# Natural Alternatives International Inc: Form 10-Q for the period ended Sep 30, 2022

- Company: [Natural Alternatives International Inc](/companies/naii.md) (CIK 787253)
- Form: 10-Q
- Filed: 2022-11-09
- Accepted by EDGAR: Nov 9, 2022, 16:31 ET
- Period: 2022-09-30
- Accession: 0001437749-22-026615
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/787253/000143774922026615/naii20220930_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/787253/000143774922026615/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-07-01 to 2022-09-30 | $43.1m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Cost of revenue | 3 months, 2022-07-01 to 2022-09-30 | $37.8m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2022-07-01 to 2022-09-30 | $5.4m | us-gaap:GrossProfit |
| Selling, general and administrative | 3 months, 2022-07-01 to 2022-09-30 | $3.8m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2022-07-01 to 2022-09-30 | $1.5m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2022-07-01 to 2022-09-30 | $265.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-07-01 to 2022-09-30 | $1.1m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.18 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-07-01 to 2022-09-30 | $0.18 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-07-01 to 2022-09-30 | 5,943,446 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2022-07-01 to 2022-09-30 | −$4.6m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2022-07-01 to 2022-09-30 | $7.8m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Share repurchases | 3 months, 2022-07-01 to 2022-09-30 | $497.0k | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2022-09-30 | $12.3m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-09-30 | $74.4m | us-gaap:AssetsCurrent |
| Total assets | at 2022-09-30 | $149.6m | us-gaap:Assets |
| Current liabilities | at 2022-09-30 | $26.8m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-09-30 | $59.7m | us-gaap:Liabilities |
| Shareholders' equity | at 2022-09-30 | $89.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 20,994 characters.

The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three months ended September 30, 2022. You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to the condensed consolidated financial statements included under Item 1 in this Report, as well as the risk factors and other information included in our 2022 Annual Report and other reports and documents we file with the SEC. 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.

### Executive Overview

*The following overview does not address all of the matters covered in the other sections of this Item 2 or other items in this Report nor does it 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 2 and this Report.*

Our primary business activity is providing private-label contract manufacturing services to companies that market and distribute vitamins, minerals, herbal and other nutritional supplements, as well as other health care products, to consumers both within and outside the U.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 and royalty and licensing revenue generated from license and supply agreements with third parties, granting them the right to use our patents, trademarks and other intellectual property in connection with 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.

During the first three months of fiscal 2023, our net sales were 12% higher than in the first three months of fiscal 2022. Private-label contract manufacturing sales increased 24% primarily due to higher sales to our two largest customers, partially offset by decreased sales to other smaller customers and lower average exchange rates applied to sales denominated in Euro as compared to the prior year period. Our foreign exchange rates as applied to sales denominated in Euro decreased to a weighted average of 1.12 EUR/USD in the first three months of fiscal 2023 compared to a weighted average of 1.18 EUR/USD during the first three months of fiscal 2022. Revenue concentration risk for our largest private-label contract manufacturing customer as a percentage of our total net sales remained consistent at 35% for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021. We expect our annualized fiscal year 2023 revenue concentration for our largest customer to be comparable to fiscal 2022 revenue.

During the first three months of fiscal 2023, patent and trademark licensing revenue decreased 72% to $1.4 million, compared to revenue of $4.8 million for the first three months of fiscal 2022. The decrease in patent and trademark licensing revenue during the first three months of fiscal 2023 was primarily due to a decrease in orders from existing customers as a result of market and inflationary factors along with a general slowdown in the Sports Nutrition sales channel. Included in the market factors is the fact that the first three months of fiscal 2022 benefited from a ramp up of Sports Nutrition sales activity due to easing COVID restrictions on athletic activities with no corresponding activity in the first three months of fiscal 2023.

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 and our patents, trademarks and other intellectual property, we incurred litigation and patent compliance expenses of approximately $30,000 during the first three months of fiscal 2023 as compared to $0.1 million during the comparable period in fiscal 2022. Our legal expense associated with our CarnoSyn® business has remained low as we have no active litigation and the current run-rate of expenses is only related to maintenance of the patent estate. 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, obtain the raw material beta-alanine when and in the amounts needed, 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 the remainder of fiscal 2023, 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 now anticipate our fiscal 2023 consolidated net sales will be slightly up as compared to fiscal 2022. While sales are expected to increase during fiscal 2023 when compared to fiscal 2022, we anticipate operating income will be negatively impacted by changes in sales mix, unfavorable foreign exchange rates, and inflationary factors including increased operational costs impacted by increased labor, raw material, freight and supply chain costs. We are working with both suppliers and customers to attempt to mitigate the expected negative impact on our fiscal 2023 financial results. There can be no assurances our expectations will result in the currently anticipated increase in net sales and expected operating income levels.

### Impact of COVID-19 on Our Business

The COVID-19 pandemic has resulted, and is likely to continue to result, in significant economic disruption and has and will likely continue to affect our business. Significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic. Our facilities, located both in the United States and Europe, have maintained operations throughout the duration of the COVID-19 pandemic, 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 materials included in 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;
- Limitation on the availability of qualified individuals to adequately staff our manufacturing facilities;
- Limitations on the ability of our suppliers to manufacture and meet timelines associated with capital improvement projects;
- 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.

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 the remainder of fiscal year 2023, we also 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 to assist us in developing relationships with additional quality oriented customers;
- Completing construction on our new high-volume powder blending and packaging facility, which we expect to be operational by mid-to-late fiscal year 2023;
- 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.

18

### Discussion of Critical Accounting Estimates

We have identified the following as our most critical accounting estimates, which are those that are most important to the portrayal of the Company’s financial condition and results, and that require management’s most subjective and complex judgments. Information regarding our other significant accounting estimates and policies are disclosed in Note 1 of Item 1 of this report and are disclosed in the 2022 Annual Report.

Revenue Recognition — Revenue is measured as the net amount of consideration expected to be received in exchange for fulfilling one or more performance obligations. For certain contracts with volume rebates and discounts, our estimates of future sales used to assess the volume rebate and discount estimates are subject to a high degree of judgement and may differ from actual sales due to, among other things, changes in customer orders and raw material availability.

### Results of Operations

The results of our operations for the three months ended September 30 were as follows (dollars in thousands):

|  | Three Months Ended September 30, 2022 | 2021 | % Change |
| --- | ---: | ---: | ---: |
| Private-label contract manufacturing | $41,776 | $33,594 | 24% |
| Patent and trademark licensing | 1,351 | 4,746 | (72)% |
| Total net sales | 43,127 | 38,340 | 12% |
| Cost of goods sold | 37,756 | 30,059 | 26% |
| Gross profit | 5,371 | 8,281 | (35)% |
| Gross profit % | 12.5% | 21.6% |  |
| Selling, general and administrative expenses | 3,829 | 4,053 | (6)% |
| % of net sales | 8.9% | 10.6% |  |
| Income from operations | 1,542 | 4,228 | (64)% |
| % of net sales | 3.6% | 11.0% |  |
| Total other expense | (224) | (26) | 762% |
| Income before income taxes | 1,318 | 4,202 | (69)% |
| % of net sales | 3.1% | 11.0% |  |
| Provision for income taxes | 265 | 946 | (72)% |
| Net income | $1,053 | $3,256 | (68)% |
| % of net sales | 2.4% | 8.5% |  |

Private-label contract manufacturing net sales increased 24% during the three months ended September 30, 2022, when compared to the same period in the prior year. The increase in sales during the three months ended September 30, 2022 was primarily due to increased sales to our two largest customers, partially offset by decreased sales to other smaller customers and lower average exchange rates applied to sales denominated in Euro as compared to the prior year period. Our foreign exchange rates as applied to sales denominated in Euro decreased to a weighted average of 1.12 EUR/USD in the first three months of fiscal 2023 compared to a weighted average of 1.18 EUR/USD during the first three months of fiscal 2022.

Net sales from our patent and trademark licensing segment decreased 72% during the three months ended September 30, 2022, when compared to the same period in the prior year. The decrease in patent and trademark licensing revenue during the three months ended September 30, 2022 was primarily due to a decrease in orders from existing customers as a result of market and inflationary factors along with a general slowdown in the Sports Nutrition sales channel. Included in the market factors is the fact that the first three months of fiscal 2022 benefited from a ramp up of Sports Nutrition sales activity due to easing COVID restrictions on athletic activities with no corresponding activity in the first three months of fiscal 2023.

The change in gross profit margin for the three months ended September 30, 2022, was as follows:

|  | Three Months Ended |
| --- | ---: |
| Contract manufacturing(1) | (2.6)% |
| Patent and trademark licensing(2) | (6.5) |
| Total change in gross profit margin | (9.1)% |

1 Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales decreased 2.6 percentage points during the three months ended September 30, 2022 when compared to the comparable prior year period. The decrease in gross profit as a percentage of sales for private-label contract manufacturing during the first quarter of fiscal 2023 is primarily due to an increase in per unit manufacturing costs, particularly related to increased labor and freight costs, and unfavorable foreign exchange rates applied to sales denominated in Euro.

2 Patent and trademark licensing gross profit margin as a percentage of consolidated net sales decreased 6.5 percentage points during the three months ended September 30, 2022 when compared to the comparable prior year period. The decrease in margin contribution during the three month period ended September 30, 2022 was primarily due to decreased patent and trademark licensing net sales as a percentage of total consolidated net sales, as patent and trademark licensing historically provides higher profit margins than our private-label contract manufacturing business. The three months ended September 30, 2021 also included a favorable change in estimate regarding certain volume rebate programs that was not repeated during the three months ended September 30, 2022.

Selling, general and administrative expenses decreased $0.2 million, or 6%, during the three months ended September 30, 2022 as compared to the comparable prior year period.

Other expense increased $0.2 million during the three months ended September 30, 2022 when compared to the comparable period during the prior year. The increase was primarily due to unfavorable foreign exchange revaluation activity and fluctuations in unhedged foreign currency rates when compared to the same period in the prior fiscal year.

Our income tax expense decreased $0.7 million during the three months ended September 30, 2022 when compared to the same period in fiscal 2022. The decrease in income tax expense was primarily related to a decrease in pre-tax income as compared to the same period in the prior year.

### 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 facility. Net cash used by operating activities was $4.6 million for the three months ended September 30, 2022 compared to $3.8 million in the comparable period in the prior fiscal year.

At September 30, 2022, changes in accounts receivable, consisting of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, provided $2.6 million in cash compared to using $2.4 million of cash during the comparable three month period in the prior year. The increase in cash provided by accounts receivable during the three months ended September 30, 2022 primarily resulted from the timing of sales and related collections. Days sales outstanding was 34 days during the three months ended September 30, 2022 as compared to 46 days for the prior year period.

Changes in inventory used $7.5 million in cash during the three months ended September 30, 2022 compared to using $4.7 million in the comparable prior year period. During the three months ended September 30, 2022, the change in cash related to inventory was primarily related to the difference in the amount and timing of orders and anticipated sales as compared to the same period in the prior year. Changes in accounts payable and accrued liabilities provided $1.0 million in cash during the three months ended September 30, 2022 compared to providing $0.3 million during the three months ended September 30, 2021. The change in cash flow activity related to accounts payable and accrued liabilities was primarily due to the timing of inventory receipts and payments.

Cash used in investing activities in the three months ended September 30, 2022 was $7.8 million compared to $18.3 million in the comparable prior year period. The primary reason for the change was due to the purchase of a new manufacturing and warehouse facility in Carlsbad, CA during the first quarter of fiscal 2022.

Cash provided by financing activities for the three months ended September 30, 2022, was $2.8 million, compared to $10.0 million in the comparable prior year period. The difference is primarily due to a net withdrawal of $3.4 million on our credit facility in the three months ended September 30, 2022, whereas the three months ended September 30, 2021 had no corresponding credit facility withdrawal. The three months ended September 30, 2021 included borrowings related to the purchase of our new manufacturing and warehouse facility in Carlsbad, CA. The decrease in borrowings was partially offset by an increase in repurchase of treasury stock for the three months ended September 30, 2022 compared to the three months ended September 30, 2021.

As of September 30, 2022, we had $3.4 million outstanding on our credit facility and $16.6 million available for borrowing under our credit facility with Wells Fargo Bank. During the three months ending September 30, 2022, we were in compliance with all of the financial and other covenants required under the Credit Agreement. Refer to Item 1, Note F., "Debt," in this Quarterly Report, for terms of our Credit Agreement.

As of September 30, 2022, we had $9.7 million outstanding under the Term Note used in the purchase of the warehouse in August 2021.

As of September 30, 2022, we had $12.3 million in cash and cash equivalents. We believe our available cash, cash equivalents, credit facility and potential cash flows from operations will be sufficient to fund our current working capital needs, capital expenditures, and minimum debt and interest payments through the next 12 months. Our capital requirements for fiscal 2023 include amounts that will be required to complete our planned retrofit of the facility we purchased in August 2021 that is planned to become a powder blending, packaging, and storage facility.

### Off-Balance Sheet Arrangements

As of September 30, 2022, we did not have any 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 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.

### Recent Accounting Pronouncements

Recent accounting pronouncements are discussed in the notes to our consolidated financial statements included under Item 1, Note A. of this Report. Other than those pronouncements, we are not aware of any other pronouncements that materially affect our financial position or results of operations.

## Controls and procedures

As filed, 1,354 characters.

We maintain certain disclosure controls and procedures as defined under the Securities Exchange Act of 1934. They are designed to help ensure that material information is: (1) gathered and communicated to our management, including our principal executive and financial officers, in a manner that allows for timely decisions regarding required disclosures; and (2) recorded, processed, summarized, reported and filed with the SEC as required under the Securities Exchange Act of 1934 and within the time periods specified by the SEC.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (principal financial and accounting officer), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2022. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective for their intended purpose described above as of September 30, 2022.

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 556 characters.

When evaluating our business and future prospects you should carefully consider the risks described under Item 1A of our 2022 Annual Report, as well as the other information in our 2022 Annual Report, this Report and other reports and documents we file with the SEC. If any of the identified risks actually occur, our business, financial condition and results of operations could be seriously harmed. In that event, the market price of our common stock could decline, and you could lose all or a portion of the value of your investment in our common stock.

Filed Nov 9, 2022.
Source: SEC EDGAR, the filing index for accession 0001437749-22-026615. Last ingested by Listed: Oct 24, 2026, 14:56 ET. No prices; not investment advice.