New | | $ | 2.6 | | | $ | 2.1 | | | $ | 0.5 | | | | 23.8 | %
Continuing | | | 1.3 | | | | 0.9 | | | | 0.4 | | | | 44.4 | %
Total | | $ | 3.9 | | | $ | 3.0 | | | $ | 0.9 | | | | 30.0 | %

| | Six Months | | | Change |
| | 2013 | | | 2012 | | | Dollar | | | Percentage |
New | | $ | 4.0 | | | $ | 4.2 | | | $ | (0.2 | ) | | | (4.8 | )%
Continuing | | | 2.3 | | | | 1.9 | | | | 0.4 | | | | 21.1 | %
Total | | $ | 6.3 | | | $ | 6.1 | | | $ | 0.2 | | | | 3.3 | %

Total pack sales for the three months ended June 30, 2013 increased by $0.9 million, or 30.0%, to $3.9 million, as compared to $3.0 million for the same period in 2012. Average pack value for the three months ended June 30, 2013 was $141 as compared to $168 for the same period in 2012. The total number of packs sold increased by 9,670, or 53.6%, to 27,725, and the average pack value decreased by $26.70, or 15.94%, for the three months ended June 30, 2013, as compared to the same period in 2012. The decrease in the average pack value is due to a change in the sales mix of the type of packs purchased. Approximately $1.4 million of the increase in pack sales resulted from the increase in the number of packs sold during the period, which was offset by the decrease in average pack value.

The number of new independent associates and members for the second quarter of 2013 increased 31.2% to approximately 36,200 as compared to approximately 27,600 for the same period in 2012.
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Total pack sales for the six months ended June 30, 2013 increased by $0.2 million, or 3.3%, to $6.3 million, as compared to $6.1 million for the same period in 2012. Average pack value for the six months ended June 30, 2013 was $134, as compared to $157 for the same period in 2012. The total number of packs sold increased by 8,037, or 20.8%, to 46,632, and the average pack value decreased by $23.17, or 14.7%, for the six months ended June 30, 2013, as compared to the same period in 2012. The decrease in the average pack value is due to a change in the sales mix of the type of packs purchased. Approximately $1.1 million of the increase in pack sales resulted from the increased number of packs sold during the period but was offset by the decrease in average pack value.

The approximate number of new and continuing associates and members who purchased our packs or products during the twelve months ended June 30, 2013 and 2012 were as follows:
| | 2013 | | | 2012 |
New | | | 108,000 | | | | 45.0 | % | | | 87,000 | | | | 38.0 | %
Continuing | | | 132,000 | | | | 55.0 | % | | | 143,000 | | | | 62.0 | %
Total | | | 240,000 | | | | 100 | % | | | 230,000 | | | | 100 | %

There was an overall increase of 10,000, or 4.4%, for the twelve months ended June 30, 2013 in the number of associates and members who purchased our products as compared to the same period in 2012, which was due to an increase in the number of new associates and members.

During 2012 and the first half of 2013, we took the following actions to recruit and retain associates and members:

| • | registered our 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) freight revenue charged to our associates and members; (ii) sales of promotional materials; (iii) monthly fees collected for Success Tracker ^TM  and Navig8™ customized electronic business-building and educational materials, databases and applications; (iv) training and event registration fees; and (v) a reserve for estimated sales refunds and returns.  Promotional materials, training, database applications and business management tools support our independent associates, which in turn helps stimulate product sales.

For the three months ended June 30, 2013, other sales increased by $0.3 million, or 17.6%, to $2.0 million, as compared to $1.7 million for the same period in 2012.  Other sales for the six months ended June 30, 2013 increased by $0.8 million, or 25.0%, to $4.0 million, as compared to $3.2 million for the same period in 2012. The increase was primarily due to an increase in freight fees charged on our products and pack shipments.

Gross Profit

For the three months ended June 30, 2013, gross profit increased by $1.3 million, or 3.9%, to $36.1 million, as compared to $34.8 million for the same period in 2012. For the three months ended June 30, 2013, gross profit as a percentage of net sales increased to 80.6%, as compared to 79.7% for the same period in 2012.

To improve the matching of costs associated with revenue from freight and shipping fees, beginning December 31, 2012, freight costs associated with shipping products to our customers were reclassified to cost of sales from selling and administrative expenses, with prior periods’ presentations adjusted accordingly.  Total freight costs associated with shipping products to our customers included in cost of sales were approximately $1.7 million and $1.9 million for the three months ended June 30, 2013 and 2012, respectively.  Additionally, to more closely conform to the financial presentation of our competitors, royalty costs were reclassified to cost of sales from selling and administrative expenses beginning in December 31, 2012.  Total royalty costs included in cost of sales were approximately $0.1 million for each of the three months ended June 30, 2013 and 2012.
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Cost of sales during the three months ended June 30, 2013 decreased by 1.8%, or $0.2 million, to $8.7 million, as compared to $8.9 million for the same period in 2012. The reduction in cost of sales was primarily due to lower inventory obsolescence reserve adjustments and changes in the standard cost of the inventory, which was partially offset by a reserve booked for the Korean customs audit. Cost of sales as a percentage of net sales for the three months ended June 30, 2013 was 19.4%, as compared to 20.3% for the same period in 2012.

For the six months ended June 30, 2013, gross profit decreased by $0.9 million, or 1.3%, to $70.1 million, as compared to $71.0 million for the same period in 2012. For the six months ended June 30, 2013, gross profit as a percentage of net sales increased to 81.0%, as compared to 80.6% for the same period in 2012.

Total freight costs associated with shipping products to our customers included in cost of sales were approximately $3.3 million and $3.7 million for six months ended June 30, 2013 and 2012, respectively.  Total royalty costs included in cost of sales were approximately $0.2 million for each of the six months ended June 30, 2013 and 2012.

Cost of sales during the six months ended June 30, 2013 decreased by 4.3%, or $0.7 million, to $16.4 million, as compared to $17.1 million for the same period in 2012. The reduction in cost of sales was primarily due to the decline in sales for the year and a lower inventory obsolescence reserve adjustments and changes in the standard cost of the inventory, which was partially offset by a reserve booked for the Korean customs audit. Cost of sales as a percentage of net sales for the six months ended June 30, 2013 was 19.0%, as compared to 19.4% for the same period in 2012.

Commission and Incentives

In order to more closely conform to the financial presentations of our competitors, beginning December 31, 2012, commission and incentive expenses have been reclassified to operating expenses from cost of sales with prior periods’ presentations adjusted accordingly.  Total commission and incentive expenses reclassified to operating expenses were approximately $19.1 million and $18.6 million for the three months ended June 30, 2013 and 2012, respectively.

Commission costs for the three months ended June 30, 2013 increased by 0.6%, or $0.1 million, to $17.8 million, as compared to $17.7 million for the same period in 2012.  The increase in commissions was due to the increase in commissionable net sales.  For the three months ended June 30, 2013, commissions as a percentage of net sales decreased to 39.9% from 40.6% for the same period in 2012.

Commission costs for the six months ended June 30, 2013 decreased by 3.4%, or $1.2 million, to 34.6 million, as compared to $35.8 million for the same period in 2012.  The decrease in commissions was due to the decrease in commissionable net sales.  For the six months ended June 30, 2013, commissions as a percentage of net sales decreased to 40.0% from 40.6% for the same period in 2012.

Incentive costs for the three months ended June 30, 2013 increased by 44.4%, or $0.4 million, to $1.3 million, as compared to $0.9 million for the same period in 2012. The costs of incentives as a percentage of net sales increased during this period to 2.9% from 2.1% for the same period in 2012.

Incentive costs for the six months ended June 30, 2013 increased by 16.7%, or $0.3 million, to $2.1 million, as compared to $1.8 million for the same period in 2012. The costs of incentives as a percentage of net sales increased during this period to 2.5%, as compared to 2.1% for the same period in 2012.  Incentive costs for both the three months and six months ended June 30, 2013 increased as the number of associates qualifying for the travel incentive in U.S. and Canada exceeded the levels achieved during the same period in 2012.

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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, 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, 2013, selling and administrative expenses decreased by $1.4 million, or 14.1%, to $8.5 million, as compared to $9.9 million for the same period in 2012. The decrease in selling and administrative expenses consisted primarily of a $1.4 million decrease in payroll and payroll-related costs.  Selling and administrative expenses as a percentage of net sales for the three months ended June 30, 2013 decreased to 19.1% from 22.8% for the same period in 2012.

For the six months ended June 30, 2013, selling and administrative expenses decreased by $2.4 million, or 12.4%, to $17.2 million, as compared to $19.6 million for the same period in 2012. The decrease in selling and administrative expenses consisted primarily of a $2.8 million decrease in payroll and payroll-related costs. Selling and administrative expenses as a percentage of net sales for the six months ended June 30, 2013 decreased to 19.9% from 22.2% for the same period in 2012.

Other Operating Costs

Other operating costs include travel, accounting, legal and consulting fees, credit card processing fees, banking fees, off-site storage fees, utilities, and other miscellaneous operating expenses. Changes in other operating costs are associated with changes in our net sales.

For the three months ended June 30, 2013, other operating costs decreased by $0.4 million, or 6.2%, to $6.2 million, as compared to $6.7 million for the same period in 2012. For the three months ended June 30, 2013, other operating costs as a percentage of net sales decreased to 13.9% from 15.3% for the same period in 2012. The decrease in other operating costs was primarily due to a reduction in office and occupancy expenses of $0.4 million.

For the six months ended June 30, 2013, other operating costs decreased by $1.1 million, or 7.9%, to $12.8 million, as compared to $13.8 million for the same period in 2012. For the six months ended June 30, 2013, other operating costs as a percentage of net sales decreased to 14.7% from 15.7 % for the same period in 2012. The decrease in other operating costs was primarily due to a reduction in office and occupancy expenses of $0.9 million and legal and consulting fees of $0.6 million.

Depreciation and Amortization Expense

Depreciation and amortization expense for the three months ended June 30, 2013 decreased by 36.2%, or $0.3 million, to $0.6 million, as compared to $0.9 million for the same period in 2012. As a percentage of net sales, depreciation and amortization expense was 1.3%, as compared to 2.1% for the same period in 2012.

Depreciation and amortization expense for the six months ended June 30, 2013 decreased by 63.8%, or $2.2 million, to $1.2 million, as compared to $3.4 million for the same period in 2012. As a percentage of net sales, depreciation and amortization expense was 1.4%, as compared to 3.8% for the same period in 2012.

For the three and six months ended June 30, 2013, the decrease in depreciation expense was due to the Company’s enterprise resource planning software system becoming fully depreciated at the end of the first quarter of 2012.

Other Income (Expense), Net

Other income (expense), net primarily consists of foreign currency gains and losses related to the remeasurement of our foreign subsidiaries’ assets, liabilities, revenues, and expenses to the United States dollar and revaluing monetary accounts in the United States, Switzerland, Japan, Republic of Korea, Taiwan, Norway, Sweden, Mexico, and Ukraine using current and weighted-average currency exchange rates. Net foreign currency transaction gains and losses are the result of the United States dollar fluctuating in value against foreign currencies.
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Other income (expense), net for the three months ended June 30, 2013 was ($1.4) million, as compared to other income (expense), net of ($0.8) million for the same period in 2012.  The increase in Other expense is associated with a $0.4 million reserve for surtaxes related to a Korean customs audit and an increase in the unfavorable foreign currency exchange during the three months ended June 30, 2013, as compared to the same period in 2012.

Other income (expense), net for the six months ended June 30, 2013 was ($1.0) million, as compared to other income, net of $0.1 million for the same period in 2012.  The increase in Other expense is associated with a $0.4 million reserve for surtaxes related to a Korean customs audit and an increase in the unfavorable foreign currency exchange during the six months ended June 30, 2013, as compared to the same period in 2012.

(Provision) Benefit for Income Taxes

 (Provision) benefit for income taxes includes current and deferred income taxes for both our domestic and foreign operations. Our statutory income tax rates by jurisdiction are as follows for the three and six months ended June 30:
Country | | 2013 | | 2012
Australia | | 30.0% | | 30.0%
Canada | | 26.5% | | 26.0%
Denmark | | 25.0% | | 25.0%
Hong Kong | | 16.5% | | N/A
Japan | | 39.4% | | 42.0%
Mexico | | 30.0% | | 30.0%
Norway | | 28.0% | | 28.0%
Republic of Korea | | 22.0% | | 22.0%
Singapore | | 17.0% | | 17.0%
South Africa | | 28.0% | | 28.0%
Sweden | | 22.0% | | 26.3%
Switzerland | | 16.2% | | 16.2%
Taiwan | | 17.0% | | 17.0%
Ukraine | | 19.0% | | N/A
United Kingdom | | 23.0% | | 24.0%
United States | | 37.5% | | 37.5%

Income from our international operations is subject to taxation in the countries in which we operate. Although we may receive foreign income tax credits that would reduce the total amount of income taxes owed in the United States, we may not be able to fully utilize our foreign income tax credits in the United States.

We use the recognition and measurement provisions of FASB ASC Topic 740, Income Taxes, to account for income taxes. The provisions of the Income Tax Topic require a company to record a valuation allowance when the “ more likely than not ” criterion for realizing net deferred tax assets cannot be met. Furthermore, the weight given to the potential effect of such evidence should be commensurate with the extent to which it can be objectively verified. As a result, we reviewed the operating results, as well as all of the positive and negative evidence related to realization of such deferred tax assets to evaluate the need for a valuation allowance in each tax jurisdiction.

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For each of the periods ended June 30, 2013 and December 31, 2012, we maintained the following valuation allowances for deferred tax assets totaling  $8.5 million as we believe the “ more likely than not ” criterion for recognition and realization purposes, as defined in FASB ASC Topic 740, cannot be met:
Country | | June 30, 2013 | | | December 31, 2012 |
| | (in millions) |
Mexico | | $ | 2.5 | | | $ | 2.3 |
Norway | | | 0.2 | | | | 0.2 |
Sweden | | | 0.1 | | | | 0.1 |
Switzerland | | | 1.2 | | | | 1.0 |
Taiwan | | | 1.2 | | | | 1.2 |
United States | | | 3.3 | | | | 3.7 |
Total | | $ | 8.5 | | | $ | 8.5 |

The dollar amount of the provisions for income taxes is directly related to our profitability and changes in the taxable income among countries.  For the three and six months ended June 30, 2013, our effective tax rate was (429.5)% and (18.4)%, respectively, as compared to (12.1%) and (13.1)% for the same periods in 2012, respectively. For the three months ended June 30, 2013 and 2012, the Company’s effective income tax rate was determined based on the estimated annual effective income tax rate.

The examination of our 2005-2009 tax years by the IRS for U.S. federal tax purposes was settled during the second quarter of 2013.  In connection with the audit, the IRS and the Company agreed to a net tax deficiency of $0.8 million and the payment of interest accrued through June 30, 2013 of $0.2 million, without any penalties.  In connection with the settlement of the audit, the Company reclassified amounts owed to the IRS and previously recorded as uncertain tax positions as taxes payable, resulting in a $1.0 million tax benefit during the three months ended June 30, 2013.

Excluding the release of uncertain income tax positions in connection with the settlement of the IRS audit, the effective tax rate for the three and six months ended June 30, 2013 would have been 263.2% and 66.7%.  These rates are higher than what would have been expected if the federal statutory income tax rate were applied to income before taxes primarily from the unfavorable differences from foreign operations.

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Equivalents

As of June 30, 2013, our cash and cash equivalents increased by 23.7%, or $3.4 million, to $17.8 million from $14.4 million as of December 31, 2012.   Our restricted cash balance was increased during the period ending June 30, 2013 by $0.5 million with funds from our cash and cash equivalents balances. Finally, fluctuations in currency rates produced a decline of $0.8 million in cash and cash equivalents.  The remaining change in cash and cash equivalents was related to recurring operating sources and uses of cash and cash equivalents.

Our principal use of cash is to pay for operating expenses, including commissions and incentives, capital assets, inventory purchases, and international expansion. In August 2009, the quarterly cash dividend was suspended and remained suspended as of June 30, 2013. We fund our business objectives, operations, and expansion of our operations through net cash flows from operations rather than incurring long-term debt.

Working Capital

Working capital represents total current assets less total current liabilities. At June 30, 2013, our working capital increased by $0.5 million, or 4.9%, to $11.6 million from $11.1 million at December 31, 2012. The increase in working capital is primarily related to the Company’s settlement with the IRS and the resulting reduction in uncertain income tax positions that were previously classified as current liabilities at December 31, 2012.

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Net Cash Flows

Our net consolidated cash flows consisted of the following, for the six months ended June 30 (in millions):
Used in: | | 2013 | | | 2012 |
Operating activities | | $ | 6.0 | | | $ | (4.4 | )
Investing activities | | $ | (1.0 | ) | | $ | (0.5 | )
Financing activities | | $ | (0.8 | ) | | $ | (0.6 | )

Operating Activities

Cash provided in operating activities was $6.0 million for the six months ended June 30, 2012 compared to cash used in operating activities of $4.4 million for the same period in 2012.

 We expect that our net operating cash flows for the remainder of the year will be sufficient to fund our current operations. There can be no assurance, however, that we will continue to generate cash flows at or above current levels. Certain events, such as the uncertainty of the worldwide economic environment, could impact our available cash or our ability to generate cash flows from operations.

Investing Activities

For the six months ended June 30, 2013, our net investing activities used cash of $1.0 million compared to cash used of $0.5 million for the same period of 2012. During the six months ended June 30, 2013, we used cash of $0.3 million to purchase capital assets as compared to purchasing $0.2 million in capital assets for the same period in 2012. In the first two quarters of 2013, we had an increase in restricted cash of $0.7 million as compared to a $0.3 million increase for the same period in 2012.

Financing Activities

For the six months ended June 30, 2013 and 2012, we used cash of $0.8 million and $0.4 million, respectively, to repay capital lease obligations.

General Liquidity and Cash Flows

Short Term Liquidity

We believe our existing liquidity and anticipated return to positive cash flows from operations are adequate to fund our normal expected future business operations and possible international expansion costs for the next 12 months.  As our primary source of liquidity is our cash flow from operations, this will be dependent on our ability to maintain and increase revenue and/or continue to reduce operational expenses.  However, if our existing capital resources or cash flows become insufficient to meet current business plans, projections, and existing capital requirements, we may be required to raise additional funds, which may not be available on favorable terms, if at all.

We entered into an Investment Agreement with Dutchess Opportunity Fund, II, LP, a Delaware limited partnership on September 16, 2010. Dutchess committed to purchase, subject to certain restrictions and conditions, up to $10 million of our common stock, over a period of 36 months from the first trading following the effectiveness of the registration statement, which was October 28, 2010. We may draw funds from the Equity Line by selling shares of common stock to Dutchess from time to time. We will not receive any proceeds from the resale of these shares of common stock offered by Dutchess. We will however, receive proceeds from the sale of shares to Dutchess pursuant to the Equity Line. The proceeds will be used for general working capital needs and for other general corporate purposes. For more information on the Equity Line, see Note 6 “ Shareholders’ Equity” , to our consolidated financial statements.  As of June 30, 2013, no shares of common stock have been issued pursuant to the Investment Agreement.

We are engaged in ongoing audits in various tax jurisdictions and other disputes in the normal course of business. It is impossible at this time to predict whether we will incur any liability, or to estimate the ranges of damages, if any, in connection with these matters. Adverse outcomes on these uncertainties may lead to substantial liability or enforcement actions that could adversely affect our cash position. For more information, see Note 3 “ Income Taxes ” and Note 7 “Litigation”  to our consolidated financial statements.
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Long Term Liquidity

We believe our return to positive cash flows from operations should be adequate to fund our normal expected future business operations and possible international expansion costs for the long term.  As our primary source of liquidity is from our cash flow from operations, this will be dependent on our ability to maintain and increase revenue and/or continue to reduce operational expenses.

However, if our existing capital resources or cash flows become insufficient to meet anticipated business plans and existing capital requirements, we may be required to raise additional funds, which may not be available on favorable terms, if at all.

Our future access to the capital markets may be adversely impacted if we fail to maintain compliance with the Nasdaq Marketplace Rules for the continued listing of our stock.  We continuously monitor our compliance with the Nasdaq continued listing rules and as of the date of the issuance of this report, we are in compliance with the Nasdaq Marketplace Rules.

CONTRACTUAL OBLIGATIONS

The following summarizes our future commitments and obligations associated with various agreements and contracts as of June 30, 2012, for the years ending December 31  (in thousands) :
| | Remaining 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | 2018 | | | Thereafter | | | Total |
Capital lease obligations and other financing arrangements | | $ | 735 | | | $ | 545 | | | $ | 346 | | | $ | 135 | | | $ | 12 | | | $ | — | | | $ | — | | | $ | 1,773 |
Purchase obligations ^(1) ^(2) | | | 3,742 | | | | 1,200 | | | | 1,200 | | | | 324 | | | | — | | | | — | | | | — | | | | 6,466 |
Operating leases | | | 1,464 | | | | 2,356 | | | | 1,755 | | | | 1,117 | | | | 777 | | | | 176 | | | | -- | | | | 7,645 |
Post-employment royalty | | | 25 | | | | 66 | | | | 33 | | | | — | | | | — | | | | — | | | | — | | | | 124 |
Employment agreements | | | 1,073 | | | | 628 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 1,701 |
Royalty agreement | | | 42 | | | | 84 | | | | 66 | | | | — | | | | — | | | | — | | | | — | | | | 192 |
Tax liability ^(3)(4) | | | 897 | | | | 135 | | | | 33 | | | | — | | | | — | | | | — | | | | — | | | | 1,065 |
Other obligations^(5) | | | 318 | | | | 295 | | | | 279 | | | | 108 | | | | 30 | | | | 26 | | | | 554 | | | | 1,610 |
Total commitments and obligations | | $ | 8,296 | | | $ | 5,309 | | | $ | 3,712 | | | $ | 1,684 | | | $ | 819 | | | $ | 202 | | | $ | 554 | | | $ | 20,576 |

(1) | For purposes of the table, a purchase obligation is defined as “an agreement to purchase goods or services that is non-cancelable, enforceable and legally binding on the Company that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.”

(2) | Excludes approximately $9.5 million of finished product purchase orders that may be cancelled or delivery dates changed as of June 30, 2013.

(3) | Represents the tax liability associated with uncertain tax positions, see Note 3 "Income Taxes" to our consolidated financial statements.

(4) | Includes approximately $0.9 million associated with the Korean customs audit assessment, see Note 11,”Subsequent Events ” to our consolidated financial statements.

(5) | Other obligations are composed of pension obligations related to the Company’s Japan operations (approximately $1.0 million), lease restoration obligations (approximately $0.4 million), and McAnnalley royalty obligations (approximately $0.2 million).

We have maintained purchase commitments with certain raw material suppliers to purchase minimum quantities and to ensure exclusivity of our raw materials and the proprietary nature of our products. Currently, we have two supply agreements that require minimum purchase commitments. We also maintain other supply agreements and manufacturing agreements to protect our products, regulate product costs, and help ensure quality control standards. These agreements do not require us to purchase any set minimums. We have no present commitments or agreements with respect to acquisitions or purchases of any manufacturing facilities; however, management from time to time explores the possible benefits of purchasing a raw material manufacturing facility to help control costs of our raw materials and help ensure quality control standards.
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OFF-BALANCE SHEET ARRANGEMENTS

We do not have any special-purpose entity arrangements, nor do we have any off-balance sheet arrangements.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The application of GAAP requires us to make estimates and assumptions that affect the reported values of assets and liabilities at the date of our financial statements, the reported amounts of revenues and expenses during the reporting period, and the related disclosures of contingent assets and liabilities. We use estimates throughout our financial statements, which are influenced by management’s judgment and uncertainties. Our estimates are based on historical trends, industry standards, and various other assumptions that we believe are applicable and reasonable under the circumstances at the time the consolidated financial statements are prepared. Our Audit Committee reviews our critical accounting policies and estimates. We continually evaluate and review our policies related to the portrayal of our consolidated financial position and consolidated results of operations that require the application of significant judgment by our management. We also analyze the need for certain estimates, including the need for such items as allowance for doubtful accounts, inventory reserves, long-lived fixed assets and capitalization of internal-use software development costs, reserve for uncertain income tax positions and tax valuation allowances, revenue recognition, sales returns, and deferred revenues, accounting for stock-based compensation, and contingencies and litigation. Historically, actual results have not materially deviated from our estimates. However, we caution readers that actual results could differ from our estimates and assumptions applied in the preparation of our consolidated financial statements. If circumstances change relating to the various assumptions or conditions used in our estimates, we could experience an adverse effect on our financial position, results of operations, and cash flows. We have identified the following applicable critical accounting policies and estimates as of June 30, 2013:

Inventory Reserves

Inventory consists of raw materials, finished goods, and promotional materials that are stated at the lower of cost (using standard costs that approximate average costs) or market. We record the amounts charged by the vendors as the costs of inventory. Typically, the net realizable value of our inventory is higher than the aggregate cost. Determination of net realizable value can be complex and, therefore, requires a high degree of judgment. In order for management to make the appropriate determination of net realizable value, the following items are considered: inventory turnover statistics, current selling prices, seasonality factors, consumer demand, regulatory changes, competitive pricing, and performance of similar products. If we determine the carrying value of inventory is in excess of estimated net realizable value, we write down the value of inventory to the estimated net realizable value.

We also review inventory for obsolescence in a similar manner, and any inventory identified as obsolete is reserved or written off. Our determination of obsolescence is based on assumptions about the demand for our products, product expiration dates, estimated future sales, and general future plans. We monitor actual sales compared to original projections, and if actual sales are less favorable than those originally projected by us, we record an additional inventory reserve or write-down. Historically, our estimates have been close to our actual reported amounts. However, if our estimates regarding inventory obsolescence are inaccurate or consumer demand for our products changes in an unforeseen manner, we may be exposed to additional material losses or gains in excess of our established estimated inventory reserves.
 
Long Lived Fixed Assets and Capitalization of Software Development Costs

In addition to capitalizing long lived fixed asset costs, we also capitalize costs associated with internally-developed software projects (collectively “fixed assets”) and amortize such costs over the estimated useful lives of such fixed assets. Fixed assets are carried at cost, less accumulated depreciation computed using the straight-line method over the assets’ estimated useful lives. Leasehold improvements are amortized over the shorter of the remaining lease terms or the estimated useful lives of the improvements. Expenditures for maintenance and repairs are charged to operations as incurred. If a fixed asset is sold or otherwise retired or disposed of, the cost of the fixed asset and the related accumulated depreciation or amortization is written off and any resulting gain or loss is recorded in other operating costs in our consolidated statement of operations.
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We review our fixed assets for impairment whenever an event or change in circumstances indicates the carrying amount of an asset or group of assets may not be recoverable, such as plans to dispose of an asset before the end of its previously estimated useful life. Our impairment review includes a comparison of future projected cash flows generated by the asset, or group of assets, with its associated net carrying value. If the net carrying value of the asset or group of assets exceeds expected cash flows (undiscounted and without interest charges), an impairment loss is recognized to the extent the carrying amount exceeds the fair value. The fair value is determined by calculating the discounted expected future cash flows using an estimated risk-free rate of interest. Any identified impairment losses are recorded in the period in which the impairment occurs. The carrying value of the fixed asset is adjusted to the new carrying value, and any subsequent increases in fair value of the fixed asset are not recorded. In addition, if we determine the estimated remaining useful life of the asset should be reduced from our original estimate; the periodic depreciation expense is adjusted prospectively, based on the new remaining useful life of the fixed asset.

The impairment calculation requires us to apply judgment and estimates concerning future cash flows, strategic plans, useful lives, and discount rates. If actual results are not consistent with our estimates and assumptions, we may be exposed to an additional impairment charge, which could be material to our results of operations. In addition, if accounting standards change, or if fixed assets become obsolete, we may be required to write off any unamortized costs of fixed assets, or if estimated useful lives change, we would be required to accelerate depreciation or amortization periods and recognize additional depreciation expense in our consolidated statement of operations.

Historically, our estimates and assumptions related to the carrying value and the estimated useful lives of our fixed assets have not materially deviated from actual results. As of June 30, 2013, the estimated useful lives and net carrying values of fixed assets were as follows:
 
| | Estimated useful life | | | Net carrying value at June 30, 2013 |
Computer hardware and software | | 3 to 5 years | | $ | 1.0million |
Leasehold improvements | | 2 to 10 years^(1) | | | 1.8million |
Office furniture and equipment | | 5 to 7 years | | | 0.9million |
Automobiles | | 3 to 5 years | | | 0.1million |
Total net carrying value at June 30, 2013 | | | | $ | 3.8million |

(1) | We amortize leasehold improvements over the shorter of the useful estimated life of the leased asset or the lease term.

The net carrying costs of fixed assets and construction in progress are exposed to impairment losses if our assumptions and estimates of their carrying values change, there is a change in estimated future cash flow, or there is a change in the estimated useful life of the fixed asset. Based on management’s analysis, no impairment indicators existed for the six months ended June 30, 2013.

Uncertain Income Tax Positions and Tax Valuation Allowances

As of June 30, 2013, we recorded $0.2 million in taxes payable and $0.2 million in other long-term liabilities on our consolidated balance sheet related to uncertain income tax positions. As required by FASB ASC Topic 740, Income Taxes, we use judgments and make estimates and assumptions related to evaluating the probability of uncertain income tax positions. We base our estimates and assumptions on the potential liability related to an assessment of whether the income tax position will “ more likely than not”  be sustained in an income tax audit. We are also subject to periodic audits from multiple domestic and foreign tax authorities related to income tax and other forms of taxation. These audits examine our tax positions, timing of income and deductions, and allocation procedures across multiple jurisdictions. As part of our evaluation of these tax issues, we establish reserves in our consolidated financial statements based on our estimate of current probable tax exposures. Depending on the nature of the tax issue, we could be subject to audit over several years. Therefore, our estimated reserve balances and liability related to uncertain income tax positions may exist for multiple years before the applicable statute of limitations expires or before an issue is resolved by the taxing authority.   Additionally, we may be requested to extend the statute of limitations for tax years under audit, which may cause the classification between current and long-term to change.  We believe our tax liabilities related to uncertain tax positions are based upon reasonable judgment and estimates; however, if actual results materially differ, our effective income tax rate and cash flows could be affected in the period of discovery or resolution.
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The examination of our 2005-2009 tax years by the IRS for U.S. federal tax purposes was settled during the second quarter of 2013.  In connection with the audit, the IRS and the Company agreed to a net tax deficiency of $0.8 million and the payment of interest accrued through June 30, 2013 of $0.2 million, without any penalties.  In connection with the settlement of the audit, the Company reclassified amounts owed to the IRS and previously recorded as uncertain tax positions as taxes payable, resulting in a $1.0 million tax benefit during the three months ended June 30, 2013.  There are other ongoing income tax audits in various international jurisdictions that are not material to our financial statements.

We also review the estimates and assumptions used in evaluating the probability of realizing the future benefits of our deferred tax assets and record a valuation allowance when we believe that a portion or all of the deferred tax assets may not be realized. If we are unable to realize the expected future benefits of our deferred tax assets, we are required to provide a valuation allowance. We use our past history and experience, overall profitability, future management plans, and current economic information to evaluate the amount of valuation allowance to record. As of June 30, 2013, we maintained a valuation allowance for deferred tax assets arising from our operations of $8.5 million because they did not meet the  “more likely than not”  criteria as defined by the recognition and measurement provisions of FASB ASC Topic 740, Income Taxes.   In addition, as of June 30, 2013, we had deferred tax assets, after valuation allowance, totaling $3.3 million, which may not be realized if our assumptions and estimates change, which would affect our effective income tax rate and cash flows in the period of discovery or resolution.

Revenue Recognition and Deferred Revenue

We derive revenue from sales of individual products, sales of starter and renewal packs, and shipping fees. Substantially all product and pack sales are made to associates at published wholesale prices and to members at discounted published retail prices. We record revenue net of any sales taxes and record a reserve for expected sales returns based on historical experience. We recognize revenue from shipped packs and products upon receipt by the customer. We recognize corporate-sponsored event revenue when the event is held. We defer certain components of our revenue, which primarily consists of: (i) revenue received from sales of packs and products shipped but not received by the customers at period end; and (ii) revenue received from prepaid registration fees from customers planning to attend a future corporate-sponsored event. At June 30, 2013, total deferred revenue was $1.5 million. Significant changes in our shipping methods could result in additional revenue deferrals.

Product Return Policy

We stand behind our packs and products and believe we offer a reasonable and industry-standard product return policy to all of our customers. We do not resell returned products. Refunds are not processed until proper approval is obtained. All refunds must be processed and returned in the same form of payment that was originally used in the sale. Each country in which we operate has specific product return guidelines. However, we allow our associates and members to exchange products as long as the products are unopened and in good condition. Our return policies for our retail customers and our associates and members are as follows:

| • | Retail Customer Product Return Policy. This policy allows a retail customer to return any of our products to the original associate who sold the product and receive a full cash refund from the associate for the first 180 days following the product’s purchase if located in the United States and Canada, and for the first 90 days following the product’s purchase in the remaining countries.  The associate may then return or exchange the product based on the associate product return policy.

| • | Associate and Member Product Return Policy. This policy allows the associate or member to return an order within one year of the purchase date upon terminating his/her account. If an associate or member returns a product unopened and in good condition, he/she may receive a full refund minus a 10% restocking fee. We may also allow the associate or member to receive a full satisfaction guarantee refund if they have tried the product and are not satisfied for any reason, excluding promotional materials. This satisfaction guarantee refund applies in the United States and Canada, only for the first 180 days following the product’s purchase, and applies in the remaining countries for the first 90 days following the product’s purchase; however, any commissions earned by an associate will be deducted from the refund. If we discover abuse of the refund policy, we may terminate the associate’s or member’s account.
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Historically, sales returns estimates have not materially deviated from actual sales returns, as the majority of our customers who return merchandise do so within the first 90 days after the original sale. Based upon our return policies and historical experience, we estimate a sales return reserve for expected sales refunds over a rolling six month period. If actual results differ from our estimated sales returns reserves due to various factors, the amount of revenue recorded each period could be materially affected. Historically, our sales returns have not materially changed through the years and have averaged 1.5% or less of our gross sales.

Accounting for Stock-Based Compensation

We grant stock options to our employees, board members, and consultants. At the date of grant, we determine the fair value of a stock option award and recognize compensation expense over the requisite service period, or the vesting period of such stock option award, which is two to four years. The fair value of the stock option award is calculated using the Black-Scholes option-pricing model (“calculated fair value”). The Black-Scholes option-pricing model requires us to apply judgment and use highly subjective assumptions, including expected stock option life, expected volatility, expected average risk-free interest rates, and expected forfeiture rates. For the six months ended June 30, 2013, our assumptions and estimates used for the calculated fair value of stock options granted in 2013 were as follows:
| | February 2013 Grant | | | March 2013 Grant | | | June 2013 Grant |
Estimated fair value per share of options granted: | | $ | 3.57 | | | $ | 3.53 | | | $ | 6.07 |
Assumptions: | | | | | | | | | | | |
Annualized dividend yield | | | 0.00 | % | | | 0.00 | % | | | 0.00 | %
Risk-free rate of return | | | 0.75 | % | | | 0.66 | % | | | 0.89 | %
Common stock price volatility | | | 82.3 | % | | | 82.0 | % | | | 80.3 | %
Expected average life of stock options (in years) | | | 4.5 | | | | 4.5 | | | | 4.5 |

The assumptions we use are based on our best estimates and involve inherent uncertainties related to market conditions that are outside of our control. If actual results are not consistent with the assumptions we use, the stock-based compensation expense reported in our consolidated financial statements may not be representative of the actual economic cost of stock-based compensation. For example, if actual employee forfeitures significantly differ from our estimated forfeitures, we may be required to make an adjustment to our consolidated financial statements in future periods. As of June 30, 2013, using our current assumptions and estimates, we anticipate recognizing $0.3 million in gross compensation expense through 2016 related to unvested stock options outstanding.

If we grant additional stock options in the future, we would be required to recognize additional compensation expense over the vesting period of such stock options in our consolidated statement of operations. Gross compensation expense would equal the calculated fair value of such stock options, which is dependent on the assumptions used to calculate such fair value, but has historically ranged between 34% to 69% of the exercise price multiplied by the number of stock options awarded. As of June 30, 2013, we had 74,741 shares available for grant in the future.

Contingencies and Litigation

Each quarter, we evaluate the need to establish a reserve for any legal claims or assessments. We base our evaluation on our best estimates of the potential liability in such matters. The legal reserve includes an estimated amount for any damages and the probability of losing any threatened legal claims or assessments. We consult with our general and outside counsel to determine the legal reserve, which is based upon a combination of litigation and settlement strategies. Although we believe that our legal reserve and accruals are based on reasonable judgments and estimates, actual results could differ, which may expose us to material gains or losses in future periods. If actual results differ, if circumstances change, or if we experience an unanticipated adverse outcome of any legal action, including any claim or assessment, we would be required to recognize the estimated amount which could reduce net income, earnings per share, and cash flows.

RECENT ACCOUNTING PRONOUNCEMENTS

See “Recent Accounting Pronouncements” in Note 8 of the Notes to our Consolidated Financial Statements, which is incorporated herein by reference.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk

We do not engage in trading market risk sensitive instruments and do not purchase investments as hedges or for purposes “other than trading” that are likely to expose us to certain types of market risk, including interest rate, commodity price, or equity price risk. Although we have investments, we believe there has been no material change in our exposure to interest rate risk. We have not issued any debt instruments, entered into any forward or futures contracts, purchased any options, or entered into any swap agreements.

We are exposed, however, to other market risks, including changes in currency exchange rates as measured against the United States dollar. Because the change in value of the United States dollar measured against foreign currency may affect our consolidated financial results, changes in foreign currency exchange rates could positively or negatively affect our results as expressed in United States dollars. For example, when the United States dollar strengthens against foreign currencies in which our products are sold or weakens against foreign currencies in which we may incur costs, our consolidated net sales or related costs and expenses could be adversely affected.

We believe inflation has not had a material impact on our consolidated operations or profitability. We expanded into Canada in 1996, into Australia in 1998, into the United Kingdom in 1999, into Japan in 2000, into New Zealand in 2002, into the Republic of Korea in 2004, into Taiwan and Denmark in 2005, into Germany in 2006, into South Africa and Singapore in 2008, into Austria, the Netherlands, Norway, and Sweden in September 2009, into Mexico in January 2011, into the Czech Republic, Estonia, Finland, and the Republic of Ireland in June 2011 and into the Republic of Namibia in August 2011. During 2013, we have expanded into Hong Kong and Ukraine.  We translate our revenues and expenses in foreign markets using an average rate.

We maintain policies, procedures, and internal processes in an effort to help monitor any significant market risks and we do not use any financial instruments to manage our exposure to such risks. We assess the anticipated foreign currency working capital requirements of our foreign operations and maintain a portion of our cash and cash equivalents denominated in foreign currencies sufficient to satisfy most of these anticipated requirements.

We caution that we cannot predict with any certainty our future exposure to such currency exchange rate fluctuations or the impact, if any, such fluctuations may have on our future business, product pricing, operating expenses, and on our consolidated financial position, results of operations, or cash flows. However, to combat such market risk, we closely monitor our exposure to currency fluctuations. The foreign currencies in which we currently have exposure to foreign currency exchange rate risk include the currencies of Canada, Australia, the United Kingdom, Japan, New Zealand, the Republic of Korea, Taiwan, Denmark, Germany, South Africa, Singapore, Austria, the Netherlands, Norway,  Sweden, Mexico, the Czech Republic, Estonia, Finland, the Republic of Ireland, Hong Kong, and Ukraine.

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The current (spot) rate, average currency exchange rates, and the low and high of such currency exchange rates as compared to the United States dollar, for each of these countries as of and for the six months ended June 30, 2013 were as follows:
Country (foreign currency name) | | Low | | High | | Average | | Spot |
Australia (Dollar) | | 0.91460 | | 1.05690 | | 1.01547 | | 0.91460 |
Austria, Germany, the Netherlands, Estonia, Finland, the Republic of Ireland (Euro) | | 1.27990 | | 1.36420 | | 1.31334 | | 1.30130 |
Canada (Dollar) | | 0.95100 | | 1.01680 | | 0.98502 | | 0.95100 |
Czech Republic (Koruna) | | 0.04930 | | 0.05336 | | 0.05119 | | 0.05008 |
Denmark (Krone) | | 0.17170 | | 0.18290 | | 0.17612 | | 0.17450 |
Hong Kong (Dollar) | | 0.12880 | | 0.12900 | | 0.12888 | | 0.12890 |
Japan (Yen) | | 0.00969 | | 0.01161 | | 0.01049 | | 0.01009 |
Mexico (Peso) | | 0.07492 | | 0.08352 | | 0.07973 | | 0.07731 |
New Zealand (Dollar) | | 0.77440 | | 0.86220 | | 0.82822 | | 0.77440 |
Norway (Krone) | | 0.16380 | | 0.18340 | | 0.17473 | | 0.16490 |
Republic of Korea (Won) | | 0.00086 | | 0.00098 | | 0.00091 | | 0.00088 |
Singapore (Dollar) | | 0.78300 | | 0.81930 | | 0.80470 | | 0.78940 |
South Africa (Rand) | | 0.09780 | | 0.11810 | | 0.10891 | | 0.10130 |
Sweden (Krona) | | 0.14860 | | 0.15900 | | 0.15401 | | 0.14920 |
Switzerland (Franc) | | 1.02770 | | 1.10200 | | 1.06840 | | 1.05910 |
Taiwan (Dollar) | | 0.03310 | | 0.03477 | | 0.03380 | | 0.03341 |
Ukraine (Hryvnia) | | 0.12290 | | 0.12670 | | 0.12457 | | 0.12370 |
United Kingdom (British Pound) | | 1.48940 | | 1.62890 | | 1.54489 | | 1.52160 |

Item 4. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal financial officer), have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d – 15(e) under the Exchange Act) are effective to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

During the quarter ended June 30, 2013, there were no changes in our internal control over our financial reporting that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION

Item 1. | Legal Proceedings

See “Litigation” in Note 7 of the Notes to our Unaudited Consolidated Financial Statement, which is incorporated herein by reference.

Item 1A. | Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, which could materially affect our business or our consolidated financial position, results of operations, and cash flows. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be insignificant also may become materially adverse or may affect our business in the future or our consolidated financial position, results of operations, or cash flows.

Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. | Defaults Upon Senior Securities

None.

Item 4. | Mine Safety Disclosures
 
Not Applicable.

Item 5. | Other Information

None.

Item 6. | Exhibits

See Index to Exhibits following the signature page of this Quarterly Report on Form 10-Q.
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
| MANNATECH, INCORPORATED
Dated: August 7, 2013 | By: | /s/ Robert A. Sinnott |
| | Robert A. Sinnott |
| | Chief Executive Officer and Chief Science Officer |
| | (principal executive officer) |
Dated: August 7, 2013 | By: | /s/ S. Mark Nicholls |
| | S. Mark Nicholls |
| | Chief Financial Officer |
| | (principal financial officer) |

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INDEX TO EXHIBITS
| | Incorporated by Reference

Exhibit
Number

Exhibit Description

Form

File No.

Exhibit (s)

Filing Date

3.1 | Amended and Restated Articles of Incorporation of Mannatech, dated May 19, 1998. | S-1 | 333-63133 | 3.1 | October 28.1998
3.2 | Certificate of Amendment to the Amended and Restated Articles of Incorporation of Mannatech, dated January 13, 2012. | 8-K | 000-24657 | 3.1 | January 17, 2012
3.3 | Fourth Amended and Restated Bylaws of Mannatech, dated August 8, 2001 (Corrected). | 10-K | 000-24657 | 3.2 | March 16, 2007
3.4 | First Amendment to the Fourth Amended and Restated Bylaws of Mannatech, effective November 30, 2007. | 8-K | 000-24657 | 3.1 | December 6, 2007
4.1 | Specimen Certificate representing Mannatech’s common stock, par value $0.0001 per share. | S-1 | 333-63133 | 4.1 | October 28, 1998
10.1 | Consulting Agreement, effective June 1, 2013, by and between Mannatech and Wonder Enterprises, LLC and Samuel L. Caster, dated June 3, 2013. | 8-K | 000-24657 | 10.1 | June 4, 2013
31.1* | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer of Mannatech. | * | * | * | *
31.2* | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer of Mannatech. | * | * | * | *
32.1* | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer of Mannatech. | * | * | * | *
32.2* | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer of Mannatech. | * | * | * | *
101.INS** | XBRL Instance Document | ** | ** | ** | **
101.SCH** | XBRL Taxonomy Extension Schema Document | ** | ** | ** | **
101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document | ** | ** | ** | **
101.LAB** | XBRL Taxonomy Extension Label Linkbase Document | ** | ** | ** | **
101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document | ** | ** | ** | **
101.DEF** | XBRL Taxonomy Extension Definition Linkbase Document | ** | ** | ** | **

* Filed herewith.
** Furnished herewith. In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

Exhibit 31.1

CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Robert A. Sinnott, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Mannatech, Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 7, 2013 | /s/ Robert A. Sinnott

Robert A. Sinnott
Chief Executive Officer and
Chief Science Officer

Exhibit 31.2

CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, S. Mark Nicholls, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Mannatech, Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 7, 2013 | /s/  S. Mark Nicholls

S. Mark Nicholls
Chief Financial Officer

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Mannatech, Incorporated (the “Company”) on Form 10-Q for the period ending June 30, 2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Robert A. Sinnott, Chief Executive Officer and Chief Science Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 7, 2013 | /s/ Robert A. Sinnott

Robert A. Sinnott
Chief Executive Officer and
Chief Science Officer

 

A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN PROVIDED TO MANNATECH, INCORPORATED AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST.

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Mannatech, Incorporated (the “Company”) on Form 10-Q for the period ending June 30, 2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, S. Mark Nicholls, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 7, 2013 | /s/  S. Mark Nicholls

S. Mark Nicholls
Chief Financial Officer

A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN PROVIDED TO MANNATECH, INCORPORATED AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST.