Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2014, the three months ended September 30, 2013. Comparative results are for the three months ended September 30, 2012. Balance sheet comparisons are with June 30, 2013. Amounts below are in U.S. dollars; financial statement amounts are in thousands unless stated otherwise.
Business context
NAI primarily manufactures nutritional supplements under contract for third parties. It also earns income from beta-alanine patent and trademark licensing, including its CarnoSyn brand, and sells branded products, mainly Pathway to Healing. Management’s stated priorities include diversifying customers, commercializing and protecting its beta-alanine patent estate, and improving operational efficiency and profitability.
Financial performance
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Net sales | $17.155 million | $16.460 million |
| Gross profit / margin | $2.734 million / 15.9% | $3.702 million / 22.5% |
| Operating income / margin | $90,000 / 0.5% | $1.029 million / 6.3% |
| Net income | $88,000 | $697,000 |
| Basic and diluted EPS | $0.01 | $0.10 |
| Operating cash flow | $(1.572) million | $313,000 |
| Capital expenditures | $412,000 | $258,000 |
Sales rose 4.2%. Contract manufacturing sales increased 3.9% to $15.320 million, licensing sales increased 10.5% to $1.518 million, and branded product sales declined 7.3% to $317,000. Despite higher sales, gross profit fell 26.1% and gross margin contracted 6.6 percentage points. Management attributed the contract manufacturing margin decline chiefly to lower prices on some high-volume products, an unfavorable product mix, material costs, and lower average euro exchange rates. SG&A decreased 1.1% to $2.644 million. Net income fell 87.4%.
Operating cash use reflected a $1.580 million increase in accounts receivable and a $1.475 million inventory build, partly associated with new customer product launches and shipment timing. Cash and cash equivalents were $14.782 million at quarter-end, down from $16.697 million at June 30.
Financial position and liquidity
At September 30, 2013, total assets were $47.554 million, total liabilities were $7.298 million, and stockholders’ equity was $40.256 million. Current assets were $36.486 million and current liabilities were $7.002 million. NAI reported no consolidated debt outstanding and $5.6 million available under its credit facilities; it was in compliance with credit agreement covenants. The $5.0 million Wells Fargo line is subject to financial eligibility requirements and is secured by specified company assets.
The company reported a $359,000 net liability on foreign exchange forward contracts at quarter-end. The contracts had approximately $11.8 million notional value; NAI expected $282,000 of hedge losses to be reclassified into earnings during the following 12 months.
Material changes, outlook, risks and unusual items
- Customer concentration remained substantial: the two largest private-label manufacturing customers represented 58% of that segment’s sales, down from 72% in the comparable quarter. Three customers individually represented at least 10% of private-label sales in Q1 FY2014; together they accounted for 71% of total company sales. Management expected concentration to decrease marginally during the rest of fiscal 2014 as new and existing customer sales grew.
- Sales to NSA International declined, including a customer-directed inventory reduction and weaker demand. Management expected the inventory reduction program to conclude in the quarter ending December 31, 2013. Sales to Mannatech rose, while sales to other customers also increased.
- CarnoSyn royalty and licensing revenue increased, primarily with market demand. Abbott could terminate its agreement through December 1, 2013; accordingly, NAI cautioned that additional license fees and royalties were not assured. Management did not anticipate material direct purchases and sales of beta-alanine raw material during the remainder of fiscal 2014.
- NAI incurred approximately $800,000 of patent litigation and compliance expenses in the quarter. Patent disputes involving DNP and Woodbolt remained pending, including patent re-examination proceedings. The company also faced two product-liability suits involving products it said it did not formulate, manufacture, distribute, or sell; insurance provided defense counsel, and NAI sought indemnification. Motions to dismiss remained pending as described in the filing.
- Management said available cash, potential operating cash flows, and credit availability should fund current working-capital needs and capital spending for at least 12 months. No quantified revenue or earnings guidance was provided. Management highlighted customer order timing, customer concentration, raw-material availability, foreign exchange, margins, patent protection, and litigation as risks.
- Other comprehensive loss was $208,000, primarily reflecting changes in the fair value of cash-flow hedges. A prior-period expense reclassification of $118,000 between cost of goods sold and SG&A was made to reflect NAIE’s expanded selling and administrative activity; it did not affect previously reported net income.
Most important facts for investors to verify
- Whether gross margin stabilizes after the sharp contraction and whether lower pricing, product mix, material costs, and currency continue to pressure contract manufacturing profitability.
- Whether operating cash flow recovers as receivables and inventory convert to cash, particularly following the inventory build and NAIE cash use.
- Whether customer concentration continues to decline and the expected NSA inventory reduction ends as management anticipated.
- Whether Abbott continues the beta-alanine agreement and what license fees, supply sales, or royalties are ultimately received.
- Developments in the patent disputes, patent re-examinations, and product-liability cases, including potential costs or effects on NAI’s patent rights and business.
- Foreign-exchange hedge outcomes and the timing and earnings impact of amounts expected to be reclassified from accumulated other comprehensive income.