UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-Q
QUARTERLY REPORT
pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED March 31,SEPTEMBER 30, 2018
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 Carlsbad, | (760) |
(Address of principal executive offices) | ( |
Indicate by check mark whether Natural Alternatives International, Inc. (NAI)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 such 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, a non-accelerated filer, a smaller reporting company, or an emerging growth company.
Large accelerated filer | ☐ | Accelerated filer | ☐ | Emerging Growth Company | ☐ |
Non-accelerated filer | ☐ | Smaller reporting company | ☒ |
If an emerging growth company, 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 May 14,November 13, 2018, 7,558,4097,570,871 shares of NAI's common stock were outstanding, net of 1,098,2681,105,806 treasury shares.
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PART I | ||
Item 1. | ||
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Condensed Consolidated Statements of Income and Comprehensive Income | 3 | |
4 | ||
5 | ||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 15 |
Item 4. | 20 | |
PART II |
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Item 1. | 21 | |
Item 1A. |
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Item 2. |
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Item 3. |
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Item 5. |
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Item 6. |
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SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report,report, including information incorporated by reference, are “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. TheyThese 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 each identify a statement as a forward-looking statement. Any statements contained herein 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 our future operating results, are forward-looking statements. Forward-looking statements in this Quarterly Reportreport 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, the effect of changes in tax law 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;
future levels of our revenue concentration risk;
our ability to protect our intellectual property;
future economic and political conditions, including implementation of new or increased tariffs;
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 we may be reclassifiedreclassify 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 levelsthe outcome of currently pending litigation, regulatory and tax matters, the costs associated with such matters and the effect of such matters on our revenue concentration risk;business and results of operations;
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sources and availability of raw materials, including the limited number of suppliers of beta-alanine meeting our quality requirements;
inventory levels, including the adequacy of raw material and other inventory levels to meet future customer demand and demand;
the future adequacy and intended use of our facilities;
potential manufacturing and distribution channels, product returns, and potential product recalls;
current or future customer orders;
the impact of external factors on our business and results of operations, fromespecially variations in our 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);Practices;
our ability to successfully expand our operations, including outside the United States (U.S.);
the adequacy of our financial reserves and allowances;
current and future economic and political conditions;
the sufficiency of our available cash, cash equivalents, and potential cash flows from our operations to fund our current working capital needs and capital expendituresexpenditure needs through the next 12 months;months and longer;
the impact of accounting pronouncements and our adoption of certain accounting guidance; and
other assumptions described in this Quarterly Reportreport underlying or relating to any forward-looking statements.
The forward-lookingForward-looking statements in this Quarterly Reportreport speak only as of the date of this Quarterly Reportreport and caution should be taken not to place undue reliance on any such forward-looking statements. Forward-looking statements are subject to certain events, risks, and uncertainties that are or may be outside of our control. When considering forward-looking statements, you should carefully review the risks, uncertainties and other cautionary statements in this Quarterly Reportreport 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 Quarterly Report,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 Quarterly Report to the “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, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
March 31, 2018 | June 30, 2017 | September 30, 2018 | June 30, 2018 | |||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 27,618 | $ | 27,843 | $ | 27,613 | $ | 23,613 | ||||||||
Accounts receivable - less allowance for doubtful accounts of $43 at March 31, 2018 and $18 at June 30, 2017 | 11,325 | 8,410 | ||||||||||||||
Notes receivable | 1,556 | — | ||||||||||||||
Accounts receivable - less allowance for doubtful accounts of $63 at September 30, 2018 and $49 at June 30, 2018 | 12,733 | 14,621 | ||||||||||||||
Note receivable | 1,500 | 1,500 | ||||||||||||||
Inventories, net | 23,785 | 13,729 | 24,972 | 23,567 | ||||||||||||
Income tax receivable | — | 261 | ||||||||||||||
Prepaids and other current assets | 1,789 | 1,456 | 3,087 | 1,882 | ||||||||||||
Total current assets | 66,073 | 51,699 | 69,905 | 65,183 | ||||||||||||
Property and equipment, net | 18,832 | 18,136 | 19,277 | 19,290 | ||||||||||||
Deferred income taxes | 2,443 | 2,002 | ||||||||||||||
Other noncurrent assets, net | 749 | 774 | 920 | 734 | ||||||||||||
Total assets | $ | 88,097 | $ | 72,611 | $ | 90,102 | $ | 85,207 | ||||||||
Liabilities and Stockholders’ Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 13,799 | $ | 5,116 | $ | 10,064 | $ | 9,649 | ||||||||
Accrued liabilities | 2,323 | 1,931 | 2,302 | 2,346 | ||||||||||||
Accrued compensation and employee benefits | 1,017 | 1,594 | 1,612 | 1,498 | ||||||||||||
Forward contract | 2,631 | 422 | ||||||||||||||
Income taxes payable | 1,041 | 1,207 | 1,442 | 787 | ||||||||||||
Total current liabilities | 20,811 | 10,270 | 15,420 | 14,280 | ||||||||||||
Long-term pension liability | 460 | 557 | 57 | 45 | ||||||||||||
Deferred rent | 558 | 537 | 555 | 556 | ||||||||||||
Forward contract, noncurrent | 480 | 99 | ||||||||||||||
Income taxes payable, noncurrent | 2,950 | — | 1,546 | 1,546 | ||||||||||||
Deferred income taxes | 648 | 532 | ||||||||||||||
Total liabilities | 25,259 | 11,463 | 18,226 | 16,959 | ||||||||||||
Commitments and contingencies | ||||||||||||||||
Commitments and contingencies (Note K) | ||||||||||||||||
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) 7,568,817 at March 31, 2018 and 6,937,018 at June 30, 2017 | 85 | 79 | ||||||||||||||
Common stock; $.01 par value; 20,000,000 shares authorized; issued and outstanding (net of treasury shares) 7,577,735 at September 30, 2018 and 7,558,408 at June 30, 2018 | 85 | 85 | ||||||||||||||
Additional paid-in capital | 23,832 | 22,260 | 25,177 | 24,486 | ||||||||||||
Retained earnings | 47,955 | 45,788 | 53,399 | 50,839 | ||||||||||||
Treasury stock, at cost, 1,087,860 shares at March 31, 2018 and 1,044,659 June 30, 2017 | (6,579 | ) | (6,074 | ) | ||||||||||||
Treasury stock, at cost, 1,098,942 shares at September 30, 2018 and 1,098,268 June 30, 2018 | (6,590 | ) | (6,584 | ) | ||||||||||||
Accumulated other comprehensive loss | (2,455 | ) | (905 | ) | (195 | ) | (578 | ) | ||||||||
Total stockholders’ equity | 62,838 | 61,148 | 71,876 | 68,248 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 88,097 | $ | 72,611 | $ | 90,102 | $ | 85,207 |
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Ofof Income Andand Comprehensive Income
(In(In thousands, except share and per share data)
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
March 31, | March 31, | Three Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
Net sales | $ | 31,815 | $ | 25,135 | $ | 93,224 | $ | 89,761 | $ | 36,532 | $ | 28,074 | ||||||||||||
Cost of goods sold | 25,105 | 20,017 | 73,522 | 70,479 | 29,369 | 21,704 | ||||||||||||||||||
Gross profit | 6,710 | 5,118 | 19,702 | 19,282 | 7,163 | 6,370 | ||||||||||||||||||
Selling, general and administrative | 4,187 | 4,125 | 13,015 | 11,640 | ||||||||||||||||||||
Selling, general and administrative expenses | 4,439 | 4,487 | ||||||||||||||||||||||
Income from operations | 2,523 | 993 | 6,687 | 7,642 | 2,724 | 1,883 | ||||||||||||||||||
Other income (expense): | ||||||||||||||||||||||||
Interest income | 269 | 109 | 823 | 358 | 555 | 250 | ||||||||||||||||||
Interest expense | (6 | ) | (1 | ) | (6 | ) | (1 | ) | (3 | ) | - | |||||||||||||
Foreign exchange (loss) gain | (182 | ) | (45 | ) | (413 | ) | 158 | |||||||||||||||||
Foreign exchange loss | (78 | ) | (143 | ) | ||||||||||||||||||||
Other, net | (5 | ) | (6 | ) | (18 | ) | (21 | ) | 23 | 1 | ||||||||||||||
Total other income | 76 | 57 | 386 | 494 | 497 | 108 | ||||||||||||||||||
Income before income taxes | 2,599 | 1,050 | 7,073 | 8,136 | 3,221 | 1,991 | ||||||||||||||||||
Provision for income taxes | 548 | 305 | 4,906 | 2,435 | 662 | 557 | ||||||||||||||||||
Net income | $ | 2,051 | $ | 745 | $ | 2,167 | $ | 5,701 | $ | 2,559 | $ | 1,434 | ||||||||||||
Unrealized (loss) gain resulting from change in fair value of derivative instruments, net of tax | (219 | ) | (451 | ) | (1,550 | ) | 401 | |||||||||||||||||
Unrealized gain (loss) resulting from change in fair value of derivative instruments, net of tax | 383 | (1,134 | ) | |||||||||||||||||||||
Comprehensive income | $ | 1,832 | $ | 294 | $ | 617 | $ | 6,102 | $ | 2,942 | $ | 300 | ||||||||||||
Net income per common share: | ||||||||||||||||||||||||
Basic | $ | 0.31 | $ | 0.11 | $ | 0.33 | $ | 0.87 | $ | 0.38 | $ | 0.22 | ||||||||||||
Diluted | $ | 0.30 | $ | 0.11 | $ | 0.32 | $ | 0.86 | $ | 0.37 | $ | 0.21 | ||||||||||||
Weighted average common shares outstanding | ||||||||||||||||||||||||
Weighted average common shares outstanding: | ||||||||||||||||||||||||
Basic | 6,639,098 | 6,581,632 | 6,620,324 | 6,569,165 | 6,764,962 | 6,606,518 | ||||||||||||||||||
Diluted | 6,909,475 | 6,613,955 | 6,860,870 | 6,648,091 | 6,964,942 | 6,831,230 |
See accompanying notes to condensed consolidated financial statements.
NATURAL ALTERNATIVES INTERNATIONAL, INC.
Condensed Consolidated Statements Ofof Cash Flows
(In thousands)(In thousands, except share and per share data)
(Unaudited)
Nine Months Ended | ||||||||||||||||
March 31, | ||||||||||||||||
2018 | 2017 | Three Months Ended September 30, | ||||||||||||||
2018 | 2017 | |||||||||||||||
Cash flows from operating activities | ||||||||||||||||
Net income | $ | 2,167 | $ | 5,701 | $ | 2,559 | $ | 1,434 | ||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation and amortization | 2,222 | 1,711 | 792 | 717 | ||||||||||||
Deferred income taxes | 306 | — | ||||||||||||||
Non-cash sales discount | 653 | — | 245 | 163 | ||||||||||||
Non-cash compensation | 925 | 729 | 409 | 301 | ||||||||||||
Pension expense, net of contributions | (97 | ) | 149 | |||||||||||||
Gain on disposal of assets | (9 | ) | (23 | ) | ||||||||||||
Pension expense | 12 | 51 | ||||||||||||||
(Gain) loss on disposal of assets | (1 | ) | 1 | |||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable and notes receivable, net | (2,971 | ) | 5,298 | |||||||||||||
Accounts receivable, net | 1,888 | (799 | ) | |||||||||||||
Notes Receivable | - | - | ||||||||||||||
Inventories, net | (10,056 | ) | 4,802 | (1,405 | ) | (5,267 | ) | |||||||||
Prepaids and other assets | (308 | ) | 450 | (993 | ) | 52 | ||||||||||
Accounts payable and accrued liabilities | 8,674 | (8,579 | ) | 471 | 5,773 | |||||||||||
Accrued compensation and employee benefits | (577 | ) | (1,813 | ) | 114 | (604 | ) | |||||||||
Forward contracts | 715 | (268 | ) | |||||||||||||
Income taxes | 3,045 | (291 | ) | 655 | 492 | |||||||||||
Net cash provided by operating activities | 4,689 | 7,866 | 4,746 | 2,314 | ||||||||||||
Cash flows from investing activities | ||||||||||||||||
Purchases of property and equipment | (2,937 | ) | (4,332 | ) | (796 | ) | (956 | ) | ||||||||
Proceeds from sale of property and equipment | 28 | 24 | 19 | 5 | ||||||||||||
Issuance of notes receivable | (1,500 | ) | — | — | (1,500 | ) | ||||||||||
Net cash used in investing activities | (4,409 | ) | (4,308 | ) | (777 | ) | (2,451 | ) | ||||||||
Cash flows from financing activities | ||||||||||||||||
Repurchase of common stock | (505 | ) | (712 | ) | (6 | ) | — | |||||||||
Net cash used in financing activities | (505 | ) | (712 | ) | ||||||||||||
Issuance of common stock | 37 | — | ||||||||||||||
Net cash provided by financing activities | 31 | — | ||||||||||||||
Net (decrease) increase in cash and cash equivalents | (225 | ) | 2,846 | |||||||||||||
Net increase (decrease) in cash and cash equivalents | 4,000 | (137 | ) | |||||||||||||
Cash and cash equivalents at beginning of period | 27,843 | 19,747 | 23,613 | 27,843 | ||||||||||||
Cash and cash equivalents at end of period | $ | 27,618 | $ | 22,593 | $ | 27,613 | $ | 27,706 | ||||||||
Supplemental disclosures of cash flow information | ||||||||||||||||
Cash paid during the period for: | ||||||||||||||||
Interest | $ | 6 | $ | — | $ | 3 | $ | — | ||||||||
Taxes | $ | 1,578 | $ | 2,761 | $ | 7 | $ | 76 | ||||||||
Disclosure of non-cash activities: | ||||||||||||||||
Change in unrealized (loss) gain resulting from change in fair value of derivative instruments, net of tax | $ | (1,550 | ) | $ | 401 | |||||||||||
Change in unrealized gain (loss) resulting from change in fair value of derivative instruments, net of tax | $ | 383 | $ | (1,134 | ) |
See accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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-Q10-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’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 nine months ended March 31,September 30, 2018 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-K10-K for the fiscal year ended June 30, 2017 (“20172018 (“2018 Annual Report”). The accounting policies used to prepare the financial statements included in this Quarterly Reportreport are the same as those described in the notes to the consolidated financial statements in our 20172018 Annual Report unless otherwise noted below.
RecentRecently Adopted Accounting Pronouncements
In March 2016, April 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-10, Revenue from Contracts with Customers (Topic 606)(ASU 2017-10), 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 2017, the FASB issued Accounting Standards Update No. 2017-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815) (ASU 2017-11), which amends and rescinds certain revenue recognition guidance previously released within ASU 2014-09. In May 2017, the FASB issued Accounting Standards Update No. 2017-12, Revenue from Contracts with Customers (Topic 606) (ASU 2017-12), which provides narrow scope improvements and practical expedients related to ASU 2014-09. All of these ASUs have been codified under Accounting Standards Codification (ASC) 606.
This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current historical revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods and services in an amount that reflects the consideration to which the entity expects to be entitled to receive in exchange for those goods and services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with their respective customers.
The new revenue standard is required to be applied either retrospectively to each prior reporting period presented or prospectively with the cumulative effect of initially applying the standard recognized at the date of the initial application, supplemented with certain disclosures related to the effect of adoption on previously reported amounts, if any (the modified retrospective method). We adopted the standard on July 1, 2018 for contracts that were not completed before the adoption date, using the modified retrospective method. We evaluated the effect of the standard and concluded it is not material to the timing or amount of revenues or expenses recognized in our historical consolidated financial statements. As a result, we concluded the application of the standard does not have a material effect that requires a retrospective adjustment for reporting disclosure purposes to any previously reported amounts in our historical consolidated financial statements.
On December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”) directing taxpayers to consider the impact of the U.S. legislation as “provisional” when the taxpayer does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, we calculated our taxes for fiscal 2018 to the best of our ability and we do not expect any significant changes, however our estimated income tax could change once we complete our tax return and thus our tax expense for fiscal 2018 is considered provisional and is expected to be finalized by the end of the one-year measurement period ending December 22, 2018.
In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2018-03 is intended to improve certain aspects of recognition, measurement, presentation, and disclosure of certain financial instruments, i.e. forward contracts, purchased options and option liabilities. We do not expect this ASU to have a material impact on our consolidated financial statements. ASU 2018-03 is effective for us beginning in this quarter, our first quarter of fiscal 2019.
Recently Issued Accounting Pronouncements
In March 2016,-02, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842)842) (ASU 2016-02)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. In July 2018, the FASB issued ASU 2016-022018-10, Codification Improvements to Topic 842, Leases. This ASU affects narrow aspects of the guidance issued in the amendments in ASU No. 2016-02 including those regarding residual value guarantees, the interest rate implicit in the lease, lessee reassessment of lease classification, lessor reassessment of lease term and purchase option, variable lease payments that depend on an index or a rate, investment tax credits, lease term and purchase option, transition guidance for amounts previously recognized in business combinations, certain transition adjustments, transition guidance for leases previously classified as capital leases under Topic 840, transition guidance for modifications to leases previously classified as direct financing or sales-type leases under Topic 840, transition guidance for sale and leaseback transactions, impairment of net investment in the lease, unguaranteed residual asset, effect of initial direct costs on the interest rate implicit in the lease, and failed sale and leaseback transactions. These ASUs will be effective for us beginning in our first quarter of fiscal 2020. Early adoption is permitted. We continue to evaluateare currently evaluating the impact of adopting the new standardthese ASUs will have on our consolidated financial statements and the timing and presentation of our adoption.statements.
In April 2016, August 2017, 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) and2017-12, 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 (that we should recognize revenue in an amount that reflects the consideration to which we expect to be entitled in exchange for goods or services provided) and, in doing so, possibly requiring more judgment and estimates may be required within the revenue recognition process than are required under present U.S. GAAP. These judgments and estimates may include identifying each performance obligation 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. ASU 2016-12 also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant additional judgments and changes in existing judgments. All of these new standards will be effective for us concurrently with ASU 2014-09, beginning in our first quarter of fiscal 2019. 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 continue to evaluate the impact of adopting the new standard.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815)815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-122017-12 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 2017-122017-12 will be effective for us beginning in our first quarter of fiscal 2020.
On December 22, 2017, In February 2018, the SECFASB issued guidance under Staff Accounting Bulletin No.118,ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Accounting Implications ofEffect from Accumulated Other Comprehensive Income. ASU 2018-02 allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“SAB 118”) directing taxpayersAct. We are currently evaluating the impact of adopting the new standard on our consolidated financial statements. ASU 2018-02 will be effective for us beginning in our first quarter of fiscal 2020.
In June 2018, the FASB issued ASU 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to considerNonemployee Share-Based Payment Accounting. The ASU clarifies that Topic 718 does not apply to share-based payments used to effectively provide financing to the issuer or awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers. We are currently evaluating the impact of the U.S. legislation as “provisional” when it does new standard. ASU 2018-07 will be effective for us beginning in our first quarter of fiscal 2020.
Other recently issued accounting pronouncements did not or are not believed by management to have the necessary information available, prepareda material impact on our present or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law. In accordance with SAB 118, our estimated income tax is considered provisional and is expected to be finalized by the end of our fiscal year.future financial statements.
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 diluted net income per common share by taking into considerationusing 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 | Nine Months Ended | |||||||||||||||||||||||
March 31, | March 31, | Three Months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
Numerator | ||||||||||||||||||||||||
Net income | $ | 2,051 | $ | 745 | $ | 2,167 | $ | 5,701 | $ | 2,559 | $ | 1,434 | ||||||||||||
Denominator | ||||||||||||||||||||||||
Basic weighted average common shares outstanding | 6,639 | 6,582 | 6,620 | 6,569 | 6,765 | 6,607 | ||||||||||||||||||
Dilutive effect of stock options and restricted stock | 270 | 32 | 241 | 79 | ||||||||||||||||||||
Dilutive effect of stock options | 200 | 224 | ||||||||||||||||||||||
Diluted weighted average common shares outstanding | 6,909 | 6,614 | 6,861 | 6,648 | 6,965 | 6,831 | ||||||||||||||||||
Basic net income per common share | $ | 0.31 | $ | 0.11 | $ | 0.33 | $ | 0.87 | $ | 0.38 | $ | 0.22 | ||||||||||||
Diluted net income per common share | $ | 0.30 | $ | 0.11 | $ | 0.32 | $ | 0.86 | $ | 0.37 | $ | 0.21 |
We excluded shares related to restricted stock totaling 175,00015,000 shares for the three and nine months ended March 31,September 30, 2018, as their impact would have been anti-dilutive. No shares related to stock options were excluded for the three months ended September 30, 2018. No shares related to stock options or restricted stock were excluded for the three and nine months ended March 31,September 30, 2017.
Revenue Recognition
To recognizeWe record revenue four basic criteria must be met: 1) there is evidence that an arrangementbased on the five-step model which includes: (1) identifying a contract with a buyer exists; 2) delivery has occurred; 3)customer; (2) identifying the feeperformance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price among the performance obligations; and (5) recognizing revenue when the various performance obligations are satisfied.
Revenue is fixed or determinable;measured as the net amount of consideration expected to be received in exchange for fulfilling one of more performance obligations. We identify purchase orders from customers as contracts. The amount of consideration expected to be received and 4) collectabilityrevenue recognized includes estimates of variable consideration, including estimates for early payment discounts and volume rebates. Such estimates are calculated using historical averages adjusted for any expected changes due to current business conditions and experience. We review and update these estimates at the end of each reporting period and the impact of any adjustments is reasonably assured. Revenuerecognized in the period the adjustments are identified. In assessing whether collection of consideration from sales transactions wherea customer is probable, we consider both the buyer hascustomer's ability and intent to pay that amount of consideration when it is due. Payment of invoices are due as specified in the rightunderlying customer agreement, typically 30 days from the invoice date, which occurs on the date of transfer of control of the products ordered to return the productcustomer.
Revenue is recognized at the point in time that our performance obligation is fulfilled, and control of sale only if (a) the seller’s priceordered products is transferred to the buyercustomer. This occurs when the product is substantially fixedshipped, or determinable atin some cases, when the date of sale; (b) the buyer has paid the seller, or the buyerproduct is obligated to pay the seller and the obligation is not contingent on resale of the product; (c) the buyer’s obligationdelivered to the seller would not be changed in the event of theft or physical destruction or damage of the product in its present location; (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 of the foregoing 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.customer.
We record reductionsprovide early payment discounts to gross revenuecertain customers. Based on historical payment trends, we expect that these customers will take advantage of these early payment discounts. The cost of these discounts is reported as a reduction to the transaction price. If the actual discounts differ from those estimated, the difference is reported as a change in the transaction price.
Except for estimatedproduct defects, no right of return exists on the sale of our products. We estimate returns of private-label contract manufacturing products and beta-alanine raw material sales. The estimated returns are based on the trailing nine months of private-label contract manufacturing gross sales and our historical experience and recognize a returns liability for both private-label contract manufacturing and beta-alanine raw material salesany estimated returns. However, the estimate for productAs of September 30, 2018, we have no known returns does not reflect the impactliability.
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 them with certain of their products within 24 countries where Juice Plus+ currently sells those products. Pursuant to the Restricted Stock Award Agreement, NAI has granted 500,000 shares of NAI common stock to Juice Plus+, (the “Shares”), and Juice Plus+ has agreed the Shares are subject to certain restrictions and risk of forfeiture. Pursuant to the Irrevocable Proxy, Juice Plus+ has also granted to the NAI Board of Directors the right to vote the Shares that remain subject to the risk of forfeiture. Each Agreement is for a term of 5 years, and each may be terminated by either party only upon the occurrence of specified events. The expense associated with the sharesShares granted to Juice Plus+ is recorded as a reduction to revenue. We recorded $245,000$245,000 of expense during the three months ended September 30, 2018 and $163,000 for the three months ended September 30, 2017 as a "Non-cash Sales Discount" which is an offset to net sales during the three months ended March 31, 2018 and $653,000 during the nine months ended March 31, 2018.sales.
We currently own certain U.S. patents, and patent applications, andeach patent’s corresponding foreign patents and patent applications. All of these patents and patent rights relate to the ingredient known as beta-alanine which we marketmarketed and sellsold under our CarnoSyn® and SR CarnoSyn® trade names. We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of $6.2$5.4 million during the three months ended March 31,September 30, 2018 and $16.0$5.9 million during the ninethree months ended March 31, 2018. We recorded $6.6 million during the three months ended March 31, 2017 and $20.0 million during the nine months ended March 31,September 30, 2017. These royalty income and raw material sale amounts resulted in royalty expense from payments madepaid to the original patent holders from whom NAIwe acquired itsthe patents and patent rights. We recognized royalty expense as a component of cost of goods sold in the amount of $215,000$263,000 during the three months ended March 31,September 30, 2018, and $659,000$284,000 during the ninethree months ended March 31, 2018. We recognized $233,000 of royalty expense during the three months ended March 31, 2017 and $799,000 during the nine months ended March 31,September 30, 2017.
Notes Receivable
On September 30, 2017, we accepted a 12-month12-month note (Loan Agreement) from Kaged Muscle, LLC (“Kaged Muscle”), one of our contract manufacturing customers, in exchange for $1.5$1.5 million of trade receivables due to us from Kaged Muscle. On September 30, 2018, we entered into a First Amendment (the “First Amendment”) with Kaged Muscle in connection with the Loan Agreement. The First Amendment modifies the Loan Agreement and related promissory note by extending the maturity date from September 30, 2018 to December 28, 2018 in exchange for an extension fee in the amount of $25,000. Kaged Muscle is one of our fastest growing sports nutrition customers and we executed this note receivable conversion, and subsequent amendment, to assist them with their near term financing needs. The note carries an interest rate of fifteen percent (15%(15%) per annum andwith payments of interest only. Repayment of the note is an interest only note secured by all of the assets of Kaged Muscle and a personal guaranteethe note is personally guaranteed by the co-founder and President of Kaged Muscle. Interest is due quarterly and the note can be paid downprepaid in any amount at any time without penalty. WeIn association with this note, we recognized $56,000$58,000 in interest income during the three months ended March 31,September 30, 2018 and $114,000zero interest income during the ninethree months ended March 31, 2018 associated with this note from Kaged Muscle.September 30, 2017.
Stock-Based Compensation
We have an omnibus equity 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,2009 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-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 and freely transferable. Option valuation models require the inputuse 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 onin the dateperiod 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.
We recognize forfeitures as they occur.
We did not grant any options during the three month months ended September 30, 2018 or nine month periodsthe three months ended March 31, 2018 or September 30, 2017. All remaining outstanding stock options are fully vested. NoDuring the three months ended September 30, 2018, 5,000 options were exercised. There were no options exercised during the three month or nine month periods months ended March 31, 2018 or September 30, 2017. There were no forfeitures during the three months ended March 31, 2018. DuringSeptember 30, 2018 or the ninethree months ended March 31, 2018, 5,000 options were forfeited. There were no forfeitures during the three month or nine month periods ended March 31,September 30, 2017.
During the three and nine months ended March 31,September 30, 2018, we granted 175,000 sharesa total of 15,000 restricted stock shares to the members of our Board of Directors and certain key membersa new member of our management team. DuringWe did not grant any shares to employees during the three months ended March 31, 2017, we granted 140,000 shares of restricted stock to the members of our Board of Directors and certain key members of our management team. During the nine months ended March 31, 2017, we granted 150,000 shares of restricted stock to the members of our Board of Directors and certain key members of our management team.September 30, 2017. Our net income included stock based compensation expense of approximately $322,000$409,000 for the three months ended March 31,September 30, 2018, and $925,000$301,000 for the ninethree months ended March 31, 2018. Our net income included stock based compensation expense of approximately $223,000 for the three months ended March 31, 2017, and $729,000 for the nine months ended March 31,September 30, 2017.
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 liability (i.e., the “exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-levelthree-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 we have 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 March 31,September 30, 2018, and June 30, 2017, 2018, we did not have any financial assets or liabilities classified as Level 1, except for cashassets and cash equivalents, and assetsliabilities 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 March 31,September 30, 2018 was a net liabilityasset of $3.1$1.0 million. The fair value of our forward exchange contracts as of June 30, 2017 was2018 included a net asset of $55,000 and a net liability of $521,000.$55,000, with no right of offset. As of March 31,September 30, 2018, and June 30, 2017 2018, we did not have any financial assets or liabilities classified as Level 3. We did not transfer any assets or liabilities between Levels during fiscal 20172018 or the ninethree months ended March 31,September 30, 2018.
Concentrations of Credit Risk
Financial instruments that subject us to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. We place our cash and cash equivalents with highly rated financial institutions. Credit risk with respect to receivables is concentrated with our three largest customers, whose receivable balances collectively represented 65.4%67.6% of gross accounts receivable at March 31,September 30, 2018 and 65.6%76.6% at June 30,2017. 2018. Additionally, amounts due related to our beta-alanine raw material sales were 26.1%20.4% of gross accounts receivable at March 31,September 30, 2018, and 21.3%17.3% of gross accounts receivable at June 30, 2017. 2018. Concentrations of credit risk related to the remaining accounts receivable balances are limited due to the number of customers comprising our remaining customer base.
B. Inventories, net
Inventories, net consisted of the following (in thousands):
March 31, 2018 | June 30, 2017 | |||||||
Raw materials | $ | 14,774 | $ | 9,469 | ||||
Work in progress | 4,148 | 1,312 | ||||||
Finished goods | 5,119 | 3,562 | ||||||
Reserves | (256 | ) | (614 | ) | ||||
Inventories, net | $ | 23,785 | $ | 13,729 |
September 30, 2018 | June 30, 2018 | |||||||
Raw materials | $ | 17,092 | $ | 16,209 | ||||
Work in progress | 3,256 | 4,268 | ||||||
Finished goods | 5,005 | 3,462 | ||||||
Reserve | (381 | ) | (372 | ) | ||||
$ | 24,972 | $ | 23,567 |
C. Property and Equipment
Property and equipment consisted of the following (in thousands):
Depreciable Life In Years | March 31, 2018 | June 30, 2017 | |||||||||||||||||||||||
| Depreciable Life In Years |
| September 30, 2018 |
| June 30, 2018 |
| |||||||||||||||||||
Land | N/A | $ | 1,200 | $ | 1,200 |
|
| NA |
| $ | 1,200 |
| $ | 1,200 |
| ||||||||||
Building and building improvements | 7 | – | 39 | 3,723 | 3,706 |
| 7 | – | 39 |
| 3,721 |
| 3,721 |
| |||||||||||
Machinery and equipment | 3 | – | 12 | 25,638 | 24,194 |
| 3 | – | 12 |
| 28,393 |
| 28,185 |
| |||||||||||
Office equipment and furniture | 3 | – | 5 | 4,398 | 3,954 |
| 3 | – | 5 |
| 4,861 |
| 4,883 |
| |||||||||||
Vehicles | 3 | 209 | 209 |
|
| 3 |
|
| 313 |
| 209 |
| |||||||||||||
Leasehold improvements | 1 | – | 15 | 17,574 | 17,038 |
| 1 | – | 15 |
|
| 15,821 |
|
| 15,688 |
| |||||||||
Total property and equipment | 52,742 | 50,301 |
|
|
|
|
| 54,309 |
| 53,886 |
| ||||||||||||||
Less: accumulated depreciation and amortization | (33,910 | ) | (32,165 | ) |
|
|
|
|
|
| (35,032 | ) |
|
| (34,596 | ) | |||||||||
Property and equipment, net | $ | 18,832 | $ | 18,136 |
|
|
|
|
| $ | 19,277 |
| $ | 19,290 |
|
D. Other Comprehensive (Loss) IncomeLoss
Other comprehensive (loss) income (“OCL” and “OCI”) consisted of the following during the three and nine months ended March 31,September 30, 2018 and March 31,September 30, 2017 (in(in thousands):
Three Months Ended | Nine Months Ended | Three months ended September 30, 2018 | ||||||||||||||||||||||||||||||||||
March 31, 2018 | March 31, 2018 | Defined Benefit Pension Plan | Unrealized (Losses) Gains on Cash Flow Hedges | Total | ||||||||||||||||||||||||||||||||
Unrealized | Unrealized | |||||||||||||||||||||||||||||||||||
Balance as of June 30, 2018 | $ | (387 | ) | $ | (191 | ) | $ | (578 | ) | |||||||||||||||||||||||||||
Defined | Gains | Defined | Gains | |||||||||||||||||||||||||||||||||
Benefit | (Losses) on | Benefit | (Losses) on | |||||||||||||||||||||||||||||||||
Pension | Cash Flow | Pension | Cash Flow | |||||||||||||||||||||||||||||||||
Plan | Hedges | Total | Plan | Hedges | Total | |||||||||||||||||||||||||||||||
Beginning Balance | $ | (491 | ) | $ | (1,745 | ) | $ | (2,236 | ) | $ | (491 | ) | $ | (414 | ) | $ | (905 | ) | ||||||||||||||||||
OCI/OCL before reclassifications | - | (987 | ) | (987 | ) | - | (3,430 | ) | (3,430 | ) | — | 945 | 945 | |||||||||||||||||||||||
Amounts reclassified from OCI | - | 768 | 768 | - | 1,133 | 1,133 | — | (446 | ) | (446 | ) | |||||||||||||||||||||||||
Tax effect of OCI activity | - | - | - | - | 747 | 747 | — | (116 | ) | (116 | ) | |||||||||||||||||||||||||
Net current period OCI/OCL | - | (219 | ) | (219 | ) | - | (1,550 | ) | (1,550 | ) | — | 383 | 383 | |||||||||||||||||||||||
Ending Balance | $ | (491 | ) | $ | (1,964 | ) | $ | (2,455 | ) | $ | (491 | ) | $ | (1,964 | ) | $ | (2,455 | ) | ||||||||||||||||||
Balance as of September 30, 2018 | $ | (387 | ) | $ | 192 | $ | (195 | ) |
During the three months ended September 30, 2018, the amounts reclassified from OCI were comprised of $41,000 of losses reclassified to net revenues and $487,000 related to the amortization of forward points reclassified to other income.
Three Months Ended | Nine Months Ended | Three months ended September 30, 2017 | ||||||||||||||||||||||||||||||||||
March 31, 2017 | March 31, 2017 | Defined Benefit Pension Plan | Unrealized Gains (Losses) on Cash Flow Hedges | Total | ||||||||||||||||||||||||||||||||
Unrealized | Unrealized | |||||||||||||||||||||||||||||||||||
Balance as of June 30, 2017 | $ | (491 | ) | $ | (414 | ) | $ | (905 | ) | |||||||||||||||||||||||||||
Defined | Gains | Defined | Gains | |||||||||||||||||||||||||||||||||
Benefit | (Losses) on | Benefit | (Losses) on | |||||||||||||||||||||||||||||||||
Pension | Cash Flow | Pension | Cash Flow | |||||||||||||||||||||||||||||||||
Plan | Hedges | Total | Plan | Hedges | Total | |||||||||||||||||||||||||||||||
Beginning Balance | $ | (775 | ) | $ | 947 | $ | 172 | $ | (775 | ) | $ | 95 | $ | (680 | ) | |||||||||||||||||||||
OCI/OCL before reclassifications | - | (322 | ) | (322 | ) | - | 1,512 | 1,512 | — | (1,953 | ) | (1,953 | ) | |||||||||||||||||||||||
Amounts reclassified from OCI | - | (383 | ) | (383 | ) | - | (884 | ) | (884 | ) | — | 178 | 178 | |||||||||||||||||||||||
Tax effect of OCI activity | - | 254 | 254 | - | (227 | ) | (227 | ) | — | 641 | 641 | |||||||||||||||||||||||||
Net current period OCI/OCL | - | (451 | ) | (451 | ) | - | 401 | 401 | — | (1,134 | ) | (1,134 | ) | |||||||||||||||||||||||
Ending Balance | $ | (775 | ) | $ | 496 | $ | (279 | ) | $ | (775 | ) | $ | 496 | $ | (279 | ) | ||||||||||||||||||||
Balance as of September 30, 2017 | $ | (491 | ) | $ | (1,548 | ) | $ | (2,039 | ) |
$422,000 of losses reclassified to net revenues and $244,000 related to the amortization of forward points reclassified to other income.
E. Debt
On March 20, 2018, we executed an amendment to our credit facility with Wells Fargo Bank, N.A. to extend the maturity date for our working line of credit from February 1, 2020, to February 1, 2021.In addition, the amendment removed any restrictions included in the credit facility on our ability to repurchase our stock. The Credit Agreement provides us with a credit line of up to $10.0$10.0 million. The line of credit may be used to finance working capital requirements. There is was no commitment fee underrequired as part of this agreement. There are no amounts currently drawn under the lineamendment.
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 NAIus from time to time; provided, however, that if the outstanding principal amount is less than $100,000$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 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,$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, 2021, and with Bank of America, N.A. in effect until August 15, 2019.
On March 31,September 30, 2018, 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, 2019.
We did not use our working capital line of credit nor did we have any long-term debt outstanding during the ninethree months ended March 31,September 30, 2018. As of March 31,September 30, 2018, we had $10.0$10.0 million available under our credit facilities.
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 any of (i) the in sales to these customers, (ii) the growth rate of sales to these customers, or (iii) in these customers’ ability to make payments when due, each 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 March 31, | Nine Months Ended March 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Customer 1 | $ | 17,229 | $ | 11,046 | $ | 49,521 | $ | 43,198 | ||||||||
Customer 2 | 3,668 | (a) | 10,908 | (a) | ||||||||||||
$ | 20,897 | $ | 11,046 | $ | 60,429 | $ | 43,198 |
|
|
Three months Ended September 30, | ||||||||
2018 | 2017 | |||||||
Customer 1 | $ | 21,078 | $ | 13,157 | ||||
Customer 2 | 3,729 | 3,161 | ||||||
$ | 24,807 | $ | 16,318 |
We buy certain products, including beta-alanine, from a limited number of raw material suppliers.suppliers who meet our quality standards. 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(dollars in thousands):
Three Months Ended March 31, | Nine Months Ended March 31, | Three months Ended September 30, | ||||||||||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||||
Raw Material Purchases by Supplier | % of Total Raw Material Purchases | Raw Material Purchases by Supplier | % of Total Raw Material Purchases | |||||||||||||||||||||||||||||
Supplier 1 | $ | 2,076 | 1,317 | $ | 5,068 | (a) | $ | 3,107 | 15 | % | (a | ) | (a | ) | ||||||||||||||||||
Supplier 2 | (a) | 1,683 | (a) | (a) | (a | ) | (a | ) | 1,967 | 14 | % | |||||||||||||||||||||
Supplier 3 | (a) | 1,646 | (a) | (a) | ||||||||||||||||||||||||||||
$ | 2,076 | $ | 4,646 | $ | 5,068 | — | $ | 3,107 | 15 | % | $ | 1,967 | 14 | % |
| (a) Purchases were less than 10% of the respective period’s total raw material purchases. |
G. Segment Information
Our business consists of two segments for financial reporting purposes,purposes. The two segments are identified as (i) private labelprivate-label contract manufacturing, which primarily relates to the provision of private labelprivate-label contract manufacturing services to companies that market and distribute nutritional supplements and other health care products;products, and (ii) patent and trademark licensing, which primarily includes direct raw material sales and related royalty income from our license and supply agreements associated with the sale and use of beta-alanine under our CarnoSyn® and SR CarnoSyn® trade names.
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 level expense allocations. Operating income or loss for each segment does not 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.expenses, which are not allocated to any segment. Transfers of raw materials between segments are recorded at cost. The accounting policies of our segments are the same as those described in the summary of significant accounting policies in Note A above and in the consolidated financial statements included in our 20172018 Annual Report.
Our operating results by business segment were as follows (in thousands):
Three Months Ended March 31, | Nine Months Ended March 31, | Three months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
Net Sales | ||||||||||||||||||||||||
Private label contract manufacturing | $ | 25,648 | $ | 18,544 | $ | 77,225 | $ | 69,787 | ||||||||||||||||
Private-label contract manufacturing | $ | 31,087 | $ | 22,222 | ||||||||||||||||||||
Patent and trademark licensing | 6,167 | 6,591 | 15,999 | 19,974 | 5,445 | 5,852 | ||||||||||||||||||
Total Net Sales | $ | 31,815 | $ | 25,135 | $ | 93,224 | $ | 89,761 | ||||||||||||||||
$ | 36,532 | $ | 28,074 |
Three Months Ended March 31, | Nine Months Ended March 31, | Three months Ended September 30, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||
Income from Operations | ||||||||||||||||||||||||
Private label contract manufacturing | $ | 2,229 | $ | 749 | $ | 7,870 | $ | 6,182 | ||||||||||||||||
Private-label contract manufacturing | $ | 3,145 | $ | 2,257 | ||||||||||||||||||||
Patent and trademark licensing | 2,023 | 1,786 | 3,715 | 6,026 | 1,802 | 1,188 | ||||||||||||||||||
Income from operations of reportable segments | 4,252 | 2,353 | 11,585 | 12,208 | 4,947 | 3,445 | ||||||||||||||||||
Corporate expenses not allocated to segments | (1,729 | ) | (1,542 | ) | (4,898 | ) | (4,566 | ) | (2,223 | ) | (1,562 | ) | ||||||||||||
Total Income from Operations | $ | 2,523 | $ | 993 | $ | 6,687 | $ | 7,642 | ||||||||||||||||
$ | 2,724 | $ | 1,883 |
Total Assets | March 31, 2018 | June 30, 2017 | ||||||
Private label contract manufacturing | $ | 73,959 | $ | 60,489 | ||||
Patent and Trademark Licensing | 14,138 | 12,122 | ||||||
Total | $ | 88,097 | $ | 72,611 |
September 30, 2018 | June 30, 2018 | |||||||
Total Assets | ||||||||
Private-label contract manufacturing | $ | 72,677 | $ | 69,037 | ||||
Patent and trademark licensing | 17,425 | 16,170 | ||||||
$ | 90,102 | $ | 85,207 |
Our private labelprivate-label contract manufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe, Canada, Australia, New Zealand, and Asia, as well as Canada, Mexico and South Africa.Asia. Our primary marketmarkets outside the U.S. is Europe.are Europe and Asia. Our patent and trademark licensing 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 March 31, | Nine Months Ended March 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
United States | $ | 17,235 | $ | 14,605 | $ | 48,855 | $ | 43,484 | ||||||||
Markets outside of the United States | 14,580 | 10,530 | 44,369 | 46,277 | ||||||||||||
Total | $ | 31,815 | $ | 25,135 | $ | 93,224 | $ | 89,761 |
Three months Ended September 30, | ||||||||
2018 | 2017 | |||||||
United States | $ | 17,646 | $ | 15,194 | ||||
Markets outside the United States | 18,886 | 12,880 | ||||||
Total net sales | $ | 36,532 | $ | 28,074 |
Products manufactured by NAIE accounted for 89%72% of net sales in markets outside the U.S. for the three months ended March 31,September 30, 2018, and 82%75% for the ninethree months ended March 31, 2018. Products manufactured by NAIE accounted for 62% of net sales in markets outside the U.S. for the three months ended March 31, 2017, and 55% for the nine months ended March 31,September 30, 2017. No products manufactured by NAIE were sold in the U.S. during the three month or nine month periods months ended March 31,September 30, 2018 and 2017.
Assets and capital expenditures by geographic region, based on the location of the company or subsidiary at which they were located or made, were as follows (in thousands):
Long-Lived Assets | Total Assets | Capital Expenditures | Long-Lived Assets | Total Assets | Capital Expenditures | |||||||||||||||||||||||||||||||||||||||||||
Nine Months Ended | Three Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||
March 31, 2018 | June 30, 2017 | March 31, 2018 | June 30, 2017 | March 31, 2018 | March 31, 2017 | September 30, 2018 | June 30, 2018 | September 30, 2018 | June 30, 2018 | September 30, 2018 | September 30, 2017 | |||||||||||||||||||||||||||||||||||||
United States | $ | 10,650 | $ | 10,753 | $ | 53,982 | $ | 47,777 | $ | 966 | $ | 2,090 | $ | 10,841 | $ | 10,887 | $ | 54,279 | $ | 51,562 | $ | 337 | $ | 89 | ||||||||||||||||||||||||
Europe | 8,182 | 7,383 | 34,115 | 24,834 | 1,971 | 2,242 | 8,436 | 8,403 | 35,823 | 33,645 | 459 | 867 | ||||||||||||||||||||||||||||||||||||
$ | 18,832 | $ | 18,136 | $ | 88,097 | $ | 72,611 | $ | 2,937 | $ | 4,332 | $ | 19,277 | $ | 19,290 | $ | 90,102 | $ | 85,207 | $ | 796 | $ | 956 |
H. Income Taxes
The Tax Cuts and Jobs Act (the “Act”)effective tax rate for the three months ended September 30, 2018 was enacted on December 22, 2017. Among other things, the Act reduces20.6%. The rate differs slightly from the U.S. federal corporatestatutory rate of 21% primarily due to the favorable impact of foreign earnings of NAIE, which are taxed at less than the U.S. statutory rate. The effective tax rate to 21% and requires companies to pay a one-time deemed repatriation transition tax on earnings of U.S.-owned foreign subsidiaries that were previously tax deferred. At March 31, 2018, we had not completed our accounting for the tax effects of the Act; however, in certain cases, as described below and in accordance with SAB 118, we made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. In other cases, we were not able to make a reasonable estimate and continue to account for those items based on our existing accounting under ASC 740, Income Taxes. For the items for which we did determine a reasonable estimate, we recognized a provisional amount as a discrete component of our provision for income taxes. The impact of the Tax Legislation may differ from these estimates, possibly materially, during the one-year measurement period ending December 22, 2018 due to, among other things, further refinement of our calculations, changes in interpretations and assumptions we made, guidance that may be issued and actions we may take as a result of the Act.three months ended September 30, 2017 was 28.0%.
To determine our quarterly provision for income taxes, we use an estimated annual effective tax rate, thatwhich is based on expected annual income, statutory tax rates and tax planning opportunities available in the various jurisdictions to which we are subject. Certain significant or unusual items are separately recognized as discrete items in the quarter in which they occur and can be a source of variability in the effective tax rate from quarter to quarter. There were no significant discrete items for the three months ended September 30, 2018. We recognize interest and penalties related to uncertain tax positions, if any, as an income tax expense.
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 effectiveultimate realization of deferred tax rate forassets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the three months ended March 31,September 30, 2018, there was 21.1% and the effective tax rateno change to our valuation allowance for the nine months ended March 31, 2018 was 69.4%. In comparison, the effective tax rate for the three months ended March 31, 2017 was 29.0 % and the effective tax rate for the nine months ended March 31, 2017 was 29.9%. The effective tax rate for the three months ended March 31 2018 differs from the estimated U.S. federal statutory rate of 28.06% primarily due to the favorable impact of foreign earnings taxed at less than the U.S. statutory rate. The effective tax rate for the nine months ended March 31, 2018 differ from the estimated U.S. federal statutory rate of 28.06% primarily due to the impact of the Act’s required one-time transition tax and the reevaluation of our deferred taxes, offset by the favorable impact of foreign earnings taxed at less than the U.S. statutory rate. As a fiscal taxpayer, our U.S. federal statutory rate for the year ending June 30, 2018 is estimated to be 28.06% and is a blended rate of the historic 35% statutory rate and the newly enacted 21% rate. We expect our U.S. federal statutory rate to be 21% for fiscal years beginning after June 30, 2018.
As part of the Act, we are required to recognize a one-time deemed repatriation transition tax based on our total post-1986 earnings and profits (E&P) from our Swiss subsidiary, NAIE. This accumulated E&P amount has historically been considered permanently reinvested thereby allowing us to defer recognizing any U.S. income tax on the amount. As a result of the Act we recorded a provisional amount for our one-time transition tax liability resulting in an increase in income tax expense during the nine months ended March 31, 2018 of $1.8 million, which was treated as a discrete expense. In accordance with the provisions of the Act, we will elect to pay this tax over an eight-year period. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation at the conclusion of fiscal 2018. As of March 31, 2018, we no longer consider undistributed foreign earnings from NAIE as indefinitely reinvested. As a result, we have recorded $775,000 in estimated foreign withholding taxes on the amounts deemed repatriated under the Act, which was also treated as a discrete expense during the period.
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, and the tax rates expected to apply to taxable income in the years in which those 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. As of December 31, 2017, we remeasured certain deferred tax assets and liabilities based on the tax rates expected to apply in the future. For deferred tax asset and liability balances we expect to reverse during fiscal 2018 we used the blended U.S. statutory rate of 28.06% anddate for amounts expected to reverse in future periods we used the newly enacted 21% tax rate. However, we are still analyzing certain aspects of the Act and refining our calculations accordingly. This analysis and refinement could potentially affect the measurement of these balances or give rise tosuch new deferred tax amounts. The provisional amount we recorded from remeasuring our deferred tax balance was $664,000 and was treated as a discrete expense for the nine months ended March 31, 2018.
We record valuation allowances to reduce our deferred tax assets to an amount that we believe 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 ultimately 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 three and nine months ended March 31, 2018, there was no change to our valuation allowance.rates.
We are subject to taxation in the U.S., Switzerland and various U.S. state jurisdictions. Our tax returnsyears for the fiscal yearsyear ended June 30,2015 and forward are subject to examination by the U.S. tax authorities and our years for the fiscal yearsyear ended June 30, 2007 and forward are subject to examination by the state tax authorities. Our tax filingsyears for the fiscal year ended June 30,2015 and forward are subject to examination by the Swiss tax authorities.
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. Our tax reserves are analyzed quarterly and adjustments are made as events occur that we believe warrant adjustments to thethose reserves. There were no adjustments to these reserves in the three and nine months ended March 31,September 30, 2018.
I. Treasury Stock
On June 2,2011, the Board of Directors authorized the repurchase of up to $2.0$2.0 million of our common stock. On February 6, 2015, the Board of Directors authorized a $1.0$1.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $3.0$3.0 million. On May 11, 2015, the Board of Directors authorized a $2.0$2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $5.0$5.0 million. On March 28, 2017, 2018, the Board of Directors authorized a $2.0$2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $7.0$7.0 million. Under the repurchase plan, we may, from time to time, purchase shares of our common stock, depending upon market conditions. Purchase of the shares of our common stock may beconditions, in open market or privately negotiated transactions.
During the three and nine months ended March 31,September 30, 2018 and September 30, 2017, we did not repurchase any shares under this repurchase plan. During the nine months ended March 31, 2017, we repurchased 39,547 shares under this plan at a weighted average cost of $8.74 per share and a total cost of $345,000 including commissions and fees.
During the three months ended March 31,September 30, 2018, we acquired 35,203674 shares from employees in connection with restricted stock shares owned by such employees that vested during that period at a weighted average cost of $11.90$9.65 per share and a total cost of $419,000.$6,000. During the ninethree months ended March 31, 2018, September 30, 2017, we acquired 43,201734 shares from employees in connection with restricted stock shares owned by such employees that vested during that period at a weighted average cost of $11.69$10.70 per share and a total cost of $505,000. During the three months ended March 31, 2017, we acquired 32,325 shares from employees in connection with restricted stock shares that vested during the period at a weighted average cost of $8.75 per share and a total cost of $283,000. During the nine months ended March 31, 2017, we acquired 38,729 shares from employees in connection with restricted stock shares that vested during the period at a weighted average cost of $9.47 per share and a total cost of $367,000.
$8,000. These shares were returned to NAIus by the relatedsubject employees and in return NAIexchange therefor we paid each employee’s required tax withholding required as a result ofliability incurred due to the income recognized upon vesting of thetheir restricted shares.stock shares during that period. The valuation of the shares acquired and therebytherefor the number of shares returned to NAIus was calculated based on the closing share price on the date the restricted shares vested.
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 to other transactions of NAIE, our foreign subsidiary denominated in foreign currencies.subsidiary. As part of our overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, we sometimesmay use foreign exchange contracts in the form of forward 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 March 31,September 30, 2018, we had forward contracts designated as cash flow hedges primarily to protect against the foreign exchange risks inherent in our forecasted sales of products at prices denominated in currencies other than the U.S. Dollar. These contracts are expected to be settled through August 2019. 2020. 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 (loss)(“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.expense. We measure effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item. WeDuring the three months ended September 30, 2018, we did not have any losses or gains related to the ineffective portion of our hedging instruments during the three and nine months ended March 31, 2018. During the three months ended March 31, 2017, we recorded a $97,000 gain related to the ineffective portion of ourinstruments. No hedging instruments to other income. During the nine months ended March 31, 2017, we recorded a $189,000 gain related to the ineffective portion of our hedging instruments to other income. None of our foreign currency forward contractsrelationships were terminated as a result of ineffective hedging or as a result of forecasted transactions no longer probable of occurring for foreign currency forward contracts. We monitor the probability of forecasted transactions as part of ourthe hedge effectiveness testing on a quarterly basis.
As of March 31,September 30, 2018, the notional amounts of our foreign exchange contracts designated as cash flow hedges were approximately $47.1$83.3 million (EUR 40.068.9 million). As of March 31,September 30, 2018, a net lossgain of approximately $2.9 million$171,000 related to derivative instruments designated as cash flow hedges was recorded in OCI. It is expected that $2.4 million$119,000 will be reclassified into earnings in the next 12 months along with the earnings effects of the related forecasted transactions.
As of March 31,September 30, 2018, the fair value of our cash flow hedges was a liabilityan asset of $3.1 million,$955,000, of which $2.6 million$680,000 was classified as ain prepaids and other current liability,assets, and $480,000$275,000 was classified in other noncurrent liabilitiesnon-current assets in our Consolidated Balance Sheets. During the three months ended March 31,September 30, 2018, we recognized $1.2 million$458,000 of net lossesgains in OCI and reclassified $974,000$41,000 of losses from OCI to revenue. During the nine months ended March 31, 2018, we recognized $4.1 million of net losses in OCI and reclassified $1.8 million of lossesgains from OCI to revenue. As of June 30,2017,$422,000 2018, $55,000 of the fair value of our cash flow hedges was classified in accrued liabilities,prepaids and $99,000other current assets, $46,000 was classified in other noncurrentnon-current assets, and $101,000 was classified in accrued liabilities in our Consolidated Balance Sheets. During the three months ended March 31,September 30, 2017, we recognized $322,000$2.2 million of net losses in OCI and reclassified $278,000$422,000 of gains from OCI to revenue. During the nine months ended March 31, 2017, we recognized $1.5 million of net gains in OCI and reclassified $549,000 of gains from OCI to revenue.
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 and if and when they arise, 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 currently do not expect.
L. Subsequent Events
On October 19, 2018, Natural Alternatives International Europe Ltd. SA, a Swiss corporation ("NAIE") and wholly-owned subsidiary of Natural Alternatives International, Inc. entered into a new lease with its current landlord providing five additional years to the term of NAIE's leasehold for its primary manufacturing facility in Manno Switzerland. The new lease term runs from July 1, 2019 through June 30, 2024 and is automatically extended for successive one-year periods thereafter unless NAIE provides a one-year advance notice not to extend.
On November 5, 2018, Natural Alternatives International Europe Ltd. SA, a Swiss corporation ("NAIE") and wholly-owned subsidiary of Natural Alternatives International, Inc. entered into a lease with Sofinol SA for approximately 2,870 square meters of commercial warehouse space in a building located on the property adjacent to the leasehold for the primary existing NAIE facility in Manno Switzerland. NAIE intends to use the space primarily for raw material storage. The lease is for an initial five-year term commencing on January 1, 2019 and NAIE can terminate the lease with 12 months advance notice given on June 30th or December 31st each year of the initial term. At the end of the initial term the lease converts to a year to year lease at the same rental rate terminable by NAIE or the landlord upon 12 months' advance notice.
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 nine months ended March 31,September 30, 2018. You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to the condensed consolidated financial statements included under Item 1 in this Quarterly Report,report, as well as the risk factors and other information included in our 20172018 Annual Report and other reports and documents we file with the SEC. Our future financial condition and results of operations will vary from our historical financial condition and results of operations described below based on a variety of factors.
Executive Overview
The following overview does not address all of the matters covered in the other sections of this Item 2 or other items in this Quarterly Reportreport 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 Quarterly Report.report.
Our primary business activity is providing private label contract manufacturing services to companies that market and distribute vitamins, minerals, herbs and other nutritional supplements, as well as other health care products, to consumers both within and outside the U.S. Historically, our revenue has been largely dependent on sales to two or three private label contract manufacturing customers and thus sensitivesubject to variations in the timing of such customers’ orders, which variations in turn have beenis 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® and SR CarnoSyn® trademarks.
A cornerstone of our business strategy is to achieve long-term growth and profitability and to diversify our sales base. We have sought and expect to continue to seek to diversify our sales by developing relationships with additional, quality-oriented, private label contract manufacturing customers, and commercializing our patent estate through sales of beta-alanine under our CarnoSyn®Carnosyn® and SR CarnoSyn®Carnosyn® trade names, royalties from license agreements, and potentially additional contract manufacturing, opportunities with these licensees.and license agreements.
During the first ninethree months of fiscal 2018,2019, our net sales were 4%30% higher than in the first ninethree months of fiscal 2017.2018. Private label contract manufacturing sales increased 11%40% due primarily to the sale of new products to existing customers and higher volumes of current products to existing customers located primarily in U.S., Asian, Australia, and European markets, which increases were partially offset by discontinued customer relationships. During our third quarter of fiscal 2018, our contract manufacturing sales increased 38% as compared to the comparable prior year period due primarily to sales to Asian and European markets returning to historical levels and anmarkets. The increase in sales included shipment of new products and increased sales of existing products to our largest customer including shipment of new 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 increased to 53%58% for the ninethree months ended March 31,September 30, 2018 compared to 48% in47% for the first ninethree months of fiscal 2017.ended September 30, 2018. We expect our annualized fiscal 20182019 revenue concentration for this customer to be higher thanconsistent with fiscal 2017.2018.
During the first ninethree months of fiscal 2018,2019, CarnoSyn® beta-alanine revenue decreased 20%7% to $16.0$5.4 million as compared to $20.0$5.9 million for the first ninethree months of fiscal 2017.2018. The decrease in beta-alanine revenue was primarily due to decreased material shipments as a result of market and seasonal factors and lower average material sales prices. During the quarter ended December 31, 2017, the sports nutrition retail market conditions declined most notably in the standard “brick and mortar” sales channels as products transitioned to higher levels of internet based sales. This transition resulted in excess inventory in certain channels and delayed the re-order rates for many of our customer brands. Additionally, while we still have active patents covering instant release CarnoSyn® beta-alanine, we experienced increased competition from companies selling generic beta-alanine during the second quarter of fiscal 2018 resulting in certain customers discontinuing the use of our CarnoSyn® beta-alanine. To offset this decline and in addition to legal actions we have prosecuted and others we may institute, we have increased our sales and marketing activities to consumers, customers, potential customers, and brand owners on multiple platforms to promote and reinforce the features and benefits of utilizing CarnoSyn® beta-alanine. During the third quarter of fiscal 2018, our re-order rates improved and reached historical levels suggesting both improved sports nutrition retail market conditions and the positive impact of our marketing activities. Additionally, our SR CarnoSyn® raw material sales continued to rise as more brands adopted product offerings of this sustained release delivery system.There can be no assurance our sales and marketing efforts or the recent apparent improvement in retail market conditions will reverse or decelerate potential future declines of our CarnoSyn® beta-alanine sales.
To protect our CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses of approximately $2.4 million$618,000 during the first nine monthsquarter of fiscal 20182019 and $3.0 million$972,000 during the comparable period in fiscal 2017. We describe our efforts to protect our patent estate in more detail under Item 1 of Part II of our 2017 Annual Report.2018. 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® tradename,trademark, maintenance of our patent rights, the availability of the raw material beta-alanine when and in the amounts needed, the ability to expand distribution of beta-alanine to new and existing customers, the 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 2018,2019, 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 developassist us in developing 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® tradename,trademark, new contract manufacturing opportunities, license agreements and protecting our proprietary rights; and
Improving operational efficiencies and managing costs and business risks to improve profitability.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires that we make estimates and assumptions that affect the amounts reported in our financial statements and their accompanying notes. We have identified certain policies we believe are important to the complete and accurate 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 we believe are reasonable under the circumstances. Actual results could differ from these estimates where actual circumstances differ from ourunder different assumptions or if these conditions are not satisfied.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 used in, or satisfaction (or failure) of conditions used in such estimates andor assumptions.
Our critical accounting policies are discussed under Item 7 of our 20172018 Annual Report and recent accounting pronouncements are discussed under Item A to our Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report. There have been no significantReport
In the three months ended September 30, 2018, there were changes to thesethe application of critical accounting policies previously disclosed in our most recent Annual Report on Form 10-K related to the adoption of ASU 2014-09 on July 1, 2018, as described below.
Revenue Recognition
Revenue is recognized at the point in time that our performance obligation is fulfilled, and control of the ordered products is transferred to the customer. Generally, this occurs when the product is shipped, or pronouncements duringin some cases, when the nine months ended March 31, 2018.product is delivered to the customer. Refer to Revenue Recognition in Note A, "Basis of Presentation and Summary of Significant Accounting Policies," in this Quarterly Report, for additional information.
Results of Operations
The results of our operations for the three and nine months ended March 31September 30 were as follows (in(dollars in thousands):
Three Months Ended | Nine Months Ended | Three Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||
March 31, | March 31, | September 30, 2018 | September 30, 2017 | Increase (Decrease) | ||||||||||||||||||||||||||||||||||||||||||||
2018 | 2017 | % Change | 2018 | 2017 | % Change | |||||||||||||||||||||||||||||||||||||||||||
Private label contract manufacturing | $ | 25,648 | $ | 18,544 | 38 | % | $ | 77,225 | $ | 69,787 | 11 | % | ||||||||||||||||||||||||||||||||||||
Private-label contract manufacturing | $ | 31,087 | 85 | % | $ | 22,222 | 79 | % | $ | 8,865 | 40 | % | ||||||||||||||||||||||||||||||||||||
Patent and trademark licensing | 6,167 | 6,591 | (6 | )% | 15,999 | 19,974 | (20 | )% | 5,445 | 15 | % | 5,852 | 21 | % | (407 | ) | (7 | )% | ||||||||||||||||||||||||||||||
Total net sales | 31,815 | 25,135 | 27 | % | 93,224 | 89,761 | 4 | % | 36,532 | 100 | % | 28,074 | 100 | % | 8,458 | 30 | % | |||||||||||||||||||||||||||||||
Cost of goods sold | 25,105 | 20,017 | 25 | % | 73,522 | 70,479 | 4 | % | 29,369 | 80 | % | 21,704 | 77 | % | 7,665 | 35 | % | |||||||||||||||||||||||||||||||
Gross profit | 6,710 | 5,118 | 31 | % | 19,702 | 19,282 | 2 | % | 7,163 | 20 | % | 6,370 | 23 | % | 793 | 12 | % | |||||||||||||||||||||||||||||||
Gross profit % | 21.1 | % | 20.4 | % | 21.1 | % | 21.5 | % | ||||||||||||||||||||||||||||||||||||||||
Selling, general and administrative expenses | 4,187 | 4,125 | 1 | % | 13,015 | 11,640 | 12 | % | ||||||||||||||||||||||||||||||||||||||||
% of net sales | 13.2 | % | 16.4 | % | 14.0 | % | 13.0 | % | ||||||||||||||||||||||||||||||||||||||||
Selling, general & administrative expenses | 4,439 | 12 | % | 4,487 | 16 | % | (48 | ) | (1 | )% | ||||||||||||||||||||||||||||||||||||||
Income from operations | 2,523 | 993 | 154 | % | 6,687 | 7,642 | (12 | )% | 2,724 | 7 | % | 1,883 | 7 | % | 841 | 45 | % | |||||||||||||||||||||||||||||||
% of net sales | 7.9 | % | 4.0 | % | 7.2 | % | 8.5 | % | ||||||||||||||||||||||||||||||||||||||||
Total other income | 76 | 57 | 33 | % | 386 | 494 | (22 | )% | ||||||||||||||||||||||||||||||||||||||||
Other income, net | 497 | 1 | % | 108 | 0 | % | 389 | 360 | % | |||||||||||||||||||||||||||||||||||||||
Income before income taxes | 2,599 | 1,050 | 148 | % | 7,073 | 8,136 | (13 | )% | 3,221 | 9 | % | 1,991 | 7 | % | 1,230 | 62 | % | |||||||||||||||||||||||||||||||
% of net sales | 8.2 | % | 4.2 | % | 7.6 | % | 9.1 | % | ||||||||||||||||||||||||||||||||||||||||
Provision for income taxes | 548 | 305 | 80 | % | 4,906 | 2,435 | 101 | % | 662 | 2 | % | 557 | 2 | % | 105 | 19 | % | |||||||||||||||||||||||||||||||
Net income | $ | 2,051 | $ | 745 | 175 | % | $ | 2,167 | $ | 5,701 | (62 | )% | $ | 2,559 | 7 | % | $ | 1,434 | 5 | % | $ | 1,125 | 78 | % | ||||||||||||||||||||||||
% of net sales | 6.4 | % | 3.0 | % | 2.3 | % | 6.4 | % |
Private-labelPrivate label contract manufacturing net sales increased 38% during the three months ended March 31, 2018 and 11% during the nine months ended March 31, 2018, when compared to the same periods in the prior year. These increases were40% due primarily to the sale of new products to existing customers includingand higher volumes of current products to existing customers located primarily in U.S., Asian, Australian, and European markets. The increase in sales included shipment of new products and increased sales of existing products to our largest customer under our previously announced expanded relationship, and higher volumes of current products to existing customers primarily in Asian and European markets, which increases were partially offset by discontinued customer relationships.relationship.
Net sales from our patent and trademark licensing segment decreased 6%7% during the three months ended March 31, 2018 and decreased 20% during the nine months ended March 31, 2018, when compared to the same periods in the prior year.first quarter of fiscal 2019. The decrease in beta-alanine raw material sales was primarily due to decreased shipments of beta-alanine as a result of market and seasonal factors and lower average material sales prices for the material.prices.
The change in gross profit margin betweenfor the three and nine month periodsmonths ended March 31,September 30, 2018, was as follows:
Three Months | Nine months | |||||||
Ended | Ended | |||||||
Contract manufacturing(1) | 3.3 | % | 1.4 | % | ||||
Patent and trademark licensing(2) | (2.6 | ) | (1.8 | ) | ||||
Total change in gross profit margin | 0.7 | % | (0.4 | )% |
Percentage | ||||
Contract manufacturing (1) | 0.1 | |||
Patent and trademark licensing (2) | (3.2 | ) | ||
Total change in gross profit margin | (3.1 | ) |
1 | Private-label contract manufacturing gross profit margin contribution increased 0.1 percentage points during the first quarter of fiscal 2019 as compared to the comparable period in fiscal 2018. The increase in gross profit as a percentage of |
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Selling, general and administrative expenses decreased $48,000, or 1%, during the first quarter of fiscal 2019 primarily due to lower legal, marketing, and advertising costs associated with our patent and trademark licensing segment partially offset by increased employee compensation and consulting costs.
Selling, general and administrative expenses increased $62,000, or 2%, during the three months ended March 31, 2018 and increased $1.4 million, or 12%, during the nine months ended March 31, 2018, as compared to the comparable prior year periods. These increases were primarily related to increased compensation costs and increased marketing, advertising, and research and development costs supporting our CarnoSyn® and SR CarnoSyn® brands, which increases were partially offset by a reduction in patent litigation costs.
Other income, net increased $19,000$389,000 during the three months ended March 31, 2018 and decreased $108,000 during the nine months ended March 31, 2018, when compared to the comparable prior year periods. These changes were primarily due to fluctuations in foreign exchange rates and our currency hedge contracts associated with foreign denominated sales.
Our income tax expense increased $0.2 million, or 80%, during the three months ended March 31, 2018 compared to the comparable period in the prior year, primarily due to an increase in pretax income. Income tax expense increased $2.5 million, or 101%, during the nine months ended March 31, 2018, as compared to the comparable prior year periods. The increases were primarily due to the discrete income tax expense amounts recorded as a resultfirst quarter of the Tax Cuts and Jobs Act enacted on December 22, 2017. Among other things, the Act reduces the U.S. federal corporate tax rate to 21% and requires companies to pay a one-time deemed repatriation transition tax on earnings of U.S.-owned foreign subsidiaries that were previously tax deferred. We have not completed our accounting for all of the tax effects of the Act; however, in certain cases, as described below and in accordance with SAB 118, we have made a reasonable estimate of the effects on our existing deferred tax balances and of the one-time transition tax. In other cases, we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under ASC 740, Income Taxes. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount as a discrete component of our provision for income taxes. The impact of the Act may differ from these estimates, possibly materially, during the one-year measurement period ending December 22, 2018 due to, among other things, further refinement of our calculations, changes in the interpretations and assumptions we made, guidance that may be issued and actions we may take as a result of the Act.
Included in our tax expense for the nine months ended March 31, 2018 is $3.3 million of discrete tax items related to the Act. The discrete tax items include:
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Our effective tax rate, excluding the impact of the above noted discrete items, for the three months ended March 31, 2018 was 21.1% as compared to an effective tax rate of 29.0% for the three months ended March 31, 2017. As a fiscal taxpayer, our U.S. federal statutory rate for the year ended June 30, 2018 is estimated to be 28.06% and is a blended rate of the historic 35% statutory rate and the newly enacted 21% rate. The year over year improvement in our third fiscal quarter effective tax rate is primarily due to the reduction of the U.S. federal tax rate used in our estimated tax calculation, which reduced to a blended rate of 28.06% as compared to 34.0% used in the same period in the prior year. Our effective tax rate, for the nine months ended March 31, 2018 excluding the impact of the above noted discrete items, was 23.3% as compared to an effective tax rate of 29.9% for the nine months ended March 31, 2017. The improvement in our year to date fiscal 2018 effective tax rate2019 as compared to the same period in the prior fiscal year is primarily due to favorable interest income associated with our foreign currency hedge contracts.
Our income tax expense increased $105,000 during the reductionfirst quarter of the U.S. federal tax rate used in our estimated tax calculation, which reduced to a blended rate of 28.06%fiscal 2019 as compared to 34.0% used in the effective tax rate calculation in the same period in the prior fiscal year.
We expect our U.S. federal statutory ratefiscal 2019 as compared to be 21% for fiscal years beginning after June 30, 2018, which should further reduce ourthe comparable prior year period partially offset by a lower effective tax rate on an annualized basis.
rate.
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 $4.7 million duringfor the ninethree months ended March 31,September 30, 2018 as compared to net cash provided by operating activities of $7.9$2.3 million duringin the comparable period in the prior fiscalquarter last year.
During the nine months ended March 31,At September 30, 2018, changes in accounts receivable, used $3.0consisting of amounts due from our private label contract manufacturing customers and our patent and trademark licensing activities, provided $1.9 million in cash compared to having provided $5.3 millionusing $799,000 of cash duringin the comparable nine month period in the prior year.year quarter. The decreaseincrease in cash provided by accounts receivable during the nine month periodquarter ended March 31,September 30, 2018 primarily resulted from timing and amount of sales and the related collections. Days sales outstanding was 2934 days during the ninethree months ended March 31,September 30, 2018 and 32as compared to 29 days duringfor the nine months ended March 31, 2017.prior year period.
During the nine months ended March 31, 2018, changesChanges in inventory used $10.1$1.4 million in cash during the three months ended September 30, 2018 compared to having provided $4.8using $5.3 million in the comparable prior year period.quarter. The increasechange in cash used by inventory during the periodquarter ended March 31,September 30, 2018 was primarily related to increased inventory levels as of March 31, 2018 in order to support increased sales to our largest private label contract manufacturing customer, including orders expected to ship in the coming quarter, and timing of orderssales and shipments to all other customers.new order activity. Changes in accounts payable and accrued liabilities provided $8.7 million$471,000 in cash during the ninethree months ended March 31,September 30, 2018 compared to having used $8.6providing $5.8 million during the ninethree months ended March 31,September 30, 2017. The change in cash flow activity related to accounts payable and accrued liabilities is primarily due to increases in inventory associated with increased sales associated with our largest customer andthe timing of inventory receipts and payments.
During the nine months ended March 31, 2018, NAIE’s operations used $1.0 million of our operating cash flow primarily due to the timing of inventory receipts, payments and sales.
Cash used in investing activities duringin the ninethree months ended March 31,September 30, 2018 was $4.4 million,$777,000 compared to $4.3$2.5 million duringin the comparable nine month periodquarter last year. The primary reason for the change iswas due to the conversion of $1.5 million of accounts receivable into a note receivable during the first quarter of fiscal 2018. This was partially offset by lower2018 with no similar activity in the first quarter of fiscal 2019. In addition, we made capital equipment purchases of $2.9 million during$796,000 in the ninethree months ended March 31,September 30, 2018 as compared to $4.3 million duringcapital equipment purchases of $956,000 in the same nine month period of fiscalthree months ended September 30, 2017. Capital expenditures for both yearsduring fiscal 2019 and fiscal 2018 were primarily for manufacturing equipment used in our Vista, California and Manno, Switzerland facilities.
Cash used in financing activities during the nine months ended March 31, At September 30, 2018 primarily related to treasury shares returned to NAI by employees whose restricted stock vested during the quarter. In exchange for the shares returned, NAI paid each employee’s required tax withholding.
We did not have any consolidated debt as of March 31, 2018 orand June 30, 2017.2018, on a consolidated basis, we had no outstanding balances due in connection with our loan facility.
On March 20, 2018, we executed an amendment to our credit facility with Wells Fargo Bank, N.A. to extend the maturity date for our working line of credit from February 1, 2020 to February 1, 2021. In addition, the amendment removed any restrictions included in the credit facility on our ability to repurchase our stock. The Credit Agreement provides us with a credit line of up to $10.0 million. The line of credit may be used to finance working capital requirements. There is no commitment fee under 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 interest rate per annum would be equal to 1.25% above the daily one month LIBOR rate as in effect from time to time during the period loan amounts are outstanding. If a fixed interest rate is elected, the interest rate would equal a per annum rate of 1.25% above the LIBOR rate in effect on the first day of the term for which the fixed rate is elected. Any amounts outstanding under the line of credit must be paid in full on or before 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 differences in monthly payments (calculated by comparing the fixed rate to the variable rate that would have been applied, had it been elected) for each month from the month of prepayment through the month in which the then applicable fixed rate term matures.
Our obligations underDuring 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. that is effect until January 31, 2019, and a similar facility with Bank of America, N.A. that is in effect until August 15, 2019.
On March 31,three months ending September 30, 2018, we were in compliance with all of the financial and other covenants required under the Credit Agreement. Refer to Note E, "Debt," in this Quarterly Report, for terms of Credit Agreement and additional information.
As of March 31,September 30, 2018, we had $27.6 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 from operations will be sufficient to fund our current working capital needs and planned capital expenditures through at least the next 12 months.
Off-Balance Sheet Arrangements
As of March 31,September 30, 2018, 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 adverse effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses that are or could be material to investors.
Recent Accounting Pronouncements
Recent accounting pronouncements are discussed in the notes to our consolidated financial statements included under Item 1 of this Quarterly Report.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 that are prescribedas defined under the Securities Exchange Act of 1934. These controls and proceduresThey are designed to help ensure that material information is: (1) gathered and communicated to our management, including our principal executive and financial officers, in a manner that allows for timely decisions regarding required disclosures; and (2) recorded, processed, summarized, reported and filed with the SEC as required under the Securities Exchange Act of 1934 and within the time periods specified by the SEC.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (principal financial and accounting officer), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31,September 30, 2018. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2018 our disclosure controls and procedures were effective for their intended purpose described above.above as of September 30, 2018.
On July 1, 2018, we adopted Topic 606 (see Note 1). We implemented internal controls to ensure we adequately evaluate our contracts and properly assess the impact of the new accounting standards on our condensed consolidated financial statements. Although adoption of the new revenue standard had no material impact on July 1, 2018 retained earnings or financial statement activity for the quarter ended September 30, 2018, and is not expected to have a material impact on our ongoing financial statements, we implemented changes to our business processes related to revenue recognition and the control activities within them. The changes included training within management, as well as new processes for ongoing contract review and monitoring to ensure completeness and accuracy of the information for new disclosures.
There were no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended September 30, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
There were no other changes to our internal controlscontrol over financial reporting during the quarterly period ended March 31,September 30, 2018 that have materially affected, or that are reasonably 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 by us.resources. While unfavorable outcomes are possible, based on available information, we generally do not believe the resolution of these matters, even if unfavorable, 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 May 14,November 13, 2018, except as described below, neither NAI nor its subsidiary were a party to any material pending legal proceeding nor was any of our property the subject of aany material pending legal proceeding. We are currently involved in several legal 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’s request rejected the claims of two NAI patents. The rulings rejecting the claims of two NAI patents were subsequently confirmed by the Patent Trial and Appeal Board (PTAB) at the USPTO. NAI filed Notices of Appeal with the U.S. Court of Appeals for the Federal Circuit requesting that certain findings of the PTAB be reversed. No hearing date has been set by the Court. Both NAI patents rejected by the USPTO expired in August 2017.
On September 18, 2015, NAI filed a complaint against Creative Compounds, 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, NAI and defendant resolved their disputes and entered into settlement and the case was dismissed.
On August 24, 2016, NAI filed a separate complaint against Creative Compounds, LLC, alleging infringement of U.S. patent 7,825,084. On October 5, 2016, Creative filed its answer and counterclaims. On January 19, 2017, NAI 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 adding the following additional parties: Core Supplement Technology, Inc., Honey Badger LLC, and Myopharma, Inc. The Court granted NAI's motion. On May 2, 2017, the Court issued a revised scheduling order and set a trial date for July 31, 2018. On July 19, 2017, Creative filed a motion for judgment on the pleadings to dismiss the patent infringement claims with prejudice, On September 5, 2017, the Court granted Creative's motion, which was a non-final decision and subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. NAI has stated it will appeal the District Court rulings. 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 Court. On October 17, 2017, NAI and defendant Honey Badger LLC filed a voluntary stipulation of dismissal, which the Court granted on October 20, 2017. On October 31, 2017, NAI and defendant Myopharma, Inc. filed a voluntary stipulation of dismissal, which the Court granted on November 6, 2017. On November 9, 2017, NAI and Creative Compounds filed a joint motion to dismiss, which the Court granted on November 20, 2017. On November 21, 2017, NAI and Core Supplement Technology, Inc. filed a joint motion to dismiss, which the Court granted on November 27, 2017. On December 8, 2017, NAI filed a Notice of Appeal to the U.S. Court of Appeals for the Federal Circuit regarding the patents asserted against the defendants. NAI submitted its opening brief to the Federal Circuit on April 13, 2018. No hearing date has been set.
On July 6, 2016, NAI filed a complaint against Allmax Nutrition, Inc. in U.S. District Court for the Southern District of California, alleging (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, NAI filed an amended complaint adding HBS International Corp., Allmax's exclusive distributor, as a co-defendant and to add a civil conspiracy claim. On May 2, 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 NAI's trademark and patent infringement and civil conspiracy claims. On June 26, 2017, the Court granted Defendants’ motions, dismissing NAI's patent infringement claim with prejudice and dismissing the trademark and civil conspiracy claims without prejudice. NAI filed a Second Amended Complaint on July 10, 2017. On August 29, 2017, the Court denied NAI'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. NAI has stated it will appeal the District Court rulings. On August 30, 2017, the Court denied Defendants' motion to dismiss NAI'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. NAI filed its response to the asserted counterclaim on November 10, 2017. The parties subsequently engaged in settlement discussions. On December 22, 2017, NAI and defendants filed a joint stipulation of dismissal of the remaining claims, which the Court granted on January 2, 2018.
On September 16, 2016, NAI 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. NAI 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 NAI, 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.). 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), or at a minimum, until the documents relevant to this case can be retrieved by the defendants. The Court granted the parties' motion to stay on November 9, 2017. The case remains stayed as of this date.
Although we believe our claims in the above litigation matters are valid, thereThere is no assurance weNAI will prevail in these litigation matters or in similar proceedings weit 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 20172018 Annual Report, as well as the other information in our 20172018 Annual Report, this Quarterly Reportreport 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 materially adversely affected.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. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases
During the quarter ended March 31,September 30, 2018, we did not sell any unregistered equity securities and we did not repurchase any shares of our common stock under ourany stock repurchase plan.plans.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
None.
The following exhibit index shows those exhibits filed with this Quarterly Reportreport 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 | |||
| Filed herewith | |||
| Filed herewith | |||
10.03 | Filed herewith | |||
10.04 | Filed herewith | |||
10.05 | Filed herewith | |||
10.06 | Lease of Facilities in Manno, Switzerland between NAIE and Sofinol SA dated November 5, 2018 | Filed herewith | ||
10.07 | First Amendment to Loan Agreement with Kaged Muscle LLC, dated September 30, 2018 | Exhibit 10.53 of NAI’s Current Report on Form 8-K dated October 2, 2018, filed with the commission on October 2, 2018. | ||
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 | ||
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| 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 Quarterly Reportreport to be signed on its behalf by the undersigned, duly authorized officers.
Date: May 14,November 13, 2018
| 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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