UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q10-Q
QUARTERLY REPORT
pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED December 31, 2016September 30, 2017
000-15701
(Commission file number)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware | 84-1007839 | ||
(State of incorporation) | (IRS Employer Identification No.) | ||
1535 Faraday Drive Carlsbad, California |
(760) 744-7340 | ||
(Address of principal executive offices) | (Registrant's telephone number) | ||
Indicate by check mark whether Natural Alternatives International, Inc. (NAI) (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that NAI was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark whether NAI has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for suchsuch shorter period that NAI was required to submit and post such files).
[X] Yes [ ][_] No
Indicate by check mark whether NAI is a large accelerated filer, an accelerated filer,filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company.
Large accelerated filer | ☐ | Accelerated filer | ☐ | Emerging Growth Company | ☐ |
Non-accelerated filer | ☐ | Smaller reporting company | ☒ |
Large accelerated filer [__] Accelerated filer [__] Non-accelerated filer [__] Smaller reporting
If an emerging growth company, [X]indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether NAI is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[_] Yes [X] No
As of February 10, 2017, 6,872,224November 13, 2017, 7,429,020 shares of NAI's common stock were outstanding, net of 964,4531,052,657 treasury shares.
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PART I | |||
Item 1. | |||
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Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 13 | |
Item 4. | 17 | ||
PART II |
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Item 1. |
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Item 1A. |
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Item 2. | 19 | ||
Item 3. | 19 | ||
Item 5. | 19 | ||
Item 6. | 20 | ||
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SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
Certain statements in this report, including information incorporated by reference, are “forward-looking“forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect current views about future events and financial performance based on certain assumptions. They include opinions, forecasts, intentions, plans, goals, projections, guidance, expectations, beliefs, or other statements that are not statements of historical fact. Words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “believes,” “anticipates,” “intends,” “estimates,” “approximates,” “predicts,” “forecasts,” or “projects,” or the negative or other variation of such words, and similar expressions may identify a statement as a forward-looking statement. Any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business, our goals, strategies, focus and plans, and other characterizations of future events or circumstances, including statements expressing general optimism about future operating results, are forward-looking statements. Forward-looking statements in this report may include statements about:
future financial and operating results, including projections of net sales, revenue, income or loss, net income or loss per share, profit margins, expenditures, liquidity, and other financial items;
our ability to maintain or increase our patent and trademark licensing revenues;
our ability to develop market acceptance for and increase sales of new products, develop relationships with new customers and maintain or improve existing customer relationships;
our ability to protect our intellectual property;
our ability to improve operating efficiencies, manage costs and business risks and improve or maintain profitability;
currency exchange rates, their effect on our results of operations, including amounts that may be reclassified as earnings, the availability of foreign exchange facilities, our ability to effectively hedge against foreign exchange risks and the extent to which we may seek to hedge against such risks;
future levels of our revenue concentration risk;
sources and availability of raw materials, including the limited number of suppliers of beta-alanine and certain other raw materials;
• | inventories, including the | |
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inventories, including the adequacy of raw material and other inventory levels to meet future customer demand and the adequacy and intended use of our facilities;
product sales and timing of product shipments;
current or future customer orders, product returns, and potential product recalls;
the impact on our business and results of operations from variations in quarterly net sales from seasonal and other factors;
our ability to operate within the standards set by the U.S. Food and Drug Administration’s (FDA) Good Manufacturing Practices (GMP);
our ability to successfully expand our operations, including outside the United States (U.S.);
the adequacy of our reserves and allowances;
currentthe outcome of pending litigation, regulatory and future economictax matters, the costs associated with such matters and political conditions; the effect of such matters on our business and results of operations;
the sufficiency of our available cash, cash equivalents, and potential cash flows from operations to fund our current working capital needs and capital expenditures through the next 12 months;
current and future economic and political conditions;
the impact of accounting pronouncements and our adoption of certain accounting guidance; and
other assumptions described in this report underlying or relating to any forward-looking statements.
The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to place undue reliance on any such forward-lookingforward-looking statements. Forward-looking statements are subject to certain events, risks, and uncertainties that may be outside of our control. When considering forward-looking statements, you should carefully review the risks, uncertainties and other cautionary statements in this report as they identify certain important factors that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. These factors include, among others, the risks described under Item 1A of Part II and elsewhere in this report, as well as in other reports and documents we file with the United States Securities and Exchange Commission (SEC).
Unless the context requires otherwise, all references in this report to the “Company,“Company,” “NAI,” “we,” “our,” and “us” refer to Natural Alternatives International, Inc. and, as applicable, Natural Alternatives International Europe S.A. (NAIE).
PART I – FINANCIAL INFORMATION
NATURAL ALTERNATIVES INTERNATIONAL,INTERNATIONAL, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
December 31, 2016 | June 30, 2016 | September 30, 2017 | June 30, 2017 | |||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 21,362 | $ | 19,747 | $ | 27,706 | $ | 27,843 | ||||||||
Accounts receivable - less allowance for doubtful accounts of $15 at December 31, 2016 and $45 at June 30, 2016 | 9,838 | 13,217 | ||||||||||||||
Accounts receivable - less allowance for doubtful accounts of $33 at September 30, 2017 and $18 at June 30, 2017 | 9,209 | 8,410 | ||||||||||||||
Notes receivable | 1,500 | — | ||||||||||||||
Inventories, net | 17,067 | 20,768 | 18,996 | 13,729 | ||||||||||||
Income tax receivable | 14 | 14 | 548 | 261 | ||||||||||||
Prepaids and other current assets | 3,985 | 2,136 | 1,825 | 1,456 | ||||||||||||
Total current assets | 52,266 | 55,882 | 59,784 | 51,699 | ||||||||||||
Property and equipment, net | 17,469 | 15,167 | 18,369 | 18,136 | ||||||||||||
Deferred income taxes | 2,227 | 2,227 | ||||||||||||||
Deferred income taxes | 2,002 | 2,002 | ||||||||||||||
Other noncurrent assets, net | 832 | 899 | 794 | 774 | ||||||||||||
Total assets | $ | 72,794 | $ | 74,175 | $ | 80,949 | $ | 72,611 | ||||||||
Liabilities and Stockholders’ Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 6,291 | $ | 12,821 | $ | 10,892 | $ | 5,116 | ||||||||
Accrued liabilities | 2,021 | 2,242 | 2,351 | 1,931 | ||||||||||||
Accrued compensation and employee benefits | 1,076 | 2,802 | ||||||||||||||
Accrued compensation and employee benefits | 990 | 1,594 | ||||||||||||||
Forward contract | 1,626 | 422 | ||||||||||||||
Income taxes payable | 2,076 | 1,340 | 1,345 | 1,207 | ||||||||||||
Total current liabilities | 11,464 | 19,205 | 17,204 | 10,270 | ||||||||||||
Other noncurrent liabilities, net | 858 | 758 | ||||||||||||||
Long-term pension liability | 608 | 557 | ||||||||||||||
Deferred rent | 516 | 486 | 544 | 537 | ||||||||||||
Forward contract, noncurrent | 689 | 99 | ||||||||||||||
Total liabilities | 12,838 | 20,449 | 19,045 | 11,463 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
Stockholders’ equity: | ||||||||||||||||
Preferred stock; $.01 par value; 500,000 shares authorized; none issued or outstanding | — | — | ||||||||||||||
Common stock; $.01 par value; 20,000,000 shares authorized; issued and outstanding (net of treasury shares) 6,872,224 at December 31, 2016 and 6,868,628 at June 30, 2016 | 77 | 77 | ||||||||||||||
Preferred stock; $.01 par value; 500,000 shares authorized; none issued or outstanding | — | — | ||||||||||||||
Common stock; $.01 par value; 20,000,000 shares authorized; issued and outstanding (net of treasury shares) 7,436,284 at September 30, 2017 and 6,937,018 at June 30, 2017 | 84 | 79 | ||||||||||||||
Additional paid-in capital | 21,644 | 21,138 | 22,719 | 22,260 | ||||||||||||
Accumulated other comprehensive (loss) | 172 | (680 | ) | |||||||||||||
Retained earnings | 43,509 | 38,553 | ||||||||||||||
Treasury stock, at cost, 964,453 shares at December 31, 2016 and 958,049 June 30, 2016 | (5,446 | ) | (5,362 | ) | ||||||||||||
Retained earnings | 47,222 | 45,788 | ||||||||||||||
Treasury stock, at cost, 1,045,393 shares at September 30, 2017 and 1,044,659 June 30, 2017 | (6,082 | ) | (6,074 | ) | ||||||||||||
Accumulated other comprehensive loss | (2,039 | ) | (905 | ) | ||||||||||||
Total stockholders’ equity | 59,956 | 53,726 | 61,904 | 61,148 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 72,794 | $ | 74,175 | $ | 80,949 | $ | 72,611 | ||||||||
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Of Income And Comprehensive Income
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended September 30, | ||||||||
2017 | 2016 | |||||||
Net sales | $ | 28,074 | $ | 34,067 | ||||
Cost of goods sold | 21,704 | 26,398 | ||||||
Gross profit | 6,370 | 7,669 | ||||||
Selling, general and administrative expenses | 4,487 | 4,133 | ||||||
Income from operations | 1,883 | 3,536 | ||||||
Other income (expense): | ||||||||
Interest income | 250 | 116 | ||||||
Foreign exchange loss | (143 | ) | (59 | ) | ||||
Other, net | 1 | (7 | ) | |||||
Total other income | 108 | 50 | ||||||
Income before income taxes | 1,991 | 3,586 | ||||||
Provision for income taxes | 557 | 1,096 | ||||||
Net income | $ | 1,434 | $ | 2,490 | ||||
Unrealized loss resulting from change in fair value of derivative instruments, net of tax | (1,134 | ) | (390 | ) | ||||
Comprehensive income | $ | 300 | $ | 2,100 | ||||
Net income per common share: | ||||||||
Basic | $ | 0.22 | $ | 0.38 | ||||
Diluted | $ | 0.21 | $ | 0.37 | ||||
Weighted average common shares outstanding: | ||||||||
Basic | 6,606,518 | 6,558,395 | ||||||
Diluted | 6,831,230 | 6,646,963 | ||||||
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Of Cash Flows
(In thousands)
(Unaudited)
Three Months Ended September 30, | ||||||||
2017 | 2016 | |||||||
Cash flows from operating activities | ||||||||
Net income | $ | 1,434 | $ | 2,490 | ||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 717 | 458 | ||||||
Non-cash sales discount | 163 | — | ||||||
Non-cash compensation | 301 | 250 | ||||||
Pension expense | 51 | 50 | ||||||
Loss (gain) on disposal of assets | 1 | (19 | ) | |||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable, net | (799 | ) | 649 | |||||
Inventories, net | (5,267 | ) | (2,545 | ) | ||||
Prepaids and other assets | (389 | ) | 71 | |||||
Accounts payable and accrued liabilities | 5,773 | (875 | ) | |||||
Accrued compensation and employee benefits | (604 | ) | (1,131 | ) | ||||
Forward contracts | 441 | (36 | ) | |||||
Income taxes | 492 | 514 | ||||||
Net cash provided by (used in) operating activities | 2,314 | (124 | ) | |||||
Cash flows from investing activities | ||||||||
Purchases of property and equipment | (956 | ) | (1,716 | ) | ||||
Proceeds from sale of property and equipment | 5 | 19 | ||||||
Issuance of notes receivable | (1,500 | ) | — | |||||
Net cash used in investing activities | (2,451 | ) | (1,697 | ) | ||||
Cash flows from financing activities | ||||||||
Repurchase of common stock | — | (79 | ) | |||||
Net cash used in financing activities | — | (79 | ) | |||||
Net decrease in cash and cash equivalents | (137 | ) | (1,900 | ) | ||||
Cash and cash equivalents at beginning of period | 27,843 | 19,747 | ||||||
Cash and cash equivalents at end of period | $ | 27,706 | $ | 17,847 | ||||
Supplemental disclosures of cash flow information | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | — | $ | — | ||||
Taxes | $ | 76 | $ | 593 | ||||
Disclosure of non-cash activities: | ||||||||
Change in unrealized loss resulting from change in fair value of derivative instruments, net of tax | $ | (1,134 | ) | $ | (390 | ) | ||
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Of Income And Comprehensive Income
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Net sales | $ | 30,559 | $ | 26,911 | $ | 64,626 | $ | 48,496 | ||||||||
Cost of goods sold | 24,064 | 21,242 | 50,462 | 38,094 | ||||||||||||
Gross profit | 6,495 | 5,669 | 14,164 | 10,402 | ||||||||||||
Selling, general and administrative | 3,382 | 2,934 | 7,515 | 5,939 | ||||||||||||
Income from operations | 3,113 | 2,735 | 6,649 | 4,463 | ||||||||||||
Other income (expense): | ||||||||||||||||
Interest income | 133 | 25 | 249 | 56 | ||||||||||||
Interest expense | - | (2 | ) | - | (3 | ) | ||||||||||
Foreign exchange gain (loss) | 262 | (96 | ) | 203 | (104 | ) | ||||||||||
Other, net | (8 | ) | (2 | ) | (15 | ) | (10 | ) | ||||||||
Total other income (expense) | 387 | (75 | ) | 437 | (61 | ) | ||||||||||
Income before income taxes | 3,500 | 2,660 | 7,086 | 4,402 | ||||||||||||
Provision for income taxes | 1,034 | 792 | 2,130 | 1,321 | ||||||||||||
Net income | $ | 2,466 | $ | 1,868 | $ | 4,956 | $ | 3,081 | ||||||||
Unrealized gain resulting from change in fair value of derivative instruments, net of tax | 1,242 | 230 | 852 | 274 | ||||||||||||
Comprehensive income | $ | 3,708 | $ | 2,098 | $ | 5,808 | $ | 3,355 | ||||||||
Net income per common share: | ||||||||||||||||
Basic | $ | 0.38 | $ | 0.29 | $ | 0.76 | $ | 0.47 | ||||||||
Diluted | $ | 0.37 | $ | 0.28 | $ | 0.74 | $ | 0.46 | ||||||||
Weighted average common shares outstanding | ||||||||||||||||
Basic | 6,567,468 | 6,509,893 | 6,562,932 | 6,515,280 | ||||||||||||
Diluted | 6,683,356 | 6,628,752 | 6,665,159 | 6,662,036 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended | ||||||||
December 31, | ||||||||
2016 | 2015 | |||||||
Cash flows from operating activities | ||||||||
Net income | $ | 4,956 | $ | 3,081 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 1,059 | 944 | ||||||
Non-cash compensation | 506 | 280 | ||||||
Pension expense | 100 | 25 | ||||||
(Gain) loss on disposal of assets | (23 | ) | (232 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable, net | 3,379 | 2,322 | ||||||
Inventories, net | 3,701 | (5,657 | ) | |||||
Prepaids and other assets | (449 | ) | 880 | |||||
Accounts payable and accrued liabilities | (6,721 | ) | 2,078 | |||||
Income taxes | 255 | 1,262 | ||||||
Accrued compensation and employee benefits | (1,726 | ) | 146 | |||||
Net cash provided by operating activities | 5,037 | 5,129 | ||||||
Cash flows from investing activities | ||||||||
Purchases of property and equipment | (3,362 | ) | (1,410 | ) | ||||
Proceeds from sale of property and equipment | 24 | 568 | ||||||
Net cash used in investing activities | (3,338 | ) | (842 | ) | ||||
Cash flows from financing activities | ||||||||
Repurchase of common stock | (84 | ) | (212 | ) | ||||
Net cash used in financing activities | (84 | ) | (212 | ) | ||||
Net increase in cash and cash equivalents | 1,615 | 4,075 | ||||||
Cash and cash equivalents at beginning of period | 19,747 | 18,551 | ||||||
Cash and cash equivalents at end of period | $ | 21,362 | $ | 22,626 | ||||
Supplemental disclosures of cash flow information | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | - | $ | - | ||||
Taxes | $ | 1,897 | $ | 468 | ||||
Disclosure of non-cash activities: | ||||||||
Change in unrealized gain resulting from change in fair value of derivative instruments, net of tax | $ | 852 | $ | 274 | ||||
See accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSEDCONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A.A. Basis of Presentation and Summary of Significant Accounting Policies
The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and applicable rules and regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. In management’smanagement’s opinion, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows have been included and are of a normal, recurring nature. The results of operations for the three and six months ended December 31, 2016September 30, 2017 are not necessarily indicative of the operating results for the full fiscal year or any future periods.
You should read the financial statements and these notes, which are an integral part of the financial statements, together with our audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 20162017 (“20162017 Annual Report”). The accounting policies used to prepare the financial statements included in this report are the same as those described in the notes to the consolidated financial statements in our 20162017 Annual Report unless otherwise noted below.
Recent Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-09, Compensation-Stock Compensation (Topic 718) (ASU 2016-09), which provides guidance improvements to employee share-based payment accounting. The standard amends several aspects of current employee share-based payment accounting including income taxes, forfeitures, earnings per share, and statutory tax withholding requirements, as well as classification in the statement of cash flows. We adopted ASU 2016-09 effective July 1, 2017. ASU 2016-09 also requires all excess tax benefits and tax deficiencies associated with employee stock compensation awards to be recognized as income tax expense or benefit as part of the Statement of Operations. Adopting this standard did not result in any significant impact to our results of operation or financial position. During the quarter ended September 30, 2017, there was no impact to the Statement of Cash Flows.
In March 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which amends existing standards for leases to increase transparency and comparability among organizations by requiring recognition of lease assets and liabilities on the balance sheet and requiring disclosure of key information about such arrangements. ASU 2016-02 will be effective for us beginning in our first quarter of fiscal 2020. Early adoption is permitted. We are currently evaluating the impact of adopting the new standard on our consolidated financial statements and the timing and presentation of our adoption.
In April 2016, the FASB issued Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic 606)(ASU 2016-10), which amends and adds clarity to certain aspects of the guidance set forth in the upcoming revenue standard (ASU 2014-09) related to identifying performance obligations and licensing. In May 2016, the FASB issued Accounting Standards Update No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815) (ASU 2016-11), which amends and rescinds certain revenue recognition guidance previously released within ASU 2014-09. In May 2016 the FASB issued Accounting Standards Update No. 2016-12, Revenue from Contracts with Customers (Topic 606) (ASU 2016-12), which provides narrow scope improvements and practical expedients related to ASU 2014-09. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible that more judgment and estimates may be required within the revenue recognition process than is required under present U.S. GAAP. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price, and allocating the transaction price to each separate performance obligation. The new standard also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. All of these new standards will be effective for us concurrently with ASU 2014-09, beginning in our first quarter of fiscal 2019. Early adoption is not permitted. Currently, we do not expect our annual revenue to be materially different under Topic 606. The most significant change will be to our quarterly and annual financial statement disclosures. We are continuing to evaluate the impact of adopting the new standard.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The ASU is intended to improve and simplify accounting rules around hedge accounting and improve the disclosures of hedging arrangements. We are currently evaluating the impact of adopting the new standard on our consolidated financial statements. ASU 2017-12 will be effective for us beginning in our first quarter of fiscal 2020.
Net Income per Common Share
We compute net income per common share using the weighted average number of common shares outstanding during the period, and diluteddiluted net income per common share using the additional dilutive effect of all dilutive securities. The dilutive impact of stock options accountaccounts for the additional weighted average shares of common stock outstanding for our diluted net income per common share computation. We calculated basic and diluted net income per common share as follows (in thousands, except per share data):
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
December 31, | December 31, | Three Months Ended September 30, | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||||||
Numerator | ||||||||||||||||||||||||
Net Income | $ | 2,466 | $ | 1,868 | $ | 4,956 | $ | 3,081 | ||||||||||||||||
Net income | $ | 1,434 | $ | 2,490 | ||||||||||||||||||||
Denominator | ||||||||||||||||||||||||
Basic weighted average common shares outstanding | 6,567 | 6,510 | 6,563 | 6,515 | 6,607 | 6,558 | ||||||||||||||||||
Dilutive effect of stock options | 116 | 119 | 102 | 147 | 224 | 89 | ||||||||||||||||||
Diluted weighted average common shares outstanding | 6,683 | 6,629 | 6,665 | 6,662 | 6,831 | 6,647 | ||||||||||||||||||
Basic net income per common share | $ | 0.38 | $ | 0.29 | $ | 0.76 | $ | 0.47 | $ | 0.22 | $ | 0.38 | ||||||||||||
Diluted net income per common share | $ | 0.37 | $ | 0.28 | $ | 0.74 | $ | 0.46 | $ | 0.21 | $ | 0.37 | ||||||||||||
No shares related to stock options or restricted stock were excluded for the three or six months ended December 31,September 30, 2017 or September 30, 2016. We excluded shares related to stock options totaling 100,000 for the three and six months ended December 31, 2015 from the calculation of diluted net income per common share, as the effect of their inclusion would have been anti-dilutive.
Revenue Recognition
To recognize revenue, four basic criteriacriteria must be met: 1) there is evidence that an arrangement with a buyer exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. Revenue from sales transactions where the buyerbuyer has the right to return the product is recognized at the time of sale only if (a) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (b) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (c) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (d) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (e) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (f) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon completion of delivery is deferred until the shipment has been delivered.
We record reductions to gross revenue for estimated returns of private-label contract manufacturing products and beta-alanine raw material sales. The estimated returns are based on the trailing six monthsmonths of private-label contract manufacturing gross sales and our historical experience for both private-label contract manufacturing and beta-alanine raw material productsales returns. However, the estimate for product returns does not reflect the impact of a potential large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable.
On August 7, 2017, we entered into three agreements (“Agreements”), with The Juice Plus+ Company LLC (“Juice Plus+”). The Agreements are an Exclusive Manufacturing Agreement, a Restricted Stock Award Agreement, and an Irrevocable Proxy. Pursuant to the Exclusive Manufacturing Agreement, Juice Plus+ has granted us exclusive rights to manufacture and supply Juice Plus+ with certain Juice Plus+ products within 24 countries where Juice Plus+ currently sells those products. Pursuant to the Restricted Stock Award Agreement, NAI has agreed to grant 500,000 shares of NAI common stock to Juice Plus+, (the “Shares”), and Juice Plus+ agreed the Shares are subject to certain restrictions and risk of forfeiture. Pursuant to the Irrevocable Proxy, Juice Plus+ has granted to the NAI Board of Directors Juice Plus+’s right to vote the Shares as long as the Shares are subject to the associated risk of forfeiture. The Agreements each are for a term of 5 years, and each may be terminated by either party only upon on the occurrence of specified events. For the three months ended September 30, 2017, $163,000 of expense associated with the shares granted to Juice Plus+ was recorded as a reduction to revenue.
We currently own certain U.S. patents, and each patent’s corresponding foreign patent applications. All of these patents and patent rights relate to the ingredient known as beta-alanine and marketed and sold under the CarnoSyn® and SR CarnoSyn® trademarks.trade names. We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of $5.9 million during the three months ended September 30, 2017 and $6.7 million during the three months ended December 31, 2016 and $13.4 million during the six months ended December 31,September 30, 2016. We recorded $5.3 million during the three months ended December 31, 2015 and $10.6 million during the six months ended December 31, 2015. These royalty income and raw material sale amounts resulted in royalty expense paid to the original patent holders from whom NAI acquired its patents and patent rights. We recognized royalty expense as a component of cost of goods sold in the amount of $250,000$284,000 during the three months ended December 31, 2016September 30, 2017, and $566,000 during the six months ended December 31, 2016. We recorded $209,000$316,000 during the three months ended December 31, 2015September 30, 2016.
Notes Receivable
On September 30, 2017, we entered into a note receivable with Kaged Muscle, LLC (“Kaged Muscle”), one of our contract manufacturing customers, converting $1.5 million of trade receivables to a 12 month note. Kaged Muscle is one of our fastest growing sports nutrition customers and $473,000 duringwe executed this note receivable conversion to assist them with their near term financing needs. The note carries an interest rate of fifteen percent (15%) per annum and is an interest only note secured by the six months ended December 31, 2015.assets of Kaged Muscle and a personal guarantee by the co-founder and President of Kaged Muscle. Interest is due quarterly and the note can be paid down at any time without penalty.
Stock-Based Compensation
We have an omnibus incentive plan that was approved by our Board of Directors effective as of October 15, 2009 and approved by our stockholders at the Annual Meeting of Stockholders held on November 30, 2009. Under the plan, we may grant nonqualified and incentive stock options and other stock-based awards to employees, non-employee directors and consultants.
We estimate the fair value of stock option awards at the date of grant using the Black-ScholeBlsack-Scholes option valuation model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions. Black-Scholes uses assumptions related to volatility, the risk-free interest rate, the dividend yield (which we assume to be zero, as to date we have not paid any cash dividends) and employee exercise behavior. Expected volatilities used in the model are based on the historical volatility of our stock price. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect inon the perioddate of grant. The expected life of stock option grants is derived from historical experience. The fair value of restricted stock shares granted is based on the market price of our common stock on the date of grant. We amortize the estimated fair value of our stock awards to expense over the related vesting periods.
The Company did not grant any optionsoptions during the three or six months ended December 31, 2016September 30, 2017 or 2015.the three months ended September 30, 2016. All remaining outstanding stock options are fully vested. No options were exercised during the three or six months ended December 31, 2016September 30, 2017 or 2015.
Our net income included stock based compensation expense of approximately $256,000 forthree months ended September 30, 2016. During the three months ended December 31, 2016, and $506,000 forSeptember 30, 2017, 5,000 options were forfeited. There were no forfeitures during the sixthree months ended December 31,September 30, 2016.
We did not grant any shares to employees during the three months ended September 30, 2017. We granted 10,000 restricted shares to a new member of management during the three months ended September 30, 2016. Our net income included stock based compensation expense of approximately $150,000$301,000 for the three months ended December 31, 2015,September 30, 2017, and $280,000$250,000 for the sixthree months ended December 31, 2015.September 30, 2016.
Fair Value of Financial Instruments
Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liabilityliability (i.e., the “exit“exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants aton the measurement date. We use a three-level hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the inputs that market participants would use in pricing the asset or liability and are developed based on the best information available under the circumstances.
The fair value hierarchy is broken down into three levels based on the source of inputs. In general, fair values determined by Level 1 inputs use quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. We classify cash, cash equivalents, and marketable securities balances as Level 1 assets. Fair values determined by Level 2 inputs are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and models for which all significant inputs are observable or can be corroborated, either directly or indirectly by observable market data. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. These include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
As of December 31, 2016September 30, 2017 and June 30, 2016,2017, we did not have any financial assets or liabilities classified as Level 1.1, except for assets and liabilities related to our pension plan. We classify derivative forward exchange contracts as Level 2 assets. The fair value of our forward exchange contracts as of December 31, 2016September 30, 2017 was a net assetliability of $2.0$2.3 million. The fair value of our forward exchange contracts as of June 30, 20162017 was a net assetliability of $250,000.$521,000. As of December 31, 2016September 30, 2017 and June 30, 20162017 we did not have any financial assets or liabilities classified as Level 3. We did not transfer transfer any assets or liabilities between Levels during fiscal 20162017 or the sixthree months ended December 31, 2016.September 30, 2017.
B.B. Inventories, net
Inventories, net consisted ofof the following (in thousands):
December 31, 2016 | June 30, 2016 | September 30, 2017 | June 30, 2017 | |||||||||||||
Raw materials | $ | 11,475 | $ | 14,751 | $ | 13,828 | $ | 9,469 | ||||||||
Work in progress | 2,096 | 3,487 | 3,562 | 1,312 | ||||||||||||
Finished goods | 3,836 | 2,832 | 2,269 | 3,562 | ||||||||||||
Reserves | (340 | ) | (302 | ) | (663 | ) | (614 | ) | ||||||||
Inventories, net | $ | 17,067 | $ | 20,768 | $ | 18,996 | $ | 13,729 | ||||||||
C.C. Property and Equipment
Property and equipment consisted of the following (in thousands):
Depreciable Life In Years | December 31, 2016 | June 30, 2016 | Depreciable Life In Years | September 30, 2017 | June 30, 2017 | ||||||||||||||||||||||
Land | N/A | $ | 1,200 | $ | 1,200 | N/A | $ | 1,200 | $ | 1,200 | |||||||||||||||||
Building and building improvements | 7 | – | 39 | 3,616 | 3,324 | 7 | – | 39 | 3,680 | 3,706 | |||||||||||||||||
Machinery and equipment | 3 | – | 12 | 24,772 | 23,846 | 3 | – | 12 | 24,900 | 24,194 | |||||||||||||||||
Office equipment and furniture | 3 | – | 5 | 3,577 | 2,994 | 3 | – | 5 | 4,073 | 3,954 | |||||||||||||||||
Vehicles | 3 | 3 | 209 | 209 | 3 | 209 | 209 | ||||||||||||||||||||
Leasehold improvements | 1 | – | 15 | 16,432 | 15,261 | 1 | – | 15 | 17,159 | 17,038 | |||||||||||||||||
Total property and equipment | 49,806 | 46,834 | 51,221 | 50,301 | |||||||||||||||||||||||
Less: accumulated depreciation and amortization | (32,337 | ) | (31,667 | ) | |||||||||||||||||||||||
Less: accumulated depreciation and amortization | (32,852 | ) | (32,165 | ) | |||||||||||||||||||||||
Property and equipment, net | $ | 17,469 | $ | 15,167 | $ | 18,369 | $ | 18,136 | |||||||||||||||||||
D. AccumulatedD. Other Comprehensive (Loss) IncomeLoss
Accumulated otherOther comprehensive (loss) income (“OCL” and “OCI”) consisted of the following during the three and six months ended December 31,September 30, 2017 and September 30, 2016 and December 31, 2015 (in thousands):
Three Months Ended | Six Months Ended | Defined Benefit Pension Plan | Unrealized Gains (Losses) on Cash Flow Hedges | Total | ||||||||||||||||||||||||||||||||
December 31, 2016 | December 31, 2016 | |||||||||||||||||||||||||||||||||||
Balance as of June 30, 2017 | $ | (491 | ) | $ | (414 | ) | $ | (905 | ) | |||||||||||||||||||||||||||
OCI/OCL before reclassifications | — | (1,953 | ) | (1,953 | ) | |||||||||||||||||||||||||||||||
Amounts reclassified from OCI | — | 178 | 178 | |||||||||||||||||||||||||||||||||
Tax effect of OCI activity | — | 641 | 641 | |||||||||||||||||||||||||||||||||
Net current period OCI/OCL | — | (1,134 | ) | (1,134 | ) | |||||||||||||||||||||||||||||||
Balance as of September 30, 2017 | $ | (491 | ) | $ | (1,548 | ) | $ | (2,039 | ) | |||||||||||||||||||||||||||
Defined | Unrealized | Defined | Unrealized | |||||||||||||||||||||||||||||||||
Benefit | Gains on | Benefit | Gains on | |||||||||||||||||||||||||||||||||
Balance as of June 30, 2016 | $ | (775 | ) | $ | 95 | $ | (680 | ) | ||||||||||||||||||||||||||||
Pension | Cash Flow | Pension | Cash Flow | |||||||||||||||||||||||||||||||||
Plan | Hedges | Total | Plan | Hedges | Total | |||||||||||||||||||||||||||||||
Beginning balance | $ | (775 | ) | $ | (295 | ) | $ | (1,070 | ) | $ | (775 | ) | $ | 95 | $ | (680 | ) | |||||||||||||||||||
OCI/OCL before reclassifications | - | 2,287 | 2,287 | - | 1,834 | 1,834 | — | (452 | ) | (452 | ) | |||||||||||||||||||||||||
Amounts reclassified from OCI | - | (343 | ) | (343 | ) | - | (501 | ) | (501 | ) | — | (158 | ) | (158 | ) | |||||||||||||||||||||
Tax effect of OCI activity | - | (702 | ) | (702 | ) | - | (481 | ) | (481 | ) | — | 220 | 220 | |||||||||||||||||||||||
Net current period OCI/OCL | - | 1,242 | 1,242 | - | 852 | 852 | — | (390 | ) | (390 | ) | |||||||||||||||||||||||||
Ending balance | $ | (775 | ) | $ | 947 | $ | 172 | $ | (775 | ) | $ | 947 | $ | 172 | ||||||||||||||||||||||
Balance as of September 30, 2016 | $ | (775 | ) | $ | (295 | ) | $ | (1,070 | ) | |||||||||||||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||||||||||
December 31, 2015 | December 31, 2015 | |||||||||||||||||||||||
Defined | Unrealized | Defined | Unrealized | |||||||||||||||||||||
Benefit | Gains on | Benefit | Gains on | |||||||||||||||||||||
Pension | Cash Flow | Pension | Cash Flow | |||||||||||||||||||||
Plan | Hedges | Total | Plan | Hedges | Total | |||||||||||||||||||
Beginning balance | $ | (643 | ) | $ | (79 | ) | $ | (722 | ) | $ | (643 | ) | $ | (123 | ) | $ | (766 | ) | ||||||
OCI/OCL before reclassifications | - | 424 | 424 | - | 482 | 482 | ||||||||||||||||||
Amounts reclassified from OCI | - | (69 | ) | (69 | ) | - | (58 | ) | (58 | ) | ||||||||||||||
Tax effect of OCI activity | - | (125 | ) | (125 | ) | - | (150 | ) | (150 | ) | ||||||||||||||
Net current period OCI/OCL | - | 230 | 230 | - | 274 | 274 | ||||||||||||||||||
Ending balance | $ | (643 | ) | $ | 151 | $ | (492 | ) | $ | (643 | ) | $ | 151 | $ | (492 | ) | ||||||||
E. Debt
During the three months ended December 31, 2016, the amounts reclassified from OCI were comprised of $213,000 of gains reclassified to net revenues and $130,000 related to the amortization of forward points reclassified to other income. During the six months ended December 31, 2016, the amounts reclassified from OCI were comprised of $271,000 of gains reclassified to net revenues and $230,000 related to the amortization of forward points reclassified to other income.
During the three months ended December 31, 2015, the amounts reclassified from OCI were comprised of $45,000 of gains reclassified to net revenues and $24,000 related to the amortization of forward points reclassified to other income. During the six months ended December 31, 2015, the amounts reclassified from OCI were comprised of $7,000 of gains reclassified to net revenues and $51,000 related to the amortization of forward points reclassified to other income.
E. Debt
On February 1, 2016, we executedThe Company has a new Credit Agreement with Wells Fargo Bank, N.A. The Credit Agreement replaced the previous credit facility and increased ourprovides us with a credit line from $5.0 millionof up to $10.0 million.million and matures on February 1, 2020. The line of credit may be used to finance working capital requirements.
On September 29, 2017, we executed an amendment to our credit facility with Wells Fargo Bank, N.A, which amendment now allows us to make loans or advances to third parties not exceeding $1.5 million. We executed this amendment in order to issue a note receivable of $1.5 million to a customer. There wasis no commitment fee required as part ofunder this agreement. There are no amounts currently drawn under the line of credit.
Under the terms of the Credit Agreement, borrowings are subject to eligibility requirements including maintaining (i) a ratio of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time; and (ii) a ratio of total current assets to total current liabilities of not less than 1.75 to 1.0 at each fiscal quarter end. Any amounts outstanding under the line of credit will bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of interest. If elected, the fluctuating rate per annum would be equal to 1.25% above the daily one month LIBOR rate as in effect from time to time. If a fixed rate is elected, it would equal a per annum rate of 1.25% above the LIBOR rate in effect on the first day of the applicable fixed rate term. Any amounts outstanding under the line of credit must be paid in full on or before January 31, 2019.the maturity date. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of $100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which the then applicable fixed rate term matures.
Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general intangibles, inventory, equipment and fixtures.
During the three months ended September 30, 2017, we were in compliance with all of the financial and other covenants required under the Credit Agreement.
We also have a foreign exchange facility with Wells Fargo Bank, N.A. in effect until January 31, 2019, and with Bank of America, N.A. in effect until August 15, 2017.
On December 31, 2016, we were in compliance with all of the financial and other covenants required under the Credit Agreement.
Our wholly owned subsidiary, NAIE, formerly had a credit facility with Credit Suisse that would provide NAIE with a credit line of up to CHF 500,000, or approximately $488,000. We terminated this line of credit in December 2016 as we determined that it was unnecessary as we believe our current cash position and on going cash from operations are sufficient to support our cash requirements.2019.
We did not use our working capital line of credit nor did we have any long-term debt outstanding during the sixthree months ended December 31, 2016.September 30, 2017. As of December 31, 2016,September 30, 2017, we had $10.0 million available under our credit facilities.
F.F. Economic Dependency
We had substantial net sales to certain customers during the periods shown in the following table. The loss of any of these customers, or a significant decline in sales to these customers, the growth rate of sales to these customers,customers, or in these customers’ ability to make payments when due, could have a material adverse impact on our net sales and net income. Net sales to any one customer representing 10% or more of the respective period's consolidated net sales were as follows (in thousands):
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | Three months Ended September 30, | ||||||||||||||||||||
2017 | 2016 | |||||||||||||||||||||||
Customer 1 | $ | 15,074 | $ | 11,902 | $ | 32,152 | $ | 18,691 | $ | 13,157 | $ | 17,090 | ||||||||||||
Customer 2 |
| (a) | 3,304 |
| (a) | 6,339 | 3,161 | (a) | ||||||||||||||||
| $ | 15,074 | $ | 15,206 | $ | 32,152 | $ | 25,030 | $ | 16,318 | $ | 17,090 | |||||||||||||
(a) Sales were less than 10% of the respective period’speriod’s total revenues.sales.
We buy certain products, including beta-alanine, from a limited number of raw material suppliers.suppliers. The loss of any of these suppliers could have a material adverse impact on our net sales and net income. Raw material purchases from any one supplier representing 10% or more of the respective period’s total raw material purchases were as follows (in thousands):
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||||
Supplier 1 | (a) | (a) | (a) | $ | 3,097 | 12% | ||||||||||||
Supplier 2 | (a) | $ | 1,395 | 12% | (a) |
| (a) | |||||||||||
| $ | - | $ | 1,395 | 12% | $ | - | $ | 3,097 | 12% | |||||||||
Three months Ended September 30, | ||||||||
2017 | 2016 | |||||||
Supplier 1 | $ | 1,967 | (b) | |||||
| $ | 1,967 | (a) | ||||||
(a) (b) Purchases were less than 10% of the respective period’s total raw material purchases.
G.G. Segment Information
Our businessbusiness consists of two segments for financial reporting purposes, identified as (i) private label contract manufacturing, which primarily relates to the provision of private label contract manufacturing services to companies that market and distributedistribute nutritional supplements and other health care products; and (ii) patent and trademark licensing, which primarily includes direct raw material sales and royalty income from our license and supply agreements associated with the sale and use of beta-alanine under our CarnoSyn® trade name.
We evaluate performance based on a number of factors. The primary performance measures for each segment are net sales and income or loss from operations before corporate allocations. Operating income or loss for each segmentsegment does notnot include corporate general and administrative expenses, interest expense and other miscellaneous income and expense items. Corporate general and administrative expenses, which are not allocated to any segment, include, but are not limited to: human resources, corporate legal, finance, information technology, and other corporate level related expenses, which are not allocated to any segment.expenses. The accounting policies of our segments are the same as those described in Note A above and in the consolidated financial statements included in our 20162017 Annual Report.
Our operating results by business segment were as follows (in thousands):
Three Months Ended December 31, | Six Months Ended December 31, | Three Months Ended September 30, | ||||||||||||||||||||||
2016 | 2015 | 2016 | 2015 | 2017 | 2016 | |||||||||||||||||||
Net Sales | ||||||||||||||||||||||||
Private label contract manufacturing | $ | 23,864 | $ | 21,619 | $ | 51,243 | $ | 37,884 | $ | 22,222 | $ | 27,379 | ||||||||||||
Patent and trademark licensing | 6,695 | 5,292 | 13,383 | 10,612 | 5,852 | 6,688 | ||||||||||||||||||
Total Net Sales | $ | 30,559 | $ | 26,911 | $ | 64,626 | $ | 48,496 | ||||||||||||||||
| Total | $ | 28,074 | $ | 34,067 | ||||||||||||||||||||
Three Months Ended September 30, | ||||||||
| 2017 | 2016 | |||||||
Income from Operations | ||||||||
Private label contract manufacturing | $ | 2,257 | $ | 3,314 | ||||
Patent and trademark licensing | 1,188 | 1,900 | ||||||
Income from operations of reportable segments | 3,445 | 5,214 | ||||||
Corporate expenses not allocated to segments | (1,562 | ) | (1,678 | ) | ||||
Total net sales | $ | 1,883 | $ | 3,536 | ||||
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
Income from Operations | ||||||||||||||||
Private label contract manufacturing | $ | 2,148 | $ | 2,543 | $ | 5,462 | $ | 4,603 | ||||||||
Patent and trademark licensing | 2,340 | 1,692 | 4,240 | 2,691 | ||||||||||||
Income from operations of reportable segments | 4,488 | 4,235 | 9,702 | 7,294 | ||||||||||||
Corporate expenses not allocated to segments | (1,375 | ) | (1,500 | ) | (3,053 | ) | (2,831 | ) | ||||||||
Total Income from Operations | $ | 3,113 | $ | 2,735 | $ | 6,649 | $ | 4,463 | ||||||||
September 30, 2017 | June 30, 2017 | |||||||||||||||
Total Assets | December 31, 2016 | June 30, 2016 | ||||||||||||||
Private label contract manufacturing | $ | 62,742 | $ | 66,375 | $ | 67,795 | $ | 60,489 | ||||||||
Patent and Trademark Licensing | 10,052 | 7,800 | ||||||||||||||
Total | $ | 72,794 | $ | 74,175 | ||||||||||||
Patent and trademark licensing | 13,154 | 12,122 | ||||||||||||||
| Total assets | $ | 80,949 | $ | 72,611 | ||||||||||||
Our private label contract manufacturingmanufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe, Australia and Asia, as well as Canada, Mexico and South Africa. Our primary market outside the U.S. is Europe. Our patent and trademark licensinglicensing activities are primarily based in the U.S.
Net sales by geographic region, based on the customers’ location, were as follows (in thousands):
Three Months Ended December 31, | Six Months Ended December 31, | |||||||||||||||
2016 | 2015 | 2016 | 2015 | |||||||||||||
United States | $ | 13,654 | $ | 12,498 | $ | 28,879 | $ | 25,291 | ||||||||
Markets outside of the United States | 16,905 | 14,413 | 35,747 | 23,205 | ||||||||||||
Total | $ | 30,559 | $ | 26,911 | $ | 64,626 | $ | 48,496 | ||||||||
Three Months Ended September 30, | ||||||||
2017 | 2016 | |||||||
United States | $ | 15,194 | $ | 15,225 | ||||
Markets outside the United States | 12,880 | 18,842 | ||||||
Total net sales | $ | 28,074 | $ | 34,067 | ||||
Products manufactured by NAIE accounted for 60%75% of net sales in markets outside the U.S. for the three months ended December 31, 2016,September 30, 2017, and 53% for the six months ended December 31, 2016. Products manufactured by NAIE accounted for 71% of net sales in markets outside the U.S.48% for the three months ended December 31, 2015, and 74% for the six months ended December 31, 2015.September 30, 2016. No products manufactured by NAIE were sold in the U.S. during the three or six months ended December 31, 2016September 30, 2017 and 2015.2016.
Assets and capitalcapital expenditures by geographic region, based on the location of the company or subsidiary at whichwhich they were located or made, were as follows (in thousands):
Long-Lived Assets | Total Assets | Capital Expenditures | Long-Lived Assets | Total Assets |
Capital Expenditures | |||||||||||||||||||||||||||||||||||||||||||
Six Months Ended | Three Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||
December 31, 2016 | June 30, 2016 | December 31, 2016 | June 30, 2016 | December 31, 2016 | December 31, 2015 | September 30, 2017 | June 30, 2017 | September 30, 2017 | June 30, 2017 | September 30, 2017 | September 30, 2016 | |||||||||||||||||||||||||||||||||||||
United States | $ | 10,897 | $ | 9,678 | $ | 46,424 | $ | 49,755 | $ | 1,812 | $ | 320 | $ | 10,491 | $ | 10,753 | $ | 53,045 | $ | 47,777 | $ | 89 | $ | 1,227 | ||||||||||||||||||||||||
Europe | 6,572 | 5,489 | 26,370 | 24,420 | 1,550 | 1,090 | 7,878 | 7,383 | 27,904 | 24,834 | 867 | 489 | ||||||||||||||||||||||||||||||||||||
| $ | 17,469 | $ | 15,167 | $ | 72,794 | $ | 74,175 | $ | 3,362 | $ | 1,410 | $ | 18,369 | $ | 18,136 | $ | 80,949 | $ | 72,611 | $ | 956 | $ | 1,716 | |||||||||||||||||||||||||
H.H. Income Taxes
The effective tax rate for the three months ended December 31, 2016September 30, 2017 was 29.6% and the effective rate for the six months ended December 31, 2016 was 30.1%28.0%. The rate differs from the U.S. federal statutory rate of 34% primarily due to the favorable impact ofof foreign earnings taxed at less than the U.S. statutory rate.
To determine our quarterly provision for income taxes, we use an estimated annual effective tax rate, which is based on expected annual income, statutory tax rates and tax planning opportunitiesopportunities available in the various jurisdictions to which we are subject. Certain significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rate from quarter to quarter.quarter. There were no significant discrete items for the sixthree months ended December 31, 2016.September 30, 2017. We recognize interest and penalties related to uncertain tax positions, if any, as an income tax expense.
We record valuation allowances to reduce our deferred tax assets to an amount thatthat we believebelieve is more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the sixthree months ended December 31, 2016,September 30, 2017, there was no change to our valuation allowance.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are measured using enacted tax rates, for each of the jurisdictions in which we operate, expected to apply to taxable income in the years in which thosethose temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized inas income or expense in the period that includes the enactment date.
We are subject to taxation in the U.S., SwiSwitzerltzerlandand and various state jurisdictions. Our tax years for the fiscal year ended June 30, 20132014 and forward are subject to examination by the U.S. tax authorities and our tax years for the fiscal year ended June 30, 20082007 and forward are subject to examination by the state tax authorities. Our tax years for the fiscal year ended June 30, 2015 and forward are subject to examination by Swissthe Switzerland tax authorities.
We do not record U.S. income tax expense for NAIE’s retained earnings that are declared as indefinitely reinvested offshore, thus reducing our overall income tax expense. The amount of earnings designated as indefinitely reinvested in NAIE is based on the actual deployment of such earnings in NAIE’s assets and our expectations of the future cash needs of our U.S. and foreign entities. Currently incomeIncome tax laws are also a factor in determining the amount of foreign earnings to be indefinitely reinvested offshore.
It is our policy to establish reserves based on management’s assessment of exposure for certain positions taken in previously filed tax returns that may become payable upon audit by tax authorities. The tax reserves are analyzed quarterly and adjustments are made as events occur that we believe warrant adjustments to the reserves. There were no adjustments to reserves in the sixthree months ended December 31, 2016.September 30, 2017.
I.I. Treasury Stock
On June 2, 2011, the Board of Directors authorized the repurchase of up to $2.0 million of our common stock. On February 6, 2015, the Board of Directors authorized a $1.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $3.0 million. On May 11, 2015, the Board of Directors authorized a $2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $5.0 million. On March 28, 2017, the Board of Directors authorized a $2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $7.0 million. Under the repurchase plan, we may, from time to time, purchase shares of our common stock, depending upon market conditions. When we do so we may purchase the sharesconditions, in open market or privately negotiated transactions.
During the sixthree months ended December 31,September 30, 2017 and September 30, 2016, we did not repurchaserepurchase any shares under this repurchase plan.
During the sixthree months ended December, 2015,September 30, 2017, we repurchased 35,703acquired 734 shares under this planin connection with restricted stock shares that vested during that year at a weighted average cost of $5.91$10.70 per share and a total cost of $212,000 including commissions$8,000. During the three months ended September 30, 2016, we acquired 6,037 shares from employees in connection with restricted stock shares that vested during the year at a weighted average cost of $13.14 per share and fees.a total cost of $79,000. These shares were returned to the Company by the related employees and in return the Company paid each employee’s required tax withholding. The valuation of the shares acquired and thereby the number of shares returned to the Company was calculated based on the closing share price on the date the shares vested.
J.J. Derivatives and Hedging
We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to forecasted product sales denominated in foreign currencies and transactions of NAIE, our foreign subsidiary. As part of our overall strategystrategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, we may use foreign exchange contracts in the form of forward contracts.contracts. To the extent we enter into such contracts, there can be no guarantee any such contracts will be effective hedges against our foreign currency exchange risk.
As of December 31, 2016,September 30, 2017, we had forward contracts designated as cash flow hedges primarily to protect against the foreign exchange risks inherent in our forecasted sales of productsproducts at prices denominated in currencies other than the U.S. Dollar. These contracts are expected to be settled through February 2018.August 2019. For derivative instruments that are designated and qualify as cash flow hedges, we record the effective portion of the gain or loss on the derivative in accumulated other comprehensive income (“OCI”) as a separate component of stockholders’ equity and subsequently reclassify these amounts into earnings in the period during which the hedged transaction is recognized in earnings.
For foreign currency contracts designated as cash flow hedges, hedge effectiveness is measured using the spot rate. Changes in the spot-forward differential are excluded from the test of hedge effectiveness and are recorded currently in earnings as interest expense or income.interest expense. We measure effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item.item. During the three and six months ended December 31, 2016,September 30, 2017, we recorded a $92,000 gain related to the ineffective portion of our hedging instruments to other income. We did not have any losses or gains related to the ineffective portion of our hedging instruments during the three and six months ended December 31, 2015.instruments. No hedging relationships were terminated as a result of ineffective hedging or forecasted transactions no longer probable of occurring for foreign currency forward contracts. We monitor the probability of forecasted transactions as part of the hedge effectiveness testing on a quarterly basis.
As of December 31, 2016,September 30, 2017, the notional amounts of our foreign exchange contracts designated as cash flow hedges were approximately $35.2$62.7 million (EUR 31.154.2 million). As of December 31, 2016,September 30, 2017, a net gainloss of approximately $1.5$2.4 million related to derivative instrumentsinstruments designated as cash flow hedges was recorded in OCI. It is expected that $1.3$1.6 million will be reclassified into earnings in the next 12 months along with the earnings effects of the related forecasted transactions.
As of December 31, 2016,September 30, 2017, the fair value of our cash flow hedges was an asseta liability of $2.0$2.3 million, of which $1.6 million was classified as a current liability, and $689,000 was classified in prepaids and other current assetsnoncurrent liabilities in our Consolidated Balance Sheets. During the three months ended December 31, 2016,September 30, 2017, we recognized $2.3$2.2 million of net gainslosses in OCI and reclassified $213,000 of gains from OCI to revenue. During the six months ended December 31, 2016, we recognized $1.8 million of net gains in OCI and reclassified $271,000$422,000 of gains from OCI to revenue. As of June 30, 2016, $226,0002017, $422,000 of the fair value of our cash flow hedges was classified in prepaidsaccrued liabilities, and $99,000 was classified other current assetsnoncurrent liabilities, net in our Consolidated Balance Sheets. During the three months ended December 31, 2015,September 30, 2016, we recognized $424,000$452,000 of net gains in OCI and reclassified $45,000$58,000 of gains from OCI to revenue. During the six months ended December 31, 2015, we recognized $482,000 of gains in OCI and reclassified $7,000 of gainslosses from OCI to revenue.
K.K. Contingencies
From time to time, we become involved in various investigations, claims and legal proceedings that arise in the ordinary course of our business. These matters may relate to product liability, employment, intellectual property, tax, regulation, contract or other matters. The resolution of these matters as they arise will be subject to various uncertainties and, even if such claims are without merit, could result in the expenditure of significant financial and managerial resources. While unfavorable outcomes are possible, based on available information, we generally do not believe the resolution of these matters will result in a material adverse effect on our business, consolidated financial condition, or results of operations. However, a settlement payment or unfavorable outcome could adversely impact our results of operations. Our evaluation of the likely impact of these actions could change in the future and we could have unfavorable outcomes that we do not expect.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and six monthsmonths ended December 31, 2016.September 30, 2017. You should read the following discussion and analysis together with our unauditedunaudited 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 20162017 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 overviewoverview does not address all of the matters covered in the other sections of this Item 2 or other items in this report or contain all of the information that may be important to our stockholders or the investing public. 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, herbs and other nutritional supplements, as wellwell as other health care products, to consumers both within and outside the U.S. Historically, our revenue has been largely dependent on sales to one or two 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 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® trademark.and SR CarnoSyn® trademarks.
A cornerstone of our business strategy is to achieve long-term growth and profitability and to diversify our sales base.base. We have sought and expect to continue to seek to diversify our sales by developing relationships with additional, quality-oriented,quality-oriented, private label contract manufacturing customers, and commercializing our patent estate through sales of beta-alanine under our CarnoSyn®Carnosyn® and SR CarnoSyn®Carnosyn® trade names, contract manufacturing, and license agreements.
During the first sixthree months of ffiscal iscal 2017,2018, our net sales were 33% higher18% lower than in the first sixthree months of fiscal 2016.2017. Private label contract manufacturing sales increased 35%decreased 19% due primarily to the saletiming and shipments of higher volumesorders of existing products to existing customers and new productdiscontinued customer relationships. The current quarter contract manufacturing sales decline resulted primarily from reduced orders from our largest customer for specific products associated with an inventory reduction program. During our second quarter of fiscal 2018 we expect sales of these products to increase to historical levels as we believe this excess inventory has been effectively sold through to consumers. Additionally, we expect our Fiscal Q2 2018 sales to new and existing customers. Our first half fiscal 2017 sales were favorably impacted dueour largest customer to the timing and shipments of orders and new product launches.increase as we begin shipping products under our previously announced expanded relationship. Revenue concentration risk for our largest private label contract manufacturing customer as a percentage of our total net sales increaseddecreased to 47% for the three months ended September 30, 2017 compared to 50% for the sixthree months ended December 31, 2016 compared to 39% in the first six months of fiscalSeptember 30. 2016. We expect our annualized fiscal 2018 revenue concentration for this customer to remain relatively consistent at 50% for the remainder ofbe higher than fiscal 2017.
During the first sixthree months of fiscal 2017,2018, CarnoSyn® beta-alanine revenue increased 26%decreased 13% to $13.4$5.9 million as compared to $10.6$6.7 million for the first sixthree months of fiscal 2016.2017. The increasedecrease in beta-alanine revenue was primarily due to thedecreased material shipments as a result of market and seasonal factors and lower average material sales prices. While we still have active patents covering instant release CarnoSyn® beta-alanine we are beginning to see increased competition from companies selling generic beta-alanine. In addition of newto legal actions we have prosecuted and others we may institute, to offset this decline, we have increased our sales and marketing activities to consumers, customers, potential customers, and increased material shipmentsbrand owners on multiple platforms to existing customers.
On an annualized basis, we now expectpromote and reinforce the features and benefits of utilizing CarnoSyn® beta-alanine. We have also recently seen improved activity with our consolidated fiscal 2017 revenue growth percentageefforts to further commercialize our SR CarnoSyn® patent estate with multiple customers having launched or in the process of launching products containing SR CarnoSyn®.There can be approximately 5% to 10% due to reductions in contract manufacturing ordersno assurance that our sales and customer forecasts from Australia, Asia, and Europe. We expect a majority of this decline to occur in our third fiscal quarter ending March 31, 2017 and to a lesser extent in our fourth fiscal quarter. We believe this international revenue decline will be temporary in nature andmarketing efforts will reverse as we enter fiscal 2018 beginning July 1, 2017. With respect to ouror decelerate potential future declines of CarnoSyn® beta-alanine business, we expect our current sales growth rate to continue for the balance of this fiscal year as we continue to expand our research, our patent estate and our client base.sales.
To protect our CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses of approximately $2.0 million$972,000 during the first six monthsquarter of fiscal 20172018 and $779,000$994,000 during the comparable period in fiscal 2016. The increase in these legal expenses on a year over year basis is due to our efforts to enforce compliance with our patents related to instant release CarnoSyn® and to protect our tradename in the marketplace against parties who are using it without our consent.2017. We describe our efforts to protect our patent estate in more detail under Item 1 of Part II of our 20162017 Annual Report. 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, maintainmaintenance of our longer term patent rights, the availability of the raw material beta-alanine when and in the amounts needed, ourthe ability to expand distribution of beta-alanine to new and existing customers, ourthe ability to further commercialize our existing patents, and the continued compliance by third parties with our license agreements and patent and trademark rights.
During the remainder of fiscal 2017,2018, 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 develop relationships with additional quality oriented customers;
Expanding the commercialization of our beta-alanine patent estate through raw material sales, developing a market for our sustained release form of beta-alanine marketed under our SR Carnosyn® trademark, new contract manufacturing opportunities, license agreements and protecting our proprietary rights;
Improving operational efficiencies and managing costs and business risks to improve profitability.
• | 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 develop relationships with additional quality oriented customers; | |
| • | Expanding the commercialization of our beta-alanine patent estate through raw material sales, developing a market for our sustained release form of beta-alanine marketed under our SR Carnosyn® trademark, developing new contract manufacturing opportunities, and license agreements and protecting our proprietary rights; | |
| • | Improving operational efficiencies and managing costs and business risks to improve profitability. |
Critical Accounting Policies and Estimates
The preparation of our financial statements requiresrequires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanyingaccompanying notes. We have identified certain policies that we believe are important to the portrayal of our financial condition and results of operations. These policies require 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 under different assumptions or conditions. 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 such estimates or assumptions.
Our critical accounting policies are discussed under Item 7 of our 20162017 Annual Report and recent accounting pronouncements are discussed under Item A to our Notes to Condensed Consolidated FinancialFinancial Statements contained in this Quarterly Report. There have been no significant changes to these policies or pronouncements during the sixthree months ended December 31, 2016.September 30, 2017.
Results of Operations
The results of our operations for the three and six months ended December 31September 30 were as follows (in(dollars in thousands):
Three Months Ended | Six Months Ended | Three Months Ended September 30, | ||||||||||||||||||||||||||||||||||
December 31, | December 31, | 2017 | 2016 | Change | ||||||||||||||||||||||||||||||||
2016 | 2015 | % Change | 2016 | 2015 | % Change | |||||||||||||||||||||||||||||||
Private label contract manufacturing | $ | 23,864 | $ | 21,619 | 10 | % | $ | 51,243 | $ | 37,884 | 35 | % | $ | 22,222 | $ | 27,379 | (19)% | |||||||||||||||||||
Patent and trademark licensing | 6,695 | 5,292 | 27 | % | 13,383 | 10,612 | 26 | % | 5,852 | 6,688 | (13)% | |||||||||||||||||||||||||
Total net sales | 30,559 | 26,911 | 14 | % | 64,626 | 48,496 | 33 | % | 28,074 | 34,067 | (18)% | |||||||||||||||||||||||||
Cost of goods sold | 24,064 | 21,242 | 13 | % | 50,462 | 38,094 | 32 | % | 21,704 | 26,398 | (18)% | |||||||||||||||||||||||||
Gross profit | 6,495 | 5,669 | 15 | % | 14,164 | 10,402 | 36 | % | 6,370 | 7,669 | (17)% | |||||||||||||||||||||||||
Gross profit % | 21.3 | % | 21.1 | % | 21.9 | % | 21.4 | % | ||||||||||||||||||||||||||||
Selling, general and administrative expenses | 3,382 | 2,934 | 15 | % | 7,515 | 5,939 | 27 | % | ||||||||||||||||||||||||||||
Gross Profit % | 22.7 | % | 22.5 | % | ||||||||||||||||||||||||||||||||
Selling, general & administrative expenses | 4,487 | 4,133 | 9% | |||||||||||||||||||||||||||||||||
% of net sales | 11.1 | % | 10.9 | % | 11.6 | % | 12.2 | % | 16.0 | % | 12.1 | % | ||||||||||||||||||||||||
Income from operations | 3,113 | 2,735 | 14 | % | 6,649 | 4,463 | 49 | % | 1,883 | 3,536 | (47)% | |||||||||||||||||||||||||
% of net sales | 10.2 | % | 10.2 | % | 10.3 | % | 9.2 | % | 6.7 | % | 10.4 | % | ||||||||||||||||||||||||
Total other income | 387 | (75 | ) | 616 | % | 437 | (61 | ) | 816 | % | ||||||||||||||||||||||||||
Other income, net | 108 | 50 | 116% | |||||||||||||||||||||||||||||||||
Income before income taxes | 3,500 | 2,660 | 32 | % | 7,086 | 4,402 | 61 | % | 1,991 | 3,586 | (44)% | |||||||||||||||||||||||||
% of net sales | 11.5 | % | 9.9 | % | 11.0 | % | 9.1 | % | 7.1 | % | 10.5 | % | ||||||||||||||||||||||||
Provision for income taxes | 1,034 | 792 | 31 | % | 2,130 | 1,321 | 61 | % | ||||||||||||||||||||||||||||
Income tax expense | 557 | 1,096 | (49)% | |||||||||||||||||||||||||||||||||
Net income | $ | 2,466 | $ | 1,868 | 32 | % | $ | 4,956 | $ | 3,081 | 61 | % | $ | 1,434 | $ | 2,490 | (42)% | |||||||||||||||||||
% of net sales | 8.1 | % | 6.9 | % | 7.7 | % | 6.4 | % | 5.1 | % | 7.3 | % | ||||||||||||||||||||||||
Private-labelPrivate label contract manufacturing net sales increased 10% during the three months ended December 31, 2016 and 35% during the six months ended December 31, 2016, compared to the same periods in prior year. These increases weredecreased 19% primarily due to the sale timing and shipments of higher volumesorders of existing products to existing customers and new product sales to new and existing customers.discontinued customer relationships. Net sales to our largest customer represented a majority of our increasedecrease in private-labelprivate label contract manufacturing sales during both the three and six months ended December 31, 2016. The increase was primarily due to increased consumer demand for existing products as well as the shipmentresult of a new product awarded to our domestic operations in fiscal 2016.timing and shipments of orders.
Net sales from our patent and trademark licensing segment increased 27%decreased 13% during the three months ended December 31, 2016 and 26% during the six months ended December 31, 2016, comparedfirst quarter of fiscal 2018. The decrease in beta-alanine raw material sales was primarily due to the same periods in the prior year. These increases were primarily thedecreased material shipments as a result of growth in our customer basemarket and increasedseasonal factors and lower average material shipments. The change in grosssales prices.
Gross profit margin between the three and six month periods ended December 31, 2016 wasincreased 0.2 percentage points as follows:
Three Months | Six Months | |||||||
Ended | Ended | |||||||
Contract manufacturing(1) | (2.4 | )% | (1.1 | )% | ||||
Patent and trademark licensing(2) | 2.6 | 1.6 | ||||||
Total change in gross profit margin | 0.2 | % | 0.5 | % | ||||
Contract manufacturing(1) | (1.4)% | |||
Patent and trademark licensing(2) | 1.6 | |||
Total change in gross profit margin | 0.2% |
1 | Private label contract manufacturing gross profit margin as a percentage of consolidated net sales decreased |
2 | Patent and trademark licensing gross profit margin as a percentage of consolidated net sales increased |
Selling, general andand administrative expenses increased $0.4 million,$354,000, or 15%9%, during the three months ended December 31, 2016 and increased $1.6 million, or 27%, during the six months ended December 31, 2016, as compared to the comparable prior year periods. These increases werefirst quarter of fiscal 2018 primarily due to increased compensationmarketing, advertising and research and development costs associated with the growth in sales and increased litigation and patent compliance expenses. The increase in expenses associated withsupporting our patent and trademark licensing segment are primarily associated with our efforts to enforce compliance with our patents related to instant release CarnoSyn® and to protect our tradename in the marketplace against parties who are using them without our consent.SR CarnoSyn® brands partially offset by lower employee compensation costs.
Other income, net increased $0.5 million$58,000 during the three and six months ended December 31, 2016,first quarter of fiscal 2018 as compared to the same period in the prior periods. These increases werefiscal year primarily due to favorable interest income associated with our foreign currency hedge contracts and a $0.1 million realized gain associated with the ineffective portion of certain foreign currency hedge contracts.
Our income tax expense increased $0.2 million, orde 31%,creased $539,000 during the three months ended December 31, 2016 and increased $0.8 million, or 61%, duringfirst quarter of fiscal 2018 as compared to the six months ended December 31, 2016,same period in the prior fiscal year. The decrease was primarily due to the lower pre-tax income in the first quarter of fiscal 2018 as compared to the comparable prior year periods. The increases were primarily due to the higher pre-tax income duringperiod, as well as a lower estimated annual effective tax rate for fiscal 2017 as compared to the comparable prior year periods.2018.
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 provided by operating activities was $5.0$2.3 million for the sixthree months ended December 31, 2016September 30, 2017 compared to net cash provided byused in operating activities of $5.1$0.1 million in the comparable period in the priorquarter last year.
At December 31, 2016,September 30, 2017, changes in accounts receivable, provided $3.4 millionconsisting of amounts due from our private label contract manufacturing customers and our patent and trademark licensing activities, used $799,000 in cash compared to providing $2.3 million$649,000 of cash in the comparable period in the prior year.year quarter. The increasedecrease in cash used in/provided by accounts receivable during the periodquarter ended December 31, 2016September 30, 2017 primarily resulted from the increase and timing of sales and the related collections. Days sales outstanding was 3329 days during both the sixthree months ended December 31, 2016 andSeptember 30, 2017 as compared to 35 days for the six months ended December 31, 2015.prior year period.
At December 31, 2016,September 30, 2017, changes in inventory provided $3.7used $5.3 million in cash during the three months ended September 30, 2016 compared to $5.7$2.5 million used in the comparable prior year quarter. The change in cash providedused by inventory during the periodquarter ended December 31, 2016September 30, 2017 was primarily related to the conversion ofinventory purchased to support an anticipated increase in private label contract manufacturing inventory into sales during the first six months of fiscal 2017 versus inventory growth during the first six months of fiscal 2016 related to private label contract manufacturing growth.sales. Changes in accounts payable and accrued liabilities used $6.7provided $5.8 million in cash during the sixthree months ended December 31, 2016September 30, 2017 compared to providing $2.1 millionusing $875,000 during the sixthree months ended December 31, 2015.September 30, 2016. The change in cash flow activity related to accounts payable and accrued liabilities is primarily due to the timing of inventory receipts and payments.
During the sixthree months ended December 31, 2016, NAIEende’sd September 30, 2017, NAIE’s operations provided $2.2used $2.0 million of our operating cash flow primarily due to the timing of inventory receipts, payments and sales. As of December 31, 2016,September 30, 2017, NAIE’s undistributed retained earnings were considered indefinitely reinvested.
Cash used in investing activities in the sixthree months ended December 31, 2016September 30, 2017 was $3.3 million$2.5 million compared to cash used of $0.8$1.7 million in the comparable periodquarter last year. The primary reason for the change was due to capital equipment purchases of $3.4$1.7 million in the first halfquarter of fiscal 2017 as compared to $1.4capital equipment purchases of $1.0 million in of the same periodfirst quarter of fiscal 2016.2018. In addition, we converted $1.5 million of accounts receivable into a note receivable during the first quarter of fiscal 2018. Capital expenditures for both years were primarily for manufacturing equipment used in our Vista, California and Manno, Switzerland facilities. The first half of fiscal 2016 also included $568,000 in proceeds from the sale of property and equipment as compared to $24,000 in the first half of fiscal 2017.
Cash used in financing activities for the six months ended December 31, 2016 primarily related to payroll taxes paid on behalf of employees whose restricted stock vested during the quarter in exchange for a transfer to the Company of a portion of the employee’s vested shares equal in market value to the payroll taxes paid.
We did not have any consolidated debt as of December 31, 2016September 30, 2017 or June 30, 2016.2017.
On February 1, 2016, we executedThe Company has a new Credit Agreement with Wells Fargo Bank, N.A. TheThe Credit Agreement replaced the previous credit facility and increased ourprovides us with a credit line from $5.0 millionof up to $10.0 million. million and matures on February 1, 2020. The line of credit may be used to finance working capital requirements. On September 29, 2017, we executed an amendment to our credit facility with Wells Fargo Bank, N.A, which amendment now allows us to make loans or advances to third parties not exceeding $1.5 million. We executed this amendment in order to issue a note receivable of $1.5 million to a customer.There was no commitment fee required as part of this agreement.amendment. There are no amounts currently drawn under the line of credit.
Under the terms of the Credit Agreement, borrowings are subject to eligibility requirements includingincluding maintaining (i) a ratio of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time; and (ii) a ratio of total current assets to total current liabilities of not less than 1.75 to 1.0 at each fiscal quarter end. Any amounts outstanding under the line of credit will bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of interest. If elected, the fluctuating rate per annum would be equal to 1.25% above the daily one month LIBOR rate as in effect from time to time. If a fixed rate is elected, it would equal a per annum rate of 1.25% above the LIBOR rate in effect on the first day of the applicable fixed rate term. Any amounts outstanding under the line of credit must be paid in full on or before January 31, 2019.the maturity date. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of $100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which the then applicable fixed rate term matures.
Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general intangibles, inventory, equipment and fixtures. We also have a foreign exchange facility with Wells Fargo Bank, N.A. in effect until January 31, 2019, and with Bank of America, N.A. in effect until August 15, 2017.2019.
On December 31, 2016,During the three months ending on September 30, 2017, we were in compliance with all of the financial and other covenants required under the Credit Agreement.
Our wholly owned subsidiary, NAIE, formerly had a credit facility with Credit Suisse that would provide NAIE with a credit line of up to CHF 500,000, or approximately $488,000. We terminated this line of credit in December 2016 as we determined that it was unnecessary as we believe our current cash position and on going cash from operations are sufficient to support our cash requirements.
As of December 31, 2016,September 30, 2017, we had $21.4$27.7 million in cash and cash equivalents and $10.0 million available under our credit facilities. We believe our available working capital, cash, and cash equivalents and potential cash flows fromfrom 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 of December 31, 2016,September 30, 2017, 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 auditedconsolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016.under Item 1 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.
ITEM 4. CONTROLS AND PROCEDURES
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), evaluatedevaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2016.September 30, 2017. 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 December 31, 2016.September 30, 2017.
There were no changes to our internal control over financial reporting during the quarterly period ended December 31, 2016September 30, 2017 that have materially affected, or that are reasonablyreasonably likely to materially affect, our internal control over financial reporting.
From time to time, we become involved in various investigations, claims and legal proceedings that arise in the ordinary course of our business. These matters may relate to intellectual property, product liability, employment, tax, regulation, contract or other matters. The resolution of these matters as they arise will be subject to various uncertainties and, even if such claims are without merit, could result in the expenditure of significant financial and managerial resources. While unfavorable outcomes are possible, based on available information, we generally do not believe the resolution of these matters will result in a material adverse effect on our business, consolidated financial condition, or results of operations. However, a settlement payment or unfavorable outcome could adversely impact our results of operations. Our evaluation of the likely impact of these actions could change in the future and we could have unfavorable outcomes we do not expect.
As of February 14,November 13, 2017, except as described below, neither NAI nor its subsidiarysubsidiary were a party to any material pending legal proceeding nor was any of our property the subject of anany material pending legal proceeding. We are currently involved in several matters in the ordinary course of our business, each of which is related to enforcing our intellectual property rights. Some of these matters are summarized below.
In 2011, NAI filed a lawsuit against Woodbolt Distribution, LLC, also known as Cellucor (“Woodbolt”), and both NAI and Woodbolt filed additional lawsuits and countersuits against each other. NAI and Woodbolt subsequently settled all of the lawsuits between them, but not before the United States Patent and Trademark Office (“USPTO”) at Woodbolt’sWoodbolt’s request rejected the claims of onetwo NAI patent.patents. The rulingrulings rejecting the claims of onetwo NAI patent waspatents were subsequently confirmed by the Patent Trial and Appeal Board (PTAB) at the USPTO, andUSPTO. NAI filed Notices of Appeal with the U.S. Court of Appeals for the Federal Circuit requesting that confirmation is presently subject to a request by NAI for a rehearing. The USPTO subsequent rejectedcertain findings of the claims of a second NAI patent, which was also confirmedPTAB's be reversed. No hearing date has been set by the PTAB and is the subject of a pending request by NAI for a rehearing.Court. Both NAI patents rejected by the USPTO expireexpired in August 2017.
On SeptemberSeptember 18, 2015, the Company filed a complaint against Creative Compounds, Inc.,LLC, alleging various claims including (1) violation of Section 43 of the Lanham Act, (2) violation of California's Unfair Competition Law, (3) violation of California's False Advertising Law, (4) Trade Libel and Business Disparagement and (5) Intentional Interference with Prospective Economic Advantage. Subsequently, the Company and defendant resolved their disputes and entered into settlement and the case was dismissed.
On August 24, 2016, the Company filed a separate complaint against Creative Compounds, Inc.,LLC, alleging infringement of U.S. patent 7,825,084. On October 5, 2016, Creative filed its answer and counterclaims. On January 19, 2017, the Company filed a Motion to Amend the Complaint, to add allegations of infringement of U.S. patents 5,965,596, 7,504,376, 8,993,610 and 8,470,865, and additional parties, Core Supplement Technology, Inc., Honey Badger LLC, and Myopharma, Inc.
The Court granted the Company's motion. On May 2, 2017, the Court issued a revised scheduling order and set a trial date for July 31, 2018. On July 1, 2016, the Company19, 2017, Creative filed a complaint inmotion for judgment on the pleadings to dismiss the patent infringement claims with prejudice, On September 5, 2017, the Court granted Creative's motion, which is a non-final decision and subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will appeal the District Court forrulings. The remaining non-patent claims pending against other defendants were not affected. On October 16, 2017, defendant Core Supplement Technology, Inc., filed a Notification of Bankruptcy with the Southern District of California against Cenegenics, LLC, alleging infringement of U.S. patCourt.ents 7,504,376 and 7,825,084. On August 3, 2016, the Company filed an amended complaint to assert infringement of the same patents against Cenegenics' contract manufacturer, Atlantic-Pro Nutrients d/b/a Xymogen, LLC. SubsequentlyOctober 17, 2017, the Company and defendants resolved their disputesdefendant Honey Badger LLC filed a voluntary stipulation of dismissal, which the Court granted on October 20, 2017. On October 31, 2017, the Company and entered into settlement and license agreements, anddefendant Myopharma, Inc. filed a voluntary stipulation of dismissal, which the case was dismissed.Court has not yet granted so that a final judgment can be entered.
On July 6, 2016, the Company filed a complaint against Allmax Nutrition, Inc. in U.S. District Court for the Southern District of California, allegingalleging (1) infringement of U.S. patents 5,965,596, 6,172,098, 7,825,084 and RE 45,947, (2) violation of Section 32 of the Lanham Act, and (3) copyright infringement. On October 19, 2016, the Company filed an amended complaint adding HBS International Corp., Allmax's exclusive distributor, as a co-defendant.
co-defendant and to add a civil conspiracy claim.On AugustMay 2, 2016,2017, the Court issued a scheduling order setting a trial date for July 31, 2018. On April 25, 2017, defendants filed a motion for judgment on the pleadings and a motion to dismiss as to the Company's trademark and patent infringement and civil conspiracy claims. On June 26, 2017, the Court granted Defendants’ motions, dismissing the Company's patent infringement claim with prejudice and dismissing the trademark and civil conspiracy claims without prejudice. The Company filed a complaint against Muscle Sports Products, LLC inSecond Amended Complaint on July 10, 2017. On August 29, 2017, the Court denied the Company's motion to partially reconsider the dismissal of the patent infringement claim, which is a non-final decision and subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will appeal the District Court rulings. On August 30, 2017, the Court denied Defendants' motion to dismiss the Company's trademark and conspiracy claims. On September 29, 2017, both defendants filed their amended answers. Defendant HBS International Corp. also asserted a counterclaim for tortious interference with contract. The Company has not yet filed its response to the Southern District of California, alleging infringement of its CarnoSyn® and CarnoSyn Beta Alanine® trademarks. asserted counterclaim.
On September 15, 2016, the Company filed a complaint against Arnet Pharmaceutical Corporation in the U.S. District Court for the Southern District
On September 16, 2016, the Company filed a complaint against Hi-Tech Pharmaceuticals, Inc. d/b/a ALR Industries, APS Nutrition, Innovative Laboratories, Formutech Nutrition, LG Sciences and Sports 1 in U.S. District Court for the Southern District of California, alleging (1) infringement of U.S. patents 5,965,596, 7,825,084, 8,993,610 and RE 45,947, (2) violation of Section 32 of the Lanham Act and (3) breach of contract. On May 2, 2017, the Court issued a scheduling order setting a trial date for July 31, 2018. On July 10, 2017, Defendants filed a motion for judgment on the pleadings to dismiss the patent infringement claims with prejudice. On September 5, 2017, the Court granted Defendants' motion, which is a non-final decision and subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will appeal the District Court rulings. The remaining non-patent claims pending against the Defendants were not affected. On September 28, 2017, in a separate matter not involving the Company, the United States of America filed a First Superseding Criminal Indictment against defendants Hi-Tech Pharmaceuticals, Inc and its Chief Executive Officer, Jared Wheat. United States v. Hi-Tech Pharmaceuticals, et al., No.1:17-CR-0229 (N.D. Ga. 2017). On or about October 4, 2017, items in the possession of Hi-Tech were seized pursuant to a search warrant, including the documentation relevant to this case. In light of this development, the parties moved the Court on November 3, 2017, seeking an order staying all proceedings in the pending action until disposition of United States v. Hi-Tech Pharmaceuticals, et al., 1:17-CR-00229 (N.D. Ga 2017), or at a minimum, until the documents relevant to this case can be retrieved by the defendants. The Court has not yet ruled on the parties' pending motion.
Although we believe our claims in the above litigation matters are valid, there is no assurance we will prevail in these litigationlitigation matters or in proceedings we may initiate or that our litigation expenses will not be greater than anticipated.
When evaluating our business and future prospects you should carefully consider the risks described under Item 1A of our 20162017 Annual Report, as well as the other information in our 20162017 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.
ITEM 2. 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases
During the quarter ended December 31, 2016, we did not sell any unregistered equity securities andSeptember 30, 2017, we did not repurchase any shares of our common stock.
ITEM 3. 3. DEFAULTS UPON SENIOR SECURITIES
None.
None.
The following exhibit index shows those exhibits filed with this report and those incorporated by reference:
EXHIBIT INDEX
Exhibit | Description | Incorporated By Reference To | ||||||
3(i) | Exhibit 3(i) of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2004, filed with the commission on February 14, 2005 | |||||||
3(ii) | Exhibit 3(ii) of NAI’s Current Report on Form 8-K dated February 9, 2009, filed with the commission on February 13, 2009 | |||||||
4(i) | Exhibit 4(i) of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005, filed with the commission on September 8, 2005 | |||||||
10.1 | Filed herewith | |||
10.2 | Filed herewith | |||
31.1 | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer | Filed herewith | ||
31.2 | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer | Filed herewith | ||
32 | Filed herewith | |||
101.INS | XBRL Instance Document | Filed herewith | ||
101.SCH | XBRL Taxonomy Extension Schema Document | Filed herewith | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | Filed herewith | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | Filed herewith | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | Filed herewith | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | Filed herewith |
Pursuant to the requirements of the Securities Exchange Act of 1934, Natural Alternatives International, Inc., the registrant, has duly caused this report to be signed on its behalf by the undersigned,undersigned, duly authorized officers.
Date: February 14,November 13, 2017
| NATURAL ALTERNATIVES INTERNATIONAL, INC. |
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| By: | /s/ Mark A. LeDoux |
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| Mark A. LeDoux, Chief Executive Officer |
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| By: | /s/ Michael E. Fortin | ||
| Michael E. Fortin, Chief Financial Officer | |||
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