Natural Alternatives International, Inc. — Form 10-Q
Reporting period: Fiscal third quarter and nine months ended March 31, 2015; filed May 12, 2015. Unless otherwise stated, amounts are U.S. dollars in millions. Comparisons are with the corresponding 2014 periods.
Business context
NAI primarily provides private-label contract manufacturing of nutritional and health products. It also earns revenue from beta-alanine patent and trademark licensing and had a branded-products business that it discontinued. The company reported three segments: private-label contract manufacturing, patent and trademark licensing, and branded products.
Financial performance
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | 2015: $19.61; 2014: $19.13, up 2.5% | 2015: $56.93; 2014: $52.76, up 7.9% |
| Gross profit / margin | $3.67 / 18.7%; prior year $3.44 / 18.0% | $10.45 / 18.4%; prior year $8.70 / 16.5% |
| Operating income / margin | $1.04 / 5.3%; prior year $1.17 / 6.1% | $2.99 / 5.3%; prior year $1.52 / 2.9% |
| Net income | $0.79; prior year $0.62 | $2.36; prior year $0.90 |
| Diluted earnings per share | $0.12; prior year $0.09 | $0.35; prior year $0.13 |
| Cash from operating activities | Not separately presented for the quarter | $2.23; prior year $0.57 |
| Capital expenditures | Not separately presented for the quarter | $1.36; prior year $2.20 |
Third-quarter sales growth was led by patent and trademark licensing, up 100.7% to $2.29, while contract manufacturing fell 2.1% to $17.32. For the nine months, licensing revenue rose 23.5% to $4.71 and contract manufacturing rose 7.2% to $51.52. Branded-products sales declined as the Pathway to Healing line was wound down.
Quarterly gross margin improved 0.7 percentage points, but operating income declined 11.0% as SG&A rose 15.8%, including higher employee compensation and patent litigation costs. Nine-month operating income increased 96.4%; higher gross profit and favorable foreign-exchange activity contributed to the improved results.
Liquidity, debt and capital
At March 31, 2015, cash and cash equivalents were $19.42, current assets $43.31, current liabilities $8.64, total assets $54.10, and total liabilities $9.24. NAI had no consolidated debt outstanding. A Wells Fargo working-capital facility provides up to $5.0, and the filing reports $5.5 available across credit facilities, including the subsidiary facility. NAI was in compliance with its credit covenants. Management believed available cash and operating cash flows would fund working capital and capital expenditures for at least 12 months.
Nine-month operating cash flow improved to $2.23 from $0.57. Cash was $19.42 at period-end, down $0.09 from June 30, 2014. The company repurchased $0.98 of stock during the nine months. Its board increased the authorized repurchase plan to $3.0 in February and, after quarter-end, to $5.0 on May 11, 2015.
Changes, outlook and key risks
- NAI’s CSI beta-alanine licensing and distribution agreement expired March 31, 2015. Beginning April 1, NAI planned to sell beta-alanine directly and license related patent and trademark rights, seeking growth, additional contract-manufacturing opportunities, and improved profitability. Execution and the resulting revenue and margin impact were not quantified.
- Two contract-manufacturing customers represented 61% of segment sales in the first nine months, versus 53% in the prior-year period. One customer alone accounted for 45% of segment sales. Management expected concentration to decrease marginally during the remainder of fiscal 2015, citing anticipated new and other-customer sales.
- Management’s stated priorities were to develop manufacturing customer relationships, commercialize the beta-alanine patent estate, protect proprietary rights, improve operating efficiency, and manage costs and business risks. No numerical earnings or revenue guidance was provided.
- Foreign-exchange hedges had a $1.9 net asset fair value at March 31; approximately $1.2 of net gains was recorded in accumulated other comprehensive income. A majority of that balance was expected to be reclassified into earnings over the next 12 months as related sales occurred.
- NAI discontinued its Pathway to Healing branded line; wind-down activities were substantially complete by December 31, 2014. Better-than-expected sell-through allowed a $0.19 reversal of inventory reserves during the first nine months.
- Patent litigation involving Woodbolt and related parties remained pending. The USPTO had rejected claims of the ’381 and ’422 patents, and appeals were pending; the ’381 appeal hearing occurred April 15, 2015, with no decision reported. An adverse patent outcome could materially affect the business.
- Other stated risks include dependence on a small number of major customers and raw-material suppliers, availability of beta-alanine, foreign-currency movements, and potential legal, regulatory, tax, or product-related claims. The company reported no material off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether direct beta-alanine sales and licensing after April 1 replace or exceed the economics of the expired CSI arrangement.
- Whether customer concentration declines as management anticipated, and whether orders from major customers remain stable.
- Developments and outcomes in the Woodbolt litigation and patent re-examinations, including related legal costs.
- The sustainability of improved nine-month margins and earnings, given weaker third-quarter operating income and higher SG&A.
- Cash-flow conversion, hedge gains entering revenue, foreign cash availability and any tax cost if offshore funds are repatriated.