Natural Alternatives International, Inc. — Form 10-Q Summary
Period: Three months ended September 30, 2014, compared with the three months ended September 30, 2013. This is fiscal 2015 first quarter; the request metadata labels the period “2014 Q1.” Amounts below are in millions unless stated otherwise.
Business context
NAI primarily manufactures nutritional supplements for private-label customers. It also earns royalties and licensing revenue from its CarnoSyn beta-alanine patent and trademark rights, and sells branded products. The company is seeking to diversify its customer base. Its agreements with largest customer The Juice Plus+ Company expired April 1, 2014; NAI continued fulfilling monthly purchase orders while negotiating renewal and expansion.
Financial performance
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Net sales | $18.695 | $17.155 |
| Gross profit / margin | $2.797 / 15.0% | $2.734 / 15.9% |
| Operating income / margin | $0.569 / 3.0% | $0.090 / 0.5% |
| Net income | $0.487 | $0.088 |
| Diluted EPS | $0.07 | $0.01 |
| Net cash used in operating activities | $2.636 | $1.572 |
| Capital expenditures | $0.479 | $0.412 |
Sales increased 9.0%. Private-label contract manufacturing rose 14.0% to $17.465 million, while patent and trademark licensing fell 36.7% to $0.961 million and branded products declined 15.1% to $0.269 million. Gross margin contracted 0.9 percentage points, despite better contract-manufacturing mix, as licensing revenue made up a smaller share of sales and manufacturing costs also affected results.
Operating income improved as selling, general and administrative expense fell 15.7% to $2.228 million, principally reflecting lower patent litigation costs. Other income was $0.092 million, including a $0.096 million foreign-exchange gain. The effective tax rate was 26.3%.
Financial position and liquidity
At September 30, 2014, cash and cash equivalents were $16.398 million, total assets were $51.798 million, and stockholders’ equity was $43.728 million. Current liabilities were $7.728 million. NAI reported no consolidated debt and no balances drawn on its credit facilities; $5.5 million was available under those facilities. The company was in compliance with credit covenants and said available cash and expected operating cash flows should fund working capital and capital expenditures for at least 12 months.
Cash decreased $3.114 million during the quarter. Operating activities used $2.636 million, mainly reflecting a $2.296 million cash outflow from accounts payable and accrued liabilities, along with increases in receivables and prepaids. Investing activities used $0.478 million, primarily for capital purchases. The filing reports a $1.4 million fair-value asset on foreign-exchange hedges and a $0.720 million after-tax unrealized hedge gain in other comprehensive income; the gain is not operating net income.
Changes, outlook, and material risks
- Management attributed manufacturing sales growth to increased volumes of existing products and new-product sales to new customers. Juice Plus+ international sales increased, while domestic sales declined; Mannatech sales also declined.
- CarnoSyn licensing revenue declined partly because of shipment timing and the absence of a $0.150 million Abbott license fee included in the prior-year quarter. Abbott had terminated its agreement in November 2013.
- NAI decided to discontinue its Pathway to Healing branded product line because of sustained sales declines. The related license termination took effect September 15, 2014, with wind-down activities expected to finish by the end of fiscal 2015’s second quarter. The segment was not presented as discontinued operations.
- Management planned to pursue new manufacturing customers, commercialize and protect its beta-alanine patent estate, and improve operational efficiency. It expected manufacturing concentration among its two largest customers to decline marginally during the remainder of fiscal 2015. No numerical earnings or revenue guidance was provided.
- Customer concentration remains material. The filing’s customer table reports three customers at 40%, 17%, and 13% of sales, while MD&A separately states that the top two represented 57% of private-label manufacturing sales. The table’s percentage denominator is not clearly consistent with its dollar figures; verify the underlying concentration disclosure.
- NAI depends on a limited number of suppliers for certain raw materials, including beta-alanine. Two suppliers represented 21% of raw-material purchases in the quarter. A supply interruption could affect sales and profitability.
- Patent litigation involving Woodbolt and other parties remained pending. The USPTO had rejected claims of the ’381 and ’422 patents, and NAI had appealed both decisions. The filing warns that an adverse patent outcome could materially harm the business. Separately, a lawsuit involving DNP was settled and dismissed; DNP agreed to exit the beta-alanine business.
- NAI used forward contracts to hedge forecast foreign-currency sales; their effectiveness is not guaranteed. The filing also identifies ordinary-course legal, tax, product-liability, regulatory, and other contingencies, without reporting a clear material loss estimate.
Most important facts for investors to verify
- Status and terms of renewal or expansion of the expired Juice Plus+ agreements, and the durability of monthly orders.
- Customer-concentration percentages and their denominators, particularly the discrepancy between the customer table and MD&A.
- Whether the company can sustain manufacturing growth and margins as licensing revenue falls and the branded line is wound down.
- Developments in the Woodbolt litigation and patent appeals, and the resulting implications for CarnoSyn royalties and licensing.
- Cash conversion and working-capital trends, including payable timing, and the continued availability of credit facilities and raw materials.