NATURAL ALTERNATIVES INTERNATIONAL, INC. The following discussion and analysis is intended to help you understand our financial condition and results of operations as ofJune 30, 2020 and 2019 and for each of the last two fiscal years then ended. You should read the following discussion and analysis together with our audited consolidated financial statements and the notes to the consolidated financial statements included under Item 8 in this report. Our future financial condition and results of operations will vary from our historical financial condition and results of operations described below based on a variety of factors. You should carefully review the risks described under Item 1A and elsewhere in this report, which identify certain important factors that could cause our future financial condition and results of operations to vary. Executive Overview The following overview does not address all of the matters covered in the other sections of this Item 7 or other items in this report or contain all of the information that may be important to our stockholders or the investing public. You should read this overview in conjunction with the other sections of this Item 7, the financial statements and accompanying notes, and this report. Our primary business activity is providing private-label contract manufacturing services to companies that market and distribute vitamins, minerals, herbs and other nutritional supplements, as well as other health care products, to consumers both within and outside theU.S. Historically, our revenue has been largely dependent on sales to two or three private-label contract manufacturing customers and subject to variations in the timing of such customers' orders, which in turn is impacted by such customers' internal marketing programs, supply chain management, entry into new markets, new product introductions, the demand for such customers' products, and general industry and economic conditions. Our revenue also includes raw material sales, royalty and licensing revenue generated from our patent estate pursuant to license and supply agreements with third parties for the distribution and use of the ingredient known as beta-alanine sold under our CarnoSyn® and SR CarnoSyn® trademarks. A cornerstone of our business strategy is to achieve long-term growth and profitability and to diversify our sales base. We have sought and expect to continue to seek to diversify our sales by developing relationships with additional, quality-oriented, private-label contract manufacturing customers, and commercializing our patent estate through sales of beta-alanine under our CarnoSyn® and SR CarnoSyn® trade names, royalties from license agreements, and potentially additional contract manufacturing opportunities with licensees.
Impact of COVID-19 on Our Business
OnMarch 11, 2020 , theWorld Health Organization classified the novel coronavirus, or COVID-19, as a pandemic. The COVID-19 pandemic has resulted, and is likely to continue to result, in significant economic disruption and has and will likely affect our business. Significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic. Our facilities, located both inthe United States andEurope , continue to operate as an essential and critical manufacturer in accordance with applicable federal, state, and local regulations, however, there can be no assurance our facilities will continue to operate without interruption. Factors that derive from COVID-19 and the accompanying response, and that have or may negatively impact sales and gross margin in the future include, but are not limited to the following:
? Limitations on the ability of our suppliers to manufacture, or procure from
manufacturers, the products we sell, or to meet delivery requirements and
commitments;
? Limitations on the ability of our employees to perform their work due to
illness caused by the pandemic or due to other restrictions on our employees
to keep them safe and the increased cost of measures taken to ensure employee
health and safety;
? Local, state, or federal orders requiring employees to remain at home;
? Limitations on the ability of carriers to deliver our products to customers;
? Limitations on the ability of our customers to conduct their business and
purchase our products and services; and
? Limitations on the ability of our customers to pay us on a timely basis.
As a preventative measure to provide our business with potentially needed liquidity, and out of an abundance of caution, we withdrew$10 million from our credit facility with Wells Fargo in the third quarter of fiscal 2020. We will continue to actively monitor the situation and may take further actions to alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders. While we are unable to determine or predict the nature, duration, or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we believe we will be able to remain operational and our working capital will be sufficient for us to remain operational even as the longer term consequences of this pandemic become known. During fiscal 2020, our consolidated net sales were 14% lower than in fiscal 2019. Private-label contract manufacturing sales decreased 13% due primarily to lower volumes of current products to existing customers located primarily in theU.S. and European markets partially offset by new product sales to new and existing customers in the U.S market. During fiscal 2020, sales to our largest private-label contract manufacturing customer declined 23% primarily as a result of reduced customer demand. However, a majority of this decline occurred during the first nine months of fiscal 2020 while the fourth quarter of fiscal 2020 included a year over year increase in sales for this customer, primarily due to increased consumer demand and shipments of a newly awarded product. Fiscal 2021 sales from our largest private-label contract manufacturing customer are expected to increase as compared to fiscal 2020. Revenue concentration from our largest private-label contract manufacturing customer as a percentage of our total net sales decreased to 44% in fiscal 2020 from 49% in fiscal 2019. We expect this percentage to increase in fiscal 2021. 19
--------------------------------------------------------------------------------
Table of Contents
EffectiveMarch 31, 2020 , we terminated our ongoing relationship with one private-label contract manufacturing customer, Kaged Muscle. We are working with this former customer to assist them with completing their obligations to us, transition to a replacement manufacturer, and the transfer of inventory items we hold specific to this customer. Due to uncertainty regarding the future operations of this former customer, we reserved 100% of their outstanding accounts receivable balance and a majority of the inventory we hold for their products. As ofJune 30, 2020 , our balance sheet and results of operations for fiscal 2020 included total reserves (and accompanying expense) of$4.3 million related to this former customer. During fiscal 2020, CarnoSyn® beta-alanine revenue decreased 25% to$12.6 million as compared to$16.7 million for fiscal 2019. The decrease in CarnoSyn® revenue was primarily due to decreased beta-alanine shipments as a result of changes to consumer market trends and lower average beta-alanine sales prices. We believe this sales decline was also impacted by certain customers discontinuing the use of our CarnoSyn® beta-alanine in favor of generic beta-alanine and lower overall consumer demand for our customers' CarnoSyn® products, including the negative impact COVID-19 had on the sports nutrition industry in the latter part of fiscal 2020 due to the shutdown of athletic activities and gyms across theUSA . We continue to invest in research and development for our SR CarnoSyn® sustained release delivery system. We believe SR CarnoSyn® may provide a unique opportunity within the growing Wellness and Healthy Aging markets. We believe our recent efforts to refine our formulations and product offerings will be positively received and result in significant opportunity for increased SR CarnoSyn® sales. To protect our CarnoSyn® business, we incurred litigation and patent compliance expenses of approximately$2.0 million during fiscal 2020 and$2.4 million during fiscal 2019. The decrease in these legal expenses on a year over year basis was primarily due to the successful resolution of several cases that were settled and the successful completion of an effort to gain New Dietary Ingredient status from the FDA on our patented CarnoSyn® beta-alanine. We currently expect our litigation and patent compliance expenses to decrease during fiscal 2021 to an annual rate of approximately$1.0 million to$1.5 million . Our ability to maintain or further increase our beta-alanine royalty and licensing revenue will depend in large part on our ability to develop a market for our sustained release form of beta-alanine marketed under our SR CarnoSyn® trademark, maintain our patent rights, the availability and the cost of the raw material when and in the amounts needed, the ability to expand distribution of beta-alanine to new and existing customers, and continued compliance by third parties with our license agreements and our patent, trademark and other intellectual property rights. During fiscal 2021, we will continue our sales and marketing activities to consumers, customers, potential customers, and brand owners on multiple platforms to promote and reinforce the features and benefits of utilizing CarnoSyn® and SR CarnoSyn® beta-alanine. Based on our current sales order volumes and forecasts we have received from our customers, we expect our fiscal 2021 consolidated net sales to increase as compared to fiscal 2020. We also expect operating income will increase in fiscal 2021 due to increased sales and a non-recurrence of the$4.3 million accounts receivable and inventory reserve that was recorded in fiscal 2020. There can be no assurance our customer's sales and marketing activities as well as our own sales and marketing and litigation efforts will reverse or decelerate potential future sales declines. We are also closely monitoring the impact of the COVID-19 pandemic but we cannot reasonably estimate the length of time or severity of the pandemic and cannot currently estimate the impact this pandemic may have on our consolidated financial results for fiscal 2021 and beyond.
During fiscal 2021, we plan to continue our focus on:
• Leveraging our state-of-the-art, certified facilities to increase the value of
the goods and services we provide to our highly valued private-label contract
manufacturing customers, and assist us in developing relationships with
additional quality-oriented customers;
• Expanding the commercialization of our beta-alanine patent estate through raw
material sales, developing a new sales distribution channel under the Wellness
and Healthy Aging category for our sustained release form of beta-alanine
marketed under our SR CarnoSyn® trademark, exploiting new contract
manufacturing opportunities, license and royalty agreements, and protecting
our proprietary rights; and
• Improving operational efficiencies and managing costs and business risks to
improve profitability.
Critical Accounting Policies and Estimates
Our consolidated financial statements included under Item 8 in this report have been prepared in accordance withU.S. generally accepted accounting principles (GAAP). A description of our significant accounting policies can be found in the notes to our consolidated financial statements in Item 8 of this report. The preparation of financial statements in accordance with GAAP requires we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies we believe are important to the portrayal of our financial condition and results of operations. Implementation of these policies requires the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in making such estimates or assumptions. 20
--------------------------------------------------------------------------------
Table of Contents
Results of Operations
The following table sets forth selected consolidated operating results for each
of the last two fiscal years, presented as a percentage of net sales (dollars in
thousands).
Fiscal Year Ended
June 30, 2020 June 30, 2019 Increase (Decrease)
Private-label
contract
manufacturing $ 106,291 89 % $ 121,598 88 % $ (15,307 ) (13 )%
Patent and trademark
licensing 12,585 11 % 16,692 12 % (4,107 ) (25 )%
Total net sales 118,876 100 % 138,290 100 % (19,414 ) (14 )%
Cost of goods sold 100,005 84 % 114,715 83 % (14,710 ) (13 )%
Gross profit 18,871 16 % 23,575 17 % (4,704 ) (20 )%
Selling, general &
administrative
expenses 20,380 17 % 17,614 13 % 2,766 16 %
(Loss) income from
operations (1,509 ) (1 )% 5,961 4 % (7,470 ) (125 )%
Other (loss) income,
net (229 ) - % 1,992 1 % (2,221 ) (111 )%
(Loss) income before
income taxes (1,738 ) (2 )% 7,953 6 % (9,961 ) (122 )%
(Benefit) provision
for income taxes (93 ) - % 1,412 1 % (1,505 ) (107 )%
Net (loss) income $ (1,645 ) (1 )% $ 6,541 5 % $ (8,186 ) (125 )%
Private-label contract manufacturing net sales decreased 13% due primarily to
lower volumes of current products to existing customers located primarily in the
U.S. and European markets partially offset by new product sales to new and
existing customers in the U.S market. During fiscal 2020, sales to our largest
private-label contract manufacturing customer declined 23% primarily as a result
of reduced customer demand. However, a majority of this decline occurred during
the first nine months of fiscal 2020 while the fourth quarter of fiscal 2020
included a year over year increase in sales for this customer, primarily due to
increased consumer demand and shipments of a newly awarded product.
Net sales from our patent and trademark licensing segment decreased 25% during
fiscal 2020. The decrease in patent and trademark licensing revenue was
primarily due to decreased beta-alanine shipments as a result of changes to
consumer market trends and lower average beta-alanine sales prices. We believe
this sales decline was also impacted by certain customers discontinuing the use
of our CarnoSyn® beta-alanine in favor of generic beta-alanine and lower overall
consumer demand for our customers' CarnoSyn® products, which included the
negative impact COVID-19 had on the sports nutrition industry in the latter part
of fiscal 2020 due to the shutdown of athletic activities and gyms across the
USA .
The change in gross profit margin for the year ended June 30, 2020 , was as
follows:
Percentage
Change
Contract manufacturing(1) (1.1 )
Patent and trademark licensing(2) -
Total change in gross profit margin (1.1 )
1 Private-label contract manufacturing gross profit margin contribution
decreased 1.1 percentage points in fiscal 2020 as compared to fiscal 2019. The
decrease in gross profit as a percentage of sales in fiscal 2020 is primarily
due to a
contract manufacturing customers.
2 During fiscal 2020, patent and trademark licensing gross profit margin
contribution remained relatively consistent with prior year.
Selling, general and administrative expenses increased$2.8 million , or 16%, during fiscal 2020 as compared to fiscal 2019. This increase was primarily due$3.3 million of bad debt expense recorded related to a receivable from a former contract manufacturing customer that was partially offset by decreased litigation and patent compliance expenses associated with our CarnoSyn® beta-alanine patent estate. Other income (net) decreased$2.2 million during fiscal 2020 as compared to fiscal 2019. The decrease for fiscal 2020 was primarily due to the exclusion of the amortization of forward points from cash flow hedge instruments during the year endedJune 30, 2020 as compared to including$1.6 million in fiscal 2019. This change in classification of forward points is the result of the adoption of ASU No. 2017-12 that now requires the amortization of forward points be included as a component of net revenues while they were previously included as a component of other income. The remaining portion of the decrease primarily related to foreign currency exchange losses associated with fluctuations in various foreign exchange rates used to revalue our balance sheet. Our income tax expense decreased$1.5 million during fiscal 2020 as compared to fiscal 2019. The decrease was primarily due to the decrease in income before taxes when compared to fiscal 2019. 21
--------------------------------------------------------------------------------
Table of Contents
Liquidity and Capital Resources
Our primary sources of liquidity and capital resources are cash flows provided by operating activities and the availability of borrowings under our credit facilities. Net cash provided by operating activities was$3.7 million in fiscal 2020 compared to net cash provided by operating activities of$6.6 million in fiscal 2019. We had a loss of$1.6 million in fiscal 2020 as compared to net income of$6.5 million in fiscal 2019. This decrease in net income was primarily due to lower consolidated sales and an accounts receivable and inventory reserve recorded in fiscal 2020 related to one of our former contract manufacturing customers. AtJune 30, 2020 , changes in accounts receivable, consisting primarily of amounts due from our private-label contract manufacturing customers and our patent and trademark raw material sales activities, used$4.3 million in cash compared to using$1.3 million in fiscal 2019. The increase in cash used by accounts receivable during fiscal 2020 primarily resulted from timing of sales and the related collections at the end of fiscal 2020 as compared to fiscal 2019. In addition, provision for uncollectible accounts receivable used$3.3 million in fiscal 2020 as compared to zero for fiscal 2019. The change in provision for uncollectible accounts receivable was primarily associated with a reserve recorded associated with a former contract manufacturing customer. Days sales outstanding (DSO) increased to 51 days during fiscal 2020 compared to 40 days during fiscal 2019, primarily due to customer sales mix and timing of sales and the related collections. Inventory used$2.0 million in cash during fiscal 2020 compared to using$2.4 million in fiscal 2019. The change in cash activity from inventory was primarily related to the timing of sales and anticipated sales at the end of fiscal 2020 as compared to fiscal 2019. Inventory at the end of fiscal 2020 also included a buildup of inventory associated with anticipated new product launches from multiple private-label contract manufacturing customers and increased inventory related to our CarnoSyn® beta-alanine business. Changes in accounts payable and accrued liabilities provided$2.7 million in cash during fiscal 2020 compared to using$0.5 million during fiscal 2019. The change in cash flow activity related to accounts payable and accrued liabilities is primarily due to the timing of inventory receipts and payments. Cash used in investing activities in fiscal 2020 was$4.5 million compared to$3.8 million in fiscal 2019. Capital expenditures were$4.5 million during fiscal 2020 compared to$5.3 million in fiscal 2018. Capital expenditures during fiscal 2020 and fiscal 2019 were primarily for manufacturing equipment used in ourVista, California and Manno,Switzerland facilities. Investing activities in fiscal 2019 also included the collection of the$1.5 million note receivable. Cash provided by financing activities in fiscal 2020 was$6.3 million , compared to using$1.3 million in fiscal 2019. This change is primarily due to$10.0 million in proceeds from our line of credit, withdrawn as a measure to provide our business with liquidity out of an abundance of caution due to the COVID-19 pandemic, offset by increased repurchases of our stock. AtJune 30, 2020 we had$10.0 million due in connection with our loan facility. As ofJune 30, 2019 , we had no outstanding balances due in connection with our loan facility. During fiscal 2020 we were in compliance with all of the financial and other covenants required under our Credit Agreement. Refer to Note F, "Debt," in Item 8 of this report, for terms of such Credit Agreement and additional information. As ofJune 30, 2020 , we had$30.5 million in cash and cash equivalents. Of these amounts,$13.8 million of cash and cash equivalents were held by NAIE. Overall, we believe our available cash, cash equivalents and potential cash flows from operations will be sufficient to fund our current working capital needs and capital expenditures through at least the next 12 months.
Off-Balance Sheet Arrangements
As ofJune 30, 2020 , we did not have any significant off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons, in each case that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses material to investors. Inflation During fiscal 2020 and 2019, we did not experience any significant increases in product raw material or operational costs we attributed to inflationary factors. We currently believe increasing raw material and product cost pricing pressures will exist throughout fiscal 2021 as a result of limited supplies of various ingredients, the effects of higher labor and transportation costs, and the impact of COVID-19. We do not believe current inflation rates will have a material impact on our fiscal 2021 operations or profitability. 22
--------------------------------------------------------------------------------
Table of Contents
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included under Note A in the notes to our consolidated financial statements which are included under Item 8 of this report.
© Edgar Online, source
