Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the first quarter of fiscal 2019. Comparative figures are for the three months ended September 30, 2017. Unless stated otherwise, dollar amounts below are in millions.
Business context and results
NAI primarily provides private-label contract manufacturing for nutritional and health products. It also sells beta-alanine raw materials and earns royalties and licensing revenue under its CarnoSyn and SR CarnoSyn brands.
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $36.532 | $28.074 | +30% |
| Gross profit | $7.163 | $6.370 | +12% |
| Income from operations | $2.724 | $1.883 | +45% |
| Net income | $2.559 | $1.434 | +78% |
| Diluted earnings per share | $0.37 | $0.21 | — |
| Operating cash flow | $4.746 | $2.314 | — |
Gross margin declined to 19.6% from 22.7%; operating margin rose to 7.5% from 6.7%, and net margin rose to 7.0% from 5.1%. The effective tax rate was 20.6%, versus 28.0%.
Drivers and comparison with prior period
- Private-label manufacturing sales rose 40% to $31.087 million, driven by new products and higher volumes for existing customers, including the largest customer. Segment operating income increased to $3.145 million from $2.257 million.
- Patent and trademark licensing sales fell 7% to $5.445 million, mainly due to lower average beta-alanine selling prices. Segment operating income increased to $1.802 million from $1.188 million.
- Cost of goods sold rose 35%, faster than sales, contributing to the lower gross margin. Management attributed a modest manufacturing margin improvement to lower per-unit costs; licensing margin contribution declined.
- Other income increased to $497,000 from $108,000, primarily reflecting favorable income associated with foreign currency hedge contracts. SG&A was nearly flat at $4.439 million.
Cash, liquidity, debt and other financial matters
- Cash and cash equivalents were $27.613 million at September 30, up from $23.613 million at June 30, 2018. Operating activities provided $4.746 million; investing activities used $777,000, including $796,000 of capital expenditures.
- Current assets were $69.905 million and current liabilities $15.420 million, a current ratio of approximately 4.5. Inventory was $24.972 million, up from $23.567 million at June 30.
- NAI had no borrowings on its $10 million working-capital credit line and no long-term debt; the full $10 million was available. It reported compliance with the credit facility covenants.
- Accounts receivable was $12.733 million. Days sales outstanding increased to 34 days from 29 days in the comparable quarter.
- Operating cash flow less capital expenditures was approximately $3.950 million. The company reported no material off-balance-sheet arrangements.
Outlook, risks and unusual items
- Management expects the largest customer’s annualized fiscal 2019 revenue concentration to be consistent with fiscal 2018 and believes cash, available credit and operating cash flows will fund working capital and capital expenditures for at least 12 months. No specific sales or earnings guidance was provided.
- The largest customer accounted for $21.078 million, or approximately 58% of quarterly sales, compared with $13.157 million, or approximately 47%, in the prior-year quarter. The filing’s overview contains an apparent date typo in its comparison; the sales table supports the prior-year comparison above. A second customer represented $3.729 million of current-quarter sales.
- Three largest customers together represented 67.6% of gross receivables at September 30. NAI also relies on a limited number of suppliers for certain raw materials, including beta-alanine. Loss of a major customer or qualifying supplier could materially affect results.
- NAI recorded $618,000 of litigation and patent-compliance expenses in the quarter, versus $972,000 a year earlier. It said it was involved in ordinary-course matters relating to enforcement of intellectual property rights; as of November 13, it reported no material pending legal proceeding. Outcomes and litigation costs remain uncertain.
- A $1.5 million note receivable from customer Kaged Muscle was extended from September 30 to December 28, 2018, for a $25,000 extension fee. The note bears 15% annual interest, is secured by the customer’s assets and personally guaranteed; NAI recognized $58,000 of interest income in the quarter.
- Foreign-exchange cash-flow hedges had a net fair-value asset of $955,000 and notional value of approximately $83.3 million. A $383,000 after-tax unrealized gain was recorded in comprehensive income, compared with a $1.134 million loss in the prior-year quarter. Hedge values and reclassifications can make comprehensive income volatile.
- NAI adopted the new revenue-recognition standard on July 1, 2018, using the modified retrospective method; management reported no material effect on historical or current-quarter financial statements. New Swiss facility and warehouse leases were entered into after quarter-end.
Important facts for investors to verify
- Whether sales growth and the expanded relationship with the largest customer are sustainable, and the resulting customer concentration exposure.
- Whether gross margins recover as manufacturing volume grows and product mix and beta-alanine pricing change.
- Collection and repayment of the Kaged Muscle note by its amended maturity date, and the customer’s credit condition.
- Availability and pricing of key raw materials, and the outcome and cost of ongoing intellectual-property enforcement matters.
- Foreign-exchange hedge performance, future reclassifications into earnings, and the terms and financial impact of the new Swiss leases.