# Natural Alternatives International Inc: Form 10-Q for the period ended Dec 31, 2022

- Company: [Natural Alternatives International Inc](/companies/naii.md) (CIK 787253)
- Form: 10-Q
- Filed: 2023-02-08
- Accepted by EDGAR: Feb 8, 2023, 16:15 ET
- Period: 2022-12-31
- Accession: 0001437749-23-002792
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/787253/000143774923002792/naii20221231_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/787253/000143774923002792/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2022-12-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2022-10-01 to 2022-12-31 | $42.3m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Revenue | 6 months, 2022-07-01 to 2022-12-31 | $85.4m | us-gaap:RevenueFromContractWithCustomerIncludingAssessedTax |
| Cost of revenue | 3 months, 2022-10-01 to 2022-12-31 | $36.1m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 6 months, 2022-07-01 to 2022-12-31 | $73.8m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2022-10-01 to 2022-12-31 | $6.2m | us-gaap:GrossProfit |
| Gross profit | 6 months, 2022-07-01 to 2022-12-31 | $11.6m | us-gaap:GrossProfit |
| Selling, general and administrative | 3 months, 2022-10-01 to 2022-12-31 | $3.7m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2022-07-01 to 2022-12-31 | $7.6m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2022-10-01 to 2022-12-31 | $2.5m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2022-07-01 to 2022-12-31 | $4.0m | us-gaap:OperatingIncomeLoss |
| Income tax | 3 months, 2022-10-01 to 2022-12-31 | $473.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2022-07-01 to 2022-12-31 | $738.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2022-10-01 to 2022-12-31 | $1.8m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2022-07-01 to 2022-12-31 | $2.9m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2022-10-01 to 2022-12-31 | $0.31 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2022-07-01 to 2022-12-31 | $0.49 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2022-10-01 to 2022-12-31 | $0.31 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2022-07-01 to 2022-12-31 | $0.49 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2022-10-01 to 2022-12-31 | 5,873,129 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2022-07-01 to 2022-12-31 | 5,908,287 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2022-07-01 to 2022-12-31 | $3.7m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2022-07-01 to 2022-12-31 | $11.6m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Share repurchases | 6 months, 2022-07-01 to 2022-12-31 | $1.1m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2022-12-31 | $12.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2022-12-31 | $63.1m | us-gaap:AssetsCurrent |
| Total assets | at 2022-12-31 | $140.6m | us-gaap:Assets |
| Current liabilities | at 2022-12-31 | $18.5m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2022-12-31 | $51.0m | us-gaap:Liabilities |
| Shareholders' equity | at 2022-12-31 | $89.5m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 23,285 characters.

The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and six months ended December 31, 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 six months ended December 31, 2022, our net sales were 12% higher than in the first six months ended December 31, 2021. Private-label contract manufacturing sales increased 23% primarily due to higher sales to our two largest customers, partially offset by decreased sales to other 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 1.13 EUR/USD in the six months ended December 31, 2022 compared to a weighted average of 1.18 EUR/USD during the six months ended December 31, 2021. Revenue concentration risk for our largest private-label contract manufacturing customer as a percentage of our total net sales increased from 35% for the six months ended December 31, 2021 to 36% for the six months ended December 31, 2022. We expect our annualized fiscal year 2023 revenue concentration for our largest customer to increase compared to fiscal 2022 revenue.

During the six months ended December 31, 2022, patent and trademark licensing revenue decreased 68% to $2.8 million, compared to revenue of $8.8 million for the six months ended December 31, 2021. The decrease in patent and trademark licensing revenue during six months ended December 31, 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 six months ended December 31, 2021 benefited from a ramp up of Sports Nutrition sales activity due to easing COVID restrictions on athletic activities with no corresponding activity in the six months ended December 31, 2022.

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 $0.1 million during the first six months of fiscal 2023 as compared to $0.2 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 primarily related to maintenance of our patent and trademark 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 decrease slightly 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, increased labor, raw material, freight and supply chain costs. We anticipate the negative effects of these factors will have a more significant impact to our operating income in the second half of fiscal 2023. We are actively evaluating cost reduction opportunities, including working with both suppliers and customers, to mitigate the impact of these higher operational costs on our financial results. There can be no assurance our expectations will result in the currently anticipated net sales or financial results.

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 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.

### 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 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.

### 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 as 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 and six months ended December 31 were as follows (dollars in thousands):

|  | Three Months Ended December 31, 2022 | 2021 | % Change | Six Months Ended December 31, 2022 | 2021 | % Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Private label contract manufacturing | $40,839 | $33,677 | 21% | $82,615 | $67,271 | 23% |
| Patent and trademark licensing | 1,456 | 4,050 | (64)% | 2,807 | 8,796 | (68)% |
| Total net sales | 42,295 | 37,727 | 12% | 85,422 | 76,067 | 12% |
| Cost of goods sold | 36,081 | 31,181 | 16% | 73,837 | 61,240 | 21% |
| Gross profit | 6,214 | 6,546 | (5)% | 11,585 | 14,827 | (22)% |
| Gross profit % | 14.7% | 17.4% |  | 13.6% | 19.5% |  |
| Selling, general and administrative expenses | 3,729 | 4,145 | (10)% | 7,558 | 8,198 | (8)% |
| % of net sales | 8.8% | 11.0% |  | 8.8% | 10.8% |  |
| Income from operations | 2,485 | 2,401 | 3% | 4,027 | 6,629 | (39)% |
| % of net sales | 5.9% | 6.4% |  | 4.7% | 8.7% |  |
| Other expense | (199) | (9) | 2,111% | (423) | (35) | 1,109% |
| Income before income taxes | 2,286 | 2,392 | (4)% | 3,604 | 6,594 | (45)% |
| % of net sales | 5.4% | 6.3% |  | 4.2% | 8.7% |  |
| Provision for income taxes | 473 | 545 | (13)% | 738 | 1,491 | (51)% |
| Net income | $1,813 | $1,847 | (2)% | $2,866 | $5,103 | (44)% |
| % of net sales | 4.3% | 4.9% |  | 3.4% | 6.7% |  |

Private-label contract manufacturing net sales increased 21% during the three months ended December 31, 2022, and 23% for the six months ended December 31, 2022, when compared to the same periods in the prior year. The increase in sales during the three and six months ended December 31, 2022 was primarily due to increased sales to two of our largest customers, partially offset by decreased sales to other 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 1.14 EUR/USD in the three months ended December 31, 2022 compared to a weighted average of 1.18 EUR/USD during the three months ended December 31, 2021. Our foreign exchange rates as applied to sales denominated in Euro decreased to a weighted average of 1.13 EUR/USD in the six months ended December 31, 2022 compared to a weighted average of 1.18 EUR/USD during the six months ended December 31, 2021.

Net sales from our patent and trademark licensing segment decreased 64% during the three months ended December 31, 2022, and 68% for the six months ended December 31, 2022, when compared to the same periods in the prior year. The decrease in patent and trademark licensing revenue during the three and six months ended December 31, 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 three and six months ended December 31, 2021 benefited from a ramp up of Sports Nutrition sales activity due to easing COVID restrictions on athletic activities with no corresponding activity in the three and six months ended December 31, 2022.

The change in gross profit margin for the three and six months ended December 31, 2022, was as follows:

|  | Three Months Ended | Six Months Ended |
| --- | ---: | ---: |
| Contract manufacturing(1) | 1.5% | (0.6)% |
| Patent and trademark licensing(2) | (4.2) | (5.4) |
| Total change in gross profit margin | (2.7)% | (6.0)% |

1 Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales increased 1.5 percentage points during the three months ended December 31, 2022 when compared to the comparable prior year periods. The increase in gross profit as a percentage of sales for private-label contract manufacturing during the three months ended December 31, 2022 is primarily due to favorable sales mix, partially offset by an increase in per unit manufacturing costs. For the six months ended December 31, 2022, the contract manufacturing gross profit margin as a percentage of consolidated net sales decreased 0.6 percentage points as compared to the comparable prior year period, primarily due to an increase in per-unit manufacturing costs, partially offset by favorable sales mix. The increases in per unit manufacturing costs include the negative impacts of increased labor and freight costs and the impact of unfavorable foreign exchange rates applied to sales denominated in Euros and expenses denominated in Euros and Swiss Francs.

2 Patent and trademark licensing gross profit margin as a percentage of consolidated net sales decreased 4.2 percentage points during the three months ended December 31, 2022 and 5.4 percentage points for the six months ended December 31, 2022 when compared to the comparable prior year periods. The decrease in margin contribution 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 six months ended December 31, 2021 also included a favorable change in our estimates of certain volume rebate programs while the six months ended December 31, 2022 included an unfavorable change in our estimates of certain volume rebate programs.

Selling, general and administrative expenses decreased $0.4 million, or 10%, during the three months ended December 31, 2022 and $0.6 million, or 8%, as compared to the comparable prior year periods. The decrease during the three months ended December 21, 2022 as compared to the same period in the prior fiscal year is primarily related to a partial recovery of accounts receivable that had been reserved as uncollectible in a prior fiscal year. The decrease during the six months ended December 21, 2022 as compared to the same period in the prior fiscal year is primarily related to a partial recovery of accounts receivable that had been reserved for in a prior fiscal year and lower salaries expense.

Other expense increased $0.2 million during the three months ended December 31, 2022 and $0.4 million during the six months ended December 31, 2022 when compared to the comparable periods during the prior year. The increase in both the three and six month periods is primarily associated with increased expenses related to our CHF balance sheet hedge and interest expense related to usage of our line of credit.

Our income tax expense decreased $0.1 million for the three months ended December 31, 2022 and decreased $0.8 million for the six months ended December 31, 2022 when compared to the same periods in fiscal 2022. The decrease in income tax expenses for the three and six month periods was primarily related to a decrease in pre-tax income as compared to the same periods 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 facilities. Net cash provided by operating activities was $3.7 million for the six months ended December 31, 2022 compared to net cash used in operating activities of $0.6 million in the comparable period during the prior fiscal year.

At December 31, 2022, changes in accounts receivable, consisting of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, provided $7.2 million in cash compared to providing $2.8 million of cash during the comparable six month period in the prior year. The increase in cash used by accounts receivable during the six months ended December 31, 2022 primarily resulted from the timing of sales and related collections and a partial recovery of one accounts receivable that had been reserved as uncollectible in a prior fiscal year. Days sales outstanding was 30 days during the six months ended December 31, 2022 as compared to 40 days for the prior year period.

Changes in inventory used $3.6 million in cash during the six months ended December 31, 2022 compared to using $4.8 million in the comparable prior year period. The change in cash related to inventory during the six months ended December 31, 2022 was primarily related to the difference in the amount and timing of orders and anticipated sales as compared to same period in the prior year. Changes in accounts payable and accrued liabilities used $3.1 million in cash during the six months ended December 31, 2022 compared to using $3.8 million during the six months ended December 31, 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 six months ended December 31, 2022 was $11.6 million compared to $19.6 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 six months ended December 31, 2021 while the six months ended December 31, 2022 included capital improvement costs and equipment purchases associated with the on-going project to improve the new facility to become a high capacity powder processing and storage facility.

Cash used in financing activities for the six months ended December 31, 2022, was $1.2 million, compared to $7.4 million provided in the comparable prior year period. The difference is primarily due to borrowing costs related to the purchase of our new manufacturing and warehouse facility in Carlsbad, CA, during the first quarter of fiscal 2022 offset by the difference in treasury stock repurchase activity during the same period.

At December 31, 2022, we had $9.7 million outstanding under the Term Note we used to purchase our new Carlsbad, California warehouse and manufacturing facility in August 2021. We also have $20.0 million available for borrowing under our working capital line of credit with Wells Fargo Bank, which had no amounts outstanding as of December 31, 2022. During the six months ended December 31, 2022, we were in compliance with all of the financial and other covenants required under the Credit Agreement for this credit line. Refer to Item 1, Note F., "Debt," in this Quarterly Report, for the terms of this Credit Agreement.

As of December 31, 2022, we had $12.8 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 improvements to the proposed powder blending, packaging and storage facility we purchased in August 2021.

### Off-Balance Sheet Arrangements

As of December 31, 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, 1,335 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: (1) is 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 December 31, 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 as of December 31, 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 December 31, 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 Feb 8, 2023.
Source: SEC EDGAR, the filing index for accession 0001437749-23-002792. Last ingested by Listed: Oct 24, 2026, 14:56 ET. No prices; not investment advice.