Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2012, three months ended September 30, 2011; comparisons are with the three months ended September 30, 2010 unless otherwise noted. Amounts are in U.S. dollars; financial statement amounts are generally in millions.
Business context and results
NAI provides private-label nutritional supplement manufacturing, licenses patents and trademarks related principally to CarnoSyn beta-alanine, and sells branded products, primarily Pathway to Healing. The company began reporting three business segments in fiscal 2012.
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Net sales | $18.341m | $13.355m | +37.3% |
| Gross profit / margin | $4.683m / 25.5% | $2.675m / 20.0% | +75.1%; margin +5.5 percentage points |
| Operating income / margin | $2.347m / 12.8% | $0.935m / 7.0% | +151.0% |
| Net income / margin | $1.528m / 8.3% | $0.912m / 6.8% | +67.5% |
| Diluted EPS | $0.22 | $0.13 | Increased |
| Operating cash flow | $(1.389)m | $0.063m | Decreased |
| Capital expenditures | $0.420m | $0.317m | Increased |
Revenue mix and material changes
- Private-label contract manufacturing: $16.606m, up 32.4%. Management attributed growth mainly to higher volumes of established products, a new customer, and increased international demand; some gains were offset by lower sales to other existing customers.
- Patent and trademark licensing: $1.334m, up 322.2%, primarily reflecting greater CarnoSyn beta-alanine demand. Reported royalty income was $1.3m; no Abbott royalty payments were received in the quarter.
- Branded products: $0.401m, down 18.5%, reflecting continued softness in Pathway to Healing sales.
- Sales to the two largest customers totaled $12.710m, or 69% of revenue, versus 71% a year earlier; one represented 46% of current-quarter sales. U.S. sales were $10.190m and non-U.S. sales were $8.151m.
- Gross margin improvement primarily reflected lower manufacturing labor and overhead as a percentage of sales and the larger licensing contribution. SG&A increased 34.3% to $2.336m, including higher domestic employee costs and patent litigation and prosecution expenses.
Cash, liquidity, debt, and balance sheet
- Cash and cash equivalents were $13.633m at September 30, down from $15.461m at June 30, 2011. Operating cash use was driven mainly by a $3.411m increase in accounts receivable and a $2.575m increase in inventory, partly offset by higher payables and accrued liabilities. Days sales outstanding improved to 25 days from 35 days a year earlier.
- Current assets were $32.582m and current liabilities $7.373m at quarter end. Inventory rose to $9.074m from $6.499m at June 30; receivables rose to $6.652m from $3.287m.
- NAI reported no consolidated debt outstanding. It had $5.0m available under its Wells Fargo working-capital line and an additional Swiss subsidiary facility; total available credit was reported as $5.7m. The company was in covenant compliance. The facilities are subject to conditions, and the Wells Fargo line is secured by specified assets.
- Management said cash, cash equivalents, and expected operating cash flows should fund working capital needs and capital expenditures for at least the next 12 months.
Outlook, risks, contingencies, and unusual items
- Management’s priorities for the remainder of fiscal 2012 include growing contract manufacturing relationships, commercializing and protecting the beta-alanine patent estate, pursuing focused initiatives for Pathway to Healing, and improving efficiency and cost management. The filing provides no formal revenue or earnings guidance.
- Management expected the two-largest-customer share of contract manufacturing sales to decline marginally during the rest of fiscal 2012, assuming anticipated new-customer and existing-customer sales. Results remain exposed to order timing and substantial customer concentration.
- Abbott’s 10-year beta-alanine license agreement includes an initial $0.3m fee already paid, but Abbott may terminate through March 31, 2012. Additional fees are milestone- and continuation-dependent, including $0.45m on or before March 31, 2012 and $4.25m in six annual payments beginning March 2012. Future fees and royalties are not assured.
- NAI settled its patent dispute with VPX in August 2011 under a limited covenant not to sue; litigation against DNP continued. Litigation expense was approximately $0.317m in the quarter, and management estimated $0.1m–$0.15m per quarter for the remainder of fiscal 2012. Outcome and costs are uncertain.
- Foreign-exchange hedges had a $0.715m fair-value asset at quarter end; a net gain of approximately $0.667m was in accumulated other comprehensive income and was expected to be reclassified into earnings over the next 12 months as related transactions occur. Hedge effectiveness is not guaranteed.
- The effective tax rate was 37.1%, versus a low prior-year rate when domestic net operating loss carryforwards offset domestic tax expense. The quarter also included a $0.394m after-tax unrealized derivative gain in comprehensive income.
Key facts for investors to verify
- Whether manufacturing growth and higher margins persist without increasing dependence on the two largest customers.
- Whether the receivables and inventory build converts to cash, and whether operating cash flow improves.
- Whether Abbott continues the agreement and satisfies the conditions for additional license fees and future royalties.
- The progress, outcome, and remaining cost of the DNP litigation, and any effects on the patent estate or licensing income.
- Whether CarnoSyn beta-alanine supply, distribution, and third-party compliance support continued licensing growth; whether Pathway to Healing sales stabilize.
- Whether the company remains compliant with credit-facility covenants and achieves its stated liquidity expectations.