Business context and reporting period
Natural Alternatives International, Inc. (NAI) filed this Form 10-Q for the quarter ended March 31, 2012, the third quarter of fiscal 2012, and the nine months then ended. NAI provides nutritional-supplement contract manufacturing, licenses patents and trademarks associated principally with CarnoSyn beta-alanine, and sells branded products, mainly Pathway to Healing.
Financial performance and position
Amounts below are in millions of dollars except per-share data. Income-statement comparisons are with the corresponding 2011 periods.
| Metric | Three months ended March 31, 2012 | Nine months ended March 31, 2012 |
|---|---|---|
| Net sales | $17.422 (+30%) | $51.924 (+25%) |
| Gross profit / margin | $4.123 / 23.7% (17.8% prior year) | $12.159 / 23.4% (19.1% prior year) |
| Operating income / margin | $1.630 / 9.4% | $5.203 / 10.0% |
| Net income | $1.068 (prior year $0.181) | $3.381 (prior year $1.947) |
| Diluted earnings per share | $0.15 (prior year $0.03) | $0.48 (prior year $0.27) |
For the nine-month period, contract manufacturing sales were $46.586 million (+20%), licensing revenue $4.146 million (+210%), and branded-product sales $1.192 million (-14%). The two largest customers represented 68% of sales, down from 73% in the prior-year period; the largest alone represented 47%.
Cash and cash equivalents were $11.105 million at March 31, 2012, down from $15.461 million at June 30, 2011. Current assets were $32.769 million and current liabilities $5.777 million. Operating activities used $2.395 million of cash in the first nine months, versus generating $4.585 million a year earlier; inventory growth used $6.672 million. Capital expenditures were $1.759 million. NAI reported no outstanding debt, $5.6 million available under credit facilities, and compliance with credit covenants. Stockholders’ equity was $39.248 million.
Material changes versus the prior comparable period
- Higher contract manufacturing volumes, new products and sales to new and existing customers drove growth; licensing revenue also rose substantially.
- Gross margin improved, reflecting licensing contribution and lower relative overhead and labor costs, partly offset by an unfavorable contract-manufacturing sales and material mix.
- SG&A increased $1.4 million over nine months, principally from higher patent litigation/prosecution costs and domestic manufacturing compensation.
- Income-tax expense increased as NAI recognized federal and state tax on domestic earnings; prior-year domestic federal taxes were offset by net operating loss carryforwards.
- Accounts receivable rose to $5.128 million and inventory to $13.171 million from $3.287 million and $6.499 million, respectively, at June 30, 2011.
Outlook, commentary, risks and unusual items
- Management expects available cash, operating cash flows and borrowing capacity to fund working capital and capital expenditures for at least 12 months. It planned to continue growing manufacturing relationships, commercializing and protecting its beta-alanine intellectual property, evaluating Pathway to Healing initiatives, and improving efficiency. No quantified revenue or earnings guidance was provided.
- Management expected two-customer concentration to decline marginally during the remainder of fiscal 2012. It also expected to liquidate most of the $2.9 million of beta-alanine raw material on hand over the next several quarters, subject to demand and economic conditions.
- Abbott’s beta-alanine license remained terminable through July 31, 2012. The agreement included remaining near-term fees and $3.5 million of additional fees in annual installments beginning March 2013, but NAI cautioned that it might receive none of the future fees or royalties if Abbott terminated.
- Revenue and earnings remain exposed to customer concentration, order timing, limited raw-material suppliers, demand and inventory risks, foreign currency movements, and dependence on continued patent compliance. Litigation over beta-alanine patents and related claims remained ongoing; NAI reported $1.1 million of litigation and patent-compliance expense for the nine months. BPI and Image litigation was settled with supply and licensing arrangements; other disputes remained unresolved.
- Foreign-exchange hedges had a fair value of $773,000 at March 31, 2012; $610,000 of related gains were expected to be reclassified to earnings within 12 months. NAI also repurchased 45,026 shares for $202,000 during the nine-month period.
- Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported during the quarter. Management stated ordinary-course legal matters could nevertheless result in adverse outcomes or costs.
Important facts for investors to verify
- Whether Abbott exercised its termination right by July 31, 2012, and whether the remaining license fees and future royalties were received.
- Whether the beta-alanine inventory was sold as anticipated, and the resulting effects on working capital, cash flow and margins.
- Whether customer concentration continued to decline and manufacturing sales growth was sustained.
- Developments, costs and outcomes in the patent litigation, including the remaining DNP and Woodbolt disputes.
- The sustainability of improved gross margins and earnings given negative operating cash flow and increased inventory investment.