Natural Alternatives International, Inc. Custom Contract Manufacturing of Supplements Since 1980 ANNUAL REPORT 2 0 1 3 Natural Alternatives International, Inc. Custom Contract Manufacturing of Supplements Since 1980 cGMP Manufacturing Facility Fiscal year ended June 30, 2013 San Marcos, California Dear Shareholder, According to the Roman philosopher Cato the Elder, ‘Patience is the greatest of all virtues.’ This past year has been filled with opportunities for developing this virtue within our company. As many long-term shareholders may know, we have been active over the past two decades in helping create an environment where excellence could be measured against a bona fide set of standards for the industry we call our home. To that end we have maintained and expanded our domestic and international facility and quality inspection registrations, with the clear anticipation that as more and more companies were found wanting, NAI would emerge in the minds of many potential clients as the logical manufacturing partner for strategic reasons. As a leader in contract manufacturing of dietary supplements, NAI has often indicated the need for the industry to improve self-regulation in concert with the FDA regulatory framework. In July of 2013, NAI underwent a three day inspection by a federal FDA inspector who conducted a rigorous and thorough inspection of the facilities under 21 CFR 111 (the Good Manufacturing Practices Section of the Code of Federal Regulations) and this evaluation resulted in no adverse findings. In a recent popular news article published in a major New York newspaper, the agency indicated that roughly 70% of inspections to date have resulted in some negative finding requiring corrective actions by the inspected company. Hardly a week goes by without more warning letters being released by the Federal Food and Drug Administration to companies who have significant deficiencies in compliance being identified by federal agents conducting inspections. Our company has benefited from this activity given that we have multiple opportunities being presented to us by new customer candidates. We anticipate our continued licensure by the Therapeutic Goods Administration of Australia (for US facilities) and SwissMedic licensure of Switzerland (for our Swiss facilities) will continue to contribute new sales opportunities in the year ahead. In recent weeks we have seen extraordinary demand being generated by new product releases in our sphere of influence, and many of our customers are sharing feedback that certain Asian markets have demonstrated significant growth. NAI stands ready to engage in meeting the anticipated surge in demand, which is welcome to all parties involved. New product launches and reconfigurations of existing product offerings are showing initial promise, so we remain patient but encouraged. Fiscal year ended June 30, 2013 San Marcos, California Our firm continues to exhibit patience in waiting for validation of our growing patent estate, as predicting the dates the Federal Courts will issue rulings on these matters remains an imprecise science. Continued research demonstrates the validity of the ingestion of CarnoSyn® beta-alanine for a myriad of objectives, and we remain hopeful of achieving even wider success with our growing number of sustained-release patents both in the US and abroad. NAI also has initiated a formal request for securing a health claim under the rigorous process established by the EU Health Claims Directive for beta-alanine. While the fourth quarter and year results were less than anticipated at the outset of the fiscal year, we continue to build cash along with strong capital equipment assets to further automate our capabilities while maintaining a superior balance sheet. All this is being done in expectation of new growth opportunities materializing in fiscal year 2014. While sales were lower for a variety of reasons in the last fiscal year, we believe we remain poised for experiencing meaningful growth in both our top line and bottom line numbers in this next fiscal year. We have patiently but arduously pursued our legal interests in protecting our patent estate, but we believe we are likely to receive judicial action sooner rather than later, meaning that our substantial legal costs should begin to subside. On behalf of the worldwide team of NAI, we appreciate your patience and continued support as we seek to enrich the world with the best of nutrition. Sincerely, Mark A. LeDoux Chairman, Founder and Chief Executive Officer Natural Alternatives International, Inc. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2013 000-15701 (Commission file number) NATURAL ALTERNATIVES INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) Delaware (State of incorporation) 1185 Linda Vista Drive San Marcos, California 92078 (Address of principal executive offices) 84-1007839 (IRS Employer Identification No.) (760) 744-7340 (Registrant’s telephone number) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $0.01 par value per share Name of exchange on which registered Nasdaq Global Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if Natural Alternatives International, Inc. (NAI) is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. ‘ Yes È No Indicate by check mark if NAI is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. ‘ Yes È No Indicate by check mark whether 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. È 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). È Yes ‘ No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of NAI’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ‘ Indicate by check mark whether NAI is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Large accelerated filer ‘ Non-accelerated filer ‘ Indicate by check mark whether NAI is a shell company (as defined in Rule 12b-2 of the Exchange Act): ‘ Yes È No The aggregate market value of NAI’s common stock held by non-affiliates of NAI as of the last business day of NAI’s most recently completed second fiscal quarter (December 31, 2012) was approximately $27,642,951 (based on the closing sale price of $5.02 reported by Nasdaq on December 30, 2012). For this purpose, all of NAI’s officers and directors and their affiliates were assumed to be affiliates of NAI. As of September 19, 2013, 6,912,155 shares of NAI’s common stock were outstanding, net of 496,522 treasury shares. ‘ Accelerated filer Smaller reporting company È DOCUMENTS INCORPORATED BY REFERENCE Part III (Items 10, 11, 12, 13 and 14) of this Form 10-K incorporates by reference portions of NAI’s definitive proxy statement for its Annual Meeting of Stockholders to be held December 6, 2013, to be filed on or before October 28, 2013. [THIS PAGE INTENTIONALLY LEFT BLANK] TABLE OF CONTENTS SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS PART I Item 1. Business Item 1A. Risk Factors Item 2. Item 3. Item 4. PART II Item 5. Item 6. Item 7. Item 8. Item 9. Properties Legal Proceedings Mine Safety Disclosures Market for Our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PART III Item 10. Directors, Executive Officers and Corporate Governance Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions, and Director Independence Item 14. Principal Accountant Fees and Services PART IV Item 15. Exhibits and Financial Statement Schedules SIGNATURES Page 1 2 11 19 19 21 21 23 23 33 58 58 59 59 59 59 59 59 60 66 (i) [THIS PAGE INTENTIONALLY LEFT BLANK] SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS Certain statements in this 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. They include opinions, forecasts, intentions, plans, goals, projections, guidance, expectations, beliefs or other statements that are not statements of historical fact. Words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “believes,” “anticipates,” “intends,” “estimates,” “approximates,” “predicts,” or “projects,” or the negative or other variation of such words, and similar expressions may identify a statement as a forward-looking statement. Any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business, our goals, strategies, focus and plans, and other characterizations of future events or circumstances, including statements expressing general optimism about future operating results, are forward- looking statements. Forward-looking statements in this report may include statements about: • • • • • • • • • • future financial and operating results, including projections of net sales, revenue, income or loss, net income or loss per share, profit margins, expenditures, liquidity, and other financial items; our ability to develop relationships with new customers and maintain or improve existing customer relationships; our ability to protect our intellectual property; the outcome of currently pending litigation, regulatory and tax matters, the costs associated with such matters and the effect of such matters on our business and results of operations; currency exchange rates, their effect on our results of operations, including amounts that may be reclassified as earnings, our ability to effectively hedge against foreign exchange risks and the extent to which we may seek to hedge against such risks; future levels of our revenue concentration risk; sources and availability of raw materials; inventories, including the adequacy of inventory levels to meet future customer demand and the adequacy and intended use of our facilities; development of new products and marketing strategies; our ability to increase our marketing and advertising efforts for our Pathway to Healing® product line, the timing of such efforts and their effect on future sales; • manufacturing and distribution channels, product sales and performance, and timing of product shipments; current or future customer orders; the impact on our business and results of operations and variations in quarterly net sales from seasonal and other factors; inflation rates and their impact on our operations and profitability; • • • • management’s goals and plans for future operations; • • • our ability to improve operational efficiencies, manage costs and business risks and improve or maintain profitability; growth, expansion, diversification, acquisition, divestment and consolidation strategies, the success of such strategies, and the benefits we believe can be derived from such strategies; personnel; 1 • • • • • • • • our ability to operate within the standards set by the U.S. Food and Drug Administration’s (FDA) Good Manufacturing Practices (GMP); our ability to successfully expand our operations outside the United States (U.S.); the adequacy of reserves and allowances; overall industry and market performance; competition and competitive advantages resulting from our quality commitment; current and future economic and political conditions; the impact of accounting pronouncements; and other assumptions described in this report underlying or relating to any forward-looking statements. The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to place undue reliance on any such forward-looking statements. Forward-looking statements are subject to certain events, risks, and uncertainties that may be outside of our control. When considering forward-looking statements, you should carefully review the risks, uncertainties and other cautionary statements in this report as they identify certain important factors that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. These factors include, among others, the risks described under Item 1A of Part I and elsewhere in this report, as well as in other reports and documents we file with the United States Securities and Exchange Commission (SEC). ITEM 1. BUSINESS General PART I Our vision is to enrich the world through the best of nutrition. We are a leading formulator, manufacturer and marketer of nutritional supplements. Our comprehensive strategic partnerships with our customers offer a wide range of innovative nutritional products and services to our clients including the following: scientific research, clinical studies, proprietary ingredients, customer-specific nutritional product formulation, product testing and evaluation, marketing management and support, packaging and delivery system design, regulatory review, and international product registration assistance. As our primary business activity, we provide private-label contract manufacturing services to companies that market and distribute vitamins, minerals, herbal and other nutritional supplements, as well as other health care products, to consumers both within and outside the United States. We also seek to commercialize our patent and trademark estate related to the ingredient known as beta-alanine through various licensing and similar arrangements. Additionally, we develop, manufacture and market our own branded products under the Pathway to Healing® product line, which is aimed at restoring, maintaining and improving the health of the users. History Originally founded in 1980, Natural Alternatives International, Inc. reorganized as a Delaware corporation in 1989. Our principal executive offices are located at 1185 Linda Vista Drive, San Marcos, California, 92078. In January 1999, we formed Natural Alternatives International Europe S.A. (NAIE) as our wholly owned subsidiary, based in Manno, Switzerland. In September 1999, NAIE opened its manufacturing facility and now possesses manufacturing capability in encapsulation, powders, and tablets, finished goods packaging, quality control laboratory testing, warehousing, distribution and administration. 2 In December 2005, we acquired Real Health Laboratories, Inc. (RHL), which primarily marketed branded nutritional supplements. After a careful review of our branded products portfolio and operations and a decision to narrow our branded products focus, on July 31, 2009, we completed the sale of substantially all of the assets of RHL. Unless the context requires otherwise, all references in this report to the “Company,” “NAI,” “we,” “our,” and “us” refer to Natural Alternatives International, Inc. and, as applicable, and NAIE. Overview of our Facilities and Operations Our U.S.-based operations are located in San Marcos and Vista, California and include manufacturing and distribution, sales and marketing, in-house formulation, laboratory and other research and development services. Our manufacturing facilities were recertified on December 20, 2012 by the Therapeutic Goods Administration (TGA) of Australia after its audit of our GMP. TGA evaluates new therapeutic products, prepares standards, develops testing methods and conducts testing programs to ensure that products are high in quality, safe and effective. TGA also conducts a range of assessment and monitoring activities including audits of the manufacturing practices of companies who export and sell products to Australia. TGA certification enables us to manufacture products for export into countries that have signed the Pharmaceutical Inspection Convention, which include most European countries as well as several Pacific Rim countries. TGA certifications are generally reviewed every eighteen months. Our California facilities also have been awarded GMP registration annually by NSF International (NSF) through the NSF Dietary Supplements Certification Program since October 2002 and received “GMP for Sport” NSF Certified registration on February 16, 2009. GMP requirements are regulatory standards and guidelines establishing necessary processes, procedures and documentation for manufacturers in an effort to assure the products produced by that manufacturer have the identity, strength, composition, quality and purity they are represented to possess. The NSF Certified for Sport program focuses on minimizing the risk that a dietary supplement or sports nutrition product contains banned substances and was developed due to growing demand from athletes and coaches concerned about banned substances in sports supplements. The program focuses primarily on manufacturing and sourcing processes, embedding preventative measures throughout. NAI’s participation in the program allows us to produce products bearing the NSF Sport logo. Additionally, our U.S. Operations have been certified by Health Canada as compliant with GMP requirements as outlined in Part 3 of the Canadian Natural Health Products Regulations. Health Canada is the federal department of the Canadian government with responsibility for national public health. Health Canada has initiated work to modernize its regulatory system for food and health products. Health Canada plays an active role in ensuring access to safe and effective drugs and health products while giving highest priority to public safety and striving to provide information needed to make healthy choices and informed decisions regarding one’s health. NAI was issued its initial certification in December 2011 and received its annual re-certification from Health Canada’s Natural Health Products Directorate in September 2012. Not only does this approval demonstrate yet another level of regulatory compliance for NAI, it may also ease the approval process for our customers who import products into Canada. NAIE also operates a manufacturing, warehousing, packaging and distribution facility in Manno, Switzerland. In January 2004, NAIE obtained a pharmaceutical license to process pharmaceuticals for packaging, importation, export and sale within Switzerland and other countries from the Swissmedic Authority of Bern, Switzerland. In March 2007, following the expansion of NAIE’s manufacturing facilities to include powder filling capabilities, NAIE obtained an additional pharmaceutical license from the Swissmedic Authority certifying NAIE’s expanded facilities conform to GMP. In January 2013, following the additional upgrade of NAIE’s manufacturing facilities to include the manufacture of pharmaceuticals, NAIE obtained an additional pharmaceutical approval from the Swissmedic Authority certifying NAIE’s upgraded facilities conform to GMP. We believe these licenses and NAIE’s manufacturing capabilities help strengthen our relationships with existing customers and can improve our ability to develop relationships with new customers. The Swissmedic licenses are valid until February 2014. 3 In addition to our operations in the United States and Switzerland, we have a part-time representative in Japan who provides a range of services to our customers currently present in or seeking to expand into the Japanese market and other markets in the Pacific Rim. These services include regulatory and marketing assistance along with guidance and support in adapting products to these markets. Business Strategy Our goals are to achieve long-term growth and profitability and to diversify our sales base. To accomplish these goals, we have sought and intend to continue to seek to do the following: • • • • • leverage our state-of-the-art, certified facilities to increase the value of the goods and services we provide to our highly valued private-label contract manufacturing customers and assist in developing relationships with additional quality oriented customers; provide strategic partnering services to our private-label contract manufacturing customers, as described below under “Products, Principal Markets and Methods of Distribution”; commercialize our beta-alanine patent estate through contract manufacturing, royalty and license agreements and protect our proprietary rights; improve operational efficiencies and manage costs and business risks to improve profitability; and develop and grow our own line of branded products primarily through direct-to-consumer sales and distribution channels. Overall, we believe there is an opportunity to enhance consumer confidence in the quality of our nutritional supplements and their adherence to label claims through the education provided by direct sales and direct-to- consumer marketing programs. We believe our GMP and TGA certified manufacturing operations, science-based product formulations, peer-reviewed clinical studies and regulatory expertise provide us with a sustainable competitive advantage by providing our customers with a high degree of confidence in the products we manufacture. While today’s consumer may have access to a variety of information, we believe many consumers remain uneducated about nutrition and nutritional supplementation, uncertain about the relevance or reliability of the information they have or are confused about conflicting claims or information. We believe this state of the market creates a significant opportunity for the direct sales marketing channel. The direct sales marketing channel has proved, and we believe will continue to prove, to be a highly effective method for marketing high- quality nutritional supplements as associates or other personalities educate consumers on the benefits of science based nutritional supplements. Our largest customers operate in the direct sales marketing channel. Thus, the majority of our business has relied primarily on the effectiveness of our customers in this marketing channel. As part of our business strategy, we have sought to commercialize our patent estate through contract manufacturing, royalty and license agreements. Since March 2009, we have had an agreement with Compound Solutions, Inc. (CSI) to grant a license of certain of our patent rights to customers of CSI who purchase beta- alanine under the CarnoSyn® trade name from CSI. The license allows CSI’s customers to manufacture, offer for sale and/or sell products incorporating, using or made in accordance with our patent rights. We receive a fee from CSI that varies based on the quantity and source of beta-alanine sold by CSI. Our current agreement with CSI expires on March 31, 2014. During fiscal 2011, we expanded our beta-alanine licensing programs through the execution of a supply agreement with Nestle Nutrition (Nestle) and a license and supply agreement with Abbott Laboratories (Abbott). The Nestle agreement expired on August 16, 2012 and was not renewed. Under the Abbott agreement, we agreed to grant an exclusive license to Abbott for the use of beta-alanine in certain medical foods and medical nutritionals. Our branded products segment consists primarily of the products sold under our Pathway to Healing® product line. During fiscal 2011 and 2012, we re-launched our Pathway to Healing® product line and increased our marketing and advertising activities in an effort to expand our future sales opportunities. 4 We believe our comprehensive approach to customer service is unique within our industry. We believe this approach, together with our commitment to high quality, product development and manufacturing capabilities, will provide the means to implement our strategies and achieve our goals. There can be no assurance, however, that we will successfully implement any of our business strategies or that we will increase or diversify our sales, successfully commercialize our patent estate, develop and grow our branded products segment, or improve our overall financial results. Products, Principal Markets and Methods of Distribution Our primary business activity is to provide 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. Our private-label contract manufacturing customers include companies that market nutritional supplements through direct sales marketing channels, direct response television and retail stores. We manufacture products in a variety of forms, including capsules, tablets, chewable wafers and powders to accommodate a variety of consumer preferences. We provide strategic partnering services to our private-label contract manufacturing customers, including the following: • • customized product formulation; clinical studies; • manufacturing; • marketing support; • • • international regulatory and label law compliance; international product registration; and packaging in multiple formats and labeling design. We also seek to commercialize our patent and trademark estate related to the ingredient known as beta-alanine through various license and similar arrangements. Additionally, we develop, manufacture and market our own branded products and work with a nationally recognized physician to develop brand name products that reflect his individual approach to restoring, maintaining or improving health. These products are currently sold through print media and internet distribution channels. For the last two fiscal years ended June 30, our net sales were derived from the following (in thousands): Private-label Contract Manufacturing Patent and Trademark Licensing Branded Products Total Net Sales Research and Development 2013 $ $56,672 4,799 1,326 % 90 8 2 2012 $ $63,268 7,990 1,564 % 87 11 2 $62,797 100 $72,822 100 We are committed to quality research and development. We focus on the development of new science based products and the improvement of existing products. We periodically test and validate our products to help ensure their stability, potency, efficacy and safety. We maintain quality control procedures to verify that our products comply with applicable specifications and standards established by the FDA and other regulatory agencies. We 5 also direct and participate in clinical research studies, often in collaboration with scientists and research institutions, to validate the benefits of a product and provide scientific support for product claims and marketing initiatives. We believe our commitment to research and development, as well as our facilities and strategic alliances with our suppliers and customers, allow us to effectively identify, develop and market high-quality and innovative products. As part of the services we provide to our private-label contract manufacturing customers, we may perform, but are not required to perform, certain research and development activities related to the development or improvement of their products. While our customers often do not pay directly for this service, the cost of this service is included as a component of the price we charge to manufacture and deliver their products. Research and development costs, which include costs associated with international regulatory compliance services we provide to our customers, are expensed as incurred. Our research and development expenses for the last two fiscal years ended June 30 were $1.2 million for 2013 and $1.1 million for 2012. The increase in research and development expenses was related to activity supporting our increased sales volume. Sources and Availability of Raw Materials We use raw materials in our operations including powders, excipients, empty capsules, and components for packaging and distributing our finished products. In addition, the commercialization of our beta-alanine patent estate depends on the availability of the raw material beta-alanine. We conduct identity testing for all raw materials we purchase and, on a predetermined testing protocol basis, we evaluate raw materials to ensure their quality, purity and potency before we use them in our products. We typically buy raw materials in bulk from qualified vendors located both within and outside the U.S. During fiscal 2013, we did not have any suppliers that represented more than 10% of our total raw material purchases. Our contract manufacturing business did not experience any significant shortages or difficulties obtaining adequate supplies of raw materials during fiscal 2013. However, there continues to be significant pricing pressure associated with various vitamins, minerals and herbs in the raw material marketplace. In early March 2011, the factory that produces the major supply of beta-alanine sold under our CarnoSyn® trade name was damaged as a result of the massive earthquake off the coast of Sendai, Japan resulting in a significant beta-alanine supply interruption. While this Japanese factory resumed operations in June 2011 and was able to produce beta-alanine at historical levels during fiscal 2012, there is no assurance this facility will not incur future production interruptions as a result of additional earthquake-related activity or other causes. Throughout fiscal 2014, we expect to continue to experience difficulties in sourcing various raw materials as a result of worldwide shortages, and other supply constraints. We also believe raw material and product cost pricing pressures will continue throughout fiscal 2014 as a result of limited supplies of various ingredients and the effects of higher labor and transportation costs. Major Customers NSA International, Inc. (NSA) has been our largest customer over the past several years. During the fiscal year ended June 30, 2013, NSA accounted for approximately 50% of our private-label contract manufacturing net sales. We have manufacturing agreements with NSA dated April 1, 2005. Under the terms of our agreements with NSA, we develop, manufacture, produce and package certain nutritional products for NSA based on monthly purchase orders submitted to us by NSA and provide certain consulting services, at such prices as are agreed upon from time to time. The agreements require that NSA purchase at least 75% of NSA’s monthly domestic requirements for certain of its products from us. The agreements expire on April 1, 2014, and may only be terminated in the event of a default under the agreements or 3 month’s written notice by either party. The agreements prohibit us from manufacturing or distributing any products that are substantially similar to the products we manufacture for NSA during the term of the agreements and for a period of three years thereafter. 6 Our second largest customer is Mannatech, which accounted for approximately 19% of our private-label contract manufacturing net sales during fiscal 2013. Under the terms of our manufacturing agreement with Mannatech, we manufacture, produce and bulk package certain nutritional products for Mannatech based on purchase orders submitted to us by Mannatech, at such prices as are agreed upon from time to time. The agreement automatically extends for successive one year periods unless terminated by either party in the event of a breach of the agreement by the other party or on at least 60 days written notice prior to the expiration of the then current term. We also have a Manufacturing Sales Agreement with Mannatech and its affiliates, under which we have the exclusive right to develop and manufacture certain products for Mannatech to be sold in Germany and Denmark. This agreement automatically extends for successive one year periods unless terminated by either party for cause or in the event of a breach of the agreement by the other party or upon written notice prior to the expiration of the then current term. Both NSA and Mannatech are private-label contract manufacturing customers, and the loss of either one of them could result in significant negative impact to our financial position and results of operations. No other customer accounted for 10% or more of our net sales during fiscal 2013. We continue to focus on obtaining new private- label contract manufacturing customers and growing our remaining branded products to reduce the risks associated with deriving a significant portion of our sales from a limited number of customers. Competition We compete with other manufacturers, distributors and marketers of vitamins, minerals, herbs, and other nutritional supplements both within and outside the U.S. The nutritional supplement industry is highly fragmented and competition for the sale of nutritional supplements comes from many sources. These products are sold primarily through retailers (drug store chains, supermarkets, and mass market discount retailers), health and natural food stores, and direct sales channels (network marketing, internet marketing and mail order companies). The products we produce for our private-label contract manufacturing customers may compete with our own branded products, although we believe such competition is limited. We believe private-label contract manufacturing competition in our industry is based on, among other things, customized services offered, product quality and safety, innovation, price and customer service. We believe we compete favorably with other companies because of our ability to provide comprehensive solutions for customers, our certified manufacturing operations and our commitment to quality and safety through our research and development activities. Our future competitive position for private-label contract manufacturing, patent and trademark licensing, and branded products will likely depend on, but not be limited to, the following: • • • • • • • • the continued acceptance of our products by our customers and consumers; our ability to continue to manufacture high quality products at competitive prices; our ability to protect our proprietary rights in our patent estate and the continued validity of such estate; our ability to attract and retain qualified personnel; the effect of any future governmental regulations on our products and business; the results of, and publicity from, product safety and performance studies performed by governments and other research institutions; the continued growth of the global nutrition industry; and our ability to respond to changes within the industry and consumer demand, financially and otherwise. The nutritional supplement industry is highly competitive and we expect the level of competition to remain high over the near term. We do not believe it is possible to accurately estimate the total number or size of our competitors. The nutritional supplement industry has undergone consolidation in the recent past and we expect that trend to continue in the near term. 7 Government Regulation Our business is subject to varying degrees of regulation by a number of government authorities in the U.S., including the FDA, the Federal Trade Commission (FTC), the Consumer Product Safety Commission, the U.S. Department of Agriculture, and the Environmental Protection Agency. Various agencies of the states and localities in which we operate and in which our products are sold also regulate our business, such as the California Department of Health Services, Food and Drug Branch. The areas of our business that these and other authorities regulate include, among others: • • • • product claims and advertising; product labels; product ingredients; and how we manufacture, package, distribute, import, export, sell and store our products. The FDA, in particular, regulates the formulation, manufacturing, packaging, storage, labeling, promotion, distribution and sale of vitamin and other nutritional supplements in the U.S., while the FTC regulates marketing and advertising claims. In August 2007, a new rule issued by the FDA went into effect requiring companies that manufacture, package, label, distribute or hold nutritional supplements to meet certain GMPs to ensure such products are of the quality specified and are properly packaged and labeled. We are committed to meeting or exceeding the standards set by the FDA and believe we are currently operating within the FDA mandated GMPs. The FDA also regulates the labeling and marketing of dietary supplements and nutritional products, including the following: • • • • • the identification of dietary supplements or nutritional products and their nutrition and ingredient labeling; requirements related to the wording used for claims about nutrients, health claims, and statements of nutritional support; labeling requirements for dietary supplements or nutritional products for which “high potency” and “antioxidant” claims are made; notification procedures for statements on dietary supplements or nutritional products; and premarket notification procedures for new dietary ingredients in nutritional supplements. The Dietary Supplement Health and Education Act of 1994 (DSHEA) revised the provisions of the Federal Food, Drug and Cosmetic Act concerning the composition and labeling of dietary supplements and defined dietary supplements to include vitamins, minerals, herbs, amino acids and other dietary substances used to supplement diets. DSHEA generally provides a regulatory framework to help ensure safe, quality dietary supplements and the dissemination of accurate information about such products. The FDA is generally prohibited from regulating active ingredients in dietary supplements as drugs unless product claims, such as claims that a product may heal, mitigate, cure or prevent an illness, disease or malady, trigger drug status. In December 2006, the Dietary Supplement and Nonprescription Drug Consumer Protection Act (DSNDCPA) was passed, which further revised the provisions of the Federal Food, Drug and Cosmetic Act. Under the act, manufacturers, packers or distributors whose name appears on the product label of a dietary supplement or nonprescription drug are required to include contact information on the product label for consumers to use in reporting adverse events associated with the product’s use and for us to notify the FDA of any serious adverse event report within 15 business days of receiving such report. Events reported to the FDA would not be considered an admission from a company that its product caused or contributed to the reported event. We are committed to meeting or exceeding the provisions of the DSNDCPA. 8 We are also subject to a variety of other regulations in the U.S., including those relating to bioterrorism, taxes, labor and employment, import and export, the environment and intellectual property. All of these regulations require significant financial and operational resources to ensure compliance, and we cannot assure you that we will always be in compliance despite our best efforts to do so. Our operations outside the U.S. are similarly regulated by various agencies and entities in the countries in which we operate and in which our products are sold. The regulations of these countries may conflict with those in the U.S. and may vary from country to country. The sale of our products in certain European countries is subject to the rules and regulations of the European Union, which may be interpreted differently among the countries within the European Union. In other markets outside the U.S., we may be required to obtain approvals, licenses or certifications from a country’s ministry of health or comparable agency before we begin operations or the marketing of products in that country. Approvals or licenses may be conditioned on reformulation of our products for a particular market or may be unavailable for certain products or product ingredients. These regulations may limit our ability to enter certain markets outside the U.S. As with the costs of regulatory compliance in the United States, foreign regulations require significant financial and operational resources to ensure compliance, and we cannot assure you that we will always be in compliance despite our best efforts to do so. Our failure to maintain regulatory compliance within and outside the United States could impact our ability to sell our products and thus, materially impact our financial position and results of operations. Intellectual Property Trademarks. We have developed and use registered trademarks in our business, particularly relating to corporate, brand and product names. We own 18 trademark registrations, including seventeen incontestable registrations, in the U.S. Federal registration of a trademark affords the owner nationwide exclusive trademark rights in the registered mark and the ability to prevent others from using the same or similar marks. However, to the extent a common law user has made prior use of the mark in connection with similar goods or services in a particular geographic area, the nationwide rights conferred by federal registration would be subject to that geographic area. We have eleven foreign trademark registrations. Three trademarks are registered with the Japanese Patent and Trademark Office, two with the Australia Patent and Trademark Office, two with the Trademarks and Designs Registration Office of the European Union, and two with the Chinese Patent & Trademark Office, and two with the Swiss Patent and Trademark Office. We currently have six additional trademark applications pending in various jurisdictions outside of the United States and we intend to register additional trademarks in foreign countries where our products are or may be sold in the future. We also claim common law ownership and protection of certain unregistered trademarks and service marks. Trademark rights are based on use of a mark. Common law use of a mark offers protection of a mark within the particular geographic area in which it is used. We believe our registered and unregistered trademarks constitute valuable assets, adding to the recognition of our products and services in the marketplace. These and other proprietary rights have been and will continue to be important in enabling us to compete; however, we cannot assure you that our pending trademark applications will be granted or our current trademarks will be maintained. Trade Secrets. We own certain intellectual property, including trade secrets, which we seek to protect, in part, through confidentiality agreements with employees and other parties. We regard our proprietary technology, trade secrets, trademarks and similar intellectual property as critical to our success, and we rely on a combination of trade secrets, contract, patent, copyright and trademark law to establish and protect the rights in our products and technology. The laws of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. Patents and Patent Licenses. We currently own twelve U.S. patents and nineteen corresponding patents registered in countries throughout North America, Europe and Asia. We also have pending applications in several countries. All of these patents and patent rights relate to the ingredient known as beta-alanine. Certain of these patents were assigned to NAI and we make certain ongoing royalty payments to the prior owners of the patents. 9 We also license rights to certain uses that are covered by the patents to the prior owners. The royalty payments and license continue until the expiration of the patents. We are currently exclusively licensing some of our patent rights to one customer for use in a limited market, and since March 2009 have had an agreement with CSI that allows CSI to grant a license of certain of our patent and trademark rights to customers of CSI who purchase beta-alanine from CSI. The license agreement allows CSI’s customers to manufacture, offer for sale and/or sell products incorporating, using or made in accordance with our patent rights and one or more of our trademarks. We receive royalties from CSI that vary based on the quantity and source of beta-alanine sold by CSI. Twenty- three of our patents expire in 2017, one patent expires in 2024, six patents expire in 2026 and one patent expires in 2027. Beginning in fiscal 2009, the licensing, raw material sales, and revenues we have received associated with the sale and license of beta-alanine under the CarnoSyn® trade name have grown steadily from $515,000 in fiscal 2009 to $4.8 million in fiscal 2013. During fiscal 2012 we purchased $3.2 million of beta-alanine raw material in an effort to help ensure sufficient inventory was available to meet customer demand and to remove infringing beta-alanine from the industry supply chain. A majority of this inventory was subsequently sold at a sales price of $3.4 million. We did not directly purchase or sell any material amounts of beta-alanine raw material during fiscal 2013 and do not expect to directly purchase and sell material quantities of beta-alanine raw material during fiscal 2014. We anticipate our licensing and related revenue to expand further during fiscal 2014. We incurred intellectual property litigation and patent compliance expenses of approximately $2.3 million during fiscal 2013 in connection with our efforts to protect our proprietary rights and patent estate, and we have and expect to continue to incur additional litigation expenses during fiscal 2014. Other Intellectual Property. We have license agreements with Dr. Reginald B. Cherry and his ministries pursuant to which we have the right to use the names, likenesses, styles, personas and certain other intellectual property and attributes of Dr. Cherry to market and distribute nutritional and dietary supplements and related products and materials, including the Pathway to Healing® product line. The license agreements require the payment of certain royalties based on net sales. The licenses are in effect until December 31, 2013, and automatically extend for successive one (1) year periods unless terminated by either party at least 120 days before the expiration of the then current term. As of the date of this annual report, we have not been notified that this license will not be renewed. Employees As of June 30, 2013, we employed 129 full-time employees in the U.S., two of whom held executive management positions. Of the remaining full-time employees, 19 were employed in research, laboratory and quality control, 11 in sales and marketing, and 97 in manufacturing and administration. From time to time we use temporary personnel to help us meet short-term operating requirements. These positions typically are in manufacturing and manufacturing support. As of June 30, 2013, we had 17 temporary personnel. As of June 30, 2013, NAIE employed an additional 31 full-time employees. Most of these positions were in the areas of manufacturing and manufacturing support. Our employees are not represented by a collective bargaining agreement and we have not experienced any work stoppages as a result of labor disputes. We believe our relationship with our employees is good. Seasonality Although we believe there is no material impact on our business or results of operations from seasonal factors, we have experienced and expect to continue to experience variations in quarterly net sales due to the timing of private-label contract manufacturing orders. 10 Financial Information about Our Business Segments and Geographic Areas Our operations are comprised of three reportable segments: • Private-label contract manufacturing, in which we primarily provide manufacturing services to companies that market and distribute nutritional supplements and other health care products. • Royalty, licensing and related income associated with the sale and license of beta-alanine under our CarnoSyn® trade name. • Branded products, in which we market and distribute branded nutritional supplements through direct- to-consumer marketing programs, and under which we develop, manufacture and market our own products and work with a nationally recognized physician to develop brand name products that reflect his individual approach to restoring, maintaining or improving health. These products are currently sold through print media and the internet. Our private-label contract manufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe, Canada, Mexico, Australia and Asia. The primary market outside the U.S. is Europe. Our patent and trademark licensing activities are primarily based in the U.S. and our branded products are only sold in the U.S. For additional financial information, including financial information about our business segment and geographic areas, please see the consolidated financial statements and accompanying notes to the consolidated financial statements included under Item 8 of this report. Our activities in markets outside the U.S. are subject to political, economic and other risks in the countries in which our products are sold and in which we operate. For more information about these and other risks, please see Item 1A in this report. ITEM 1A. RISK FACTORS You should carefully review and consider the risks described below, as well as the other information in this report and in other reports and documents we file with the SEC when evaluating our business and future prospects. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties, not presently known to us, or that we currently see as immaterial, may also occur. If any of the following risks or any additional risks and uncertainties actually occur or become material, our business, financial condition and results of operations could be seriously harmed. In that event, the market price of our common stock could decline and you could lose all or a portion of the value of your investment in our common stock. You should not draw any inference as to the magnitude of any particular risk from its position in the following discussion. Because we derive a significant portion of our revenues from a limited number of customers, our revenues would be adversely affected by the loss of a major customer or a significant change in its business, personnel or the timing or amount of its orders. We have in the past and expect to continue to derive a significant portion of our revenues from a relatively limited number of customers. During the fiscal year ended June 30, 2013, sales to one customer, NSA International, Inc., were approximately 50% of our total private-label contract manufacturing net sales. Our second largest customer was Mannatech, Incorporated, which accounted for approximately 19% of our private- label contract manufacturing net sales during fiscal 2013. The loss of one of these customers or other major customers, a significant decrease in sales to these customers, or a significant change in their business or personnel, would materially affect our financial condition and results of operations. Furthermore, the timing of our customers’ orders is impacted by, among others, their marketing programs, customer demand, supply chain management, entry into new markets and new product introductions, all of which are outside of our control. All of these attributes have had and will have a significant impact on our business. 11 Our future growth and stability depends, in part, on our ability to diversify our sales. Our efforts to establish new sales from existing customers and new customers and develop and grow our branded products could require significant initial investments, which may or may not result in higher sales and improved financial results. Our business strategy depends in large part on our ability to develop new product sales from current and new customer relationships. These activities often require a significant up-front investment including, among others, customized formulations, regulatory compliance, product registrations, package design, product testing, pilot production runs, and the build-up of initial inventory. In addition, we may incur increased marketing and advertising costs to the extent we seek to develop and grow our branded products. We may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time we generate net sales from new products or customers, and it is possible that we may never generate any revenue from new products or customers after incurring such expenditures. If we incur significant expenses and investments in inventory that we are not able to recover, and we are not able to compensate for those expenses, our operating results could be adversely affected. We may incur, and have incurred, significant costs defending our intellectual property or be unable to protect our intellectual property rights or may inadvertently infringe on the intellectual property rights of others. We possess and may possess in the future certain proprietary technology, trade secrets, trademarks, trade names, licenses, patents and similar intellectual property. There can be no assurance that we will not incur significant patent and trademark litigation costs associated with defending this intellectual property. During fiscal 2013, we incurred approximately $2.3 million in patent litigation and prosecution expense and expect litigation expenses during fiscal 2014 to be approximately $1.0 million to $1.5 million, in connection with our efforts to protect our proprietary rights and patent estate. These efforts are described in more detail under Item 3 of this report. There is no assurance we will be able to protect our intellectual property adequately or that our intellectual property rights will be upheld. If pending legal proceedings to invalidate our patent rights are successful this would likely have a material adverse impact upon our financial condition and results of operations. Furthermore, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. Additional litigation in the U.S. or abroad may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. This litigation, even if successful, could result in substantial additional costs and diversion of resources and could have a material adverse effect on our business, results of operation and financial condition. If any such claims are asserted against us, we may seek to obtain a license under the third party’s intellectual property rights. There can be no assurance, however, that a license would be available on terms acceptable or favorable to us, if at all. Our operating results will vary. We have experienced a decline in net sales and incurred losses in recent years and there is no guarantee that our sales will improve or that we will earn a profit in future years. Fluctuations in our operating results may adversely affect the share price of our common stock. Our net sales declined during fiscal 2013 as compared to fiscal 2012 and there can be no assurance that our net sales will improve in the near term, or that we will earn a profit in any given year. We have experienced net losses in the past and may incur losses in the future. Our operating results will fluctuate from year to year and/or from quarter to quarter due to various factors including differences related to the timing of revenues and expenses for financial reporting purposes and other factors described in this report. At times, these fluctuations may be significant. We anticipate generating net income in fiscal 2014, although there is no assurance we will be able to do so. Fluctuations in our operating results may adversely affect the share price of our common stock. Our products and manufacturing activities are subject to extensive government regulation, which could limit or prevent the sale of our products in some markets and could increase our costs. The manufacturing, packaging, labeling, advertising, promotion, distribution, and sale of our products are subject to regulation by numerous national and local governmental agencies in the U.S. and in other countries. For 12 example, we are required to comply with certain GMPs and incur costs associated with the audit and certification of our facilities. Failure to comply with governmental regulations may result in, among other things, injunctions, product withdrawals, recalls, product seizures, fines, and criminal prosecutions. Any action of this type by a governmental agency could materially adversely affect our ability to successfully market our products. In addition, if the governmental agency has reason to believe the law is being violated (for example, if it believes we do not possess adequate substantiation for product claims), it can initiate an enforcement action. Governmental agency enforcement could result in orders requiring, among other things, limits on advertising, consumer redress, divestiture of assets, rescission of contracts, and such other relief as may be deemed necessary. Violation of these orders could result in substantial financial or other penalties. Any action by the governmental agency could materially adversely affect our ability and our customers’ ability to successfully market those products. In markets outside the U.S., before commencing operations or marketing our products, we may be required to obtain approvals, licenses, or certifications from a country’s ministry of health or comparable agency. Approvals or licensing may be conditioned on reformulation of products or may be unavailable with respect to certain products or product ingredients. We must also comply with product labeling and packaging regulations that vary from country to country. Furthermore, the regulations of these countries may conflict with those in the U.S. and with each other. The sale of our products in certain European countries is subject to the rules and regulations of the European Union, which may be interpreted differently among the countries within the European Union. The cost of complying with these various and potentially conflicting regulations can be substantial and can adversely affect our results of operations. We cannot predict the nature of any future laws, regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations, when and if adopted, would have on our business. They could include requirements for the reformulation of certain products to meet new standards, the recall or discontinuance of certain products, additional record keeping, expanded or different labeling, and additional scientific substantiation. Any or all of these requirements could have a material adverse effect on our operations. A significant or prolonged economic downturn, such as the one the global economy has recently experienced, could have, and recently has had, a material adverse effect on our results of operations. Our results of operations are affected by the level of business activity of our customers and licensees, which in turn is affected by the level of consumer demand for their products. A significant or prolonged economic downturn may adversely affect the disposable income of many consumers and may lower demand for the products we produce for our private-label contract manufacturing customers, as well as our branded products and products sold or manufactured by others using our licensed patent rights. During fiscal 2011, the decline in economic conditions in the U.S. and the various foreign markets in which our customers operate negatively impacted our customers’ businesses and our operations. A continued or further decline in consumer demand and the level of business activity of our customers due to economic conditions could have a material adverse effect on our revenues and profit margins. The failure of our suppliers to supply quality materials in sufficient quantities, at a favorable price, and in a timely fashion could adversely affect the results of our operations. We buy our raw materials from a limited number of suppliers. During fiscal 2013 and fiscal 2012, we did not have any suppliers that represented more than 10% of our raw material purchases. However, during fiscal 2011, approximately 20% of our total raw material purchases were from two suppliers. The loss of any of our major suppliers or of a supplier that provides any hard to obtain materials could adversely affect our business operations. Although we believe that we could establish alternate sources for most of our raw materials, any delay in locating and establishing relationships with other sources could result in product shortages, with a resulting loss of sales and customers. In certain situations we may be required to alter our products or to substitute different materials from alternative sources. 13 We rely solely on two suppliers to process certain raw materials that we use in the product line of our largest customer. The loss of or unexpected interruption in this service would materially adversely affect our results of operations and financial condition. A shortage of raw materials or an unexpected interruption of supply could also result in higher prices for those materials. Since fiscal 2009, we have experienced increases in various raw material costs, transportation costs and the cost of petroleum based raw materials and packaging supplies used in our business, which were associated with higher oil and fuel costs. Increasing raw material and product cost pricing pressures have continued throughout fiscal 2013 as a result of limited supplies of various ingredients and the effects of higher labor and transportation costs. We expect these pressures to continue through fiscal 2014. Although we may be able to raise our prices in response to significant increases in the cost of raw materials, we may not be able to raise prices sufficiently or quickly enough to offset the negative effects of the cost increases on our results of operations or financial condition. There can be no assurance that suppliers will provide the quality raw materials needed by us in the quantities requested or at a price we are willing to pay. Because we do not control the actual production of these raw materials, we are also subject to delays caused by interruption in production of materials based on conditions outside of our control, including weather, transportation interruptions, strikes and natural disasters or other catastrophic events. In addition, our efforts to commercialize our patent estate, and the royalty, license fees and other revenues we receive from our related license and supply agreements, are substantially dependent on the availability of the raw material beta-alanine and sales of such raw material or products incorporating such raw material. The availability of the raw ingredient beta-alanine, and thus sales of such raw material and products using such material, would be negatively impacted by any shortages, interruptions and similar risks described above, which could in turn adversely affect the amount of fees we receive from CSI, as well as other parties with whom we have license or supply agreements. In early March 2011 the factory that produces the major supply of beta-alanine sold under our CarnoSyn® trade name was damaged as a result of the massive earthquake off the coast of Sendai, Japan resulting in a significant beta-alanine supply interruption. As a result, our fiscal 2011 fourth quarter beta-alanine licensing revenue declined 85% from the preceding quarter ended March 31, 2011. While this Japanese factory resumed operations in June 2011 and is producing beta-alanine at historical levels, there is no assurance this facility will not incur future production interruptions as a result of additional earthquake related activity or other causes. Our industry is highly competitive and we may be unable to compete effectively. Increased competition could adversely affect our financial condition. The market for our products, and those of our customers, is highly competitive. Many of our competitors are substantially larger and have greater financial resources and broader name recognition than we do. Our larger competitors may be able to devote greater resources to research and development, marketing and other activities that could provide them with a competitive advantage. Our market has relatively low entry barriers and is highly sensitive to the introduction of new products that may rapidly capture a significant market share. Increased competition could result in price reductions, reduced gross profit margins or loss of market share, any of which could have a material adverse effect on our financial condition and results of operations. There can be no assurance that we will be able to compete in this intensely competitive environment. We could be exposed to product liability claims or other litigation, which may be costly and could materially adversely affect our operations. We could face financial liability due to product liability claims if the use of our products results in significant loss or injury. Additionally, the manufacture and sale of our products involves the risk of injury to consumers from tampering by unauthorized third parties or product contamination. We could be exposed to future product 14 liability claims that, among others: our products contain contaminants; we provide consumers with inadequate instructions about product use; or we provide inadequate warning about side effects or interactions of our products with other substances. Even if we were to prevail in any such claims, the cost of negotiations, settlement and litigation could be significant. We maintain product liability insurance coverage, including primary product liability and excess liability coverage. The cost of this coverage has increased dramatically in recent years, while the availability of adequate insurance coverage has decreased. While we expect to be able to continue our product liability insurance, there can be no assurance that we will in fact be able to continue such insurance coverage, that our insurance will be adequate to cover any liability we may incur, or that our insurance will continue to be available at an economically reasonable cost. Additionally, it is possible that one or more of our insurers could exclude from our coverage certain ingredients used in our products. In such event, we may have to stop using those ingredients or rely on indemnification or similar arrangements with our customers who wish to continue to include those ingredients in their products. A substantial increase in our product liability risk or the loss of customers or product lines could have a material adverse effect on our results of operations and financial condition. If we or our private-label contract manufacturing customers expand into additional markets outside the U.S. or our or their sales in markets outside the U.S. increase, our business would become increasingly subject to political, economic, regulatory and other risks in those markets, which could adversely affect our business. Our future growth may depend, in part, on our ability and the ability of our private-label contract manufacturing customers to expand into additional markets outside the U.S. or to improve sales in markets outside the U.S. There can be no assurance that we or our customers will be able to expand in existing markets outside the U.S., enter new markets on a timely basis, or that new markets outside the U.S. will be profitable. There are significant regulatory and legal barriers in markets outside the U.S. that must be overcome. We will be subject to the burden of complying with a wide variety of national and local laws, including multiple and possibly overlapping and conflicting laws. We also may experience difficulties adapting to new cultures, business customs and legal systems. Our sales and operations outside the U.S. are subject to political, economic and social uncertainties including, among others: • • • • • • • • changes and limits in import and export controls; increases in custom duties and tariffs; changes in government regulations and laws; coordination of geographically separated locations; absence in some jurisdictions of effective laws to protect our intellectual property rights; changes in currency exchange rates; economic and political instability; and currency transfer and other restrictions and regulations that may limit our ability to sell certain products or repatriate profits to the U.S. Any changes related to these and other factors could adversely affect our business, profitability and growth prospects. If we or our customers expand into additional markets outside the U.S. or improve sales in markets outside the U.S., these and other risks associated with operations outside the U.S. are likely to increase. Our business is subject to the effects of adverse publicity, which could negatively affect our sales and revenues. Our business can be affected by adverse publicity or negative public perception about our industry, our competitors, our customers, or our business generally. This adverse publicity may include publicity about the nutritional supplements industry generally, the efficacy, safety and quality of nutritional supplements and other 15 health care products or ingredients in general or our products or ingredients specifically, and regulatory investigations, regardless of whether these investigations involve us or the business practices or products of our competitors, or our customers. Any adverse publicity or negative public perception will likely have a material adverse effect on our business, financial condition and results of operations. Our business, financial condition and results of operations also could be adversely affected if any of our products or any similar products distributed by other companies are alleged to be or are proved to be harmful to consumers or to have unanticipated health consequences. Because our direct-to-consumer sales rely on the marketability of key personalities, the inability of a key personality to perform his or her role or the existence of negative publicity surrounding a key personality may adversely affect our revenues. Direct-to-consumer products may be marketed with a key personality through a variety of distribution channels. The inability or failure of a key personality to fulfill his or her role, or the ineffectiveness of a key personality as a spokesperson for a product, a reduction in the exposure of a key personality due to the discontinuance of a marketing program or otherwise or negative publicity about a key personality may adversely affect the sales of our product associated with that personality and could affect the sale of other products. A decline in sales would negatively affect our results of operations and financial condition. We may not be able to raise additional capital or obtain additional financing if needed. Our cash from operations may not be sufficient to meet our working capital needs and/or to implement our business strategies. Additionally, there can be no assurance that our existing line of credit will be sufficient to meet our working capital needs. Furthermore, if we fail to maintain certain loan covenants we may no longer have access to the credit line. Our credit line terminates in November 2014. We may consider issuing additional debt or equity securities in the future to fund potential acquisitions or investments, to refinance existing debt, or for general corporate purposes. If we issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization, requiring us to pay additional interest expenses and potentially lower our credit ratings. We may not be able to market such issuances on favorable terms, or at all, in which case, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. At any given time it may be difficult for us to raise capital due to a variety of factors, some of which may be outside a our control, including a tightening of credit markets, overall poor performance of stock markets, and/or an economic slowdown in the U.S. or other countries. Thus, there is no assurance we would be able to raise additional capital if needed. To the extent we do raise additional capital the ownership position of existing stockholders could be diluted. Similarly, there can be no assurance that additional financing will be available if needed or that it will be available on favorable terms. Under the terms of our credit facility, there are limits on our ability to create, incur or assume additional indebtedness without the approval of our lender. Recent economic conditions have made it more difficult for companies to raise capital and obtain financing. Our inability to raise additional capital or to obtain additional financing if needed could negatively affect our ability to implement our business strategies and meet our goals. This, in turn, could adversely affect our financial condition and results of operations. If we are unable to attract and retain qualified management personnel, our business will suffer. Our executive officers and other management personnel are primarily responsible for our day-to-day operations. We believe our success depends largely on our ability to attract, maintain and motivate highly qualified management personnel. Competition for qualified individuals can be intense, and we may not be able to hire 16 additional qualified personnel in a timely manner or on terms that would not substantially increase our costs. Our inability to retain a skilled professional management team could adversely affect our ability to successfully execute our business strategies and achieve our goals. Our manufacturing and third party fulfillment and call center activities are subject to certain risks. We manufacture the vast majority of our products at our manufacturing facility in California. As a result, we are dependent on the uninterrupted and efficient operation of these facilities. Our manufacturing operations are subject to power failures, blackouts, the breakdown, failure or substandard performance of our leased facilities, our equipment, the improper installation or operation of equipment, natural or other disasters, and the need to comply with the requirements or directives of governmental agencies, including the FDA. In addition, we may in the future determine to expand or relocate our facilities, which may result in slowdowns or delays in our operations. While we have implemented and are evaluating various emergency, contingency and disaster recovery plans and maintain business interruption insurance, there can be no assurance that the occurrence of these or any other operational problems at our facilities in California or at NAIE’s facility in Switzerland would not have a material adverse effect on our business, financial condition and results of operations. Furthermore, there can be no assurance that our contingency plans will prove to be adequate or successful if needed or that our insurance will continue to be available at a reasonable cost or, if available, will be adequate to cover any losses that we may incur from an interruption in our manufacturing and distribution operations. We outsource our branded products fulfillment and call center activities. The operation of the third party service provider’s facilities is subject to the interruption and similar risks described above for our facilities and there can be no assurance that these interruptions or any other operational problem at such third party’s facilities would not have a material adverse effect on our business, financial condition and results of operations. We may, in the future, pursue acquisitions of other companies that, if not successful, could adversely affect our business, financial condition and results of operations. In the future, we may pursue acquisitions of companies that we believe could complement or expand our business, augment our market coverage, provide us with important relationships or otherwise offer us growth opportunities. Acquisitions involve numerous risks, including the following: • • • • • • • • potential difficulties related to integrating the products, personnel and operations of the acquired company; failure to operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices; diverting management’s attention from the normal daily operations of the business; entering markets in which we have no or limited prior direct experience and where competitors in such markets have stronger market positions; potential loss of key employees of the acquired company; potential inability to achieve cost savings and other potential benefits expected from the acquisition; an uncertain sales and earnings stream from the acquired company; and potential impairment charges, which may be significant, against goodwill and purchased intangible assets acquired in the acquisition due to changes in conditions and circumstances that occur after the acquisition, many of which may be outside of our control. There can be no assurance that acquisitions that we may pursue will be successful. If we pursue an acquisition but are not successful in completing it, or if we complete an acquisition but are not successful in integrating the acquired company’s employees, products or operations successfully, our business, financial position or results of operations could be adversely affected. 17 Collectively, our officers and directors own a significant amount of our common stock, giving them influence over corporate transactions and other matters and potentially limiting the influence of other stockholders on important policy and management issues. Our officers and directors, together with their families and affiliates, beneficially owned approximately 20% of our outstanding shares of common stock as of June 30, 2013, including approximately 17% of our outstanding shares of common stock beneficially owned by Mark LeDoux, our Chief Executive Officer and the Chairman of the Board, and his family and affiliates. As a result, our officers and directors, and in particular Mr. LeDoux, could influence such business matters as the election of directors and approval of significant corporate transactions. Various transactions could be delayed, deferred or prevented without the approval of stockholders, including the following: • transactions resulting in a change in control; • mergers and acquisitions; • • • tender offers; election of directors; and proxy contests. There can be no assurance that conflicts of interest will not arise with respect to the officers and directors who own shares of our common stock or that conflicts will be resolved in a manner favorable to us or our other stockholders. Business interruptions could limit our ability to operate our business. Our operations, including those of our suppliers, are vulnerable to damage or interruption from computer viruses, human error, natural disasters, and telecommunications failures, intentional acts of vandalism and similar events. We have not established a formal disaster recovery plan, and our back-up operations and our business interruption insurance may not be adequate to compensate us for losses that occur. A significant business interruption could result in losses or damages incurred by us and require us to cease or curtail our operations. If certain provisions of our Certificate of Incorporation, Bylaws and Delaware law are triggered, the future price investors might be willing to pay for our common stock could be limited. Certain provisions in our Certificate of Incorporation, Bylaws and Delaware corporate law may discourage unsolicited proposals to acquire our business, even if the proposal would benefit our stockholders. Our Board of Directors is authorized, without stockholder approval, to issue up to 500,000 shares of preferred stock having such rights, preferences, and privileges, including voting rights, as the Board of Directors designates. The rights of our common stockholders will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future. Any or all of these provisions could delay, deter or prevent a takeover of our company and could limit the price investors are willing to pay for our common stock. Our stock price could fluctuate significantly. Stock prices in general have been historically volatile and ours is no different. The trading price of our stock may fluctuate in response to the following, as well as other, factors: • • • broad market fluctuations and general economic and/or political conditions; fluctuations in our financial results; relatively low trading volumes; 18 • • • • • future offerings of our common stock or other securities; the general condition of the nutritional supplement product industries; increased competition; regulatory action; adverse publicity; • manipulative or illegal trading practices by third parties; and • product and other public announcements. The stock market has historically experienced significant price and volume fluctuations. There can be no assurance that an active market in our stock will continue to exist or that the price of our common stock will not decline. Our future operating results may be below the expectations of securities analysts and investors. If this were to occur, the price of our common stock would likely decline, perhaps substantially. From time to time our shares may be listed for trading on one or more foreign exchanges, with or without our prior knowledge or consent. Certain foreign exchanges may have less stringent listing requirements, rules and enforcement procedures than the Nasdaq Global Market or other markets in the U.S., which may increase the potential for manipulative trading practices to occur. These practices, or the perception by investors that such practices could occur, may increase the volatility of our stock price or result in a decline in our stock price, which in some cases could be significant. ITEM 2. PROPERTIES This table summarizes our facilities as of June 30, 2013. We believe our facilities are adequate to meet our operating requirements for the foreseeable future. Location Nature of Use San Marcos, CA USA NAI corporate headquarters and branded Square Feet How Held Lease Expiration Date Vista, CA USA(1) products operations Manufacturing, warehousing, packaging and distribution(3) 29,500 Owned N/A 162,000 Leased March 2024(4) Manno, Switzerland(2) Manufacturing, warehousing, packaging and distribution 59,239 Leased December 2022 (1) This facility is used by NAI primarily for its private-label contract manufacturing segment. (2) This facility is used by NAIE, our wholly owned Swiss subsidiary, in connection with our private-label contract manufacturing segment. (3) We use approximately 93,000 square feet for production, 60,000 square feet for warehousing and 9,000 square feet for administrative functions. (4) On July 31, 2013, we executed a third amendment to the lease for our manufacturing facility in Vista, CA. As a result of this amendment, our facility lease has been extended for an additional 10 year term through March 2024. ITEM 3. LEGAL PROCEEDINGS 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 19 and managerial resources. While unfavorable outcomes are possible, based on available information, we generally do not believe the resolution of these matters will result in a material adverse effect on our business, consolidated financial condition, or results of operations. However, a settlement payment or unfavorable outcome could adversely impact our results of operations. Our evaluation of the likely impact of these actions could change in the future and we could have unfavorable outcomes that we do not expect. As of September 19, 2013, except as described below, neither NAI nor its subsidiary were a party to any material pending legal proceeding nor was any of their property the subject of any material pending legal proceeding. On September 8, 2011, NAI and CSI filed a complaint in the U.S. District Court for the District of Delaware against DNP International Co., Inc. (DNP) alleging claims of unfair competition, violation of the Delaware Deceptive Trade Practices Act and interference with business relations. On December 22, 2011, DNP filed a complaint in the U.S. District Court for the District of Delaware against NAI and CSI for declaratory judgment of non-infringement and invalidity of three of NAI’s patents. On January 27, 2012, DNP amended its complaint to add declaratory judgment claims against a fourth NAI patent (‘381 patent). On February 6, 2012, the Company and CSI moved to dismiss the cases related to the three previously asserted patents for lack of subject matter jurisdiction. On the same day, the Company filed its answer and counterclaims for infringement by DNP of the ‘381 patent. DNP subsequently agreed to voluntarily dismiss CSI from the lawsuit. On March 2, 2012, the Court ordered the dismissal of CSI. On April 15, 2013, the Court consolidated the two lawsuits referenced above for purposes of pretrial matters. The Court also entered a Scheduling Order setting a trial date in April 2015. On December 21, 2011, NAI filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division, accusing Woodbolt Distribution, LLC, also known as Cellucor (Woodbolt), Vitaquest International, Inc., d/b/a Garden State Nutritionals (Garden State) and F.H.G. Corporation, d/b/a Integrity Nutraceuticals (Integrity), of infringing NAI’s ’381 patent. The complaint alleges that Woodbolt sells nutritional supplements, including supplements containing beta-alanine such as C4 Extreme™, M5 Extreme™, and N-Zero Extreme™, that infringe ‘381 patent. Woodbolt, in turn, filed a complaint seeking a declaratory judgment of non- infringement and invalidity of the ’381 patent in the U.S. District Court for the District of Delaware. On February 17, 2012, Woodbolt filed a First Amended Complaint, realleging its original claims against the Company and asserting new claims of violation of the Sherman Antitrust Act (15 U.S.C. § 2) and Unfair Competition. The Company reasserted the arguments in its prior motion to dismiss and moved to dismiss the new claims asserted by Woodbolt. On January 23, 2013, the Delaware Court granted the Company’s motion to dismiss Woodbolt’s case. On June 5, 2012, the Court in the above-referenced Texas case consolidated the pending suit with a second patent infringement case filed against Woodbolt by the Company on May 3, 2012, asserting infringement of its ‘422 patent. On November 9, 2012, NAI filed a supplemental complaint adding allegations of infringement of Woodbolt’s Cellucor Cor–Performance ß-BCAA™ and Cellucor Cor–Performance™ Creatine products. On June 14, 2013, NAI filed a third patent infringement lawsuit in the U.S. District Court for the Southern District of Texas Houston Division against Woodbolt, BodyBuilding.com and GNC Corporation alleging infringement of the ‘381 and ‘422 patents by Woodbolt’s Neon Sport Volt™ product. Woodbolt asserted the same defenses and counterclaims as set forth in the earlier lawsuits. On June 24, 2013, the Court consolidated the case with the earlier-filed lawsuits identified above. On June 25, 2013, Woodbolt filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division, against a newly-issued NAI U.S. patent 8,470,865, asserting declaratory judgment claims of non-infringement, invalidity and unenforceability. On July 1, 2013, Woodbolt’s lawsuit was consolidated with the three pending lawsuits filed by NAI. On July 24, 2013, NAI filed its Answer and Amended Counterclaims against Woodbolt alleging infringement of the ‘865 patent by the products accused in the pending cases previously filed by NAI. On August 14, 2013, Woodbolt filed a counterclaim to NAI’s counterclaim asserting violation of the Sherman Antitrust Act (15 U.S.C. § 2) and Unfair Competition. All of the consolidated cases remain pending. Separately, Woodbolt also requested inter partes re-examination of the ’381 and ’422 patents by the USPTO. On July 26, 2012, the USPTO accepted the request to re-exam the ’381 patent and on August 17, 2012 the USPTO accepted the request to re-exam the ’422 patent. 20 A declaration of non-infringement, invalidity or unenforceability of certain of our patents could have a material adverse impact upon our business results, operations, and financial condition. On February 13, 2013, several entities, including the Company, were sued for various causes of action pertaining to product liability in Superior Court for the State of California (County of San Diego) captioned Sparling v. USPLabs, LLC, et al. Case No. 37-2013-00034663-CU-PL-CTL. On March 21, 2013, co-defendant USP Labs LLC filed a Notice of Removal to the U.S. District Court for the Southern District of California, Civil Action No. 3:13-cv-00667-JLS-DHB. Specific allegations against the Company are for negligence, strict products liability, breach of express and implied warranties and wrongful death. The Company has been provided with defense counsel by its insurance company. Additionally, the Company has sought indemnification from co- defendant USPLabs, LLC. The Company is not involved in the manufacture, distribution or sale of the product at issue in the lawsuit. On April 19, 2013, the Company filed a motion to dismiss the allegations against it. The Company’s motion is still pending. On May 8, 2013, several entities, including the Company, were sued for various causes of action pertaining to product liability in Superior Court for the State of California (County of Los Angeles) captioned Carolyne v. USPLabs, LLC, Case No. BC 508212. Specific allegations against the Company are for negligence, strict products liability and breach of express and implied warranties. The Company has been provided with defense counsel by its insurance company. Additionally, the Company has sought indemnification from co-defendant USP Labs, LLC. The Company is not involved in the manufacture, distribution or sale of the product at issue in the lawsuit. On June 28, 2013, the Company filed a Demurrer to dismiss the allegations against it. The Company’s motion is still pending. Although we believe the above litigation matters are supported by valid claims, there is no assurance NAI will prevail in these litigation matters or in similar proceedings it may initiate or that litigation expenses will be as anticipated. ITEM 4. MINE SAFETY DISCLOSURES Not applicable. PART II ITEM 5. MARKET FOR OUR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock trades on the Nasdaq Global Market under the symbol “NAII.” Below are the high and low sales prices of our common stock as reported on the Nasdaq Global Market for each quarter of the fiscal years ended June 30, 2013 and 2012: First Quarter Second Quarter Third Quarter Fourth Quarter Holders Fiscal 2013 Fiscal 2012 High Low High Low $7.65 $6.45 $5.49 $5.01 $4.90 $4.01 $4.12 $4.03 $ 4.96 $ 9.47 $11.00 $ 8.34 $3.00 $4.06 $5.85 $6.05 As of September 13, 2013, there were approximately 274 stockholders of record of our common stock. On that same date, the last sales price of our common stock as reported on Nasdaq was $4.87 per share. 21 Dividends We have never paid a dividend on our common stock and we do not intend to pay a dividend in the foreseeable future. Our current policy is to retain all earnings to provide funds for operations and future growth. Additionally, under the terms of our credit facility, we are precluded from paying a dividend while such facility is in place. Recent Sales of Unregistered Securities During the fiscal year ended June 30, 2013, we did not sell or otherwise issue any unregistered securities. Repurchases During the quarter ended June 30, 2013, we repurchased 24,004 shares of our common stock at a total cost of $107,000 (including commissions and transaction fees) as set forth below: Period April 1, 2013 to April 30, 2013 May 1, 2013 to May 31, 2013 June 1, 2013 to June 30, 2013 Total (a) Total Number of Shares Purchased (b) Average Price Paid per Share (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1) (d) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs 2,560 20,244 1,200 24,004 $4.56 $4.44 $4.55 2,560 20,244 1,200 24,004 $466,000 1. On June 3, 2011, we announced a plan to spend up to $2 million in the purchase of our shares of common stock in open market purchases or through privately negotiated purchases. As of June 30, 2013, we still have $466,000 of the $2 million authorized under this plan. Equity Compensation Plan Information The following table sets forth information regarding outstanding options and shares reserved for future issuance under our existing equity compensation plans as of June 30, 2013: Number of Shares to be Issued Upon Exercise of Outstanding Options Weighted- Average Exercise Price of Outstanding Options Number of Shares of Outstanding Restricted Stock Weighted- Average Exercise Price of Outstanding Restricted Stock Number of Shares Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Shares Reflected in Column (a) and (c) Plan Category (a) (b) (c) Equity compensation plans approved by stockholders Equity compensation plans not approved by stockholders Total 383,350 N/A 383,350 98,000 N/A 98,000 $7.23 N/A $7.23 22 (d) N/A N/A N/A (e) 478,650 N/A 478,650 ITEM 6. SELECTED FINANCIAL DATA As a smaller reporting company, we are not required to provide Item 6 disclosure in this Annual Report. ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion and analysis is intended to help you understand our financial condition and results of operations as of June 30, 2013 and 2012 and for each of the last two fiscal years then ended. You should read the following discussion and analysis together with our audited consolidated financial statements and the notes to the consolidated financial statements included under Item 8 in this report. Our future financial condition and results of operations will vary from our historical financial condition and results of operations described below based on a variety of factors. You should carefully review the risks described under Item 1A and elsewhere in this report, which identify certain important factors that could cause our future financial condition and results of operations to vary. Executive Overview The following overview does not address all of the matters covered in the other sections of this Item 7 or other items in this report or contain all of the information that may be important to our stockholders or the investing public. You should read this overview in conjunction with the other sections of this Item 7, the financial statements and accompanying notes, and this report. Our primary business activity is providing private label contract manufacturing services to companies that market and distribute vitamins, minerals, herbs and other nutritional supplements, as well as other health care products, to consumers both within and outside the U.S. Historically, our revenue has been largely dependent on sales to one or two private label contract manufacturing customers and subject to variations in the timing of such customers’ orders, which in turn is impacted by such customers’ internal marketing programs, supply chain management, entry into new markets, new product introductions, the demand for such customers’ products, and general industry and economic conditions. Our revenue also includes royalty, licensing revenue, and raw material sales 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 and sold under our CarnoSyn® trade mark. 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, commercializing our patent estate through contract manufacturing, royalty and license agreements, and developing and growing our own line of branded products. During fiscal 2013, our net sales were 13.8% lower than in fiscal 2012. Private-label contract manufacturing sales decreased 10.4% due primarily to lower volumes of existing products in existing markets, lower average sales prices for a portion of our higher volume products and lower average EUR exchange rates. Revenue concentration to our two largest private-label contract manufacturing customers as a percentage of our total private-label contract manufacturing sales decreased to 69% in fiscal 2013 from 73% for fiscal 2012. We expect our contract manufacturing revenue concentration percentage for our two largest customers to decrease during fiscal 2014 with the anticipated addition of new customer sales and increased sales to other existing customers. During fiscal 2013, CarnoSyn® beta-alanine royalty and licensing revenue increased 2% to $4.7 million as compared to $4.6 million for fiscal 2012 and raw material sales of beta-alanine totaled $103,000 for fiscal 2013 as compared to $3.4 million during fiscal 2012. During the second and third quarters of fiscal 2012, we purchased approximately $3.2 million of beta-alanine raw material to help ensure sufficient inventory to meet anticipated future customer demand. During the third and fourth quarters of fiscal 2012, we sold or used a majority of this inventory. As of June 30, 2013, we did not have any beta-alanine raw material on hand. We do not anticipate the direct purchase and sale of material quantities of beta-alanine raw material during fiscal 2014. 23 During fiscal 2013, seven new beta-alanine patents were issued to NAI; three in the U.S., two in Canada and two in Korea. This new intellectual property related to a broad range of beta-alanine method and composition claims and included five patents covering sustained release formulations for beta-alanine. As of June 30, 2013, NAI possessed twenty-five beta-alanine patents and five sustained release beta-alanine patents. To protect our CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses of approximately $2.3 million during fiscal 2013 and $1.8 million during the fiscal 2012. We describe our efforts to protect our patent estate in more detail under Item 1 of Part II of this report. Our ability to maintain or further increase our beta-alanine royalty and licensing revenue will depend in large part on our ability to maintain 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, and the continued compliance by third parties with our patent and trademark rights. Net sales from our branded products declined 15.2% in fiscal 2013 as compared to fiscal 2012 due to the continued softening of sales of our Pathway to Healing product line. During fiscal 2011 and 2012, we re- launched our Pathway to Healing® product line with updated product formulation, packaging, and marketing activities. During fiscal 2014, we plan to continue our focus on: • Leveraging our state-of-the-art, certified facilities to increase the value of the goods and services we provide to our highly valued private-label contract manufacturing customers, and assist us in developing relationships with additional quality oriented customers; • Expanding the commercialization of our beta-alanine patent estate through contract manufacturing, royalty and license agreements and protecting our proprietary rights; • • Implementing focused initiatives to grow our Pathway to Healing® product line; and Improving operational efficiencies and managing costs and business risks to improve profitability. Critical Accounting Policies and Estimates Our consolidated financial statements included under Item 8 in this report have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). Our significant accounting policies are described in the notes to our consolidated financial statements. The preparation of financial statements in accordance with GAAP 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 that we believe are important to the portrayal of our financial condition and results of operations. These policies require the application of significant judgment by our management. We base our estimates on our historical experience, industry standards, and various other assumptions that we believe are reasonable under the circumstances. Actual results could differ from these estimates. An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions. Our critical accounting policies include those listed below. Revenue Recognition To recognize revenue, four basic criteria must be met: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that 24 provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered. We record reductions to gross revenue for estimated returns of private label contract manufacturing products and branded products. The estimated returns are based on the trailing six months of private label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and branded product returns. However, the estimate for product returns does not reflect the impact of a potential large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable. We followed the provisions of ASU No. 2009-13 for all multiple element agreements. Under this guidance, the delivered item(s) has value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control. A delivered item is considered a separate unit of accounting when the delivered item has value to the partner on a standalone basis based on the consideration of the relevant facts and circumstances for each arrangement. Arrangement consideration is allocated at the inception of the agreement to all identified units of accounting based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence, or VSOE, of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, we use our best estimate of the selling price for the deliverable. The amount of allocable arrangement consideration is limited to amounts that are fixed or determinable. The consideration received is allocated among the separate units of accounting, and the applicable revenue recognition criteria are applied to each of the separate units. Changes in the allocation of the sales price between delivered and undelivered elements can impact revenue recognition but do not change the total revenue recognized under any agreement. If facts and circumstances dictate that a deliverable has standalone value from the undelivered items, the deliverable is identified as a separate unit of accounting and the amounts allocated to the deliverable are recognized upon the delivery of the deliverable, assuming the other revenue recognition criteria have been met. However, if the amounts allocated to the deliverable through the relative selling price allocation exceed the upfront fee, the amount recognized upon the delivery of the deliverable is limited to the upfront fee received. If facts and circumstances dictate that the deliverable does not have standalone value, the transaction price, including any upfront fee payments received, are allocated to the identified separate units of accounting and recognized as those items are delivered and accepted. In addition, we enter into arrangements that provide for milestone payments upon contractually stated events. Under the Milestone Method, we recognize consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is substantive in its entirety. A milestone is considered substantive when it meets all of the following three criteria: 1) The consideration is commensurate with either the entity’s performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, 2) The consideration relates solely to past performance, and 3) The consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting from the entity’s performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to us. We currently own certain U.S. patents, and each patent’s corresponding foreign patent applications. All of these patents and patent rights relate to the ingredient known as beta-alanine marketed and sold under the CarnoSyn® 25 trade name. We have sold this ingredient to a customer for use in a limited market, and since March 2009 have had an agreement with Compound Solutions, Inc. (CSI) under which we have agreed to grant a license of certain of our patent rights to customers of CSI who purchase beta-alanine from CSI. Before October 1, 2011, we received a fee from CSI that varied based on the amount of net sales of beta-alanine sold by CSI less CSI’s costs and other agreed upon expenses. As of October 1, 2011, we receive a fee from CSI that varies based on the quantity of beta-alanine sold by CSI and the source of such beta-alanine. In June 2011, we entered into a license and supply agreement (Agreement) with Abbott Laboratories (Abbott) under which we agreed to grant an exclusive license to Abbott for the use of beta-alanine in certain medical foods and medical nutritionals. Under the terms of the agreement, Abbott paid an initial license fee of $300,000, an additional fee of $300,000 in January 2012, and upon achievement of certain milestones, an additional license fee of $150,000 was paid on October 3, 2012. The license and supply agreement provided Abbott with the right to terminate the agreement at any time up to March 31, 2012, at which time, if not terminated, Abbott was required to pay $4.3 million payable over six annual payments with the initial installment payment of $708,334 due March 31, 2012. In February 2012 and June 2012, we amended the Agreement and extended Abbott’s termination rights initially through July 31, 2012 and then further through October 31, 2012 in exchange for two payments of $354,167 each by Abbott to NAI. Abbott made the first payment on March 13, 2012 and the second payment on July 12, 2012. In October 2012, the Agreement was amended for a third time. Unless earlier terminated by Abbott, the amendment requires Abbott to pay to NAI (i) upon earlier of achievement of certain milestones or December 1, 2012, additional license fees of $204,167; (ii) upon earlier of achievement of certain milestones or June 1, 2013, additional license fees of $204,167; (iii) upon earlier of achievement of certain milestones or July 1, 2013, additional license fees of $150,000; (iv) upon earlier of achievement of certain milestones or December 1, 2013, additional license fees of $150,000; and (v) approximately $2.8 million payable over four annual payments beginning on March 31, 2014. The payment noted in (i) was collected in December 2012, the payment noted in (ii) was collected in May 2013, and the payment noted in (iii) was collected in July 2013. Subject to certain other conditions set forth in the Agreement and amendments, and until terminated by either party, Abbott is required to purchase certain material exclusively from NAI and make royalty payments to NAI upon Abbott’s sale of products subject to the Agreement. Because Abbott may terminate the agreement at any time up to December 1, 2013, there is no assurance NAI will receive any of the additional license fees or royalty payments described above. All milestone payments are recognized as revenue at the time of receipt as the payments are non-refundable and we have no continuing obligation as it relates to each payment. We have determined that each of the milestone payments meets the definition of a milestone. We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of $4.8 million during fiscal 2013 and $8.0 million during fiscal 2012. These royalty income amounts resulted in royalty expense paid to the original patent holders from whom NAI acquired its patents and patent rights. We recognized royalty expense as a component of cost of goods sold in the amount of $604,000 during the fiscal 2013 and $686,000 during fiscal 2012. Inventory Reserve We operate primarily as a private-label contract manufacturer and build products based upon anticipated demand or following receipt of customer specific purchase orders. From time to time, we build inventory for private-label contract manufacturing customers under a specific purchase order with delivery dates that may subsequently be rescheduled or canceled at the customer’s request. We value inventory at the lower of cost or market on an item- by-item basis and establish reserves equal to all or a portion of the related inventory to reflect situations in which the cost of the inventory is not expected to be recovered. This requires us to make estimates regarding the market value of our inventory, including an assessment for excess and obsolete inventory. Once we establish an inventory reserve amount in a fiscal period, the reduced inventory value is maintained until the inventory is sold or otherwise disposed of. In evaluating whether inventory is stated at the lower of cost or market, management 26 considers such factors as the amount of inventory on hand, the estimated time required to sell such inventory, the remaining shelf life and efficacy, the foreseeable demand within a specified time horizon and current and expected market conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or other factors differ from expectations. Accounting for Income Taxes We account for uncertain tax positions using the more-likely-than-not recognition threshold. Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2013 and June 30, 2012, we had not recorded any tax liabilities for uncertain tax positions. We estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure, together with assessing temporary differences resulting from differing treatment of items, such as property and equipment depreciation, for tax and financial reporting purposes. Actual income taxes could vary from these estimates due to future changes in income tax law or results from final tax examination reviews. We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that it is more likely than not that we will not realize all or part of our deferred tax assets in the future, we will record an adjustment to the carrying value of the deferred tax asset, which would be reflected as income tax expense. Conversely, if we determine we will realize a deferred tax asset, which currently has a valuation allowance, we will reverse the valuation allowance, which would be reflected as an income tax benefit. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We will continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the income statement for the period that the adjustment is determined to be required. We did not record any adjustment to the net deferred tax asset valuation allowance during fiscal 2013 or fiscal 2012. We have not recorded U.S. income tax expense for NAIE’s retained earnings that we have declared as indefinitely reinvested offshore, thus reducing our overall income tax expense. The earnings designated as indefinitely reinvested in NAIE are based on the actual deployment of such earnings in NAIE’s assets and our expectations of the future cash needs of NAIE and NAI. Income tax laws also are a factor in determining the amount of foreign earnings to be indefinitely reinvested offshore. We carefully review several factors that influence the ultimate disposition of NAIE’s retained earnings declared as reinvested offshore, and apply stringent standards to overcome the presumption of repatriation. Despite this approach, because the determination involves our future plans and expectations of future events, the possibility exists that amounts declared as indefinitely reinvested offshore may ultimately be repatriated. For instance, NAI’s actual cash needs may exceed our current expectations or NAIE’s actual cash needs may be less than our current expectations. Additionally, changes may occur in tax laws and/or accounting standards that could change our determination of the status of NAIE’s retained earnings. This would result in additional income tax expense in the fiscal year in which we determine that amounts are no longer indefinitely reinvested offshore. On an interim basis, we estimate what our effective tax rate will be for the full fiscal year and record a quarterly income tax provision in accordance with the anticipated annual rate. As the fiscal year progresses, we refine our estimate based upon actual events and earnings by jurisdiction during the year. This continual estimation process 27 periodically results in a change to our expected effective tax rate for the fiscal year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision equals the expected annual rate. Derivative Financial Instruments We may use derivative financial instruments in the management of our foreign currency exchange risk inherent in our forecasted transactions denominated in Euros. We may hedge our foreign currency exposures by entering into offsetting forward exchange contracts and currency options. To the extent we use derivative financial instruments, we account for them using the deferral method, when such instruments are intended to hedge identifiable, firm foreign currency commitments or anticipated transactions and are designated as, and effective as, hedges. Foreign exchange exposures arising from certain transactions that do not meet the criteria for the deferral method are marked-to-market. We recognize any unrealized gains and losses associated with derivative instruments in income in the period in which the underlying hedged transaction is realized. In the event the derivative instrument is deemed ineffective we would recognize the resulting gain or loss in income at that time. As of June 30, 2013, we held derivative 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. As of June 30, 2013, the notional amounts of our foreign exchange contracts were $14.1 million (EUR 10.7 million). These contracts will mature over the next 14 months. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts to reflect our estimate of current and past due receivable balances that may not be collected. The allowance for doubtful accounts is based upon our assessment of the collectability of specific customer accounts, the aging of accounts receivable and our history of bad debts. We believe that the allowance for doubtful accounts is adequate to cover anticipated losses in the receivable balance under current conditions. However, significant deterioration in the financial condition of our customers, resulting in an impairment of their ability to make payments, could materially change these expectations and an additional allowance may be required. Defined Benefit Pension Plan We sponsor a defined benefit pension plan. Effective June 21, 1999, we adopted an amendment to freeze benefit accruals to the participants. The plan obligation and related assets of the plan are presented in the notes to the consolidated financial statements. Plan assets, which consist primarily of marketable equity and debt instruments, are valued based upon third party market quotations. Independent actuaries, through the use of a number of assumptions, determine plan obligation and annual pension expense. Key assumptions in measuring the plan obligation include the discount rate and estimated future return on plan assets. In determining the discount rate, we use an average long-term bond yield. Asset returns are based on the historical returns of multiple asset classes to develop a risk free rate of return and risk premiums for each asset class. The overall rate for each asset class was developed by combining a long-term inflation component, the risk free rate of return and the associated risk premium. A weighted average rate is developed based on the overall rates and the plan’s asset allocation. Impairment of Assets Our policy is to evaluate whether there has been a permanent impairment in the value of long-lived assets when certain events have taken place that indicate the remaining unamortized balance may not be recoverable. When factors indicate that the intangible assets should be evaluated for possible impairment, we use an estimate of related undiscounted cash flows. Factors considered in the valuation include current operating results, trends and anticipated undiscounted future cash flows. We did not recognize any impairment losses during fiscal 2013. 28 Results of Operations The following table sets forth selected consolidated operating results for each of the last two fiscal years, presented as a percentage of net sales (dollars in thousands). Fiscal Year Ended June 30, 2013 June 30, 2012 Increase (Decrease) Private-label contract manufacturing Patent and trademark licensing Branded products Total net sales Cost of goods sold Gross profit Selling, general & administrative expenses Income from operations Other expense (income), net Income before income taxes Income tax provision Net income Fiscal 2013 Compared to Fiscal 2012 (10)% (40)% (15)% (14)% (11)% (24)% 4% $56,672 4,799 1,326 90% $63,268 7,990 8% 1,564 2% 87% $ (6,596) (3,191) 11% (238) 2% 62,797 51,047 11,750 9,597 2,153 60 2,093 523 100% 72,822 81% 57,371 100% (10,025) (6,324) 79% 19% 15,451 9,251 15% 21% 13% (3,701) 346 4% 0% 4% 1% 6,200 (42) 6,242 2,084 9% 0% 9% 3% (4,047) 102 (65)% 243% (4,149) (1,561) (67)% (75)% $ 1,570 3% $ 4,158 6% $ (2,588) (62)% The percentage decrease in private-label contract manufacturing net sales was primarily attributed to the following: NSA International, Inc. (NSA) Mannatech, Incorporated Other customers, net Total Percentage Change in Net Sales (6)%(1) (5)%(2) 1%(3) (10)% 1 2 3 The decrease in net sales to NSA International, Inc. for fiscal 2013 included a decrease in international sales of 15.7% and a decline in domestic sales of 7.1%. The international sales decreases were primarily due to decreased demand by NSA’s consumers and lower average EUR exchange rate. The domestic decreases were primarily due to lower average sales prices and lower sales volumes of existing products. Net sales to Mannatech, Incorporated decreased in fiscal 2013 primarily as a result of lower volumes of established products in existing markets. The increase in net sales to other customers was primarily due to increased sales of existing products to existing customers. Net sales from our patent and trademark licensing segment decreased 40% during fiscal 2013. During fiscal 2013, patent and trademark licensing sales included $3.8 million of royalty income, $103,000 of direct beta- alanine raw material sales, and $913,000 of license fees. During fiscal 2012, patent and trademark licensing sales included $4.0 million of royalty income, $3.4 million of direct beta-alanine raw material sales, and $654,000 of license fees. Net sales from our branded products segment decreased 15% during fiscal 2013 due primarily to the continued softening of sales of the Pathway to Healing® product line. 29 Consolidated gross profit margin decreased 2.5 percentage points during fiscal 2013 primarily due to the following: Contract manufacturing: Shift in sales mix and material cost Overhead expenses Incremental direct and indirect labor Patent and trademark licensing Branded products operations Total Percentage Change 0.1(1) (1.3)(1) (2.0)(1) 0.8(2) (0.1)(3) (2.5) 1 2 3 Private-label contract manufacturing gross profit margin decreased 4.2 percentage points. The decrease in gross profit as a percentage of sales was primarily due to lower average sales prices and higher per unit manufacturing costs associated with lower production levels. The increase in contribution to the consolidated gross profit percentage by the patent and trademark licensing segment during fiscal 2013 as compared to fiscal 2012 was primarily due to the increase in patent and trademark licensing revenue, including a $260,000 increase in license fee income, partially offset by a $180,000 decrease in royalty income. In addition, there was a $3.3 million decrease in beta-alanine raw material sales, which have a significantly lower profit margin than the royalty and license fee income. Branded products gross profit margin decreased 4.6 percentage points to 38.7% in fiscal 2013 from 43.3% in fiscal 2012 due primarily to sales mix and higher inventory write-offs. Selling, general and administrative expenses increased $346,000, or 3.7% during fiscal 2013. This increase was primarily attributed to a $434,000 increase associated with our patent and trademark licensing segment, which primarily related to increased patent litigation and prosecution expenses related to our patent and trademark licensing business. This increase was partially offset by a $71,000 decrease in our selling, general and administrative expenses for our branded products business and a $17,000 decrease in selling, general, and administrative expenses from our contract manufacturing business. Other net expenses (income) increased $102,000 due primarily to unfavorable foreign currency translation activity partially offset by lower net interest costs related to our foreign exchange contracts. Income tax expense decreased $1.6 million during fiscal 2013 primarily due to lower pre-tax income. During fiscal 2013, we recorded U.S.-based federal tax expense of $194,000 on U.S.-based income before income taxes. In addition, during fiscal 2013, we recorded a state tax expense of $58,000 on U.S.-based income before income taxes. We also recorded $271,000 in foreign tax expense based on income from NAIE. Liquidity and Capital Resources Our primary sources of liquidity and capital resources are cash flows provided by operating activities and the availability of borrowings under our credit facilities. Net cash provided by operating activities was $4.5 million in fiscal 2013 compared to net cash provided by operating activities of $1.7 million in fiscal 2012. Net income decreased to $1.6 million during fiscal 2013 as compared to net income of $4.2 million in the prior fiscal year. At June 30, 2013, changes in accounts receivable, consisting primarily of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, provided $2.0 million in cash compared to using $5.5 million in fiscal 2012. The increase in cash provided by accounts receivable during fiscal 2013 was the result of lower private-label contract manufacturing sales and the collection of amounts due from sales of beta-alanine raw materials. The average number of days our accounts receivable 30 were outstanding were 45 days during fiscal 2013, as compared to 30 days for fiscal 2012. Changes in income taxes provided $184,000 in cash during fiscal 2013 primarily due to the collection of income tax receivable offset by estimated tax payments in fiscal 2013 as compared to payment of estimated income taxes in fiscal 2012. Increases in inventory used $1.7 million in cash during fiscal 2013 compared to using $1.9 million in fiscal 2012. The increase in inventory in fiscal 2013 primarily related to the timing of production and sales activity. Approximately $930,000 of our operating cash flow was generated by NAIE in fiscal 2013. As of June 30, 2013, NAIE’s undistributed retained earnings of $11.4 million were considered indefinitely reinvested. Cash used in investing activities in fiscal 2013 was $1.6 million compared to $2.3 million in fiscal 2012. Capital expenditures were $1.6 million during fiscal 2013 compared to $2.3 million in fiscal 2012. Capital expenditures during fiscal 2013 and fiscal 2012 were primarily for manufacturing equipment in our Vista, California and Manno, Switzerland facilities. At June 30, 2013 and June 30, 2012, on a consolidated basis, we had no outstanding debt balances. On December 16, 2010, we executed a Credit Agreement (“Credit Agreement”) with Wells Fargo Bank, National Association. This Credit Agreement replaced our previous credit facility and provides us with a line of credit of up to $5.0 million. The line of credit may be used to finance working capital requirements. In consideration for granting the line of credit and each subsequent extension amendment, we pay an annual commitment fee of $12,500. 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) net income after taxes of not less than $750,000 on a trailing four quarter basis as of the end of each calendar quarter beginning with the four quarter period ended December 31, 2010; and (ii) a ratio of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time. Any amounts outstanding under the line of credit will bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of interest. If elected, the fluctuating rate per annum would be equal to 2.75% 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 2.50% 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 November 1, 2014; provided, however, that we must maintain a zero balance on advances under the line of credit for a period of at least 30 consecutive days during each fiscal year. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of $100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which the then applicable fixed rate term matures. Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general intangibles, inventory, equipment and fixtures. We also have a foreign exchange facility with Wells Fargo in effect until November 1, 2014, and with Bank of America, N.A. in effect until March 5, 2014. On June 30, 2013, we were in compliance with all of the financial and other covenants required under the Credit Agreement. On September 22, 2006, NAIE entered into a credit facility to provide it with a credit line of up to CHF 1.3 million, or approximately $1.4 million, which was the initial maximum aggregate amount that could be outstanding at any one time under the credit facility. This maximum amount is reduced annually by CHF 160,000, or approximately $169,000. On February 19, 2007, NAIE amended its credit facility to provide that the maximum aggregate amount that may be outstanding under the facility cannot be reduced below CHF 500,000, or approximately $530,000. As of June 30, 2013, there was no outstanding balance under this credit facility. 31 Under its credit facility, NAIE may draw amounts either as current account loan credits to its current or future bank accounts or as fixed loans with a maximum term of 24 months. Current account loans will bear interest at the rate of 5% per annum. Fixed loans will bear interest at a rate determined by the parties based on current market conditions and must be repaid pursuant to a repayment schedule established by the parties at the time of the loan. If a fixed loan is repaid early at NAIE’s election or in connection with the termination of the credit facility, NAIE will be charged a pre-payment penalty equal to 0.1% of the principal amount of the fixed loan or CHF 1,000 (approximately $1,058), whichever is greater. The bank reserves the right to refuse individual requests for an advance under the credit facility, although its exercise of such right will not have the effect of terminating the credit facility as a whole. As of June 30, 2013, we had $16.7 million in cash and cash equivalents and $5.5 million available under our credit facilities. Of these amounts, $6.4 million of cash and cash equivalents and $530,000 of the amount available under our credit facilities were held by NAIE. Our intent is to permanently reinvest all of our earnings from foreign operations, and we do not currently anticipate that we will need funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund our U.S. operations, we may be required to accrue and pay additional U.S. taxes to repatriate any such funds. Overall, we believe our available cash, cash equivalents and potential cash flows from operations will be sufficient to fund our current working capital needs and capital expenditures through at least the next 12 months. Off-Balance Sheet Arrangements As of June 30, 2013, we did not have any significant off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenue or expenses material to investors. Inflation During fiscal 2012 and 2013, we did not experience any significant increases in product raw material or operational costs due to inflationary factors. We currently believe increasing raw material and product cost pricing pressures will exist throughout fiscal 2014 as a result of limited supplies of various ingredients, including beta-alanine, and the effects of higher labor and transportation costs. We do not believe current inflation rates will have a material impact on our future operations or profitability. Recent Accounting Pronouncements A discussion of recent accounting pronouncements is included under Note A in the notes to our consolidated financial statements included under Item 8 of this report. 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Natural Alternatives International, Inc. We have audited the accompanying consolidated balance sheets of Natural Alternatives International, Inc. as of June 30, 2013 and 2012, and the related consolidated statements of operations and comprehensive income, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Natural Alternatives International, Inc. at June 30, 2013 and 2012, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP San Diego, California September 19, 2013 33 Natural Alternatives International, Inc. Consolidated Balance Sheets As of June 30 (Dollars in thousands, except share and per share data) Assets Current assets: Cash and cash equivalents Accounts receivable – less allowance for doubtful accounts of $144 at June 30, 2013 and $122 at June 30, 2012 Inventories, net Deferred income taxes Income tax receivable Prepaids and other current assets Total current assets Property and equipment, net Long-term pension asset Deferred income taxes Other noncurrent assets, net Total assets Liabilities and Stockholders’ Equity Current liabilities: Accounts payable Accrued liabilities Accrued compensation and employee benefits Income taxes payable Total current liabilities Long-term pension liability Deferred rent Total liabilities Commitments and contingencies Stockholders’ equity: Preferred stock; $.01 par value; 500,000 shares authorized; none issued or outstanding Common stock; $.01 par value; 20,000,000 shares authorized at June 30, 2013 and June 30, 2012, issued and outstanding (net of treasury shares) 6,914,555 at June 30, 2013 and 6,938,687 at June 30, 2012 Additional paid-in capital Accumulated other comprehensive (loss) income Retained earnings Treasury stock, at cost, 494,122 shares at June 30, 2013 and 361,990 at June 30, 2012 Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying notes to consolidated financial statements. 34 2013 2012 $16,697 $14,478 6,605 10,035 609 160 1,217 8,751 8,355 699 356 1,880 35,323 34,519 9,205 — 1,527 585 10,647 89 1,471 471 $46,640 $47,197 $ 3,539 1,130 807 466 $ 3,918 1,259 1,331 328 5,942 134 225 6,301 6,836 — 493 7,329 — — 73 19,662 (430) 23,667 (2,633) 72 19,530 99 22,097 (1,930) 40,339 39,868 $46,640 $47,197 Natural Alternatives International, Inc. Consolidated Statements Of Operations And Comprehensive Income For the Years Ended June 30 (Dollars in thousands, except share and per share data) Net sales Cost of goods sold Gross profit Selling, general & administrative expenses Income from operations Other income (expense): Interest income Interest expense Foreign exchange (loss) gain Other, net Income before income taxes Provision for income taxes Net income Change in minimum pension liability, net of tax Unrealized (loss) gain resulting from change in fair value of derivative instruments, net of tax Comprehensive income Net income per common share: Basic Diluted Weighted average common shares outstanding: Basic Diluted See accompanying notes to consolidated financial statements. $ 2013 2012 $ 62,797 51,047 11,750 9,597 2,153 72,822 57,371 15,451 9,251 6,200 45 (19) (86) — (60) 2,093 523 $ 1,570 $ (95) (434) 19 (105) 107 21 42 6,242 2,084 4,158 17 447 $ $ $ 1,041 $ 4,622 0.23 0.23 $ $ 0.60 0.59 6,869,224 6,884,966 6,978,469 6,988,407 35 Natural Alternatives International, Inc. Consolidated Statements Of Stockholders’ Equity For the Years Ended June 30 (Dollars in thousands) Common Stock Shares Amount Additional Paid-in Capital Retained Earnings Treasury Stock Shares Amount Accumulated Other Comprehensive Income (Loss) Total Balance, June 30, 2011 7,300,677 $ 72 $19,357 $17,939 286,964 $(1,525) $(365) $35,478 Compensation expense related to stock options Repurchase of common stock Tax effect of stock compensation Change in minimum pension liability, net of tax Unrealized gain resulting from change in fair value of derivative instruments, net of tax Net income — — — — — — Balance, June 30, 2012 7,300,677 — — — — — — 72 Issuance of common stock for stock option exercises Issuance of common stock for restricted stock grants Compensation expense related to stock compensation plans Repurchase of common stock Tax effect of stock compensation Change in minimum pension liability, net of tax Unrealized loss resulting from change in fair value of derivative instruments, net of tax Net income 10,000 — 98,000 1 — — — — — — — — — — — — 222 — (49) — — — — — — 75,026 — — (405) — — — — — — 4,158 — — — — 19,530 22,097 361,990 (1,930) 37 (1) 202 — (106) — — — — — — — — — — 1,570 — — — 132,132 — — — — — — — (703) — — — — Balance, June 30, 2013 7,408,677 $ 73 $19,662 $23,667 494,122 $(2,633) See accompanying notes to consolidated financial statements. — — — 17 447 — 99 — — — — — (95) 222 (405) (49) 17 447 4,158 39,868 37 — 202 (703) (106) (95) (434) — $(430) (434) 1,570 $40,339 36 Natural Alternatives International, Inc. Consolidated Statements Of Cash Flows For the Years Ended June 30 (in thousands) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Provision for uncollectible accounts receivable Depreciation and amortization Deferred income taxes Non-cash compensation Pension expense (Gain) loss on disposal of assets Changes in operating assets and liabilities: Accounts receivable Inventories Prepaids and other assets Accounts payable and accrued liabilities Income taxes Accrued compensation and employee benefits Net cash provided by operating activities Cash flows from investing activities Purchases of property and equipment Proceeds from sale of property & equipment Net cash used in investing activities Cash flows from financing activities Issuance of common stock Repurchase of common stock Net cash used in financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information Cash paid during the year for: Taxes Interest Disclosure of non-cash activities: Change in minimum pension liability, net of tax Change in unrealized gain resulting from change in fair value of derivative instruments, net of tax Fixed assets in accounts payable See accompanying notes to consolidated financial statements. 37 2013 2012 $ 1,570 $ 4,158 114 3,036 34 202 65 (9) 2,032 (1,680) 298 (852) 184 (524) 52 3,018 549 222 4 5 (5,516) (1,856) (583) 1,750 (194) 97 4,470 1,706 (1,621) 36 (2,284) — (1,585) (2,284) 37 (703) (666) — (405) (405) 2,219 14,478 (983) 15,461 $16,697 $14,478 $ $ $ $ $ 335 13 $ 2,087 13 $ 95 $ (17) 434 25 $ (447) 25 $ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. Organization and Summary of Significant Accounting Policies Organization We provide 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. We also seek to commercialize our patent and trademark estate related to the ingredient known as beta-alanine through various license and similar arrangements. Additionally, we develop, manufacture and market our own branded products. Subsidiaries On January 22, 1999, Natural Alternatives International Europe S.A. (NAIE) was formed as our wholly owned subsidiary, based in Manno, Switzerland. In September 1999, NAIE opened its manufacturing facility and possesses manufacturing capability in encapsulation, powders, tablets, finished goods packaging, quality control laboratory testing, warehousing, distribution and administration. Principles of Consolidation The consolidated financial statements include the accounts of Natural Alternatives International, Inc. (NAI) and our wholly owned subsidiary, NAIE. All significant intercompany accounts and transactions have been eliminated. The functional currency of NAIE, our foreign subsidiary, is the U.S. Dollar. The financial statements of NAIE have been translated at either current or historical exchange rates, as appropriate, with gains and losses included in the consolidated statements of operations. Reclassifications Certain items previously reported in prior year’s consolidated financial statement have been reclassified to conform with current year presentation. Such reclassifications had no effect on previously reported total assets, stockholder’s equity, or net income. Recent Accounting Pronouncements In May 2011, the FASB issued Accounting Standard Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments in this update are the result of the work of the FASB and the International Accounting Standards Board (IASB) to develop common requirements for measuring fair value and for disclosing information about fair value measurements. We adopted ASU 2011-04 during our first quarter of fiscal 2013 and there was no significant impact to our consolidated financial statements as a result of our adoption of this amendment. In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but continuous statements. If presented in two separate statements, the first statement should present total net income and its components followed immediately by a second statement of total other comprehensive income, its components and the total comprehensive income. In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The FASB has deferred those changes in order to reconsider whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income 38 and other comprehensive income for all periods presented. ASU 2011-12 does not impact the requirement of ASU 2011-05 to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. We adopted ASU 2011-05 during the first quarter of fiscal 2013 and there was no material impact on our financial position or results of operations as a result of our adoption of this pronouncement. In February 2013, the FASB issued ASU 2013-02. ASU 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments of ASU 2013-02 do not change the current requirements for reporting net income or other comprehensive income in financial statements. ASU 2013-02 is effective for fiscal years and interim periods within those years beginning on or after December 15, 2012. The adoption of this guidance impacts presentation disclosures only and will not have an impact on our consolidated financial statements. Cash and Cash Equivalents We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. 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-level hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the inputs that market participants would use in pricing the asset or liability and are developed based on the best information available under the circumstances. The fair value hierarchy is broken down into three levels based on the source of inputs. In general, fair values determined by Level 1 inputs use quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. We classify cash, cash equivalents, and marketable securities balances as Level 1 assets. Fair values determined by Level 2 inputs are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and models for which all significant inputs are observable or can be corroborated, either directly or indirectly by observable market data. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. These include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. As of June 30, 2013 and June 30, 2012, we did not have any financial assets or liabilities classified as Level 1, except for assets 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 June 30, 2013 was a net asset of $95,000 and the value as of June 30, 2012 was an asset of $922,000. The fair values were determined based on obtaining pricing from our bank and corroborating those values with a third party bank. As of June 30, 2013 and June 30, 2012, we did not have any financial assets or liabilities classified as Level 3. We did not transfer any assets or liabilities between any levels during fiscal 2013. 39 Accounts Receivable We perform ongoing credit evaluations of our customers and adjust credit limits based on payment history and customer credit-worthiness. An allowance for estimated doubtful accounts is maintained based on historical experience and identified customer credit issues. We monitor collections regularly and adjust the allowance for doubtful accounts as necessary to recognize any changes in credit exposure. Upon conclusion that a receivable is uncollectible, we record the respective amount as a charge against allowance for doubtful accounts. To date, such doubtful accounts reserves, in the aggregate, have been adequate to cover collection losses. Inventories We operate primarily as a private-label contract manufacturer that builds products based upon anticipated demand or following receipt of customer specific purchase orders. From time to time, we build inventory for private-label contract manufacturing customers under a specific purchase order with delivery dates that may subsequently be rescheduled or canceled at the customer’s request. We value inventory at the lower of cost (first- in, first-out) or market (net realizable value) on an item-by-item basis, including costs for raw materials, labor and manufacturing overhead. We establish reserves equal to all or a portion of the related inventory to reflect situations in which the cost of the inventory is not expected to be recovered. This requires us to make estimates regarding the market value of our inventory, including an assessment for excess and obsolete inventory. Once we establish an inventory reserve in a fiscal period, the reduced inventory value is maintained until the inventory is sold or otherwise disposed of. In evaluating whether inventory is stated at the lower of cost or market, management considers such factors as the amount of inventory on hand, the estimated time required to sell such inventory, the remaining shelf life and efficacy, the foreseeable demand within a specified time horizon and current and expected market conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable value. Property and Equipment We state property and equipment at cost. Depreciation of property and equipment is provided using the straight- line method over their estimated useful lives, generally ranging from 1 to 39 years. We amortize leasehold improvements using the straight-line method over the shorter of the life of the improvement or the term of the lease. Maintenance and repairs are expensed as incurred. Significant expenditures that increase economic useful lives are capitalized. Impairment of Long-Lived Assets We periodically evaluate the carrying value of long-lived assets to be held and used when events and circumstances indicate that the carrying amount of an asset may not be recovered. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. We did not recognize any impairment losses during fiscal 2013 or fiscal 2012. Derivative Financial Instruments We currently may use derivative financial instruments in the management of our foreign currency exchange risk inherent in our forecasted transactions denominated in Euros. We may hedge our foreign currency exposures by entering into offsetting forward exchange contracts and currency options. To the extent we use derivative financial instruments, we account for them using the deferral method, when such instruments are intended to hedge identifiable, firm foreign currency commitments or anticipated transactions and are designated as, and effective as, hedges. Foreign exchange exposures arising from certain transactions that do not meet the criteria for the deferral method are marked-to-market through the Consolidated Statements of Operations and Comprehensive Income. 40 We recognize any unrealized gains and losses associated with derivative instruments in income in the period in which the underlying hedged transaction is realized. In the event the derivative instrument is deemed ineffective we would recognize the resulting gain or loss in income at that time. As of June 30, 2013, we held derivative 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. As of June 30, 2013, the notional amounts of our foreign exchange contracts were $14.1 million (EUR 10.7 million). These contracts will mature over the next 14 months. Defined Benefit Pension Plan We sponsor a defined benefit pension plan. Effective June 21, 1999, we adopted an amendment to freeze benefit accruals to the participants. The plan obligation and related assets of the plan are presented in the notes to the consolidated financial statements. Plan assets, which consist primarily of marketable equity and debt instruments, are valued based upon third party market quotations. Independent actuaries, through the use of a number of assumptions, determine plan obligation and annual pension expense. Key assumptions in measuring the plan obligation include the discount rate and estimated future return on plan assets. In determining the discount rate, we use an average long-term bond yield. Asset returns are based on the historical returns of multiple asset classes to develop a risk free rate of return and risk premiums for each asset class. The overall rate for each asset class was developed by combining a long-term inflation component, the risk free rate of return and the associated risk premium. A weighted average rate is developed based on the overall rates and the plan’s asset allocation. Revenue Recognition To recognize revenue, four basic criteria must be met: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered. We record reductions to gross revenue for estimated returns of private label contract manufacturing products and branded products. The estimated returns are based on the trailing six months of private label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and branded product returns. However, the estimate for product returns does not reflect the impact of a potential large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable. We followed the provisions of ASU No. 2009-13 for all multiple element agreements. Under this guidance, the delivered item(s) has value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control. A delivered item is considered a separate unit of accounting when the delivered item has value to the partner on a standalone basis based on the consideration of the relevant facts and circumstances for each arrangement. Arrangement consideration is allocated at the inception of the agreement to all identified units of accounting based on their relative selling price. The relative selling price for each deliverable is determined using vendor 41 specific objective evidence, or VSOE, of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, we use our best estimate of the selling price for the deliverable. The amount of allocable arrangement consideration is limited to amounts that are fixed or determinable. The consideration received is allocated among the separate units of accounting, and the applicable revenue recognition criteria are applied to each of the separate units. Changes in the allocation of the sales price between delivered and undelivered elements can impact revenue recognition but do not change the total revenue recognized under any agreement. If facts and circumstances dictate that a deliverable has standalone value from the undelivered items, the deliverable is identified as a separate unit of accounting and the amounts allocated to the deliverable are recognized upon the delivery of the deliverable, assuming the other revenue recognition criteria have been met. However, if the amounts allocated to the deliverable through the relative selling price allocation exceed the upfront fee, the amount recognized upon the delivery of the deliverable is limited to the upfront fee received. If facts and circumstances dictate that the deliverable does not have standalone value, the transaction price, including any upfront fee payments received, are allocated to the identified separate units of accounting and recognized as those items are delivered and accepted. In addition, we enter into arrangements that provide for milestone payments upon contractually stated events. Under the Milestone Method, we recognize consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is substantive in its entirety. A milestone is considered substantive when it meets all of the following three criteria: 1) The consideration is commensurate with either the entity’s performance to achieve the milestone or the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, 2) The consideration relates solely to past performance, and 3) The consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. A milestone is defined as an event (i) that can only be achieved based in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting from the entity’s performance, (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to us. We currently own certain U.S. patents, and each patent’s corresponding foreign patent applications. All of these patents and patent rights relate to the ingredient known as beta-alanine marketed and sold under the CarnoSyn® trade name. We have sold this ingredient to a customer for use in a limited market, and since March 2009 have had an agreement with Compound Solutions, Inc. (CSI) under which we have agreed to grant a license of certain of our patent rights to customers of CSI who purchase beta-alanine from CSI. Before October 1, 2011, we received a fee from CSI that varied based on the amount of net sales of beta-alanine sold by CSI less CSI’s costs and other agreed upon expenses. As of October 1, 2011, we receive a fee from CSI that varies based on the quantity of beta-alanine sold by CSI and the source of such beta-alanine. In June 2011, we entered into a license and supply agreement (Agreement) with Abbott Laboratories (Abbott) under which we agreed to grant an exclusive license to Abbott for the use of beta-alanine in certain medical foods and medical nutritionals. Under the terms of the agreement, Abbott paid an initial license fee of $300,000, an additional fee of $300,000 in January 2012, and upon achievement of certain milestones, an additional license fee of $150,000 was paid on October 3, 2012. The license and supply agreement provided Abbott with the right to terminate the agreement at any time up to March 31, 2012, at which time, if not terminated, Abbott was required to pay $4.3 million payable over six annual payments with the initial installment payment of $708,334 due March 31, 2012. In February 2012 and June 2012, we amended the Agreement and extended Abbott’s termination rights initially through July 31, 2012 and then further through October 31, 2012 in exchange for two payments of $354,167 each by Abbott to NAI. Abbott made the first payment on March 13, 2012 and the second payment on July 12, 2012. In October 2012, the Agreement was amended for a third time. Unless earlier terminated by Abbott, the amendment requires Abbott to pay to NAI (i) upon earlier of achievement of certain milestones or December 1, 2012, additional license fees of $204,167; (ii) upon earlier of achievement of certain milestones or June 1, 2013, 42 additional license fees of $204,167; (iii) upon earlier of achievement of certain milestones or July 1, 2013, additional license fees of $150,000; (iv) upon earlier of achievement of certain milestones or December 1, 2013, additional license fees of $150,000; and (v) approximately $2.8 million payable over four annual payments beginning on March 31, 2014. The payment noted in (i) was collected in December 2012, the payment noted in (ii) was collected in May 2013, and the payment noted in (iii) was collected in July 2013. Subject to certain other conditions set forth in the Agreement and amendments, and until terminated by either party, Abbott is required to purchase certain material exclusively from NAI and make royalty payments to NAI upon Abbott’s sale of products subject to the Agreement. Because Abbott may terminate the agreement at any time up to December 1, 2013, there is no assurance NAI will receive any of the additional license fees or royalty payments described above. All milestone payments are recognized as revenue at the time of receipt as the payments are non-refundable and we have no continuing obligation as it relates to each payment. We have determined that each of the milestone payments meets the definition of a milestone in accordance with the milestone method of revenue recognition. We recorded royalty and licensing income as a component of revenue in the amount of $4.8 million during fiscal 2013 and $8.0 million during fiscal 2012. These royalty income amounts resulted in royalty expense paid to the original patent holders from whom NAI acquired its patents and patent rights. We recognized royalty expense as a component of cost of goods sold in the amount of $604,000 during the fiscal 2013 and $686,000 during fiscal 2012. Cost of Goods Sold Cost of goods sold includes raw material, labor, manufacturing overhead, and royalty expense. Shipping and Handling Costs We include fees earned on the shipment of our products to customers in sales and include costs incurred on the shipment of product to customers in costs of goods sold. Research and Development Costs As part of the services we provide to our private-label contract manufacturing customers, we may perform, but are not obligated to perform, certain research and development activities related to the development or improvement of their products. While our customers typically do not pay directly for this service, the cost of this service is included as a component of the price we charge to manufacture and deliver their products. Research and development costs are expensed when incurred. Our research and development expenses for the last two fiscal years ended June 30 were $1.2 million for 2013 and $1.1 million for 2012. These costs were included in selling, general and administrative expenses and cost of goods sold. Advertising Costs We expense the production costs of advertising the first time the advertising takes place. We incurred and expensed advertising costs in the amount of $215,000 during the fiscal year ended June 30, 2013 and $177,000 during fiscal 2012. These costs were included in selling, general and administrative expenses. Income Taxes We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and 43 tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates, for each of the jurisdictions in which we operate, expected to apply to taxable income in the years in which 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 in operations in the period that includes the enactment date. We account for uncertain tax positions using the more-likely-than-not recognition threshold. Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2013 and June 30, 2012, we had not recorded any tax liabilities for uncertain tax positions. We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that it is more likely than not that we will not realize all or part of our deferred tax assets in the future, we will record an adjustment to the carrying value of the deferred tax asset, which would be reflected as income tax expense. Conversely, if we determine we will realize a deferred tax asset, which currently has a valuation allowance, we will reverse the valuation allowance, which would be reflected as an income tax benefit. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We did not have a deferred tax asset valuation allowance as of June 30, 2013 or June 30, 2012. We will continue to assess the need for a valuation allowance on the deferred tax asset by evaluating both positive and negative evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the income statement for the period that the adjustment is determined to be required. We are subject to taxation in the U.S., Switzerland and various state jurisdictions. Our tax years for the fiscal year ended June 30, 2005 and forward are subject to examination by the U.S. and state tax authorities and our tax years for the fiscal year ended June 30, 2007 and forward are subject to examination by the Switzerland tax authorities. We do not record U.S. income tax expense for NAIE’s retained earnings that are declared as indefinitely reinvested offshore, thus reducing our overall income tax expense. The amount of earnings designated as indefinitely reinvested in NAIE is based on the actual deployment of such earnings in NAIE’s assets and our expectations of the future cash needs of our U.S. and foreign entities. Income tax laws are also a factor in determining the amount of foreign earnings to be indefinitely reinvested offshore. Stock-Based Compensation We have an omnibus incentive plan that was approved by our Board of Directors effective as of October 15, 2009 and approved by our stockholders at the Annual Meeting of Stockholders held on November 30, 2009. Under the plan, we may grant nonqualified and incentive stock options and other stock-based awards to employees, non-employee directors and consultants. Our prior equity incentive plan was terminated effective as of November 30, 2009. 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 transferable. Option valuation models require the input of highly subjective assumptions. Black-Scholes uses assumptions related to volatility, the risk-free interest rate, the dividend yield (which we assume to be zero, as 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 in the period 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. 44 The Company did not grant any options during fiscal 2013 or 2012. The aggregate intrinsic value of option awards exercised was $24,500 during fiscal 2013. We did not have any options exercised during fiscal 2012. The total remaining unrecognized compensation cost related to unvested option awards amounted to $62,000 at June 30, 2013 and the weighted average remaining requisite service period of the unvested option awards was 0.3 years. The total fair value of options vested during the fiscal year ended June 30, 2013 was $148,000. The total fair value of options vested during the fiscal year ended June 30, 2012 was $227,000. During fiscal 2013 we granted a total of 98,000 restricted stock shares to the members of our Board of Directors and certain key members of our management team pursuant to our 2009 Omnibus Incentive plan. Each restricted share will vest over three years and these shares cannot be sold or otherwise transferred and the rights to receive dividends, if declared by our Board of Directors, are forfeitable until the shares become vested. There were no vested restricted stock shares as of June 30, 2013. The total remaining unrecognized compensation cost related to unvested restricted stock shares amounted to $410,000 at June 30, 2013 and the weighted average remaining requisite service period of unvested restricted stock shares was 2.7 years. The weighted average fair value of restricted stock shares granted during fiscal 2013 was $4.74. We did not issue any restricted stock shares in fiscal 2012. Use of Estimates Our management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates. Net Income per Common Share We compute basic net income per common share using the weighted average number of common shares outstanding during the period, and diluted net income per common share using the additional dilutive effect of all dilutive securities. The dilutive impact of stock options and restricted shares account 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): Numerator Net income Denominator Basic weighted average common shares outstanding Dilutive effect of stock options Diluted weighted average common shares outstanding Basic net income per common share Diluted net income per common share For the Years Ended June 30, 2013 2012 $1,570 $4,158 6,869 16 6,885 $ 0.23 $ 0.23 6,978 10 6,988 $ 0.60 $ 0.59 Shares related to 429,000 stock options for the fiscal year ended June 30, 2013 and 456,000 for fiscal 2012, were excluded from the calculation of diluted net income per common share, as the effect of their inclusion would be anti-dilutive. 45 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 two largest customers, whose receivable balances collectively represented 44.3% of gross accounts receivable at June 30, 2013 and 29.4% at June 30, 2012. Additionally, royalty amounts due from CSI represented 20.6% of gross accounts receivable at June 30, 2013 and 10.0% at June 30, 2012. 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 Inventories, net, consisted of the following at June 30 (in thousands): Raw materials Work in progress Finished goods Reserve 2013 2012 $ 6,516 1,576 2,358 (415) $6,344 1,058 1,530 (577) $10,035 $8,355 C. Property and Equipment Property and equipment consisted of the following at June 30 (dollars in thousands): Land Building and building improvements Machinery and equipment Office equipment and furniture Vehicles Leasehold improvements Total property and equipment Less: accumulated depreciation and amortization Property and equipment, net Depreciable Life In Years NA 7–39 3–12 3–5 3 1–15 $ 2013 393 2,793 26,141 3,030 136 10,771 $ 2012 393 2,756 25,876 3,023 136 10,136 43,264 (34,059) 42,320 (31,673) $ 9,205 $ 10,647 D. Debt On December 16, 2010, we executed a Credit Agreement (“Credit Agreement”) with Wells Fargo Bank, National Association. This Credit Agreement replaced our previous credit facility and provides us with a line of credit of up to $5.0 million. The line of credit may be used to finance working capital requirements. In consideration for granting the line of credit and each subsequent extension amendment, we pay an annual commitment fee of $12,500. 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) net income after taxes of not less than $750,000 on a trailing four quarter basis as of the end of each calendar quarter beginning with the four quarter period ended December 31, 2010; and (ii) a ratio of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time. Any amounts outstanding under the line of credit will bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of interest. If elected, the fluctuating rate per annum would be equal to 46 2.75% 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 2.50% 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 November 1, 2014; provided, however, that we must maintain a zero balance on advances under the line of credit for a period of at least 30 consecutive days during each fiscal year. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of $100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month of prepayment through the month in which the then applicable fixed rate term matures. Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general intangibles, inventory, equipment and fixtures. We also have a foreign exchange facility with Wells Fargo in effect until November 1, 2014, and with Bank of America, N.A. in effect until March 5, 2014. On June 30, 2013, we were in compliance with all of the financial and other covenants required under the Credit Agreement. On September 22, 2006, NAIE entered into a credit facility to provide it with a credit line of up to CHF 1.3 million, or approximately $1.4 million, which was the initial maximum aggregate amount that could be outstanding at any one time under the credit facility. This maximum amount is reduced annually by CHF 160,000, or approximately $169,000. On February 19, 2007, NAIE amended its credit facility to provide that the maximum aggregate amount that may be outstanding under the facility cannot be reduced below CHF 500,000, or approximately $530,000. As of June 30, 2013, there was no outstanding balance under this credit facility. Under its credit facility, NAIE may draw amounts either as current account loan credits to its current or future bank accounts or as fixed loans with a maximum term of 24 months. Current account loans will bear interest at the rate of 5% per annum. Fixed loans will bear interest at a rate determined by the parties based on current market conditions and must be repaid pursuant to a repayment schedule established by the parties at the time of the loan. If a fixed loan is repaid early at NAIE’s election or in connection with the termination of the credit facility, NAIE will be charged a pre-payment penalty equal to 0.1% of the principal amount of the fixed loan or CHF 1,000 (approximately $1,058), whichever is greater. The bank reserves the right to refuse individual requests for an advance under the credit facility, although its exercise of such right will not have the effect of terminating the credit facility as a whole. We did not use our working capital line of credit nor did we have any long-term debt outstanding during the year ended June 30, 2013. As of June 30, 2013, we had $5.5 million available under our credit facilities. E. Income Taxes The provision for income taxes for the years ended June 30 consisted of the following (in thousands): Current: Federal State Foreign Deferred: Federal State Provision (benefit) for income taxes 47 2013 2012 $ (24) (4) 271 $ 873 416 294 243 1,583 218 62 280 525 (24) 501 $523 $2,084 Net deferred tax assets and deferred tax liabilities as of June 30 were as follows (in thousands): Deferred tax assets: Allowance for doubtful accounts Accrued vacation expense Tax credit carry forward Allowance for inventories Stock-based compensation Pension liability Other, net Deferred rent Accumulated depreciation and amortization Net operating loss carry forward Total gross deferred tax assets Deferred tax liabilities: Prepaid expenses Other Deferred tax liabilities Net deferred tax assets 2013 2012 $ 49 108 4 136 126 279 150 89 846 525 $ 45 147 0 200 193 216 567 196 563 517 $2,312 $2,644 (151) (25) (176) (162) (312) (474) $2,136 $2,170 At June 30, 2013, we had state tax net operating loss carry forwards of approximately $8.6 million. Under California tax law, net operating loss deductions were suspended for tax years beginning in 2008, 2009, 2010 and 2011 and the carry forward periods of any net operating losses not utilized due to such suspension were extended. Our state tax loss carry forwards will begin to expire in 2022, unless used before their expiration. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), the annual use of the net operating loss carry forwards and research and development tax credits could be limited by any greater than 50% ownership change during any three-year testing period. We did not have any ownership changes that met this criterion during the fiscal years ended June 30, 2013 and June 30, 2012. NAIE’s effective tax rate for Swiss federal, cantonal and communal taxes is approximately 18.63%. NAIE had net income of $1.3 million for the fiscal year ended June 30, 2013. Undistributed earnings of NAIE amounted to approximately $11.4 million at June 30, 2013. These earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal taxes has been provided thereon. A reconciliation of income tax provision computed by applying the statutory federal income tax rate of 34% to net income before income taxes for the year ended June 30 is as follows (dollars in thousands): Income taxes computed at statutory federal income tax rate State income taxes, net of federal income tax expense Expenses not deductible for tax purposes Foreign tax rate differential Return to provision – differences Income tax provision as reported Effective tax rate 2013 2012 $ 711 41 39 (264) (4) $2,123 265 54 (343) (15) $ 523 $2,084 25.0% 33.4% 48 F. Employee Benefit Plans We have a profit sharing plan pursuant to Section 401(k) of the Code, whereby participants may contribute a percentage of compensation not in excess of the maximum allowed under the Code. All employees with six months of continuous employment are eligible to participate in the plan. Effective January 1, 2004, the plan was amended to require that we match 100% of the first 3% and 50% of the next 2% of a participant’s compensation contributed to the plan. Effective January 1, 2009, we elected to temporarily discontinue the company match program. The match program was reinstated effective July 15, 2011. The total contributions under the plan charged to income from operations totaled $189,000 for fiscal 2013 and $183,000 for fiscal 2012. We have a “Cafeteria Plan” pursuant to Section 125 of the Code, whereby health care benefits are provided for active employees through insurance companies. Substantially all active full-time employees are eligible for these benefits. We recognize the cost of providing these benefits by expensing the annual premiums, which are based on benefits paid during the year. The premiums expensed to operating income for these benefits totaled $937,000 for the fiscal year ended June 30, 2013 and $843,000 for fiscal 2012. We sponsor a defined benefit pension plan, which provides retirement benefits to employees based generally on years of service and compensation during the last five years before retirement. Effective June 21, 1999, we adopted an amendment to freeze benefit accruals to the participants. We contribute an amount not less than the minimum funding requirements of the Employee Retirement Income Security Act of 1974 nor more than the maximum tax-deductible amount. Disclosure of Funded Status The following table sets forth the defined benefit pension plan’s funded status and amount recognized in our consolidated balance sheets at June 30 (in thousands): Change in Benefit Obligation Benefit obligation at beginning of year Interest cost Actuarial (gain) loss Benefits paid Benefit obligation at end of year Change in Plan Assets Fair value of plan assets at beginning of year Actual return on plan assets Benefits paid Plan expenses Fair value of plan assets at end of year Reconciliation of Funded Status Difference between benefit obligation and fair value of plan assets Unrecognized net actuarial loss in accumulated other comprehensive income Net amount recognized Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 49 2013 2012 $1,593 79 286 (162) $1,652 87 (83) (63) $1,796 $1,593 $1,682 142 (162) — $1,716 31 (63) (2) $1,662 $1,682 $ (134) $ 89 700 542 $ 566 $ 631 $1,796 $1,796 $1,662 $1,593 $1,593 $1,682 The weighted-average discount rate used for determining the projected benefit obligations for the defined benefit pension plan during the year ended June 30, 2013 was 4.8% and 5.5% for the year ended June 30, 2012. Net Periodic Benefit Cost The components included in the defined benefit pension plan’s net periodic benefit expense for the fiscal years ended June 30 were as follows (in thousands): Interest cost Expected return on plan assets Recognized actuarial loss Settlement loss Net periodic benefit expense 2013 2012 $ 79 (107) 28 65 $ 87 (116) 33 — $ 65 $ 4 We do not expect to make any contribution to our defined benefit pension plan in fiscal 2014. The following is a summary of changes in plan assets and benefit obligations recognized in other comprehensive income (in thousands): Net loss Settlement loss Amortization of net loss Total recognized in other comprehensive income (loss) Total recognized in net periodic benefit cost and other comprehensive income (loss) 2013 2012 $251 $ 3 (65) — (28) (33) $158 $ (30) $223 $ (25) The estimated net loss for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $46,000. We do not have any transition obligations or prior service costs recorded in accumulated other comprehensive income. The following benefit payments are expected to be paid: 2014 2015 2016 2017 2018 2019-2023 $ 24,838 27,020 45,135 76,348 95,972 719,463 $988,776 The weighted-average rates used for the years ended June 30 in determining the defined benefit pension plan’s net pension costs, were as follows: Discount rate Expected long-term rate of return Compensation increase rate 50 2013 2012 5.50% 5.50% 7.00% 7.00% N/A N/A Our expected rate of return is determined based on a methodology that considers historical returns of multiple classes analyzed to develop a risk free real rate of return and risk premiums for each asset class. The overall rate for each asset class was developed by combining a long-term inflation component, the risk free real rate of return, and the associated risk premium. A weighted average rate was developed based on those overall rates and the target asset allocation of the plan. Our defined benefit pension plan’s weighted average asset allocation at June 30 and weighted average target allocation were as follows: Equity securities Debt securities Commodities Cash and money market funds 2013 2012 48% 54% 46% 40% — — 6% 6% Target Allocation 46% 49% 2% 3% 100% 100% 100% The underlying basis of the investment strategy of our defined benefit pension plan is to ensure that pension funds are available to meet the plan’s benefit obligations when due. Our investment strategy is a long-term risk controlled approach using diversified investment options with relatively minimal exposure to volatile investment options like derivatives. The underlying basis of the investment strategy of our defined benefit pension plan is to ensure that pension funds are available to meet the plan’s benefit obligations when due. Our investment strategy is a long-term risk controlled approach using diversified investment options with relatively minimal exposure to volatile investment options like derivatives. The fair values by asset category of our defined benefit pension plan at June 30, 2013 were as follows (in thousands): Cash and money market funds Equity securities(1) Debt securities(2) Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 99 $ 792 $ 771 $1,662 $— $— $— $— $— $— $— $— Total $ 99 $ 792 $ 771 $1,662 (1) This category is comprised of publicly traded funds, of which 76% are large-cap funds, 7% are emerging markets equity funds, and 17% are international equity funds. (2) This category is comprised of publicly traded funds, of which 12% are short-term fixed income funds, 9% are high-yield fixed income funds, 44% are intermediate fixed income funds, 27% are REITs and MLPs funds, and 8% are hedge funds. 51 G. Stockholders’ Equity Treasury Stock On June 2, 2011, the Board of Directors authorized the repurchase of up to $2.0 million of our common stock. Under the repurchase plan, we may, from time to time, purchase shares of our common stock, depending upon market conditions, in open market or privately negotiated transactions. For the year ended June 30, 2012, we purchased 75,026 shares at a weighted average cost of $5.39 per share and a total cost of $405,000, including commissions and fees. During the year ended June 30, 2013, we purchased an additional 132,132 shares at a weighted average cost of $5.32 per share and a total cost of $703,000 including commissions and fees. Stock Option Plans On December 6, 1999, our stockholders approved the adoption of the 1999 Omnibus Equity Incentive Plan (the “1999 Plan”). The 1999 Plan was terminated effective as of November 30, 2009. Effective as of October 15, 2009, our Board of Directors approved an omnibus incentive plan (the “2009 Plan”). The 2009 Plan was approved by our stockholders at the Annual Meeting of Stockholders held on November 30, 2009. Under the plan, we may grant nonqualified and incentive stock options and other stock-based awards to employees, non-employee directors and consultants. As of June 30, 2013, a total of 800,000 shares of common stock were reserved under the 2009 Plan for issuance to our employees, non-employee directors and consultants. Stock option activity for the year ended June 30, 2013 was as follows: Weighted Average Exercise Price Weighted Average Contractual Term (in years) Aggregate Intrinsic Value Outstanding at June 30, 2012 Exercised Forfeited Granted Outstanding at June 30, 2013 Vested and exercisable at June 30, 2013 1999 Plan 315,000 (10,000) (145,000) — 160,000 $8.28 $3.70 $9.19 $ — $7.73 160,000 $7.73 0.97 0.97 $— $— Available for grant at June 30, 2013 — Outstanding at June 30, 2012 Exercised Forfeited Granted Outstanding at June 30, 2013 2009 Plan 226,700 — (3,350) — 223,350 Vested and exercisable at June 30, 2013 150,750 Weighted Average Exercise Price Weighted Average Contractual Term (in years) Aggregate Intrinsic Value $6.88 $ — $7.50 $ — $6.87 $6.87 6.58 6.59 $43,000 $29,000 52 Restricted stock activity for the year ended June 30, 2013 was as follows (2009 Plan): Nonvested at June 30, 2012 Granted Vested Forfeited Nonvested at June 30, 2013 Weighted Average Grant Date Fair Value $ — $4.74 $ — $ — $4.74 Number of Shares — 98,000 — — 98,000 As of June 30, 2013, there were 478,650 shares available for grant under the 2009 Plan. H. Commitments We lease a total of 162,000 square feet at our manufacturing facility in Vista, California from an unaffiliated third party under a non-cancelable operating lease. On July 31, 2013, we executed a third amendment to the lease for our manufacturing facility in Vista, CA. As a result of this amendment, our facility lease has been extended for an additional 10 year term through March 2024. NAIE leases facility space in Manno, Switzerland. The leased space totals approximately 59,239 square feet. We primarily use the facilities for manufacturing, packaging, warehousing and distributing nutritional supplement products for the European marketplace. The NAIE lease expires in December 2022. Minimum rental commitments (exclusive of property tax, insurance and maintenance) under all non-cancelable operating leases with initial or remaining lease terms in excess of one year, including the lease agreements referred to above, are set forth below as of June 30, 2013 (in thousands): Gross minimum rental commitments $2,624 $2,467 $2,328 $2,191 $2,223 $12,328 $24,161 2014 2015 2016 2017 2018 There- after Total Rental expense totaled $2.2 million for the fiscal year ended June 30, 2013 and $2.5 million for fiscal 2012. I. Economic Dependency We had substantial net sales to certain customers during the fiscal years ended June 30 shown in the following table. The loss of any of these customers, or a significant decline in sales or the growth rate of sales to these customers, or in their ability to make payments when due, could have a material adverse impact on our net sales and net income. Net sales to any one customer representing 10% or more of the respective year’s total private- label contract manufacturing net sales were as follows (dollars in thousands): Customer 1 Customer 2 2013 2012 Net Sales by Customer % of Total Net Sales Net Sales by Customer % of Total Net Sales $28,404 10,638 $39,042 50% 19% 69% $31,994 13,884 $45,878 51% 22% 73% Accounts receivable from these customers totaled $3.0 million at June 30, 2013 and $2.6 million at June 30, 2012. 53 We buy certain products, including beta-alanine, from a limited number of raw material suppliers. The loss of any of these suppliers could have a material adverse impact on our net sales and net income. During fiscal 2013 and 2012, we did not have any suppliers that individually represented greater than 10% of our raw material purchases. J. Derivatives and Hedging We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to forecasted product sales denominated in foreign currencies and transactions of NAIE, our foreign subsidiary. As part of our overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, we may use foreign exchange contracts in the form of forward contracts. There can be no guarantee any such contracts, to the extent we enter into such contracts, will be effective hedges against our foreign currency exchange risk. During the year ended June 30, 2013 and prior, we entered into 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 2014. For derivative instruments that are designated and qualify as cash flow hedges, we record the effective portion of the gain or loss on the derivative in accumulated other comprehensive income (“OCI”) as a separate component of stockholders’ equity and subsequently reclassify these amounts into earnings in the period during which the hedged transaction is recognized in earnings. For foreign currency contracts designated as cash flow hedges, hedge effectiveness is measured using the spot rate. Changes in the spot-forward differential are excluded from the test of hedge effectiveness and are recorded currently in earnings as interest expense. We measure effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item. During the year ended June 30, 2013, we did not have any losses or gains related to the ineffective portion of our hedging instruments. No hedging relationships were terminated as a result of ineffective hedging or forecasted transactions no longer probable of occurring for foreign currency forward contracts. We monitor the probability of forecasted transactions as part of the hedge effectiveness testing on a quarterly basis. As of June 30, 2013, the notional amounts of our foreign exchange contracts designated as cash flow hedges were approximately $14.1 million (EUR 10.7 million). As of June 30, 2013, a net gain of approximately $63,000, offset by $25,000 of deferred taxes, related to derivative instruments designated as cash flow hedges was recorded in OCI. As of June 30, 2012, a gain of approximately $784,000 offset by $312,000 of deferred taxes, related to derivative instruments designated as cash flow hedges was recorded in OCI. It is expected that $25,000 of the gross gain, as of June 30, 2013, will be reclassified into earnings in the next 12 months along with the earnings effects of the related forecasted transactions. As of June 30, 2013, $133,000 of the fair value of our cash flow hedges was classified in prepaids and other current assets, $38,000 was classified in other non-current assets, net and $76,000 was classified in accrued liabilities in our Consolidated Balance Sheets. During the year ended June 30, 2013, we recognized $152,000 of gains in OCI and reclassified $570,000 of gains from OCI to revenue. During the year ended June 30, 2012, we recognized $1.9 million of gains in OCI and reclassified $1.2 million 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 54 generally do not believe the resolution of these matters will result in a material adverse effect on our business, consolidated financial condition, or results of operation. However, a settlement payment or unfavorable outcome could adversely impact our results of operation. Our evaluation of the likely impact of these actions could change in the future and we could have unfavorable outcomes that we do not expect. On September 8, 2011, NAI and CSI filed a complaint in the U.S. District Court for the District of Delaware against DNP International Co., Inc. (DNP) alleging claims of unfair competition, violation of the Delaware Deceptive Trade Practices Act and interference with business relations. On December 22, 2011, DNP filed a complaint in the U.S. District Court for the District of Delaware against NAI and CSI for declaratory judgment of non-infringement and invalidity of three of NAI’s patents. On January 27, 2012, DNP amended its complaint to add declaratory judgment claims against a fourth NAI patent (‘381 patent). On February 6, 2012, the Company and CSI moved to dismiss the cases related to the three previously asserted patents for lack of subject matter jurisdiction. On the same day, the Company filed its answer and counterclaims for infringement by DNP of the ‘381 patent. DNP subsequently agreed to voluntarily dismiss CSI from the lawsuit. On March 2, 2012, the Court ordered the dismissal of CSI. On April 15, 2013, the Court consolidated the two lawsuits referenced above for purposes of pretrial matters. The Court also entered a Scheduling Order setting a trial date in April 2015. On December 21, 2011, NAI filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division, accusing Woodbolt Distribution, LLC, also known as Cellucor (Woodbolt), Vitaquest International, Inc., d/b/a Garden State Nutritionals (Garden State) and F.H.G. Corporation, d/b/a Integrity Nutraceuticals (Integrity), of infringing NAI’s ’381 patent. The complaint alleges that Woodbolt sells nutritional supplements, including supplements containing beta-alanine such as C4 Extreme™, M5 Extreme™, and N-Zero Extreme™, that infringe the ‘381 patent. Woodbolt, in turn, filed a complaint seeking a declaratory judgment of non- infringement and invalidity of the ’381 patent in the U.S. District Court for the District of Delaware. On February 17, 2012, Woodbolt filed a First Amended Complaint, realleging its original claims against the Company and asserting new claims of violation of the Sherman Antitrust Act (15 U.S.C. § 2) and Unfair Competition. The Company reasserted the arguments in its prior motion to dismiss and moved to dismiss the new claims asserted by Woodbolt. On January 23, 2013, the Delaware Court granted the Company’s motion to dismiss Woodbolt’s case. On June 5, 2012, the Court in the above-referenced Texas case consolidated the pending suit with a second patent infringement case filed against Woodbolt by the Company on May 3, 2012, asserting infringement its ‘422 patent. On November 9, 2012, NAI filed a supplemental complaint adding allegations of infringement of Woodbolt’s Cellucor Cor –Performance ß-BCAA™ and Cellucor Cor – Performance™ Creatine products. On June 14, 2013, NAI filed a third patent infringement lawsuit in the U.S. District Court for the Southern District of Texas Houston Division against Woodbolt, BodyBuilding.com and GNC Corporation alleging infringement of the ‘381 and ‘422 patents by Woodbolt’s Neon Sport Volt™ product. Woodbolt asserted the same defenses and counterclaims as set forth in the earlier lawsuits. On June 24, 2013, the Court consolidated the case with the earlier-filed lawsuits identified above. On June 25, 2013, Woodbolt filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division, against a newly-issued NAI U.S. patent 8,470,865, asserting declaratory judgment claims of non-infringement, invalidity and unenforceability. On July 1, 2013, Woodbolt’s lawsuit was consolidated with the three pending lawsuits filed by NAI. On July 24, 2013, NAI filed its Answer and Amended Counterclaims against Woodbolt alleging infringement of the ‘865 patent by the products accused in the pending cases previously filed by NAI. On August 14, 2013, Woodbolt filed a counterclaim to NAI’s counterclaim asserting violation of the Sherman Antitrust Act (15 U.S.C. § 2) and Unfair Competition. All of the consolidated cases remain pending. Woodbolt has also requested inter partes re-examination of the ’381 and ’422 patents by the USPTO. On July 26, 2012, the USPTO accepted the request to re-exam the ’381 patent and on August 17, 2012 the USPTO accepted the request to re-exam the ’422 patent. A declaration of non-infringement, invalidity or unenforceability of certain of our patents could have a material adverse impact upon our business results, operations, and financial condition. 55 On February 13, 2013, several entities, including the Company, were sued for various causes of action pertaining to product liability in Superior Court for the State of California (County of San Diego) captioned Sparling v. USPLabs, LLC, et al. Case No. 37-2013-00034663-CU-PL-CTL. On March 21, 2013, co-defendant USP Labs LLC filed a Notice of Removal to the U.S. District Court for the Southern District of California, Civil Action No. 3:13-cv-00667-JLS-DHB. Specific allegations against the Company are for negligence, strict products liability, breach of express and implied warranties and wrongful death. The Company has been provided with defense counsel by its insurance company. Additionally, the Company has sought indemnification from co- defendant USPLabs, LLC. The Company is not involved in the manufacture, distribution or sale of the product at issue in the lawsuit. On April 19, 2013, the Company filed a motion to dismiss the allegations against it. The Company’s motion is still pending. On May 8, 2013, several entities, including the Company, were sued for various causes of action pertaining to product liability in Superior Court for the State of California (County of Los Angeles) captioned Carolyne v. USPLabs, LLC, Case No. BC 508212. Specific allegations against the Company are for negligence, strict products liability, breach of express and implied warranties. The Company has been provided with defense counsel by its insurance company. Additionally, the Company has sought indemnification from co-defendant USPLabs. The Company is not involved in the manufacture, distribution or sale of the product at issue in the lawsuit. On June 28, 2013, the Company filed a Demurrer to dismiss the allegations against it. The Company’s motion is still pending. L. Segment Information Our business consists of three segments for financial reporting purposes. The three segments are identified as (i) private label contract manufacturing, which primarily relates to the provision of private label contract manufacturing services to companies that market and distribute nutritional supplements and other health care products, (ii) patent and trademark licensing, which primarily includes royalty income from our license and supply agreements associated with the sale and use of beta-alanine under our CarnosSyn® trade name, and (iii) branded products, which relates to the marketing and distribution of our branded nutritional supplements and consists primarily of the products sold under our Pathway to Healing® product line. We evaluate performance based on a number of factors. The primary performance measures for each segment are net sales and income or loss from operations before corporate allocations. Operating income or loss for each segment does not include corporate general and administrative expenses, interest expense and other miscellaneous income and expense items. Corporate general and administrative expenses include, but are not limited to: human resources, corporate legal, finance, information technology, and other corporate level related expenses, which are not allocated to any segment. The accounting policies of our segments are the same as those described in the summary of significant accounting policies in Note A. 56 Our operating results by business segment for the years ended June 30 were as follows (in thousands): Net Sales Private-label contract manufacturing Patent and trademark licensing Branded products Operating Income Private-label contract manufacturing Patent and trademark licensing Branded products Income from operations of reportable segments Corporate expenses not allocated to segments Total Assets Private-label contract manufacturing Patent and trademark licensing Branded products 2013 2012 $56,672 4,799 1,326 $63,268 7,990 1,564 $62,797 $72,822 2013 2012 $ 5,137 1,519 67 $ 8,914 2,010 160 6,723 (4,570) 11,084 (4,884) $ 2,153 $ 6,200 2013 2012 $45,032 1,388 220 $43,975 2,964 258 $46,640 $47,197 Our private-label contract manufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe, Canada, Mexico, Australia and Asia. Our primary market outside the U.S. is Europe. Our patent and trademark licensing activities are primarily based in the U.S. and our branded products are only sold in the U.S. Net sales by geographic region, based on the customers’ location, for the two years ended June 30 were as follows (in thousands): United States Markets outside the United States Total net sales 2013 2012 $36,710 26,087 $43,407 29,415 $62,797 $72,822 Products manufactured by NAIE accounted for 67% of net sales in markets outside the U.S. in fiscal 2013 and fiscal 2012. No products manufactured by NAIE were sold in the U.S. during the fiscal years ended June 30, 2013 and 2012. 57 Assets and capital expenditures by geographic region, based on the location of the company or subsidiary at which they were located or made, for the two years ended June 30 were as follows (in thousands): 2013 United States Europe 2012 United States Europe Long- Lived Assets Total Assets Capital Expenditures $ 6,728 2,477 $32,450 14,190 $ 9,205 $46,640 $ 838 783 $1,621 Long- Lived Assets Total Assets Capital Expenditures $ 8,329 2,318 $33,556 13,641 $10,647 $47,197 $1,803 481 $2,284 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures We maintain certain disclosure controls and procedures as defined under the Securities Exchange Act of 1934. They are designed to help ensure that material information is: (1) gathered and communicated to our management, including our principal executive and financial officers, in a manner that allows for timely decisions regarding required disclosures; and (2) recorded, processed, summarized, reported and filed with the SEC as required under the Securities Exchange Act of 1934 and within the time periods specified by the SEC. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2013. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2013. (b) Management’s Annual Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, and for performing an assessment of the effectiveness of internal control over financial reporting as of June 30, 2013. For this purpose, internal control over financial reporting refers to a process designed by, or under the supervision of, the Company’s principal executive and financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. 58 Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2013 based upon criteria in an Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management believes the Company’s internal control over financial reporting was effective as of June 30, 2013 based on the criteria issued by COSO. This report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not required to be attested to by the Company’s independent registered public accounting firm pursuant to applicable law and rules that permit the Company to provide only management’s report in this report. (c) Changes in Internal Control Over Financial Reporting There were no changes to our internal control over financial reporting during the fourth quarter ended June 30, 2013 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION None. PART III The information called for under Items 10- 14 of this Part III will be incorporated by reference from our definitive proxy statement for our Annual Meeting of Stockholders to be held on December 6, 2013, to be filed on or before October 28, 2013. 59 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The following documents are filed as part of this report: PART IV (1) Financial Statements. The financial statements listed below are included under Item 8 of this report: • Consolidated Balance Sheets as of June 30, 2013 and 2012; • Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2013 and 2012; • Consolidated Statements of Stockholders’ Equity for the years ended June 30, 2013 and 2012; • Consolidated Statements of Cash Flows for the years ended June 30, 2013 and 2012; and • Notes to Consolidated Financial Statements. 60 (2) Exhibits. The following exhibit index shows those exhibits filed with this report and those incorporated by reference: EXHIBIT INDEX Exhibit Number 3(i) 3(ii) Description Incorporated By Reference To Amended and Restated Certificate of Incorporation of Natural Alternatives International, Inc. filed with the Delaware Secretary of State on January 14, 2005 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 Amended and Restated By-laws of Natural Alternatives International, Inc. dated as of February 9, 2009 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) Form of NAI’s Common Stock Certificate Exhibit 4(i) of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005, filed with the commission on September 8, 2005 10.1 10.2 10.3 10.4 10.5 10.6 10.7 1999 Omnibus Equity Incentive Plan as adopted effective May 10, 1999, amended effective January 30, 2004, and further amended effective December 3, 2004* Exhibit 10.1 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 Amended and Restated Exclusive License Agreement effective as of September 1, 2004 by and among NAI and Dr. Reginald B. Cherry Exclusive License Agreement effective as of September 1, 2004 by and among NAI and Reginald B. Cherry Ministries, Inc. Exhibit 10.11 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the commission on September 14, 2004 Exhibit 10.12 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the commission on September 14, 2004 First Amendment to Exclusive License Agreement effective as of December 10, 2004 by and among NAI and Reginald B. Cherry Ministries, Inc. Exhibit 10.13 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 Lease of Facilities in Vista, California between NAI and Calwest Industrial Properties, LLC, a California limited liability company (lease reference date June 12, 2003) Exhibit 10.10 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003, filed with the commission on November 5, 2003 Form of Indemnification Agreement entered into between NAI and each of its directors Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated May 9, 2005 (English translation) Exhibit 10.15 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004, filed with the commission on September 14, 2004 Exhibit 10.19 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005, filed with the commission on May 13, 2005 61 10.8 10.9 10.10 10.11 10.12 10.13 Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated July 25, 2003 (English translation) Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated June 8, 2004 (English translation) Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated February 7, 2005 (English translation) Exhibit 10.19 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 Exhibit 10.20 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 Exhibit 10.21 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 Amendment effective as of September 15, 2005 to Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated May 9, 2005 (English translation) Exhibit 10.24 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005, filed with the commission on November 4, 2005 Loan Agreement between NAIE and Credit Suisse dated as of September 22, 2006, including general conditions (portions of the Loan Agreement have been omitted pursuant to a request for confidential treatment) First Amendment to Loan Agreement between NAIE and Credit Suisse dated as of February 19, 2007 10.14 2009 Omnibus Incentive Plan* 10.15 10.16 10.17 10.18 10.19 Manufacturing Agreement by and between NSA, Inc. and NAI dated April 1, 2005 Manufacturing Agreement by and between Mannatech, Inc. and NAI dated April 22, 1998 First Amendment to Manufacturing Agreement by and between Mannatech, Incorporated and NAI dated May 23, 2003 Second Amendment to Manufacturing Agreement by and between Mannatech, Incorporated and NAI dated July 1, 2003 Third Amendment to Manufacturing Agreement by and between Mannatech, Incorporated and NAI dated July 1, 2004 62 Exhibit 10.36 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006, filed with the commission on November 1, 2006 Exhibit 10.41 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007, filed with the commission on May 14, 2007 Exhibit D of NAI’s definitive Proxy Statement filed with the commission on October 16, 2009 Exhibit 10.43 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exhibit 10.44 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exhibit 10.45 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exhibit 10.46 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exhibit 10.47 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 10.20 10.21 10.22 10.23 10.24 10.25 10.26 10.27 10.28 10.29 10.30 10.31 Fourth Amendment to Manufacturing Agreement by and among Mannatech, Incorporated, Mannatech Swiss International GmbH and NAI dated January 1, 2008 Exhibit 10.48 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Manufacturing Sales Agreement by and between Mannatech, Incorporated and NAI dated November 19, 2004 Exhibit 10.49 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Amendment to Manufacturing Sales Agreement by and among Mannatech, Incorporated, Mannatech Swiss International GmbH and NAI dated January 1, 2008 Exhibit 10.50 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exclusive Manufacturing Agreement by and between NSA, Inc., NAI and NAIE dated as of April 1, 2005 Amended and Restated Employment Agreement dated as of August 31, 2010, by and between NAI and Mark A. LeDoux* Amended and Restated Employment Agreement dated as of August 31, 2010, by and between NAI and Kenneth E. Wolf Exhibit 10.51 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2009, filed with the commission on February 16, 2010 Exhibit 10.41 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010, filed with the commission on September 17, 2010 Exhibit 10.42 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010, filed with the commission on September 17, 2010 License and Fee Agreement effective November 10, 2010 by and among Roger Harris, Mark Dunnett, Kenny Johansson and NAI Exhibit 10.40 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2010, filed with the commission on November 12, 2010 Credit Agreement by and between NAI and Wells Fargo Bank, N.A. effective as of December 1, 2010 Exhibit 10.1 of NAI’s Current Report on Form 8-K dated December 16, 2010, filed with the commission on December 22, 2010 ISDA 2002 Master Agreement dated as of March 10, 2011 by and between Bank of America N.A. and NAI (with Schedule dated March 10, 2011) Exhibit 10.31 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011, filed with the commission on May 16, 2011 Agreement to License by and between NAI and Compound Solutions, Inc. effective as of July 1, 2011 Exhibit 10.31 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2011, filed with the commission on September 22, 2011 First Amendment to Credit Agreement by and between NAI and Wells Fargo Bank, N.A. effective as of November 28, 2011 Exhibit 10.1 of NAI’s Current Report on Form 8-K dated December 27, 2011, filed with the commission on December 30, 2011 Revolving Line of Credit Note made by NAI for the benefit of Wells Fargo Bank, N.A. dated November 28, 2011 in the amount of $5,000,000 Exhibit 10.2 of NAI’s Current Report on Form 8-K dated December 27, 2011, filed with the commission on December 30, 2011 63 10.32 10.33 10.34 10.35 10.36 10.37 10.38 10.39 10.40 10.41 10.42 Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated January 1, 2012 (English translation) First Amendment to Agreement to License by and between NAI and Compound Solutions, Inc. effective as of January 6, 2012 Second Amendment to Agreement to License by and between NAI and Compound Solutions, Inc. effective as of March 19, 2012 First Amendment to Manufacturing Agreement by and between NSA, Inc. and NAI effective as of April 1, 2012 First Amendment to Exclusive Manufacturing Agreement by and between NSA, Inc., NAI and NAIE effective as of April 1, 2005. Lease of Facilities in Manno, Switzerland between NAIE and Mr. Silvio Tarchini dated September 3, 2012 (English translation). Second Amendment to Credit Agreement by and between NAI and Wells Fargo Bank, N.A. effective as of December 7, 2012 Revolving Line of Credit Note made by NAI for the benefit of Wells Fargo Bank, N.A. dated December 7, 2012 in the amount of $5,000,000 Exhibit 10.32 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2011, filed with the commission on February 13, 2012 Exhibit 10.33 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012, filed with the commission on May 14, 2012 Exhibit 10.34 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012, filed with the commission on May 14, 2012 Exhibit 10.35 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012, filed with the commission on May 14, 2012 Exhibit 10.36 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012, filed with the commission on May 14, 2012 Exhibit 10.37 of NAI’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012, filed with the commission on September 21, 2012 Exhibit 10.38 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2012, filed with the commission on February 12, 2013 Exhibit 10.39 of NAI’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2012, filed with the commission on February 12, 2013 Third amendment to the Lease of Facilities in Vista, California between NAI and CWCA Vista Distribution 77, LLC, a Delaware limited liability company Second amendment to the Amended and Restated Employment Agreement, by and between NAI and Mark A. LeDoux, effective July 1, 2013* Second amendment to the Amended and Restated Employment Agreement, by and between and Kenneth E. Wolf, effective July 1, 2013* Filed herewith Filed herewith Filed herewith 21 Subsidiaries of the Company Filed herewith 64 23.1 31.1 31.2 32 Consent of Independent Registered Public Accounting Firm Filed herewith Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer Filed herewith Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer Filed herewith Section 1350 Certification 101.INS XBRL Instance Document Filed herewith Furnished herewith 101.SCH XBRL Taxonomy Extension Schema Document Furnished herewith 101.CAL 101.DEF 101.LAB 101.PRE XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Extension Definition Linkbase Document Furnished herewith Furnished herewith XBRL Taxonomy Extension Label Linkbase Document Furnished herewith XBRL Taxonomy Extension Presentation Linkbase Document Furnished herewith * Indicates management contract or compensatory plan or arrangement. 65 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Natural Alternatives International, Inc., the registrant, has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: September 19, 2013 NATURAL ALTERNATIVES INTERNATIONAL, INC. By: /s/ Mark A. LeDoux Mark A. LeDoux, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Natural Alternatives International, Inc. and in the capacities and on the dates indicated. Signature Title Date /s/ Mark A. LeDoux (Mark A. LeDoux) /s/ Ken Wolf (Ken Wolf) /s/ Joe E. Davis (Joe E. Davis) /s/ Alan G. Dunn (Alan G. Dunn) /s/ Alan J. Lane (Alan J. Lane) /s/ Lee G. Weldon (Lee G. Weldon) Chief Executive Officer and Chairman of the Board of Directors (principal executive officer) September 19, 2013 Chief Financial Officer (principal financial officer and principal accounting officer) September 19, 2013 Director September 19, 2013 Director September 19, 2013 Director September 19, 2013 Director September 19, 2013 66 Corporate Information OFFICERS Mark LeDoux Chairman and Chief Executive Offi cer Kenneth Wolf Chief Operating Offi cer, Chief Financial Offi cer and Secretary BOARD OF DIRECTORS Mark LeDoux Joe Davis Alan Dunn Alan Lane Lee Weldon INVESTOR RELATIONS Natural Alternatives International, Inc. 1185 Linda Vista Drive San Marcos, California 92078 USA E: investor@nai-online.com www.nai-online.com/investor_relations.html INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young LLP 4370 La Jolla Village Drive Suite 500 San Diego, California 92122 ANNUAL MEETING The annual meeting of the stockholders will be held at 11:00 a.m. PST on Friday, December 6, 2013 at Natural Alternatives International, Inc. Vista Manufacturing Facility 1215 Park Center Drive Vista, California 92081 CORPORATE COUNSEL K & L Gates LLP 3580 Carmel Mountain Road Suite 200 San Diego, California 92130 TRANSFER AGENT & REGISTRAR Computershare 250 Royall Street Canton, MA 02021 T: 877-290-2260 www.Computershare.com/investor TRADEMARKS NAI®, CarnoSyn®, SR CarnoSyn® and Pathway to Healing® are registered trademarks of Natural Alternatives International, Inc. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements that are not historical facts and information. These statements represent our intentions, expectations and beliefs concerning future events, including, among other things, our future fi nancial and operating results, including the amount of our future revenue and profi ts and our future fi nancial condition, our ability to maintain the viability of our patents and generate revenues from the commercialization of our patents and trademarks, secure compliance with our intellectual property rights, and develop, maintain or increase sales to new and existing customers, as well as the availability of quality raw materials, future economic conditions and the impact of such conditions on our business. We wish to caution readers these statements involve risks and uncertainties that could cause actual results and outcomes for future periods to diff er materially from any forward-looking statement or cause actual results and outcomes for future periods to diff er materially from any forward-looking statement or views expressed herein. Our fi nancial performance and the forward-looking statements contained herein are further qualifi ed by other risks including those set forth from time to time in the documents fi led by us with the Securities and Exchange Commission, including our most recent 2013 Annual Report on Form 10-K. North America • Europe • Asia CORPORATE HEADQUARTERS Natural Alternatives International, Inc. 1185 Linda Vista Drive San Marcos, California 92078 USA T: 760-744-7340 F: 760-744-9589 E: info@nai-online.com www.nai-online.com 1-800-VITAMIN NAI EUROPE Centro Galleria 1 Via Cantonale 6928 Manno Switzerland T: 41-91-610-9460 F: 41-91-610-8470 NAI JAPAN Yokohama City Kanagawa-Ku Japan Formulating • Blending • Tablets Capsules • Powders • Packets Custom Pre-Blends • Bottling Labeling • Packaging Solutions European Manufacturing Regulatory Support www.nai-online.com