Natural Alternatives International, Inc. — Form 10-Q Summary
Business and period: NAI provides private-label nutritional supplement contract manufacturing and sells beta-alanine raw materials and licensing rights under its CarnoSyn and SR CarnoSyn brands. This report covers the quarter and six months ended December 31, 2017, the second quarter and first half of fiscal 2018. Financial statement amounts below are in millions of dollars unless otherwise stated.
Financial performance
| Metric | Quarter ended Dec. 31, 2017 | Prior-year quarter | Six months ended Dec. 31, 2017 | Prior-year six months |
|---|---|---|---|---|
| Net sales | $33.3 | $30.6 | $61.4 | $64.6 |
| Gross profit / margin | $6.6 / 19.9% | $6.5 / 21.3% | $13.0 / 21.2% | $14.2 / 21.9% |
| Operating income / margin | $2.3 / 6.8% | $3.1 / 10.2% | $4.2 / 6.8% | $6.6 / 10.3% |
| Income before taxes | $2.5 | $3.5 | $4.5 | $7.1 |
| Income tax provision | $3.8 | $1.0 | $4.4 | $2.1 |
| Net income (loss) | $(1.3) | $2.5 | $0.1 | $5.0 |
| Diluted earnings (loss) per share | $(0.20) | $0.37 | $0.02 | $0.74 |
- Quarterly sales rose 9%, led by contract manufacturing, up 23% to $29.4 million. Patent and trademark licensing sales fell 41% to $4.0 million.
- First-half sales declined 5%. Contract manufacturing was nearly flat at $51.6 million, while patent and trademark licensing fell 27% to $9.8 million. CarnoSyn beta-alanine sales and royalty income were $9.8 million versus $13.4 million in the prior-year period.
- Quarterly gross margin fell 1.4 percentage points and first-half margin fell 0.8 points. SG&A rose 28% for the quarter and 17% for the half, reflecting increased marketing, advertising, research and development, and compensation costs, partly offset by lower litigation costs.
- Reported tax expense included approximately $3.3 million of discrete Tax Cuts and Jobs Act items: a $1.8 million deemed repatriation tax, $775,000 of estimated foreign withholding taxes, and a $664,000 provisional deferred-tax remeasurement. These items drove the quarterly net loss; tax accounting remained provisional.
Cash flow, balance sheet, and liquidity
- First-half operating cash flow was $4.7 million, compared with $5.0 million in the prior year. Investing activities used $3.6 million, including a $1.5 million note receivable and $2.1 million of capital expenditures. Financing activities used $0.1 million, primarily for shares withheld for employee tax obligations.
- Cash and cash equivalents were $28.8 million at December 31, 2017, up from $27.8 million at June 30, 2017. Total assets were $84.6 million and stockholders’ equity was $60.9 million.
- Current assets were $62.7 million and current liabilities $19.2 million. Accounts receivable increased to $12.9 million from $8.4 million; inventory rose to $17.9 million from $13.7 million.
- NAI had no drawn borrowings or long-term debt. Its $10.0 million Wells Fargo working-capital line was available through February 1, 2020; the company reported compliance with covenants. Management stated cash, working capital, and expected operating cash flows should fund needs and capital expenditures for at least 12 months.
- A $1.5 million trade receivable from customer Kaged Muscle was converted to a 12-month, interest-only note bearing 15% annual interest, secured by the customer’s assets and a personal guarantee.
Material changes, outlook, and risks
- Management attributed first-quarter contract manufacturing weakness to reduced orders from its largest customer during an inventory reduction program. Second-quarter contract manufacturing sales rebounded, with the largest customer’s orders returning to historical levels and new products shipping under an expanded relationship.
- The largest customer represented 53% of first-half sales, up from 50% a year earlier; NAI expects fiscal 2018 annualized concentration to exceed fiscal 2017. The three largest customers together represented 76.1% of gross receivables at December 31.
- Beta-alanine sales were affected by market and seasonal softness, lower average selling prices, excess inventory in some retail channels, and increased generic competition. NAI said reorder rates had improved for many brands entering the third quarter and SR CarnoSyn sales continued to rise, but cautioned that these trends may not reverse future declines.
- NAI’s five-year agreements with Juice Plus+ grant exclusive manufacturing rights for certain products in 24 countries. NAI granted 500,000 restricted shares, with associated expense recorded as a reduction to revenue: $245,000 in the quarter and $408,000 year to date.
- Foreign-exchange cash-flow hedges had a $2.7 million net liability and a $52.6 million notional amount at December 31. Approximately $2.0 million of hedge losses were expected to be reclassified into earnings over the next 12 months alongside the related forecast transactions.
- NAI plans to grow contract manufacturing relationships, commercialize its beta-alanine patent portfolio, and improve efficiencies and cost management. No specific revenue or earnings guidance was provided. Key uncertainties include customer and supplier concentration, order timing, raw-material availability, generic competition, patent protection and litigation outcomes, currency fluctuations, and product quality or recall risks.
- Several intellectual-property disputes were ongoing or subject to appeal; one matter involving Hi-Tech Pharmaceuticals remained stayed. NAI said it generally did not expect ordinary-course legal matters to materially harm the business, but acknowledged outcomes and expenses are uncertain. Disclosure controls were assessed as effective, with no material internal-control changes reported.
Important facts for investors to verify
- Whether the largest customer’s elevated sales concentration and order levels persist, and how the Juice Plus+ manufacturing arrangement develops.
- Whether beta-alanine demand, pricing, SR CarnoSyn adoption, and generic competition support a recovery in licensing-segment revenue.
- The finalized tax effects of the Tax Cuts and Jobs Act and the effect of installment payments for the deemed repatriation tax.
- Whether working-capital increases, customer receivable exposure, and the Kaged Muscle note convert to cash as expected.
- The eventual outcomes, costs, and potential business effects of patent litigation and other intellectual-property enforcement efforts.