Natural Alternatives International, Inc. — Q1 FY2021 Form 10-Q
Reporting period: Three months ended September 30, 2020; filed November 10, 2020. Financial amounts below are in U.S. dollars unless noted.
Business context and results
NAI manufactures private-label nutritional and health-care products and earns revenue from beta-alanine sales and related patent and trademark licensing. Its results remain significantly dependent on a small number of contract-manufacturing customers.
- Net sales were $39.7 million, up 36% from $29.2 million a year earlier. Contract manufacturing sales rose 42% to $37.0 million; patent and trademark licensing sales fell 16% to $2.7 million.
- Gross profit increased 37% to $6.0 million. Gross margin was 15.1%, compared with 15.0%.
- SG&A fell 12% to $3.9 million, partly due to lower patent litigation costs. Operating income was $2.1 million, versus an operating loss of $55,000; operating margin was 5.2%.
- Net income was $2.3 million, or $0.35 per diluted share, versus $96,000, or $0.01 per diluted share. Results included a $494,000 income tax benefit and $321,000 of total other expense, including a $265,000 foreign-exchange loss.
Cash flow, liquidity and balance sheet
- Operating cash flow was $110,000, down from $4.6 million. A $7.2 million inventory build and $2.2 million use of cash from receivables were partly offset by a $6.6 million source from accounts payable and accrued liabilities.
- Capital expenditures were $1.5 million; share repurchases used $1.7 million. Cash declined $3.1 million during the quarter to $27.4 million.
- Current assets were $86.4 million and current liabilities were $37.1 million. Inventory rose to $35.2 million from $28.0 million at June 30, 2020.
- NAI had $10.0 million outstanding on its $10.0 million Wells Fargo credit line and no remaining availability. The facility matures November 1, 2022; the company reported compliance with its covenants. Management said cash and expected operating cash flows should fund working capital and capital expenditures for the next 12 months.
- Total liabilities were $57.4 million and stockholders’ equity was $71.1 million. Operating lease liabilities were $18.3 million long term; the company reported no finance leases.
Material changes and unusual items
- Growth was driven primarily by higher shipments to the largest manufacturing customer, sales of new products, and increased demand for customers’ immune and wellness products during the pandemic. Sales to the largest customer increased 67% and represented 60% of quarterly sales, versus 49% a year earlier.
- Beta-alanine revenue declined due to former customers switching to generic product and COVID-related weakness in sports nutrition, partly offset by higher royalty income.
- A $0.9 million discrete tax benefit contributed to the quarter’s tax benefit. It included effects of revised fiscal 2020 tax estimates and a planned CARES Act NOL carryback.
- Cash-flow hedge fair value shifted from a net asset of $0.3 million at June 30 to a net liability of $2.4 million at September 30. A net loss of $1.1 million was recorded in comprehensive income for the quarter; approximately $1.9 million of hedge losses were expected to be reclassified into earnings over the next 12 months alongside the related forecast transactions.
- The board increased the stock repurchase authorization by $2.0 million to $12.0 million. NAI repurchased 235,390 shares for $1.7 million during the quarter.
- Inventory included a reserve of $0.8 million related to former customer Kaged Muscle. NAI also carried a $3.3 million receivable from a former contract-manufacturing customer, reserved in full.
Outlook, commentary and risks
Management forecast FY2021 net sales growth of 30%–50% compared with FY2020 and operating income of 5%–7% of sales. It expected the current sales trend to continue at least through the remainder of FY2021, but cautioned that the duration and severity of COVID-19 and its financial impact could not be reliably estimated. These are expectations, not guarantees.
- COVID-19 could disrupt employees, suppliers, carriers, customer operations, demand, and collections. NAI’s U.S. and European facilities were operating as essential manufacturers at the time of the filing.
- Customer concentration is material: the largest customer accounted for 60% of quarterly sales, and two customers collectively represented 55.8% of gross receivables, excluding the fully reserved former-customer balance.
- NAI cited dependence on a limited number of qualified suppliers, including for beta-alanine; foreign-exchange exposure; and risks to CarnoSyn intellectual property and licensing revenue. It incurred approximately $0.4 million of patent and compliance litigation expense in the quarter.
- Management did not expect ordinary-course claims and proceedings to have a material adverse effect based on available information, while noting that outcomes and costs remain uncertain. No material pending legal proceeding was reported as of November 10, 2020.
Key facts for investors to verify
- Whether sales growth and the FY2021 outlook are sustainable, particularly given pandemic-related demand and the 60% customer concentration.
- Whether elevated inventory converts to sales and cash, and whether working-capital needs remain supportable with the credit line fully drawn.
- The impact of hedge losses reclassified into revenue and earnings, and the company’s foreign-exchange exposure.
- Whether the discrete tax benefits recur or materially affect comparisons with future periods.
- The adequacy of the Kaged inventory reserve and the fully reserved former-customer receivable, as well as any developments in litigation or intellectual-property matters.