Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2019, ended December 31, 2018. Comparisons are with the corresponding fiscal 2018 periods. Financial amounts below are in U.S. dollars; millions are used unless otherwise noted.
Business context
NAI provides private-label contract manufacturing of nutritional supplements and health products, and sells beta-alanine raw materials and earns royalties and licensing revenue under its CarnoSyn and SR CarnoSyn brands. Its two reportable segments are private-label contract manufacturing and patent and trademark licensing.
Financial results and position
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $36.0m | $33.3m | $72.6m | $61.4m |
| Gross profit | $6.4m | $6.6m | $13.6m | $13.0m |
| Gross margin | 17.9% | 19.9% | 18.7% | 21.2% |
| Operating income | $2.2m | $2.3m | $4.9m | $4.2m |
| Net income (loss) | $2.2m | ($1.3m) | $4.7m | $0.1m |
| Diluted EPS | $0.31 | ($0.20) | $0.68 | $0.02 |
- Revenue mix: Contract manufacturing sales increased 8% in Q2 and 22% year to date. Licensing sales increased 10% in Q2 and were essentially flat year to date.
- Profitability: Gross margin declined 2.0 percentage points in Q2 and 2.5 points year to date. Management attributed the pressure mainly to unfavorable manufacturing product mix and slightly higher unit manufacturing costs; licensing margin also faced lower average sales prices.
- Operating expenses and other income: SG&A declined 3% in Q2 and 2% year to date. Other income increased, primarily due to interest income associated with foreign-currency hedge contracts.
- Taxes: The effective tax rate was 20.7% for Q2 and 20.6% year to date, versus 153.1% and 97.31% in the prior-year periods. Prior-year tax expense included $3.3m of discrete Tax Act items, materially affecting comparability.
- Cash flow: Six-month operating cash flow was $8.2m, versus $4.7m a year earlier. Investing activities used $1.1m, including $2.7m of capital expenditures, partly offset by collection of a $1.5m note receivable. Cash increased $6.7m to $30.3m.
- Liquidity and debt: Current assets were $71.1m and current liabilities $14.6m at December 31. NAI had no borrowings under its credit line and no long-term debt; $10.0m remained available. It reported covenant compliance and expects cash, operating cash flows, and available facilities to cover working capital and capital spending for at least 12 months.
- Balance sheet: Total assets were $92.8m and stockholders’ equity $75.1m. The $1.5m Kaged Muscle note was repaid before its amended maturity date.
Material changes and management commentary
- Management attributed manufacturing growth to new products, higher volumes from existing products, and expanded business with its largest customer. CarnoSyn beta-alanine revenue was $9.8m for the six months, unchanged from the prior year.
- The largest customer represented 54% of net sales for the first six months, compared with 53% in the prior-year period. Management expects fiscal 2019 annualized concentration to be slightly lower than fiscal 2018 as sales from other customers grow.
- NAI reported approximately $1.0m of litigation and patent-compliance expense during the first six months, compared with $1.7m a year earlier. Management’s stated priorities include growing customer relationships, commercializing its beta-alanine patent portfolio, improving operating efficiency, and managing costs and risks.
- NAI adopted ASC 606 on July 1, 2018 using the modified retrospective method; it reported no material impact on revenue timing or amounts or on retained earnings.
Outlook, risks and contingencies
- No quantified revenue, earnings, or margin guidance is provided. Management’s outlook consists of strategic priorities and its expectation that largest-customer concentration will ease slightly.
- Customer concentration remains significant: the three largest customers together represented 73.0% of gross receivables at December 31, 2018. The filing also identifies dependence on a limited number of qualified suppliers, including for beta-alanine.
- Foreign-exchange exposure is managed partly through cash-flow hedge contracts. At December 31, contracts had approximately $71.0m notional value and a $2.5m net asset fair value; $859,000 was expected to be reclassified from accumulated OCI to earnings over the next 12 months. Hedging may not fully offset currency risk.
- NAI cited risks involving customer orders and concentration, raw-material availability, product demand and mix, intellectual-property protection and licensing compliance, litigation costs, foreign exchange, and regulatory and manufacturing standards. It reported ordinary-course legal matters, including intellectual-property enforcement proceedings, but no material pending legal proceeding as of February 12, 2019; outcomes and related expenses remain uncertain.
Important facts for investors to verify
- Whether manufacturing sales growth is sustainable and whether customer concentration declines as management expects.
- Whether gross-margin pressure from product mix and unit costs persists or improves.
- Beta-alanine revenue, patent and licensing developments, and the costs and outcomes of intellectual-property enforcement.
- Cash conversion, capital spending, and the effect of customer and supplier concentrations on liquidity and operations.
- Foreign-exchange hedge performance and the timing and income-statement effects of amounts reclassified from OCI.