Business context and reporting period
Natural Alternatives International, Inc. (Nasdaq: NAII) filed this Form 10-K for the fiscal year ended June 30, 2016; the filing is not for calendar 2015 Q4. NAI manufactures private-label nutritional supplements and sells beta-alanine under its CarnoSyn® brand, alongside related patent and trademark licensing. The former Pathway to Healing branded-products line was discontinued.
Financial performance and position
Amounts are in U.S. dollars; financial figures are in millions except per-share data.
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $114.2 | $79.5 |
| Gross profit / margin | $25.3 / 22.1% | $14.3 / 18.0% |
| Operating income / margin | $12.3 / 10.7% | $4.2 / 5.2% |
| Net income | $9.5 | $3.3 |
| Diluted EPS | $1.44 | $0.49 |
| Operating cash flow | $9.3 | $2.7 |
| Capital expenditures | $10.4 | $1.7 |
- Revenue by activity: private-label manufacturing $92.4 million (81% of sales); beta-alanine patent and trademark activity $21.8 million (19%). Beta-alanine revenue included $21.6 million in raw-material sales and $0.2 million in royalties.
- At June 30, 2016, cash was $19.7 million, current assets $55.9 million, current liabilities $19.2 million, total assets $74.2 million, and total liabilities $20.4 million. The current ratio was approximately 2.9.
- No debt was outstanding. The company reported $10.5 million of availability under credit facilities, including $10.0 million under its Wells Fargo line. The line is secured, covenant-dependent, and due by January 2019.
- Inventory rose to $20.8 million from $12.6 million. Operating cash flow improved, but inventory growth used $8.2 million of cash. Cash from operations was below capital spending.
Changes versus prior year
- Sales rose 44%; manufacturing sales rose 33%, driven by higher volumes and new products, while beta-alanine revenue increased 138%. Taking over direct beta-alanine sales and distribution in April 2015 shifted revenue from licensing/royalties toward raw-material sales.
- Gross margin improved about 4.1 percentage points, with management citing manufacturing throughput and lower per-unit costs, partly offset by sales and material mix and foreign exchange.
- SG&A increased 28% to $13.0 million, reflecting compensation, marketing and patent-related costs. Patent litigation and compliance expense was approximately $2.0 million, versus $1.6 million.
- A $1.6 million pretax gain on sale of the former San Marcos headquarters contributed to other income. The effective tax rate rose to 29.7% from 22.3%; the company also reduced its deferred-tax valuation allowance by $193,000.
Outlook, risks and unusual items
- Management expected positive net income in fiscal 2017, while cautioning there was no assurance. It expected beta-alanine raw-material sales to be consistent with fiscal 2016 and the largest customer’s share of sales to remain similar.
- Key concentration risk: the largest customer, The Juice Plus+ Company, contributed approximately 43% of FY2016 sales; another customer contributed 12%. Management identifies diversification as a strategic goal.
- Patents covering instant-release beta-alanine expire in August 2017. NAI is seeking to build demand for sustained-release SR CarnoSyn®, with related patents extending through 2026; successful adoption is uncertain.
- Management expected raw-material shortages and pricing pressures, including higher labor and transportation costs, to continue in fiscal 2017. Euro weakness also affected reported manufacturing sales. Foreign-exchange contracts had a $19.0 million notional value at year-end.
- Patent disputes and enforcement actions remain material uncertainties. A challenge to one patent expiring in 2017 was awaiting rehearing; additional patent and trademark suits were filed in 2016. Management expected further patent-related expense in fiscal 2017.
- Other exposures include regulated manufacturing and product claims, potential product liability or recalls, customer order timing, and reliance on key suppliers. Management stated that available liquidity and expected operating cash flows should fund working capital and capital spending for at least 12 months.
- Auditors issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not attest to internal control.
Most important facts for investors to verify
- Whether customer concentration, especially the largest customer’s 43% sales contribution, changes in subsequent periods.
- Whether direct beta-alanine sales and SR CarnoSyn® adoption sustain revenue and margins as instant-release patents expire in August 2017.
- Whether inventory converts to sales and cash, given the $8.2 million cash use from inventory growth and capital spending above operating cash flow.
- Developments and costs in patent litigation, including patent validity challenges and the expected fiscal 2017 legal expense.
- Actual fiscal 2017 profitability, raw-material availability and costs, and compliance with credit-facility covenants.