Natural Alternatives International, Inc. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2017 (the first quarter of fiscal 2018, despite the request metadata labeling it “2017 Q1”). Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context and performance
NAI manufactures private-label nutritional supplements and sells beta-alanine raw materials and licenses related CarnoSyn and SR CarnoSyn intellectual property. Revenue is substantially dependent on a small number of customers and on order timing.
| Metric | Quarter ended Sep. 30, 2017 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $28.074 million | $34.067 million | Down 18% |
| Gross profit / margin | $6.370 million / 22.7% | $7.669 million / 22.5% | Gross profit down 17%; margin up 0.2 points |
| Operating income / margin | $1.883 million / 6.7% | $3.536 million / 10.4% | Down 47% |
| Net income | $1.434 million | $2.490 million | Down 42% |
| Diluted EPS | $0.21 | $0.37 | Down $0.16 |
| Operating cash flow | $2.314 million provided | $0.124 million used | Improved |
Private-label manufacturing sales fell 19% to $22.222 million; patent and trademark licensing sales fell 13% to $5.852 million. The largest customer represented 47% of sales, versus 50% a year earlier. U.S. sales were nearly flat at $15.194 million, while sales outside the U.S. declined to $12.880 million from $18.842 million.
Gross margin improved slightly overall: manufacturing margin contribution weakened by 1.4 percentage points, while licensing improved by 1.6 points, primarily due to lower raw-material costs. SG&A rose 9% to $4.487 million, mainly on increased marketing, advertising and R&D for CarnoSyn brands, partly offset by lower compensation. The effective tax rate was 28.0%, compared with a 34% U.S. statutory rate; management attributed the difference primarily to lower-taxed foreign earnings.
Financial position, cash flow and liquidity
- Cash and cash equivalents were $27.706 million at September 30, 2017, compared with $27.843 million at June 30, 2017. Total assets were $80.949 million; stockholders’ equity was $61.904 million.
- Inventory increased to $18.996 million from $13.729 million. Management said purchases supported anticipated manufacturing sales growth. Operating cash flow included a $5.267 million inventory cash use, substantially offset by a $5.773 million cash source from accounts payable and accrued liabilities.
- Investing activities used $2.451 million, including $956,000 of capital expenditures and a $1.5 million note receivable created by converting customer trade receivables. The note to Kaged Muscle bears 15% annual interest, is interest-only, matures in 12 months, and is secured by company assets and a personal guarantee.
- NAI reported no outstanding debt and no draw on its $10 million Wells Fargo working-capital line, which matures February 1, 2020. It had $10 million available under credit facilities and was in covenant compliance. Management believes cash and expected operating cash flows will fund working capital and capital expenditures for at least 12 months.
- Foreign-exchange forward contracts had a net fair-value liability of approximately $2.3 million. A $1.134 million after-tax unrealized derivative loss reduced comprehensive income; approximately $1.6 million was expected to be reclassified into earnings over the following 12 months.
Outlook, risks and notable items
- Management expected second-quarter fiscal 2018 sales of certain products to the largest customer to recover toward historical levels after that customer’s inventory reduction, and expected additional sales from an expanded relationship. Management also expected fiscal 2018 revenue concentration in that customer to exceed fiscal 2017 levels. These are expectations, not guarantees.
- Beta-alanine revenue declined 13%, reflecting lower shipments, market and seasonal factors, and lower average selling prices. Management cited increasing generic competition despite active instant-release patents, and said there is no assurance marketing or SR CarnoSyn commercialization will reverse or slow declines. Litigation and patent-compliance expense was approximately $972,000 in the quarter.
- On August 7, 2017, NAI agreed to manufacture certain Juice Plus+ products exclusively in 24 countries for five years. The arrangement includes a restricted award of 500,000 NAI shares, subject to restrictions and forfeiture provisions; $163,000 of related expense reduced revenue in the quarter.
- Several patent-infringement claims against competitors were dismissed at the district-court level; NAI said it intended to appeal. Other claims remain, and litigation outcomes and costs are uncertain. The filing states ordinary-course claims generally are not expected to materially affect the company, but an unfavorable outcome could harm results.
- Key risks include dependence on major customers, limited suppliers for certain raw materials, order and shipment timing, foreign-exchange exposure, competition and protection of intellectual property, and product quality or recall risks. No specific full-year sales or earnings guidance was provided.
Important facts for investors to verify
- Whether the largest customer’s inventory normalization and expanded relationship produce the expected sales recovery, and how customer concentration evolves.
- Whether beta-alanine shipments, prices, SR CarnoSyn adoption, and licensing revenue stabilize amid generic competition and patent litigation.
- Repayment and collectability of the $1.5 million Kaged Muscle note, including the customer’s ability to meet interest and principal obligations.
- Future inventory conversion into sales and cash, and whether operating cash flow remains positive beyond this quarter.
- Changes in the fair value and earnings reclassification of foreign-exchange hedges, and developments in the patent cases and appeals.