Natural Alternatives International, Inc. — Form 10-Q
Reporting period: Three months ended September 30, 2015 (the company’s fiscal 2016 first quarter). The filing’s reporting period differs from the request metadata label “2015 Q1.” Amounts below are in U.S. dollars unless noted.
Business context
NAI provides private-label contract manufacturing for nutritional and health products and earns revenue from beta-alanine sales and related patent and trademark licensing. Effective April 1, 2015, NAI began selling and distributing beta-alanine directly after allowing its agreement with Compound Solutions to expire. The company discontinued its Pathway to Healing branded product line; related wind-down activities were substantially completed by December 31, 2014.
Financial results and liquidity
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Net sales | $21.585 million | $18.695 million | +15.5% |
| Gross profit / margin | $4.733 million / 21.9% | $2.797 million / 15.0% | Margin +6.9 percentage points |
| Operating income / margin | $1.728 million / 8.0% | $569,000 / 3.0% | +203.7% |
| Net income | $1.213 million | $487,000 | +149.1% |
| Diluted earnings per share | $0.18 | $0.07 | Increased |
| Operating cash flow | $(2.268) million | $(2.636) million | Less cash used |
- Private-label manufacturing sales declined 6.9% to $16.265 million. Patent and trademark licensing sales increased 453.6% to $5.320 million, primarily reflecting direct beta-alanine raw-material sales; branded-product sales were zero versus $269,000.
- SG&A increased 34.9% to $3.005 million, primarily from higher litigation and patent-compliance costs and sales and marketing spending tied to beta-alanine commercialization. Litigation and patent-compliance expense was approximately $472,000 versus $142,000.
- Cash and cash equivalents were $16.440 million at September 30, down from $18.551 million at June 30. Inventories rose to $18.786 million from $12.564 million, including higher inventory to support direct beta-alanine sales and manufacturing demand.
- Current assets were $47.078 million and current liabilities $10.747 million. Total assets were $56.674 million; total liabilities were $11.624 million.
- There was no consolidated debt outstanding. NAI reported $5.5 million available under credit facilities and compliance with its Wells Fargo credit covenants. Management said cash, operating cash flows and available borrowing capacity should fund working capital and capital expenditures for at least 12 months.
- Capital expenditures were $239,000. Investing activities provided $329,000, including $568,000 of proceeds from asset sales. Share repurchases totaled $172,000 for 29,262 shares.
Changes, outlook and risks
- Management attributed improved gross margin to manufacturing throughput and lower per-unit costs, as well as a larger contribution from beta-alanine sales. Private-label sales were affected by shipment timing and weaker euro exchange rates; euro-denominated sales used an average rate of 1.11 EUR/USD versus 1.36 a year earlier.
- Management’s stated priorities for the remainder of fiscal 2016 are to develop contract-manufacturing customers, expand beta-alanine commercialization and protect its intellectual property, and improve operating efficiency and cost management. The filing provides no specific financial guidance.
- Customer concentration remains significant: the two largest private-label customers represented 61% of private-label sales (42% and 19%) in the quarter. Management expected their combined concentration to increase marginally during the rest of fiscal 2016.
- NAI depends on a limited number of suppliers for certain inputs, including beta-alanine. Inventory investment and the transition to direct distribution increase the importance of sourcing, customer demand and collection timing; days sales outstanding increased to 41 from 36.
- Patent litigation is a material business risk. The PTAB affirmed rejection of claims for NAI’s ’381 patent in July 2015; NAI’s rehearing request was pending. Reexamination proceedings for the ’422 patent were also pending. NAI separately sued Creative Compounds in September 2015; the defendant denied the allegations, and no trial date had been set.
- Foreign-exchange hedges had a $156,000 net liability at quarter-end; approximately $121,000 of hedge losses in OCI was expected to be reclassified into earnings over the next 12 months with related forecast transactions.
- NAI had agreed to sell its San Marcos headquarters. One significant contingency remained, so the company could not estimate the final price or gain, or confirm that the sale would close.
- Management reported effective disclosure controls as of September 30, 2015, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether beta-alanine direct sales can sustain revenue and profitability, and whether supply, customer expansion and patent rights support the strategy.
- Progress and potential financial impact of the ’381 and ’422 patent proceedings and the Creative Compounds litigation.
- Customer concentration, euro exposure, hedge performance and the effect of shipment timing on manufacturing sales and cash collection.
- Whether elevated inventory converts to sales and cash, and how working-capital requirements affect liquidity.
- Whether the headquarters sale closes and, if so, its proceeds and accounting gain.