MANNATECH INC 10-K

Item 7. 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 our results of operations for each of the two years ended December 31, 2021 and 2020. This discussion should be read in conjunction with “Item 15. – Consolidated Financial Statements” beginning on page F-1 of this report and with other financial information included elsewhere in this report. 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. Refer to the Non-GAAP Financial Measure section herein for a description of how Constant dollar (“Constant dollar”) growth rate (a Non-GAAP financial metric) is determined. COMPANY OVERVIEW Mannatech is a global wellness solution provider, which was incorporated and began operations in November 1993. We develop and sell innovative, high quality, proprietary nutritional supplements, topical and skin care and anti-aging products, and weight-management products that target optimal health and wellness. We currently sell our products in three regions: (i) the Americas (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, Spain, Sweden and the United Kingdom); and (iii) Asia/Pacific (Australia, Japan, New Zealand, the Republic of Korea, Singapore, Taiwan, Hong Kong, and China). We conduct our business as a single reporting segment and primarily sell our products through a network of approximately 163,000 active associates and preferred customer positions held by individuals that purchased our products and/or packs or paid associate fees during the last 12 months, who we refer to as current associates and preferred customers . New pack sales and the receipt of new associate fees in connection with new positions in our network are leading indicators for the long-term success of our business. New associate or preferred customer positions are created in our network when our associate fees are paid or packs and products are purchased for the first time under a new account. We operate as a seller of nutritional supplements, topical and skin care and anti-aging products, and weight-management products through our network marketing distribution channels operating in 24 countries and direct e-commerce retail in China. 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 current associates and preferred customers that occupy sales or purchasing positions in our network; entry into new markets and growth of existing markets; niche market development; new product introduction; and investment in our infrastructure. Our subsidiary in China, Meitai, is currently operating as a traditional retailer under a cross-border e-commerce model. Meitai cannot legally conduct a direct selling business in China unless it acquires a direct selling license in China. Current Economic Conditions and Recent Developments Overall net sales increased $8.4 million, or 5.5%, for 2021, as compared to 2020. Our 2021 net sales increased $4.7 million, or 3.1%, on a Constant dollar basis (see Non-GAAP Financial Measures, below), and favorable foreign exchange caused a $3.7 million increase in GAAP net sales as compared to 2020. 41 Table of Contents RESULTS OF OPERATIONS Year Ended December 31, 2021 compared to Year Ended December 31, 2020 The tables below summarize our consolidated operating results in dollars and as a percentage of net sales for the years ended December 31, 2021 and 2020 (in thousands, except percentages) . 2021 2020 Change Total Dollars % of net sales Total dollars % of net sales Dollar Percentage Net sales $ 159,762 100.0 % $ 151,407 100.0 % $ 8,355 5.5 % Cost of sales 34,149 21.4 % 35,505 23.5 % (1,356) (3.8) % Gross profit 125,613 78.6 % 115,902 76.5 % 9,711 8.4 % Operating expenses: Commissions and incentives 63,784 39.9 % 61,349 40.5 % 2,435 4.0 % Selling and administrative expenses 29,427 18.4 % 27,845 18.4 % 1,582 5.7 % Depreciation and amortization 1,719 1.1 % 1,990 1.0 % (271) (13.6) % Other operating costs 21,634 13.5 % 20,227 13.4 % 1,407 7.0 % Total operating expenses 116,564 73.0 % 111,411 73.6 % 5,153 4.6 % Income from operations 9,049 5.7 % 4,491 3.0 % 4,558 101.5 % Interest income 66 — % 83 0.1 % (17) (20.5) % Other (expense) income, net (223) (0.1) % 1,151 0.8 % (1,374) 119.4 % Income before income taxes 8,892 5.6 % 5,725 3.8 % 3,167 55.3 % Income tax provision 950 0.6 % 536 0.4 % 414 77.2 % Net income $ 9,842 6.2 % $ 6,261 4.1 % $ 3,581 (57.2) % Non-GAAP Financial Measures To supplement our financial results presented in accordance with generally accepted accounting principles in the United States ("GAAP"), we disclose operating results that have been adjusted to exclude the impact of changes due to the translation of foreign currencies into U.S. dollars, including changes in: Net Sales, Gross Profit, and Income (loss) from Operations. We refer to these adjusted financial measures as Constant dollar items, which are Non-GAAP financial measures. We believe these measures provide investors an additional perspective on trends. To exclude the impact of changes due to the translation of foreign currencies into U.S. dollars, we calculate current year results and prior year results at a constant exchange rate, which is the prior year’s rate. Currency impact is determined as the difference between actual growth rates and constant currency growth rates. 2021 2020 Constant Dollar Change GAAP Measure: Total $ Non-GAAP Measure: Constant $ GAAP Measure: Total $ Dollar Percent Net sales $ 159.8 $ 156.1 $ 151.4 $ 4.7 3.1 % Product $ 151.0 $ 147.6 $ 146.2 $ 1.4 1.0 % Pack and associate fees $ 8.0 $ 7.7 $ 4.2 $ 3.5 83.3 % Other $ 0.8 $ 0.7 $ 1.0 $ (0.3) (30.0) % Gross profit $ 125.6 $ 122.8 $ 115.9 $ 6.9 6.0 % Income from operations $ 9.0 $ 8.3 $ 4.5 $ 3.8 84.4 % 42 Table of Contents Net Sales in Dollars and as a Percentage of Consolidated Net Sales Consolidated net sales by region for the years ended December 31, 2021 and 2020 were as follows (in millions, except percentages) : 2021 2020 Americas $ 46.8 29.3 % $ 44.9 29.7 % Asia/Pacific 97.7 61.1 % 92.1 60.8 % EMEA 15.3 9.6 % 14.4 9.5 % Total $ 159.8 100.0 % $ 151.4 100.0 % Consolidated domestic and foreign net sales for the years ended December 31, 2021 and 2020 were as follows (in millions, except percentages) : 2021 2020 Domestic $ 35.0 21.9 % $ 33.7 22.3 % Foreign 124.8 78.1 % 117.7 77.7 % Total $ 159.8 100.0 % $ 151.4 100.0 % Net Sales Overall net sales increased by $8.4 million, or 5.5%, for 2021, as compared to 2020. For the year ended December 31, 2021, our operations outside of the Americas accounted for approximately 70.7% of our consolidated net sales, whereas in the same period in 2020, our operations outside of the Americas accounted for approximately 70.3% of our consolidated net sales. Sales for the Americas increased by $1.9 million, or 4.2%, to $46.8 million for 2021 as compared to $44.9 million for the same period in 2020. This increase was primarily due to a 9.9% increase in revenue per active independent associate and preferred customer and a 1.7% increase in the number of active independent associates and preferred customers. Foreign currency exchange had the effect of increasing revenue by $0.2 million for the year ended December 31, 2021, as compared to the same period in 2020. The currency impact is due to the strengthening of the Mexican Peso. During 2021, Asia/Pacific sales increased by $5.6 million, or 6.1%, to $97.7 million as compared to $92.1 million for 2020. This increase was primarily due to a 20.5% increase in revenue per active independent associate and preferred customer, which was partially offset by a 4.3% decrease in the number of active independent associates and preferred customers. Foreign currency exchange had the effect of increasing revenue by $2.3 million for the year ended December 31, 2021, as compared to the same period in 2020. The currency impact is primarily due to the strengthening of the Korean Won and Australian Dollar, which was partially offset by the weakening of the Japanese Yen. During 2021, EMEA sales increased by $0.9 million, or 6.3%, to $15.3 million as compared to $14.4 million for 2020. This increase was primarily due to a 25.9% increase in revenue per active independent associate and preferred customer and a 9.0% increase in the number of active independent associates and preferred customers. Foreign currency exchange had the effect of increasing revenue by $1.2 million for the year ended December 31, 2021 as compared to the same period in 2020. The currency impact is primarily due to the strengthening of the South African Rand. Our sales mix for the years ended December 31, was as follows (in millions, except percentages) : Change 2021 2020 Dollar Percentage Consolidated product sales $ 151.0 $ 146.2 $ 4.8 3.3 % Consolidated pack sales and associate fees 8.0 4.2 3.8 90.5 % Consolidated other 0.8 1.0 (0.2) (20.0) % Total consolidated net sales $ 159.8 $ 151.4 $ 8.4 5.5 % 43 Table of Contents Product Sales Our product sales are made to our independent associates and preferred customers at published wholesale prices. Product sales for the year ended December 31, 2021 increased by $4.8 million, or 3.3%, to $151.0 million, as compared to $146.2 million for the same period in 2020. The increase in product sales was primarily due to an increase in the average order value. The average order value in 2021 was $190, as compared to $183 for the same period in 2020. The number of orders processed during the year ended December 31, 2021 decreased by 2.3% as compared to the same period in 2020. Pack Sales and Associate Fees The Company collects associate fees in lieu of selling packs in certain markets. Associate fees are paid annually by new and continuing associates to the Company, which entitle them to earn commissions, benefits and incentives for that year. The Company collected associate fees in lieu of pack sales within the United States, Canada, South Africa, Japan, Australia, New Zealand, Singapore, Hong Kong, Taiwan, Austria, the Czech Republic, Denmark, Estonia, Finland, Germany, the Republic of Ireland, the Netherlands, Norway, Spain, Sweden and the United Kingdom. In the Republic of Korea and Mexico, packs may still be purchased by our associates who wish to build a Mannatech business. These packs contain products that are discounted from both the published retail and associate prices. There are several pack options available to our associates. Pack sales may be completed during the final stages of the registration process, entitling the Associates to earn commissions, benefits, and incentives for that year. These packs 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 in these markets can also purchase an upgrade pack, which provides the associate with additional promotional materials. We also do not collect associate fees or sell packs in our non-direct selling business in mainland China. The dollar amount of pack sales and associate fees associated with new and continuing independent associate positions held by individuals in our network was as follows, for the years ended December 31 ( in millions, except percentages): Change 2021 2020 Dollar Percentage New $ 0.5 $ 0.5 $ — — % Continuing 7.5 3.7 3.8 102.7 % Total $ 8.0 $ 4.2 $ 3.8 90.5 % Total pack sales and associate fees for the year ended December 31, 2021 increased by $3.8 million, or 90.5%, to $8.0 million, as compared to $4.2 million for the same period in 2020. The number of packs sold and associate fees collected increased by 4.2%. Also, the average pack value for the year ended December 31, 2021 was $84, as compared to $45 for the same period in 2020. During 2021 and continuing into 2022, we took the following actions in an effort to increase the number of independent associates and preferred customers: • registered our most popular products with the appropriate regulatory agencies in all countries of operations where possible; • rolled out new products; • launched an aggressive marketing and educational campaign; • continued to strengthen compliance initiatives; • concentrated on publishing results of research studies and clinical trials related to our products; • initiated additional incentives; • explored new advertising and educational tools to broaden name recognition; and • implemented changes to our global associate career and compensation plan. 44 Table of Contents The approximate number of active new and continuing active associates and preferred customers who purchased our packs or products or paid associate fees during the twelve months ended December 31 was as follows: 2021 2020 New 84,000 51.5 % 83,000 45.4 % Continuing 79,000 48.5 % 100,000 54.6 % Total 163,000 100.0 % 183,000 100.0 % Other Sales Other sales consisted of: (i) sales of promotional materials; (ii) monthly fees collected for the Success Tracker™ and Mannatech+ customized electronic business-building and educational materials, databases and applications; (iii) training and event registration fees; and (iv) a reserve for estimated sales refunds and returns. Promotional materials, training, database applications and business management tools to support our independent associates, which in turn helps stimulate product sales. For the year ended December 31, 2021, other sales decreased by $0.2 million, or 20.0%, to $0.8 million, as compared to $1.0 million for the same period in 2020. The decrease was primarily due to the decrease in active new and continuing active associates and preferred customers. Gross Profit For the year ended December 31, 2021, gross profit increased by $9.7 million, or 8.4%, to $125.6 million, as compared to $115.9 million for the same period in 2020. Gross profit as a percentage of net sales increased to 78.6% for 2021, as compared to 76.5% for 2020 due to the benefits from foreign exchange (mostly Korea Won and South Africa Rand), price increases in a few markets and improvements in our supply chain. Commission and Incentives As sales grew, commission expenses increased for the year ended December 31, 2021, by 4.9%, or $2.9 million to $61.6 million, as compared to $58.7 million for the same period in 2020. Commissions as a percentage of net sales were 38.5% for the year ending December 31, 2021 and 38.8% for the same period in the prior year. Incentive costs decreased for the year ended December 31, 2021 by 18.5%, or $0.5 million, to $2.2 million as compared to $2.7 million for the same period in 2020. The costs of incentives, as a percentage of net sales decreased to 1.4% for the year ended December 31, 2021, as compared to 1.8% for the same period in 2020. This decrease was related to travel incentives in the Americas and Asia/Pacific as governments required quarantine periods before entering the country, which reduced travel. 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. For the year ended December 31, 2021, overall selling and administrative expenses increased by $1.6 million, or 5.7%, to $29.4 million, as compared to $27.8 million for the same period in 2020. The increase in selling and administrative expenses consisted of a $1.9 million increase in payroll costs and a $0.1 million increase in distribution costs, which was partially offset by a $0.3 million decrease in contract labor costs and a $0.1 million decrease in stock-based compensation. Other Operating Costs Other operating costs include accounting/legal/consulting fees, travel and entertainment expenses, credit card processing fees, off-site storage fees, utilities, bad debt, and other miscellaneous operating expenses. For the year ended December 31, 2021, other operating costs increased by $1.4 million, or 7%, to $21.6 million, as compared to $20.2 million for the same period in 2020. For the year ended December 31, 2021, other operating costs, as a percentage of net sales, were 13.5%, as compared to 13.4% for the same period in 2020. The increase was due to a $0.8 million increase in consulting fees, and the $0.6 million charge to earnings for our expected outcome from the Korea Customs Audit (see Note 11). 45 Table of Contents Depreciation and Amortization Expense For the years ended December 31, 2021 and 2020, depreciation and amortization expense was $1.7 million and $2.0 million, respectively. Other (Expense) Income, net Primarily due to foreign exchange gains, other (expense) income was $(0.2) million and $1.2 million for the years ending December 31, 2021 and 2020, respectively. Provision for Income Taxes Provision for income taxes include current and deferred income taxes for both our domestic and foreign operations. Our statutory income tax rates by jurisdiction are as follows, for the years ended December 31: Country 2021 2020 Australia 30.0 % 30.0 % Bermuda — % — % Canada 26.5 % 26.5 % China (1) 5.0 % 25.0 % Colombia (2) 31.0 % 32.0 % Cyprus 12.5 % 12.5 % Denmark 22.0 % 22.0 % Gibraltar (3) 11.3 % 10.0 % Hong Kong 16.5 % 16.5 % Japan 34.6 % 34.6 % Mexico 30.0 % 30.0 % Norway 22.0 % 22.0 % Republic of Korea 22.0 % 22.0 % Russia (4) 20.0 % 20.0 % Singapore 17.0 % 17.0 % South Africa 28.0 % 28.0 % Sweden 20.6 % 21.4 % Switzerland (5) 9.2 % 9.2 % Taiwan 20.0 % 20.0 % Ukraine (6) 18.0 % 18.0 % United Kingdom 19.0 % 19.0 % United States (7) 23.2 % 23.8 % (1) For 2020 and 2021, the Company qualifies for a reduced 5% tax rate in China as a Small Low Profit Enterprise. (2) On November 1, 2019, the Company suspended operations in Colombia, but maintains the legal entity, Mannatech Colombia SAS. (3) For 2021, the Company will pay taxes at 10% Gibraltar earnings until August 1, 2021, and 12.5% from August 1, 2021 onward. (4) On August 1, 2016, the Company established a legal entity in Russia called Mannatech RUS Ltd., but currently does not operate in Russia. (5) On July 1, 2019, the Company suspended operations in Switzerland, but maintains the legal entity. (6) On March 21, 2014, the Company suspended operations in the Ukraine, but maintains the legal entity, Mannatech Ukraine LLC. (7) Includes blended state effective rate of 2.2% for 2021 and 2.8% for 2020 in addition to the U.S federal statutory rate of 21%. Foreign Tax 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. 46 Table of Contents U.S. Tax For each of the years ended December 31, 2021 and 2020, the Company’s effective tax rate was (10.7)% and (9.4)%, respectively. In 2021, the Company’s effective rate differed from the statutory rate due to the effect of changes in valuation allowances recorded in certain jurisdictions, taking the IRC Section 250 deduction, and applying foreign tax credits. In 2020, the Company had a significant decrease in its rate due to the carryback of U.S net operating losses as allowed by the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), enacted on March 27, 2020. At December 31, 2021 and 2020, the Company’s valuation allowance was $7.9 million and $11.9 million, respectively. The provisions of Accounting Standards Codification Topic 740, Income Taxes (“ASC Topic 740”) require a company to record a valuation allowance when the “more likely than not” criterion for realizing a deferred tax asset cannot be met. A company is to use judgment in reviewing both positive and negative evidence of realizing a deferred tax asset. Furthermore, the weight given to the potential effect of such evidence is commensurate with the extent the evidence can be objectively verified. The valuation allowance against the Company’s deferred tax assets consisted of the following at December 31 (in thousands) : Country 2021 2020 Australia $ — $ 0.2 China 0.5 0.4 Colombia 0.5 0.6 Cyprus 0.2 0.2 Mexico 1.9 3.1 Norway 0.1 0.1 South Africa 0.2 0.2 Switzerland 0.5 0.5 Taiwan 0.6 1.1 United States 3.4 5.5 Total $ 7.9 $ 11.9 SEASONALITY We believe the impact of seasonality on our consolidated results of operations is minimal. We have experienced and believe we will continue to experience variations on our quarterly results of operations in response to, among other things: • the timing of the introduction of new products and incentives; • our ability to attract and retain associates and preferred customers; • the timing of our incentives and contests; • the general overall economic outlook; • government regulations; • global pandemic; • the outcome of certain lawsuits; • the perception and acceptance of network marketing; and • the consumer perception of our products and overall operations. As a result of these and other factors, our quarterly results may vary significantly in the future. Period-to-period comparisons should not be relied upon as an indication of future performance since we can give no assurances that revenue trends in new markets, as well as in existing markets, will follow our historical patterns. The market price of our common stock may also be adversely affected by the above factors. 47 Table of Contents LIQUIDITY AND CAPITAL RESOURCES Cash and Cash Equivalents As of December 31, 2021, our cash, cash equivalents and restricted cash decreased by 6.8%, or $1.9 million, to $25.6 million from $27.5 million as of December 31, 2020. 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) Australia building lease collateral. The current portion of restricted cash at each of December 31, 2021 and 2020 was $0.9 million. Fluctuations in currency rates produced a decrease of $2.7 million in cash and cash equivalents in 2021 as compared to an increase of $1.3 million in 2020. Our principal use of cash is to pay for operating expenses, including commissions and incentives, capital assets, inventory purchases, and periodic cash dividends. 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 December 31, 2021, our working capital increased by $2.2 million, or 21.0%, to $12.7 million from $10.5 million at December 31, 2020. The increase in working capital is primarily due to a decrease in our current liabilities. Net Cash Flows Our net consolidated cash flows consisted of the following, for the years ended December 31 (in millions) : Provided by / (used in): 2021 2020 Operating activities $ 10.8 $ 6.0 Investing activities $ (0.7) $ (0.9) Financing activities $ (9.3) $ (9.9) Operating Activities Cash provided by operating activities increased by $4.8 million for the year ended December 31, 2021, as compared to the same period in 2020. For the year ended December 31, 2021, this increase was due to improved operating profits and working capital management. Investing Activities During the year ended December 31, 2021 and 2020, we invested $0.7 million and $0.9 million in computer hardware and software, respectively. Financing Activities For the year ended December 31, 2021, our financing activities used cash of $9.3 million compared to cash used of $9.9 million for the same period of 2020. For the year ended December 31, 2021, we used approximately $0.4 million in the repayment of finance lease obligations and other long term liabilities, $4.3 million in the payment of dividends to shareholders, $5.1 million in the repurchase of common stock, which was partially offset by $0.5 million cash provided by the exercise of stock options. For the year ended December 31, 2020, we used approximately $0.6 million in the repayment of finance lease obligations and other long term liabilities, $3.4 million in the payment of dividends to shareholders, and $5.9 million for the repurchase of common stocks. 48 Table of Contents General Liquidity and Cash Flows Short Term Liquidity We believe our existing liquidity and cash flows from operations are adequate to fund our normal expected future business operations for the next 12 months. As our primary source of liquidity is our cash flows from operations, this will be dependent on our ability to maintain and/or continue to improve revenue as compared to our 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. As of December 31, 2021 and 2020, cash and cash equivalents held in bank accounts in foreign countries totaled $22.6 million and $18.6 million, respectively. 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. The Canada Revenue Agency is auditing the Company's GST filings from January 2019 through April 2021. Management believes the likelihood of an additional GST liability or penalty from the audit is remote and therefore has not accrued a liability related to this audit at December 31, 2021. For more information see Note 1 Organization and Summary of Significant Accounting Policies, Note 7 Income Taxes , Note 11, Commitments and Contingencies, and Note 12 Litigation to our Consolidated Financial Statements. We have contractual 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. At December 31, 2021, we have one supply agreement that requires the Company to purchase an aggregate of $4.8 million through 2022, with no purchase commitments thereafter. 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 minimum quantities. 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 possibility of the benefits of purchasing a raw material manufacturing facility to help control costs of our raw materials and help ensure quality control standards. We have operating lease liabilities for the property and equipment we use in our business operations. These operating lease liabilities represent our minimum future payment obligations on operating leases, including imputed interest. At December 31, 2021, our operating lease liabilities were $5.8 million, of which $1.5 million was recorded in Accrued expenses and $4.3 million was recorded in Other long-term liabilities. We also have finance lease liabilities of $0.1 million and lease restoration liabilities of $0.3 million. We have pension obligation of $0.9 million related to our employee benefit plan at our Japan subsidiary. Responding to COVID-19, we have taken steps to protect the health, safety and well-being of our customers, associates, employees, and communities by closing some offices and equipping various staff members to work remotely. The Company depends on an independent salesforce of distributors to market and sell its products to consumers. Developments such as social distancing and shelter-in-place directives has impacted their ability to engage with potential and existing customers. The adverse economic effects of COVID-19 includes government restriction and changes in consumer demand for the Company’s products. The Company has rescheduled corporate sponsored events, and in some cases, our associates have canceled sales meetings. For some products, the Company experienced shortages of raw materials and ingredients. We experienced challenges in getting materials and ingredients to our contract manufacturers and finished products to our distribution centers as a result of reductions in global transportation capacity. Despite the impact on the global supply chain, the Company has overcome obstacles in shipping to our customers. Prolonged workforce disruptions, continued disruption in our supply chain and potential decreases in consumer demands could negatively impact our sales as well as the Company’s overall liquidity in the next twelve months, however, such impact is currently unknown. Long Term Liquidity We believe our 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 flows from operations, this will be dependent on our ability to maintain and and/or improve revenue as compared to operational expenses. 49 Table of Contents 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. OFF-BALANCE SHEET ARRANGEMENTS We do not have any special-purpose entity arrangements, nor do we have any off-balance sheet arrangements. MARKET RISKS Please see “Quantitative and Qualitative Disclosure about Market Risk” under Item 7A of this Form 10-K for additional information about our Market Risks. 50 Table of Contents CRITICAL ACCOUNTING ESTIMATES Our consolidated financial statements are prepared in accordance with GAAP. The application of GAAP requires us to make estimates and assumptions that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of Mannatech at the date of our financial statements. 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 December 31, 2021: 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 net realizable value. 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. At December 31, 2021 and 2020, our inventory reserves were $0.4 million and $0.5 million, respectively. 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. 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. 51 Table of Contents 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. 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 material impairments existed during the years ended December 31, 2021 and 2020. Uncertain Income Tax Positions and Tax Valuation Allowances As of December 31, 2021, there was nothing recorded in other long-term liabilities on our consolidated balance sheet related to uncertain income tax positions. As required by ASC Topic 740, Income Taxes (“ASC Topic 740”), 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. 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. It is reasonably possible the tax jurisdiction may request that the statute of limitations be extended, 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. There are ongoing income tax audits in various international jurisdictions that we believe 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 December 31, 2021, we maintained a valuation allowance for deferred tax assets arising from our operations of $7.9 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 December 31, 2021, we had net deferred tax assets, after valuation allowance and deferred tax liabilities, totaling $2.8 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. Transfer Pricing In many countries, including the U.S., we are subject to transfer pricing and other tax regulations designed to ensure that appropriate levels of income are reported as earned by our U.S. and foreign entities and are taxed accordingly. In the normal course of business, we are audited by federal, state and foreign tax authorities, and subject to inquiries from those tax authorities regarding the amount of taxes due. These inquiries may relate to the timing and amount of deductions and the allocation of income among various tax jurisdictions. We believe that our tax positions comply with applicable tax law and intend to defend our positions, if necessary. Our effective tax rate in each financial statement period could be impacted if we prevailed in matters for which reserves have been established, or were required to pay amounts more than established reserves. Revenue Recognition Our revenue is derived from sales of individual products and associate fees or, in certain geographic markets, starter packs. Substantially all of our product and pack sales are to associates and preferred customers at published wholesale 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. Corporate-sponsored event revenue is recognized when the event is held. 52 Table of Contents Orders placed by associates or preferred customers constitute our contracts. Product sales placed in the form of an automatic order contain two performance obligations: (a) the sale of the product and (b) the loyalty program. For these contracts, the Company accounts for each of these obligations separately as they are each distinct. The transaction price is allocated between the product sale and the loyalty program on a relative standalone selling price basis. Sales placed through a one-time order contain only the first performance obligation noted above - the sale of the product. The Company provides associates with access to a complimentary three-month package for the Success Tracker TM and Mannatech+ online business tools with the first payment of an associate fee. The first payment of an associate fee contains three performance obligations: (a) the associate fee, whereby the Company provides an associate with the right to earn commissions, bonuses and incentives for a year, (b) three months of complimentary access to utilize the Success Tracker™ online tool and (c) three months of complimentary access to utilize the Mannatech+ online business tool. The transaction price is allocated between the three performance obligations on a relative standalone selling price basis. Associates do not have complimentary access to online business tools after the first contractual period. With regard to both of the aforementioned contracts, the Company determines the standalone selling prices based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of the contracts. Deferred Commissions We defer commissions on (i) the sales of products shipped but not received by the customers by the end of the respective period and (ii) the loyalty program. Deferred commissions are incremental costs and are amortized to expense consistent with how the related revenue is recognized. Deferred commissions were $2.4 million and $2.3 million at December 31, 2021 and December 31, 2020, respectively. Deferred Revenue We defer certain components of revenue. Deferred revenue consists of: (i) sales of products shipped but not received by the customers by the end of the respective period; (ii) revenue from the loyalty program; (iii) prepaid registration fees from customers planning to attend a future corporate-sponsored event; and (iv) prepaid annual associate fees. At December 31, 2021 and December 31, 2020, deferred revenue was $4.9 million and $5.5 million, respectively. Our customer loyalty program conveys a material right to the customer as it provides the promise to redeem loyalty points for the purchase of products, which is based on earning points through placing consecutive qualified automatic orders. The timing and recognition of loyalty points has not changed with the adoption of ASC 606, Revenue from Contracts with Customers (“ASC Topic 606”). The Company factors in breakage rates, which is the percentage of the loyalty points that are expected to be forfeited or expire, for purposes of revenue recognition. Breakage rates are estimated based on historical data and can be reasonably and objectively determined. There have not been significant changes for the breakage estimate as a result of adopting ASC Topic 606. The deferred revenue associated with the loyalty program at December 31, 2021 and December 31, 2020 was $4.3 million and $4.5 million, respectively. Loyalty program (in thousands) Loyalty deferred revenue as of January 1, 2020 $ 3,127 Loyalty points forfeited or expired (3,249) Loyalty points used (9,385) Loyalty points vested 12,771 Loyalty points unvested 1,223 Loyalty deferred revenue as of December 31, 2020 $ 4,487 Loyalty deferred revenue as of January 1, 2021 $ 4,487 Loyalty points forfeited or expired (3,987) Loyalty points used (9,809) Loyalty points vested 11,676 Loyalty points unvested 1,925 Loyalty deferred revenue as of December 31, 2021 $ 4,292 53 Table of Contents Product Return Policy We stand behind our 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. Refunds are 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 preferred customers 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 preferred customers 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 other countries where we sell our products. The associate may return or exchange the product based on the associate product return policy. In China, where we sell our products under a cross-border e-commerce model, we have a 14-day return policy. • Associate and Preferred Customer Product Return Policy. This policy allows the associate or preferred customer to return an order within one year of the purchase date upon terminating his/her account. If an associate or preferred customer 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 preferred customer 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 other countries where we sell our products 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 preferred customer's account. The Company utilizes the expected value method, as set forth by ASC Topic 606, to estimate the sales returns and allowance liability by taking the weighted average of the sales return rates over a rolling six-month period. The Company allocates the total amount recorded within the sales return and allowance liability as a reduction of the overall transaction price for the Company’s product sales. The Company deems the sales refund and allowance liability to be a variable consideration. The method for estimating the sales returns and allowance liability has remained consistent as a result of adopting ASC Topic 606. 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. Sales returns have historically averaged 1.5% or less of our gross sales. For the years ended December 31, 2021 and December 31, 2020, our sales return reserve was composed of the following (in thousands) : Sales reserve as of January 1, 2020 $ 68 Provision related to sales made in current period 1,028 Adjustment related to sales made in prior periods 5 Actual returns or credits related to current period (959) Actual returns or credits related to prior periods (71) Sales reserve as of December 31, 2020 $ 71 Sales reserve as of January 1, 2021 $ 71 Provision related to sales made in current period 778 Adjustment related to sales made in prior periods (11) Actual returns or credits related to current period (728) Actual returns or credits related to prior periods (55) Sales reserve as of December 31, 2021 $ 55 54 Table of Contents 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 or three years. The fair value of the stock option award is calculated using the Black-Scholes option-pricing model (the “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 year ended December 31, 2021, our assumptions and estimates used for the calculated fair value of stock options granted in 2021 were as follows: 2021 Grants June 2021 Grant Estimated fair value per share of options granted: $ 6.77 Assumptions: Dividend yield 2.4 % Risk-free rate of return 0.7 % Common stock price volatility 56.7 % Expected average life of stock options (in years) 4.5 Historically, our estimates and underlying assumptions have not materially deviated from our actual reported results and rates. However, we base assumptions we use on our best estimates, which involves inherent uncertainties based on 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 adjust our consolidated financial statements in future periods. As of December 31, 2021, using our current assumptions and estimates, we anticipate recognizing less than $0.1 million in gross compensation expense through 2022 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. As of December 31, 2021, we had 144,155 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 would include an estimated amount for any damages and the probability of losing any threatened legal claims or assessments. No legal reserve was deemed necessary at December 31, 2021. The legal reserve is developed in consultation with our general and outside counsel and is based upon a combination of litigation and settlement strategies. Although we believe that our legal reserves 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 that could reduce net income, earnings per share, and cash flows. In November 2021, the Busan Custom Office began an audit of the Korean customs values and while the audit continues, we have booked a $0.6 million charge to Other Operating Expenses for the most probable outcome. As we process commissions monthly Mannatech Korea receives from Mannatech Inc. payments for members’ commissions and these intercompany payments are settled by way of netting set-off with other transactions. We are seeking an official ruling from the Ministry of Economy and Finance involving the netting of receivables / payables in foreign currency between a Korean resident and a non-resident and whether this should be reported to the Bank of Korea or a designated foreign exchange bank under compliance with the Foreign Exchange Transactions Act ("FETA") of Korea. If it is confirmed in the ruling that the above transactions are subject to the advance reporting requirement under the FETA, there is a possibility of a penalty for the violation. 55 Table of Contents