Natural Alternatives
International, Inc.
Custom Contract Manufacturing
of Supplements Since 1980
ANNUAL REPORT
2 0 1 4
INTRODUCING SRCARNOSYN®
SUSTAINED RELEASE BETA-ALANINE
BUILDING A BETTER MUSCLE*
SRCarnoSyn® delivers the same ability to avoid muscle fatigue
for longer periods of time as the instant release beta-alanine
described in peer-reviewed articles.*
n
Increased muscle carnosine can lead to decreased muscle
fatigue and improved exercise performance.*
n Sustained release beta-alanine can increase muscle
carnosine content with no symptoms of parasthesia or
impact upon blood clinical chemistry.1*
n
Increased Muscle Carnosine.* A 10-week study
demonstrated an 80% increase in muscle carnosine levels.2
n
Increased Total Work Capacity.* A 28-day study
demonstrated an increase of 16.9% in physical working
capacity for men and a 12% increase in the working capacity
of women.3
n
Increased Endurance.* Cyclists saw an average increase of
11.4% in increased peak power output after 8 weeks.4
n Advanced Sports Supplement Technology. A breakthrough
in muscle science, SRCarnoSyn® beta-alanine delivers a
critical advantage for athletes of all types.
OVER 55 SCIENTIFIC STUDIES
n The benefits of beta-alanine have been researched in over
55 scientific studies, 53 of which have been published in
peer-reviewed journals.
22 GLOBAL PATENTS
n NAI is the owner of a global patent portfolio directed to
beta-alanine. NAI rigorously enforces adherence to its global
patent portfolio, ensuring guaranteed quality and exclusivity
for your product formulations.
ZERO BANNED SUBSTANCES
Exclusive distributor of CarnoSyn® beta-alanine:
Compound Solutions, Inc.
1930 Palomar Point Way, Suite 105, Carlsbad, California 92008
T: 760-739-9881 • F: 760-739-9886 • E: sales@compoundsolutions.com
Custom contract manufacturer and patent holder of SRCarnoSyn® and
CarnoSyn® beta-alanine:
Natural Alternatives International. Inc.
T: 760-744-7340 • E: info@nai-online.com • www.carnosyn.com
1 Stellingwerff et al. Amino Acids (2012).
2 Hill C A. et al, Amino Acids (2007).
3 Stout et al. J Strength Cond Res (2006).
4 Van Thienen et al. Med Sci Sports Exerc (2009).
* These statements have not been evaluated by
the Food and Drug Administration. This prod-
uct is not intended to diagnose, treat, cure, or
prevent any disease.
NAI Annual Report 2014 To Print.indd 1
10/8/14 12:54 PM
Financial Highlights 2014
Numbers From Our Fiscal Year End
Natural Alternatives International, Inc.
Custom Contract Manufacturing of Supplements Since 1980
cGMP
Manufacturing
Facility
NAI Annual Report 2014 To Print.indd 2
10/8/14 12:54 PM
Corporate Information
OFFICERS
Mark LeDoux
Chairman and
INVESTOR RELATIONS
Natural Alternatives International, Inc.
1185 Linda Vista Drive
Chief Executive Officer
San Marcos, California 92078 USA
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Ernst & Young LLP
4370 La Jolla Village Drive
E: investor@nai-online.com
Suite 500
www.nai-online.com/investor_relations.html
San Diego, California 92122
Kenneth Wolf
Chief Operating Officer,
Chief Financial Officer
and Secretary
ANNUAL MEETING
CORPORATE COUNSEL
The annual meeting of the stockholders
K & L Gates LLP
BOARD OF DIRECTORS
Wednesday, December 10, 2014 at
will be held at 11:00 a.m. PST on
1 Park Plaza, 12th Floor
Irvine, California 92614
Mark LeDoux
Joe Davis
Alan Dunn
Alan Lane
Lee Weldon
TRADEMARKS
Natural Alternatives International, Inc.
Vista Manufacturing Facility
1215 Park Center Drive
Vista, California 92081
TRANSFER AGENT & REGISTRAR
Computershare, Inc.
211 Quality Circle, Suite 210
College Station, Texas 77845
T: 877-290-2260
www.Computershare.com/investor
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 financial and operating results, including the amount of our future revenue and profits and our
future financial 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, including our major 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 differ materially from any forward-looking statement or cause actual
results and outcomes for future periods to differ materially from any forward-looking statement or views expressed herein. Our financial performance and the forward-
looking statements contained herein are further qualified by other risks including those set forth from time to time in the documents filed by us with the Securities and
Exchange Commission, including our most recent 2014 Annual Report on Form 10-K.
Natural Alternatives International, Inc.
Custom Formulating • Blending • Tablets • Capsules • Enteric Coating • Powders
Pre-Blends • Packaging Solutions Including High Speed Bottling, Packets and Blister Packs
Domestic and International Regulatory Support
1185 Linda Vista Drive • San Marcos, California 92078 USA • T: 760-744-7340 • F: 760-744-9589 • E: info@nai-online.com
CORPORATE HEADQUARTERS
Centro Galleria 1 • Via Cantonale • 6928 Manno • Switzerland • T: 41-91-610-9460 • F: 41-91-610-8470
NAI EUROPE
NAI JAPAN
Yokohama City • Kanagawa-Ku • Japan
1-800-VITAMIN • www.nai-online.com
Fiscal year ended June 30, 2014
Natural Alternatives International, Inc.
Lugano, Switzerland
Dear Shareholder,
This year was a good year in terms of growth and profitability for your firm. We
have seen expansion in both domestic and international demand and grown our client base
and product offerings. We would like to think that one reason we have generated this positive
trajectory is because we have earned a solid reputation as an excellent partner to branded
companies large and small, who want to sleep well at night when it comes to concerns about
the quality of their products!
When I founded this company with my family some 30 plus years ago, I had no
way of envisioning what a dedicated team of talented individuals could produce in terms of a
footprint in this remarkable industry. Today, NAI is recognized as a bona fide leader in
contract manufacturing of dietary supplements, and is well respected by its peers and clients
alike. Furthermore, the regulatory communities around the world respect the attention to
detail that is the hallmark of NAI sponsored presentations, both through the Council for
Responsible Nutrition (International) as well as the venerable Natural Products Association.
In my conversations with members of Congress, both Representatives and
Senators, I have continued to promote the provision of continued resources to the Food and
Drug Administration to ensure the safety of the products offered to consumers worldwide.
However, even after many years of implementation of the Good Manufacturing Practices
under the Dietary Supplement and Health Education Act of 1994 and the new provisions of the
Food Safety Modernization Act, it is disheartening to review the high level of non‐compliance
with the basics of the federal law. By most any measure, the amount of non‐compliance is
above 60% when firms are inspected by the FDA. In most cases, the failures are in the most
fundamental of requirements. This has to change. Individuals and companies that see fit to
break the law by falsely labeling their pharmaceutically tainted products as dietary
supplements need to be prosecuted to the fullest extent of the law. Criminal fines, seizures
and incarceration are warranted and responsible industry is waking up to this fact.
Fiscal Year Ended June 30, 2014
Natural Alternatives International, Inc.
Lugano, Switzerland
In the next year, NAI is going to lend its voice to others to help the agency in its
enforcement activities, because good corporate citizenship mandates this undertaking.
NAI continues to invest in science and research, and continues to secure de‐novo
patents on its CarnoSyn® beta‐alanine materials. With the issuance of new patents on the
sustained release CarnoSyn® and the demonstration of superior effects on elite military and
athlete populations, we maintain high hopes for continued growth in this arena. Many
Olympians who were victorious in the latest series of Olympic contests actively trained with SR
CarnoSyn®!
As I write this letter to you from my desk in Lugano, I am happy to report that we
have started the expansion of our Swiss facility to meet the growth demand from our
customers to produce various powdered supplement, protein and meal‐replacement products.
This expansion, which is set to be completed within the FY15 timeframe, is expected to more
than double the production capacity of our state of the art facilities in Switzerland.
On behalf of the worldwide team of NAI, we appreciate your 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.
Lugano, Switzerland
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, 2014
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 ☒ 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 ☒ 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. ☒ 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). ☒ 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 ☐
Accelerated filer
Smaller reporting company
☐
☒
Indicate by check mark whether NAI is a shell company (as defined in Rule 12b-2 of the Exchange Act): ☐ Yes ☒ 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, 2013) was approximately $30,738,044 (based on the closing sale price of $5.58 reported
by Nasdaq on December 31, 2013). For this purpose, all of NAI’s officers and directors and their affiliates were assumed to be affiliates
of NAI.
As of September 25, 2014, 6,997,754 shares of NAI’s common stock were outstanding, net of 515,923 treasury shares.
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 10, 2014, to be filed on or before October 28, 2014.
This page intentionally left blank
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS ...................................................................
Page
1
TABLE OF CONTENTS
PART I
Item 1. Business .........................................................................................................................................................
Item 1A. Risk Factors ...................................................................................................................................................
Item 2. Properties .......................................................................................................................................................
Item 3. Legal Proceedings ..........................................................................................................................................
Item 4. Mine Safety Disclosures ................................................................................................................................
PART II
Item 5. Market for Our Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ..
Item 6. Selected Financial Data .................................................................................................................................
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.........................
Item 8. Financial Statements and Supplementary Data ..............................................................................................
Item 9. 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 .............................................................................................................................................................
3
12
19
20
22
22
23
24
33
59
59
60
60
60
60
60
60
61
65
(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,” “forecasts,” or “projects,” or the negative or other variation of such words, and similar expressions may identify
a statement as a forward-looking statement. Any statements that refer to projections of our future financial performance,
our anticipated growth and trends in our business, our goals, strategies, focus and plans, and other characterizations of
future events or circumstances, including statements expressing general optimism about future operating results, are
forward-looking statements. Forward-looking statements in this report may include statements about:
•
•
•
•
•
•
•
•
•
•
future financial and operating results, including projections of net sales, revenue, income or loss, net income or
loss per share, profit margins, expenditures, liquidity, and other financial items;
our ability to maintain or increase our royalty and licensing revenues;
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;
the costs associated with defending and resolving potential new claims, even if such claims are without merit;
currency exchange rates, their effect on our results of operations, including amounts that may be reclassified as
earnings, the availability of foreign exchange facilities, our ability to effectively hedge against foreign exchange
risks and the extent to which we may seek to hedge against such risks;
future levels of our revenue concentration risk;
sources and availability of raw materials, including the limited number of suppliers of beta-alanine;
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;
• manufacturing and distribution channels, product sales and performance, and timing of product shipments;
•
•
current or future customer orders, product returns, and potential product recalls;
the impact on our business and results of operations and variations in quarterly net sales from seasonal and
other factors;
• 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, and consolidation strategies, the success of such strategies, and the benefits
we believe can be derived from such strategies;
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, including outside the United States (U.S.);
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;
the adequacy of our reserves and allowances;
the sufficiency of our available cash, cash equivalents, and potential cash flows from operations to fund our
current working capital needs and capital expenditures through the next 12 months;
overall industry and market performance;
competition and competitive advantages;
current and future economic and political conditions;
the impact of accounting pronouncements and our adoption of certain accounting guidance; and
other assumptions described in this report underlying or relating to any forward-looking statements.
The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to
place undue reliance on any such forward-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).
2
PART I
ITEM 1. BUSINESS
General
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 U.S. We also seek to commercialize our patent and trademark estate related to the ingredient
known as beta-alanine through various licensing and similar arrangements.
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.
Additionally, we have historically developed, manufactured and marketed our own branded products under the Pathway to
Healing® product line, which was aimed at restoring, maintaining and improving the health of the users. However, due to
the steady decline in sales of this product line over the prior several years, we decided to discontinue the product line.
Pursuant to the license agreements between NAI and each of Dr. Reginald Cherry and the Cherry Ministries Inc. dated as of
September 1, 2014 as amended (the License Agreements). Dr. Cherry and Cherry Ministries licensed to NAI the name,
likeness, style, persona and other attributes of Dr. Cherry in connection with the sale of nutritional products that were
marketed by NAI under its Pathway to Healing brand. Pursuant to the License Agreements, NAI was permitted to terminate
the License Agreements by written notice at any time. We have notified Dr. Cherry and Cherry Ministries of our decision
to discontinue the product line, and the termination of the related license agreement was effective as of September 15,
2014. We anticipate that all termination activities related to the Pathway to Healing® product line will be complete by the
end of our second quarter of fiscal 2015. We did not change the financial presentation in this report to reflect the branded
products segment as “Discontinued Operations” as the wind down of this product line did not meet the criteria for
discontinued operations presentation as prescribed by the Accounting Standards Codification section 205-20 Presentation
of Financial Statement – Discontinued Operations (ASC 205-20).
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 to thirty six months.
3
Our California facilities also have been awarded GMP registration annually since October 2002 by NSF International
(NSF) through the NSF Dietary Supplements Certification Program 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 October 2013. 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, import, 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 that 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 that
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 2019.
In addition to our operations in the U.S. 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; and
•
improve operational efficiencies and manage costs and business risks to improve profitability.
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.
4
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 available to them,
or 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 individuals 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 current license additionally grants to CSI a license to CSI of certain of our patent rights and 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, 2015.
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. Effective November 27, 2013, citing
further time and cost required to bring its anticipated product to market, Abbott exercised its right to terminate the
Agreement.
Additionally, we have historically developed, manufactured and marketed our own branded products under the Pathway to
Healing® product line, which was aimed at restoring, maintaining and improving the health of the users. However, due to
the steady decline in sales of this product line over the prior several years, we decided to discontinue the product line.
Pursuant to the License Agreements, Dr. Cherry and Cherry Ministries licensed to NAI the name, likeness, style, persona
and other attributes of Dr. Cherry in connection with the sale of nutritional products that were marketed by NAI under its
Pathway to Healing brand. Pursuant to the License Agreements, NAI was permitted to terminate the License Agreements
by written notice at any time. We have notified Dr. Cherry and Cherry Ministries of our decision to discontinue the product
line and the termination of the related license agreement was effective as of September 15, 2014. We anticipate that all
termination activities related to the Pathway to Healing® product line will be complete by the end of our second quarter of
fiscal 2015. We did not change the financial presentation in this report to reflect the branded products segment as
“Discontinued Operations” as the wind down of this product line did not meet the criteria for discontinued operations
presentation as prescribed by ASC 205-20.
We believe our comprehensive approach to customer service is unique within our industry. We believe this comprehensive
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, 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;
5
• 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.
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 ...................................................... $
67,339
5,444
1,159
73,942
91 $
7
2
100 $
56,672
4,799
1,326
62,797
90
8
2
100
2014
2013
$
%
$
%
Research and Development
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 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 $948,000 for 2014 and $1.2
million for 2013. The decrease in research and development expenses was primarily related to lower personnel costs as a
result of changes made to the related departmental management structure.
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 2014, 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 2014. 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
6
this or any other facility will not incur future production interruptions as a result of additional earthquake-related activity or
other causes. Throughout fiscal 2015, 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 2015 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, 2014, NSA accounted for approximately 38% of our private-label contract manufacturing net sales. We
historically have had manufacturing agreements with NSA dating back to 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 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. Our most recent
agreements with NSA expired on April 1, 2014. We are currently negotiating the terms of renewal and expansion of those
agreements with NSA. We continue to develop, manufacture, produce and package certain nutritional products for NSA
based on monthly purchase orders submitted to us by NSA.
Our second largest customer is Mannatech, which accounted for approximately 17% of our private-label contract
manufacturing net sales during fiscal 2014. 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.
Our third largest customer is Shaklee Corporation (Shaklee), which accounted for approximately 16% of our private-label
contract manufacturing net sales during fiscal 2014. We manufacture, produce and bulk package certain nutritional
products for Shaklee based on purchase orders submitted to us by Shaklee, at such prices as are agreed upon from time to
time.
NSA, Mannatech, and Shaklee are private-label contract manufacturing customers, and the loss of any 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 2014. We continue to focus on obtaining new private-label contract
manufacturing customers 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).
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.
7
Our future competitive position for private-label contract manufacturing and patent and trademark licensing 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.
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 vitamins 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;
8
•
•
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 requirements of the DSNDCPA.
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 U.S., 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 U.S. 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 . 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 sixteen foreign trademark registrations. One trademark is registered with the Australian Patent and Trademark
Office, two with the Canadian Patent and Trademark Office, two with the Chinese Patent and Trademark Office, two with
the Trademarks and Designs Registration Office of the European Union, two with the Hong Kong Patent and Trademark
Office, three with the Japanese Patent and Trademark Office, two with the South Korean Patent and Trademark Office, and
two with the Swiss Patent and Trademark Office. We currently have no additional trademark applications pending in any
other jurisdictions outside of the United States. 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.
9
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
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. 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 $5.4 million
in fiscal 2014. We did not directly purchase or sell any material amounts of beta-alanine raw material during fiscal 2013 or
fiscal 2014 and do not expect to directly purchase and sell material quantities of beta-alanine raw material during fiscal
2015. We anticipate our licensing and related revenue to expand further during fiscal 2015. We incurred intellectual
property litigation and patent compliance expenses of approximately $2.2 million during fiscal 2014 in connection with our
efforts to protect our proprietary rights and patent estate. We expect to continue to incur additional litigation expenses
during fiscal 2015, however, we expect these expenses to be lower due to the status of our various patent cases.
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.
However, due to the steady decline in sales of this product line over the prior several years, we decided to discontinue the
product line. We have notified Dr. Cherry and Cherry Ministries of this decision and the termination of the related license
agreement was effective as of September 15, 2014. We anticipate that all termination activities related to the Pathway to
Healing® product line will be complete by the end of our second quarter of fiscal 2015.
Employees
As of June 30, 2014, we employed 171 full-time employees in the U.S., two of whom held executive management
positions. Of the remaining full-time employees, 31 were employed in research, laboratory and quality control, 11 in sales
and marketing, and 127 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, 2014, we had 10 temporary personnel.
As of June 30, 2014, 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 two 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.
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, South Africa and Asia. The primary market outside the U.S. is Europe. Our patent and
trademark licensing activities are primarily based 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.
11
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, 2014, sales to one customer, NSA International, Inc., were
approximately 38% of our total private-label contract manufacturing net sales. Our most recent agreements with NSA
expired on April 1, 2014. We are currently negotiating the terms of renewal and expansion of those agreements with NSA.
We continue to develop, manufacture, produce and package certain nutritional products for NSA based on monthly
purchase orders submitted to us by NSA. There can be no guarantee that NSA will agree to a renewal or replacement
agreement on terms favorable to us or at all. Our second largest customer was Mannatech, Incorporated, which accounted
for approximately 17% of our private-label contract manufacturing net sales during fiscal 2014. Our third largest customer
was Shaklee, which accounted for approximately 16% of our private-label contract manufacturing net sales during fiscal
2014. 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.
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. We may also 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 2014, we incurred approximately $2.2
million in patent litigation and prosecution expense and expect litigation expenses during fiscal 2015 to be approximately
$500,000 to $1.0 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, they 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
12
could have a material adverse effect on our business, results of operations 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 increased during fiscal 2014 as compared to fiscal 2013 but there can be no assurance that our net sales will
continue to 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 positive
net income in fiscal 2015, 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 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 compliance costs or record keeping requirements, 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 renewed 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.
13
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 2014 and fiscal 2013, 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.
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 2014 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 2015. 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, 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 or any other 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.
14
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 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, litigation and settlement 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. or 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 to operate in such markets. 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.
15
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 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.
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 2015 and there is no guarantee that we will be able to extend or renew this credit
line on favorable terms or at all.
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 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 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 this facility. 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
16
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.
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 21% of our
outstanding shares of common stock as of June 30, 2014, 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;
17
•
•
•
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, telecommunications failures, intentional acts of vandalism, and similar events. While we have
established a formal disaster recovery plan, 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;
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.
18
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, 2014. We believe our facilities are adequate to meet our operating
requirements for the foreseeable future.
Location
San Marcos, CA USA ....NAI corporate headquarters and branded products
Nature of Use
Vista, CA USA(1) ............Manufacturing, warehousing, packaging and
operations .....................................................................
distribution(3) ................................................................
Manno, Switzerland(2) ....Manufacturing, warehousing, packaging and
distribution ...................................................................
Square
Feet
How
Held
Lease
Expiration
Date
29,500 Owned
N/A
162,000 Leased
March 2024(4)
87,763(5) Leased
June 2019(5)
(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.
(5) NAIE entered into a new lease with its current landlord effective July 1, 2014. The new lease replaced, extended, and
enlarged an existing lease between the same parties for the same building in Manno Switzerland. NAIE intends to
improve portions of the additional space acquired by the new lease, and will continue to use the entire leased premises
for offices, laboratory, warehouse and production. The new lease has a term of five years with a right for NAIE to
extend the lease for an additional five years.
19
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 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 25, 2014, 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 July 6, 2014, the Court partially stayed the case. NAI, CSI and DNP settled the case, which was dismissed with
prejudice on July 29, 2014. As part of the settlement, DNP agreed to exit the beta-alanine business.
On December 21, 2011, NAI filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division,
alleging infringement by 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 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 no. 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. On September 4, 2013, NAI
moved to have Woodbolt’s counterclaims dismissed from the case. 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. On August 17, 2012, the USPTO accepted the request to
re-exam the ’422 patent. On December 6, 2013, the USPTO rejected the claims of the ‘381 patent and issued a right of
appeal notice. On January 6, 2014, NAI filed its notice of appeal. The parties have filed briefs with the USPTO and the '381
reexamination is pending. On August 8, 2014, the USPTO rejected the claims of the ‘422 patent and issued a right of
appeal notice.
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 formulation,
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. On October 11, 2013, the Court granted co-defendant, USPLabs’ motion to transfer the
case to the U.S. District Court for the Western District of Texas. The Court has set a trial date for March 26, 2015. The
Company moved to dismiss the case. On May 28, 2014, the claims against the Company were dismissed with prejudice.
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 formulation,
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. On May 27, 2014, the claims against the Company were dismissed with prejudice.
On November 1, 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 Reed v. USPLabs, LLC,
Case No. 37-2013-00074052. 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 CSI’s insurance
company. Additionally, the Company has sought indemnification from co-defendant USPLabs. The Company is not
involved in the formulation, manufacture, distribution or sale of the product at issue in the lawsuit. The case has been
removed to U.S. District Court for the Southern District of California. On December 27, 2013, the Company filed a motion
to dismiss the allegations against it. On June 13, 2014, the claims against the Company were dismissed with prejudice.
On November 1, 2013, several entities, including the Company, were sued for various causes of action pertaining to
product liability in U.S. District Court for the Western District of Texas captioned Ogbonna v. USPLabs, LLC, Case No.
13-cv-340. While the Company is named in the caption, the complaint does not contain any specific allegations against the
Company. The Company has been provided with defense counsel by CSI’s insurance company. Additionally, the Company
has sought indemnification from co-defendant USPLabs. The Company is not involved in the formulation, manufacture,
distribution or sale of the product at issue in the lawsuit. The case has been removed to U.S. District Court for the Southern
District of California. On January 28, 2014, the Company filed a motion to dismiss the allegations against it. On February
19, 2014, the Company’s motion to dismiss was granted by the Court.
On January 24, 2014, 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 Little v. USPLabs, LLC, Case No.
BC534065. 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 CSI’s insurance company. Additionally, the
Company has sought indemnification from co-defendant USPLabs. The Company is not involved in the formulation,
manufacture, distribution or sale of the product at issue in the lawsuit. The Company is not involved in the formulation,
manufacture, distribution or sale of the product at issue in the lawsuit. On February 28, 2014, USPLabs filed a Notice of
Removal from the Superior Court for the State of California to the U.S. District Court for the Central District of California.
On March 7, 2014, the Company filed a Motion to Dismiss. On March 17, 2014, plaintiffs filed a Motion to Remand the
case back to Superior Court. On April 25, 2014, the District Court granted plaintiffs’ Motion to Remand based on a lack of
subject matter jurisdiction and therefore also denied the Company’s Motion to Dismiss as moot. On May 27, 2014, the
claims against the Company were dismissed with prejudice.
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.
21
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, 2014 and
2013:
First Quarter ......................................................... $
Second Quarter ..................................................... $
Third Quarter........................................................ $
Fourth Quarter ...................................................... $
5.90 $
6.35 $
5.93 $
5.98 $
4.37 $
4.42 $
4.90 $
5.01 $
7.65 $
6.45 $
5.49 $
5.01 $
4.90
4.01
4.12
4.03
Fiscal 2014
Fiscal 2013
High
Low
High
Low
Holders
As of September 18, 2014, there were approximately 254 stockholders of record of our common stock. On that same date,
the last sales price of our common stock as reported on Nasdaq was $5.61 per share.
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, 2014, we did not sell or otherwise issue any unregistered securities.
Repurchases
During the quarter ended June 30, 2014, we did not repurchase any shares of our common stock as part of our repurchase
plan.
22
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, 2014:
Number of
Shares
to be Issued
Upon
Exercise of
Outstanding
Options,
Warrants,
and Rights
Weighted-
Average
Exercise Price
of Outstanding
Options,
Warrants, and
Rights
Weighted-
Average
Exercise
Price of
Outstanding
Restricted
Stock
Number of
Shares of
Outstanding
Restricted Stock
Number of
Shares
Remaining
Available
for Future
Issuance
Under Equity
Compensation
Plans (Excluding
Shares
Reflected in
Column
(a) and (c))
(a)
(b)
(c)
(d)
(e)
200,019 $
6.93
163,280
N/A
523,682
N/A
200,019 $
N/A
6.93
N/A
163,280
N/A
N/A
N/A
523,682
Plan Category
Equity compensation
plans approved by
stockholders .............
Equity compensation
plans not approved
by stockholders ........
Total ...........................
ITEM 6.
SELECTED FINANCIAL DATA
As a smaller reporting company, we are not required to provide Item 6 disclosure in this Annual Report.
23
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, 2014 and 2013 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 agreements
with our largest customer, NSA expired as of April 1, 2014. We continue to develop, manufacture, produce and package
certain nutritional products for NSA based on monthly purchase orders submitted to us by NSA. We are currently
negotiating the terms of renewal and expansion of those agreements with NSA. 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 sold under our CarnoSyn® trade name.
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
and royalty and license agreements.
We have historically developed, manufactured and marketed our own branded products under the Pathway to Healing®
product line, which was aimed at restoring, maintaining and improving the health of the users. However, due to the steady
decline in sales of this product line over the prior several years, we decided to discontinue the product line. Pursuant to the
License Agreements Dr. Reginald Cherry, and the Cherry Ministries Inc., licensed to NAI the name, likeness, style, persona
and other attributes of Dr. Cherry in connection with the sale of nutritional products that were marketed by NAI under its
Pathway to Healing brand. Pursuant to the License Agreements, NAI was permitted to terminate the License Agreements
by written notice at any time. We have notified Dr. Cherry and Cherry Ministries of this decision and the termination of the
related license agreement was effective as of September 15, 2014. We anticipate that all termination activities related to the
Pathway to Healing® product line will be complete by the end of our second quarter of fiscal 2015. We did not change the
financial presentation in this report to reflect the branded products segment as “Discontinued Operations” as the wind down
of this product line did not meet the criteria for discontinued operations presentation as prescribed by ASC 205-20.
During fiscal 2014, our net sales were 17.7% higher than in fiscal 2013. Private-label contract manufacturing sales
increased 18.8% due primarily to the sale of higher volumes of existing products to existing customers and new product
sales to new customers. This increase was partially offset by 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 55% in fiscal
2014 from 69% for fiscal 2013. We expect our contract manufacturing revenue concentration percentage for our two largest
customers to remain consistent during fiscal 2015.
During fiscal 2014, CarnoSyn® beta-alanine royalty and licensing revenue increased 13.4% to $5.4 million as compared to
$4.7 million for fiscal 2013. We had raw material sales of beta-alanine totaling $103,000 for fiscal 2013 but had zero
during fiscal 2014. As of June 30, 2014, 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 2015.
24
During fiscal 2014, three new beta-alanine patents were issued to NAI; two in Japan and one in the U.S. This new
intellectual property related to a broad range of beta-alanine method and composition claims and included two patents
covering sustained release formulations for beta-alanine. As of June 30, 2014, NAI possessed twenty-six beta-alanine
patents and seven sustained release beta-alanine patents.
To protect our CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses
of approximately $2.2 million during fiscal 2014 and $2.3 million during fiscal 2013. 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 12.6% in fiscal 2014 as compared to fiscal 2013 due to the continued
softening of sales of our Pathway to Healing product line.
During fiscal 2015, 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;
•
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 (a) the seller’s price to the buyer
is substantially fixed or determinable at the date of sale; (b) the buyer has paid the seller, or the buyer is obligated to pay
the seller and the obligation is not contingent on resale of the product; (c) the buyer’s obligation to the seller would not be
changed in the event of theft or physical destruction or damage of the product; (d) the buyer acquiring the product for resale
has economic substance apart from that provided by the seller; (e) the seller does not have significant obligations for future
performance to directly bring about resale of the product by the buyer; and (f) the amount of future returns can be
reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met.
The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from
shipments where title passes upon 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.
25
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® trade name. We have
sold this ingredient to a customer and, since March 2009, we 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. Our latest license agreement further
provides CSI with a license to certain of our patent rights.
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. We have determined that each of the milestone payments
meets the definition of a milestone in accordance with the milestone method of revenue recognition.
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
26
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, the payment noted in (iii) was collected in July 2013 and the payment
noted in (iv) was collected in January 2014.
Effective November 27, 2013, citing further time and cost required to bring its anticipated product to market, Abbott
exercised its right to terminate the Agreement.
We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of
$5.4 million during fiscal 2014 and $4.8 million during fiscal 2013. 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 $722,000 during fiscal 2014 and $604,000 during fiscal
2013.
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 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, 2014 and June 30, 2013, 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. During fiscal 2014, as a result of changes in
California apportionment rules and the state nexus study which was completed during the 3rd quarter of fiscal 2014, we
determined that $193,000 of the deferred tax asset for California net operating losses was not more likely than not to be
27
realized. As a result, we have established a valuation allowance on our net deferred tax assets for this amount. We did not
record any adjustment to the deferred tax asset valuation allowance during fiscal 2013.
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 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, 2014, 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, 2014, the notional amounts of our foreign exchange
contracts were $9.7 million (EUR 7.1 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
28
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 2014.
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, 2014
June 30, 2013
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, net .........................
Income before income taxes ..........
Provision for income taxes ............
Net income .................................... $
67,339
5,444
1,159
73,942
61,204
12,738
9,961
2,777
109
2,668
674
1,994
Fiscal 2014 Compared to Fiscal 2013
91% $
7%
2%
100%
83%
17%
13%
4%
0%
4%
1%
3% $
56,672
4,799
1,326
62,797
50,661
12,136
9,983
2,153
60
2,093
523
1,570
90% $
8%
2%
100%
81%
19%
16%
3%
0%
3%
1%
2% $
10,667
645
(167)
11,145
10,543
602
(22)
624
49
575
151
424
19%
13%
(13)%
18%
21%
5%
(0)%
29%
82%
27%
29%
27%
The percentage increase 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)
1%(2)
24%(3)
19%
1 The decrease in net sales to NSA International, Inc. for fiscal 2014 included a decrease in international sales of 13.3%
and a decline in domestic sales of 9.2%. The decrease in international sales during fiscal 2014 is primarily due to a
customer driven inventory reduction program initiated during the first quarter of 2014, decreased demand by NSA’s
consumers, and lower average EUR exchange rates. NSA’s inventory reduction program was substantially completed
during our second quarter ended December 31, 2013. The domestic decrease is primarily due to lower average sales
prices and lower sales primarily associated with a customer driven packaging reconfiguration that was launched during
the first quarter of 2014. This new packaging configuration was completed as of September 30, 2013.
2 Net sales to Mannatech, Incorporated increased in fiscal 2014 primarily as a result of higher volumes of established
products in existing markets.
3 The increase in net sales to other customers was primarily due to sales of new products for new customers and a net
increase in sales of existing products for other existing customers.
29
Net sales from our patent and trademark licensing segment increased 13% during fiscal 2014. During fiscal 2014, patent
and trademark licensing sales included $5.1 million of royalty income, zero direct beta-alanine raw material sales, and
$300,000 of license fees. 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.
Consolidated gross profit margin decreased 2.1 percentage points during fiscal 2014 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 .............................................................................................................................................
Total .................................................................................................................................................................
Percentage
Change
(2.0)(1)
1.4 (1)
(0.7)(1)
(0.2)(2)
(0.6)(3)
(2.1)
1 Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales decreased 1.3
percentage points during fiscal 2014 as compared to fiscal 2013. 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.
2 During fiscal 2014, patent and trademark licensing gross profit margin as a percentage of net sales decreased 0.2
percentage points due to patent and trademark revenue representing a lower percentage of net sales year over year..
3 Branded products gross profit margin as a percentage of consolidated net sales decreased 0.6 percentage points during
fiscal 2014 due primarily to increased inventory write-downs. The inventory write-downs in fiscal 2014 included
approximately $320,000 of inventory write-downs recorded in connection with our decision to discontinue the Dr.
Cherry product line.
Selling, general and administrative expenses decreased $22,000, or 0.2% during fiscal 2014 as compared to fiscal 2013.
Other net expenses increased $49,000 primarily due to the recognition of non-income tax expense, which included
liabilities related to the current and prior years. This was partially offset by favorable foreign currency translation activity.
Our income tax expense increased $151,000 during fiscal 2014 as compared to fiscal 2013. The increases were attributed to
higher pre-tax income as compared to the comparable prior year periods and the recognition of certain discrete tax items,
which included (1) an expense to adjust the state deferred tax assets as a result of a change in the estimated state tax rate,
(2) an expense to establish a valuation allowance on a portion of the deferred tax asset for the California net operating loss,
(3) a net benefit of state taxes as a result of adjusting California apportionment and filing in other states for prior years, and
(4) a true-up of the R&D credit claimed on the federal income tax return filed in during fiscal 2014.
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 $5.3 million in fiscal 2014 compared
to net cash provided by operating activities of $4.5 million in fiscal 2013.
Net income increased by $424,000 to $2.0 million during fiscal 2014 as compared to net income of $1.6 million in the prior
fiscal year. At June 30, 2014, changes in accounts receivable, consisting primarily of amounts due from our private-label
contract manufacturing customers and our patent and trademark licensing activities, used $268,000 in cash compared to
providing $2.0 million in fiscal 2013. The decrease in cash provided by accounts receivable during fiscal 2014 was
primarily due to the collection of amounts due from sales of beta-alanine raw materials during fiscal 2013 with no such
corresponding activity in fiscal 2014 along with timing of sales year over year. The average number of days our accounts
receivable were outstanding was 33 days during fiscal 2014, as compared to 45 days for fiscal 2013. Changes in income
taxes used $212,000 in cash during fiscal 2014 as compared to providing $184,000 in fiscal 2013. The change in cash flow
activity related to taxes is primarily due to the collection of income tax receivable in fiscal 2013 with no such collections in
fiscal 2014.
30
Increases in inventory used $2.8 million in cash during fiscal 2014 compared to using $1.7 million in fiscal 2013. The
increase in inventory in fiscal 2014 primarily related to the build-up of inventory due to increased demand and the timing of
inventory shipments and receipts.
Approximately $1.6 million of our operating cash flow was generated by NAIE in fiscal 2014. As of June 30, 2014,
NAIE’s undistributed retained earnings of $12.9 million were considered indefinitely reinvested.
Cash used in investing activities in fiscal 2014 was $2.5 million compared to $1.6 million in fiscal 2013. Capital
expenditures were $2.7 million during fiscal 2014 compared to $1.6 million in fiscal 2013. Capital expenditures during
fiscal 2014 and fiscal 2013 were primarily for manufacturing equipment in our Vista, California and Manno, Switzerland
facilities.
At June 30, 2014 and June 30, 2013, 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, 2015; 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 August 15, 2015.
On June 30, 2014, we were in compliance with all of the financial and other covenants required under the Credit
Agreement.
On September 22, 2006, NAIE, our wholly owned subsidiary, entered into a credit facility with Credit Suisse to provide
NAIE with a credit line of up to CHF 1.3 million, or approximately $1.5 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 $179,000. 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 $561,000. As of June 30, 2014, 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 $1,122), 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.
31
As of June 30, 2014, we had $19.5 million in cash and cash equivalents and $5.6 million available under our credit
facilities. Of these amounts, $7.8 million of cash and cash equivalents and $561,000 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, 2014, 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 2013 and 2014, 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 2015 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we are not required to provide Item 7A disclosure in this Annual 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,
2014 and 2013, 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, 2014 and 2013, 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.
San Diego, California
September 25, 2014
/s/ Ernst & Young LLP
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 $94 at June 30,
2014 and $144 at June 30, 2013 ...........................................................................
Inventories, net .........................................................................................................
Deferred income taxes .............................................................................................
Income tax receivable ..............................................................................................
Prepaids and other current assets .............................................................................
Total current assets ...........................................................................................
Property and equipment, net ............................................................................................
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:
2014
2013
19,512 $
16,697
6,835
12,840
344
228
1,144
40,903
8,811
1,593
951
52,258 $
6,418 $
1,565
1,238
379
9,600
183
37
9,820
6,605
10,035
609
160
1,217
35,323
9,205
1,527
585
46,640
3,539
1,130
807
466
5,942
134
225
6,301
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, 2014
and June 30, 2013, issued and outstanding (net of treasury shares) 6,997,754 at
June 30, 2014 and 6,914,555 at June 30, 2013 .....................................................
Additional paid-in capital .........................................................................................
Accumulated other comprehensive loss ...................................................................
Retained earnings .....................................................................................................
Treasury stock, at cost, 515,923 shares at June 30, 2014 and 494,122 at June 30,
2013 .....................................................................................................................
Total stockholders’ equity .................................................................................
Total liabilities and stockholders’ equity .......................................................... $
74
19,865
(469)
25,661
(2,693)
42,438
52,258 $
73
19,662
(430)
23,667
(2,633)
40,339
46,640
See accompanying notes to consolidated financial statements.
34
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 ...................................................................................................
Other, net .......................................................................................................................
Income before income taxes .................................................................................................
Provision for income taxes ...................................................................................................
Net income ........................................................................................................................... $
Change in minimum pension liability, net of tax .................................................................
Unrealized loss 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:
2014
2013
73,942 $
61,204
12,738
9,961
2,777
34
(11)
(29)
(103)
(109)
2,668
674
1,994 $
(20)
(19)
1,955 $
0.29 $
0.29 $
62,797
50,661
12,136
9,983
2,153
45
(19)
(86)
—
(60)
2,093
523
1,570
(95)
(434)
1,041
0.23
0.23
Basic ..............................................................................................................................
Diluted ..........................................................................................................................
6,820,466
6,864,216
6,869,224
6,884,966
See accompanying notes to consolidated financial statements.
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
7,300,677 $
72 $
19,530 $
22,097
361,990 $
(1,930 ) $
Accumulated
Other
Comprehensive
Income (Loss)
Total
99 $
39,868
Balance, June 30, 2012 .........................
Issuance of common stock for stock
option exercises .................................
10,000
Issuance of common stock for
restricted stock grants........................
98,000
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 ............................................
Balance, June 30, 2013 .........................
Issuance of common stock for
—
—
—
—
—
—
7,408,677
restricted stock grants........................
105,000
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 ............................................
Balance, June 30, 2014 .........................
—
—
—
—
—
—
7,513,677 $
—
1
—
—
—
—
—
—
73
1
—
—
—
—
—
—
74 $
37
(1)
202
—
(106)
—
—
—
—
—
—
—
—
—
—
132,132
—
—
—
—
(703 )
—
—
—
—
—
19,662
—
1,570
23,667
—
—
494,122
—
—
(2,633 )
(1)
235
—
(31)
—
—
—
—
—
—
—
—
21,801
—
—
—
—
(60 )
—
—
—
—
—
—
—
(95)
(434)
—
(430)
—
—
—
—
(20)
37
—
202
(703)
(106)
(95)
(434)
1,570
40,339
—
235
(60)
(31)
(20)
—
—
19,865 $
—
1,994
25,661
—
—
515,923 $
—
—
(2,693 ) $
(19)
—
(469) $
(19)
1,994
42,438
See accompanying notes to consolidated financial statements.
36
Natural Alternatives International, Inc.
Consolidated Statements Of Cash Flows
For the Years Ended June 30
(in thousands)
2014
2013
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 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 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.
1,994 $
38
2,905
199
235
70
(23)
(268)
(2,805)
(329)
3,112
(212)
431
5,347
(2,679)
207
(2,472)
—
(60)
(60)
2,815
16,697
19,512 $
718 $
13 $
20 $
19 $
41 $
1,570
114
3,036
34
202
65
(9)
2,032
(1,680)
298
(852)
184
(524)
4,470
(1,621)
36
(1,585)
37
(703)
(666)
2,219
14,478
16,697
335
13
95
434
25
37
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.
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 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 our prior years’ consolidated financial statements have been reclassified to conform
with the current year presentation. The reclassification relates to the classification of certain operating expenses from our
NAIE operations previously classified as cost of goods sold, which are now being classified as part of selling, general &
administrative expenses. This reclassification was made to reflect the change in operational activity of NAIE, which has
historically been primarily a manufacturing specific operation but is now transitioning to perform additional selling and
administrative functions. The reclassified amount relating to fiscal 2013 totaled $386,000. This reclassification had no
effect on previously reported total assets, stockholders’ equity, or net income.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (the FASB) issued guidance on the presentation of an
unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This
amendment to previous income tax guidance clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax
benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss
carryforward, a similar tax loss, or a tax credit carryforward if such settlement is required or expected in the event the
uncertain tax benefit is disallowed. In situations where a net operating loss carryforward, a similar tax loss, or a tax credit
carryforward is not available at the reporting date under the tax law of the applicable jurisdiction or the tax law of the
jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized
tax benefit should be presented in the financial statements as a liability and should not be netted with the deferred tax asset.
These amendments are effective for fiscal years, and interim periods within those years, beginning after December 15,
2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that
exist at the effective date. Retrospective application is permitted. We adopted Accounting Standard Update 2013-11 during
our third quarter of fiscal 2014 and there was not significant impact to our consolidated financial statements as a result of
our adoption of this amendment.
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers
(Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. ASU 2014-09 is
based on principles that govern the recognition of revenue at an amount an entity expects to be entitled when products are
transferred to customers. ASU 2014-09 will be effective for us beginning in our first quarter of fiscal 2018. Early adoption
is not permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively
with the cumulative effect recognized as of the date of adoption. We are currently evaluating the impact of adopting the
38
new revenue standard on its consolidated financial statements and whether it will be adopted retrospectively to each period
presented or with the cumulative effect as of the date of adoption.
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, 2014 and June 30, 2013, 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, 2014 was a net liability of $24,000 and the value as of June 30, 2013 was a
net asset of $95,000. 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, 2014 and June 30, 2013, 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 2014.
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.
39
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 2014 or fiscal 2013.
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.
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, 2014, 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, 2014, the notional amounts of our foreign exchange
contracts were $9.7 million (EUR 7.1 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 (a) the seller’s price to the buyer
is substantially fixed or determinable at the date of sale; (b) the buyer has paid the seller, or the buyer is obligated to pay
the seller and the obligation is not contingent on resale of the product; (c) the buyer’s obligation to the seller would not be
changed in the event of theft or physical destruction or damage of the product; (d) the buyer acquiring the product for resale
has economic substance apart from that provided by the seller; (e) the seller does not have significant obligations for future
performance to directly bring about resale of the product by the buyer; and (f) the amount of future returns can be
reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met.
The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from
shipments where title passes upon delivery is deferred until the shipment has been delivered.
40
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® trade name. We have
sold this ingredient to a customer and, since March 2009, we 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. Our latest license agreement further
provides CSI with a license to certain of our patent rights.
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. We have determined that each of the milestone payments
meets the definition of a milestone in accordance with the milestone method of revenue recognition.
41
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, the payment noted in (iii) was collected in July 2013 and the payment
noted in (iv) was collected in January 2014.
Effective November 27, 2013, citing further time and cost required to bring its anticipated product to market, Abbott
exercised its right to terminate the Agreement.
We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of
$5.4 million during fiscal 2014 and $4.8 million during fiscal 2013. 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 $722,000 during fiscal 2014 and $604,000 during fiscal
2013.
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 $948,000 for 2014 and $1.2 million for 2013. 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 $131,000 during the fiscal year ended June 30, 2014 and $215,000 during fiscal 2013.
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 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.
42
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, 2014 and June 30, 2013, 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 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. During fiscal 2014, as a result of changes in
California apportionment rules and the state nexus study which was completed during the 3rd quarter of fiscal 2014, we
determined that $193,000 of the deferred tax asset for California net operating losses was not more likely than not to be
realized. As a result, we have established a valuation allowance on our net deferred tax assets for this amount. We did not
record any adjustment to the net deferred tax asset valuation allowance during fiscal 2013.
We are subject to taxation in the U.S., Switzerland and various state jurisdictions. Our tax years for the fiscal year ended
June 30, 2009 and forward are subject to examination by the U.S. tax authorities and our years for the fiscal year ended
June 30, 2007 and forward are subject to examination by the state tax authorities. Our tax years for the fiscal year ended
June 30, 2013 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.
The Company did not grant any options during fiscal 2014 or 2013.
We did not have any options exercised during fiscal 2014. The aggregate intrinsic value of option awards exercised was
$24,500 during fiscal 2013. All remaining outstanding stock options are fully vested and all related compensation cost was
fully recognized at June 30, 2014. The total fair value of options vested during the fiscal year ended June 30, 2014 was
$121,000. The total fair value of options vested during the fiscal year ended June 30, 2013 was $148,000.
43
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. During the three months ended September 30, 2013,
10,000 of these shares were forfeited due to the termination of employment of one of the grantees. On March 7, 2014 we
granted 105,000 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. These restricted stock grants will vest over three years
and 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 29,720 vested restricted stock shares as of June 30, 2014 and there
no vested restricted stock shares as of June 30, 2013. The total remaining unrecognized compensation cost related to
unvested restricted stock shares amounted to $757,000 at June 30, 2014 and the weighted average remaining requisite
service period of unvested restricted stock shares was 2.3 years. The weighted average fair value of restricted stock shares
granted during fiscal 2014 was $5.56. The weighted average fair value of restricted stock shares granted during fiscal 2013
was $4.74.
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):
For the Years Ended June 30,
2014
2013
Numerator
Net income ................................................................................................................... $
Denominator
Basic weighted average common shares outstanding ..................................................
Dilutive effect of stock options and restricted stock shares .........................................
Diluted weighted average common shares outstanding ...............................................
Basic net income per common share ............................................................................ $
Diluted net income per common share ......................................................................... $
1,994 $
6,820
44
6,864
0.29 $
0.29 $
1,570
6,869
16
6,885
0.23
0.23
Shares related to 268,000 stock options for the fiscal year ended June 30, 2014 and 429,000 for fiscal 2013, were excluded
from the calculation of diluted net income per common share, as the effect of their inclusion would be anti-dilutive.
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
26.9% of gross accounts receivable at June 30, 2014 and 44.3% at June 30, 2013. Additionally, royalty amounts due from
CSI represented 23.6% of gross accounts receivable at June 30, 2014 and 20.6% at June 30, 2013. Concentrations of credit
risk related to the remaining accounts receivable balances are limited due to the number of customers comprising our
remaining customer base.
44
B. Inventories
Inventories, net, consisted of the following at June 30 (in thousands):
Raw materials ............................................................................................................. $
Work in progress ........................................................................................................
Finished goods ...........................................................................................................
Reserve .......................................................................................................................
$
9,764 $
2,176
1,621
(721)
12,840 $
6,516
1,576
2,358
(415)
10,035
2014
2013
C. Property and Equipment
Property and equipment consisted of the following at June 30 (dollars in thousands):
Depreciable
Life
In Years
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 ...............................................................
NA $
7 – 39
3 – 12
3 – 5
3
1 – 15
$
2014
2013
393 $
2,793
26,772
3,189
209
10,949
44,305
(35,494)
8,811 $
393
2,793
26,141
3,030
136
10,771
43,264
(34,059)
9,205
D. Other comprehensive loss
Other comprehensive (loss) income consisted of the following at June 30 (dollars in thousands):
Twelve Months Ended June 30, 2014
Unrealized
Losses on Cash
Flow Hedges
Total
Defined Benefit
Pension Plan
Balance as of June 30, 2013 ............................................................... $
(482) $
52 $
Other comprehensive loss before reclassifications .............................
Amounts reclassified from OCI .........................................................
Tax effect of OCI activity ..................................................................
Other comprehensive loss ..................................................................
Balance as of June 30, 2014 ............................................................... $
31
(10)
(41)
(20)
(502) $
(488)
454
15
(19)
33 $
(430)
(457)
444
(26)
(39)
(469)
E. 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
45
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, 2015; 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 August 15, 2015.
On June 30, 2014, we were in compliance with all of the financial and other covenants required under the Credit
Agreement.
On September 22, 2006, NAIE, our wholly owned subsidiary, entered into a credit facility with Credit Suisse to provide
NAIE with a credit line of up to CHF 1.3 million, or approximately $1.5 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 $179,000. 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 $561,000. As of June 30, 2014, 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 $1,122), 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, 2014. As of June 30, 2014, we had $5.6 million available under our credit facilities.
F. Income Taxes
During fiscal 2014 we recognized certain discrete items as part of our income tax calculations. These discrete items
included (1) an expense to adjust the state deferred tax assets as a result of a change in the estimated state tax rate, (2) an
expense to establish a valuation allowance on a portion of the deferred tax asset for the California net operating loss, (3) a
net benefit of state taxes as a result of adjusting California apportionment and filing in other states for prior years, and (4) a
true-up of the R&D credit claimed on the federal income tax return filed in the current quarter.
In addition, during fiscal 2014, as a result of changes in California apportionment rules and the state nexus study which was
completed during the year, we determined that $193,000 of the deferred tax asset for California net operating losses was
not more likely than not to be realized. As a result, we have established a valuation allowance on our net deferred tax
assets for this amount.
46
The provision for income taxes for the years ended June 30 consisted of the following (in thousands):
2014
2013
Current:
Federal .............................................................................................................. $
State ..................................................................................................................
Foreign ..............................................................................................................
Deferred:
Federal ..............................................................................................................
State ..................................................................................................................
Valuation allowance .........................................................................................
Provision for income taxes ....................................................................................... $
559 $
(370)
343
532
(264)
213
193
142
674 $
Net deferred tax assets and deferred tax liabilities as of June 30 were as follows (in thousands):
2014
2013
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 ...............................................................................................
Valuation allowance ..................................................................................................
Net deferred tax assets .............................................................................................. $
28 $
101
51
234
157
238
106
13
911
458
2,297 $
(157)
(10)
(167)
(193)
1,937 $
(24)
(4)
271
243
218
62
—
280
523
49
108
4
136
126
279
150
89
846
525
2,312
(151)
(25)
(176)
—
2,136
At June 30, 2014, we had state tax net operating loss carry forwards of approximately $7.8 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 2021, 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, 2014 and June 30, 2013.
NAIE’s effective tax rate for Swiss federal, cantonal and communal taxes is approximately 18.2%. NAIE had net income of
$1.5 million for the fiscal year ended June 30, 2014. Undistributed earnings of NAIE amounted to approximately $12.9
million at June 30, 2014. These earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S.
federal taxes has been provided thereon.
47
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):
2014
2013
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 ...................................................................................
Adjust state deferred due to change in apportionment ...................................................
State tax planning – net savings .....................................................................................
Change in valuation allowance ......................................................................................
Other, net ........................................................................................................................
Income tax provision as reported ................................................................................... $
Effective tax rate ............................................................................................................
913 $
(35)
19
(297)
(41)
195
(239)
193
(34)
674 $
25.1%
711
41
39
(264)
(4)
—
—
—
—
523
25.0%
G. 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 $184,000 for
fiscal 2014 and $189,000 for fiscal 2013.
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 $956,000 for the fiscal year ended June 30,
2014 and $937,000 for fiscal 2013.
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.
48
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):
2014
2013
Change in Benefit Obligation .............................................................................................
Benefit obligation at beginning of year .............................................................................. $
Interest cost ........................................................................................................................
Actuarial 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 ..................................................................................................... $
1,796 $
80
165
(140)
1,901 $
1,662 $
226
(140)
(29)
1,719 $
(182) $
679
497 $
1,901 $
1,901 $
1,719 $
1,593
79
286
(162)
1,796
1,682
142
(162)
—
1,662
(134)
700
566
1,796
1,796
1,662
The weighted-average discount rate used for determining the projected benefit obligations for the defined benefit pension
plan was 4.3% during the year ended June 30, 2014 and 4.8% for the year ended June 30, 2013.
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 .............................................................................................. $
2014
2013
80 $
(105)
46
49
70 $
79
(107)
28
65
65
We do not expect to make any contribution to our defined benefit pension plan in fiscal 2015.
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 ..............................................................................................
Plan expenses ..............................................................................................................
Total recognized in other comprehensive (loss) income ................................................... $
Total recognized in net periodic benefit cost and other comprehensive income ................ $
2014
2013
45 $
(50)
(46)
29
(22) $
48 $
251
(65)
(28)
—
158
223
49
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 $8,000. We do not have any transition obligations or prior
service costs recorded in accumulated other comprehensive income.
The following benefit payments are expected to be paid (in thousands):
2015 .....................................................................................................................................................................$
2016 .....................................................................................................................................................................
2017 .....................................................................................................................................................................
2018 .....................................................................................................................................................................
2019 .....................................................................................................................................................................
2020-2024 ............................................................................................................................................................
$
14
28
35
67
86
704
934
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 ...............................................................................
2014
2013
4.80%
7.00%
N/A
5.50%
7.00%
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 ............................................................
2014
2013
Target
Allocation
49%
45%
—
6%
100%
48%
46%
—
6%
100%
48%
47%
2%
3%
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.
50
The fair values by asset category of our defined benefit pension plan at June 30, 2014 were as follows (in thousands):
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Total
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Cash and money market funds .............................. $
Equity securities(1) ................................................. $
Debt securities(2) ................................................... $
Total ............................................................... $
101 $
850 $
768 $
1,719 $
101 $
850 $
768 $
1,719 $
— $
— $
— $
— $
—
—
—
—
(1) This category is comprised of publicly traded funds, of which 70% are large-cap funds, 4% are mid-cap funds, 6% are
emerging markets equity funds, and 20% are international equity funds.
(2) This category is comprised of publicly traded funds, of which 17% are short-term fixed income funds, 3% are high-
yield fixed income funds, 53% are intermediate fixed income funds, 23% are REITs and MLPs funds, and 4% are
international/emerging markets funds.
H. 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, 2013, we purchased 132,132 shares at a
weighted average cost of $5.32 per share and a total cost of $703,000, including commissions and fees. During the twelve
months ended June 30, 2014, we purchased 5,100 shares at a weighted average cost of $4.55 per share and a total cost of
$23,000 including commissions and fees.
During fiscal 2014 we acquired 6,701 shares from employees in connection with restricted stock shares that vested during
the year. These shares were returned to the Company by the related employees and in return the Company paid each
employee’s required tax withholding. The valuation of the shares acquired and thereby the amount of shares returned to the
Company was calculated based on the closing share price on the date the shares vested.
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, 2014, a total of 900,000 shares of common stock were reserved under the 2009 Plan for
issuance to our employees, non-employee directors and consultants.
51
Stock option activity for the year ended June 30, 2014 was as follows:
Weighted
Average
Exercise
Price
Weighted
Average
Contractual
Term
(in years)
Aggregate
Intrinsic
Value
1999
Plan
Outstanding at June 30, 2013 .................................................
Exercised .........................................................................
Forfeited ..........................................................................
Granted ............................................................................
Outstanding at June 30, 2014 .................................................
Vested and exercisable at June 30, 2014 ................................
Available for grant at June 30, 2014 ......................................
160,000 $
—
(150,000) $
— $
10,000 $
10,000 $
—
7.73
—
7.57
—
10.19
10.19
0.31 $
0.31 $
—
—
Weighted
Average
Exercise
Price
Weighted
Average
Contractual
Term
(in years)
Aggregate
Intrinsic
Value
6.87
—
7.50
—
6.76
6.76
Number of
Shares
5.43 $
5.43 $
70,000
70,000
Weighted
Average Grant
Date Fair Value
4.74
5.56
4.76
4.53
5.28
98,000 $
105,000 $
(29,720 ) $
(10,000 ) $
163,280 $
Outstanding at June 30, 2013 ................................................
Exercised ........................................................................
Forfeited .........................................................................
Granted ...........................................................................
Outstanding at June 30, 2014 ................................................
Vested and exercisable at June 30, 2014 ...............................
2009
Plan
223,350 $
— $
(33,331) $
— $
190,019 $
190,019 $
Restricted stock activity for the year ended June 30, 2014 was as follows (2009 Plan):
Nonvested at June 30, 2013 ...........................................................................................
Granted ...................................................................................................................
Vested .....................................................................................................................
Forfeited ..................................................................................................................
Nonvested at June 30, 2014 ...........................................................................................
As of June 30, 2014, there were 523,682 shares available for grant under the 2009 Plan.
52
I. 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 87,763 square feet. We primarily
use the facilities for manufacturing, packaging, warehousing and distributing nutritional supplement products for the
European marketplace. Effective July 1, 2014, NAIE entered into a new lease with its current landlord. The new lease
replaced, extended, and enlarged an existing lease between the same parties for the same building in Manno Switzerland.
NAIE intends to improve portions of the additional space acquired by the new lease, and will continue to use the entire
leased premises for offices, laboratory, warehouse and production. The new lease has a term of five years with a right for
NAIE to extend the lease for an additional five years. The initial five year term expires on June 30, 2019.
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, 2014 (in thousands):
2015
Gross minimum rental commitments ...... $ 3,017 $
2016
2017
2018 2019
Thereafter Total
2,935 $
2,854 $
2,886 $ 2,920 $
6,937 $ 21,549
Rental expense totaled $2.3 million for the fiscal year ended June 30, 2014 and $2.2 million for fiscal 2013.
J. 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 ......................................................................
Customer 3 ......................................................................
$
Net Sales by
Customer
25,252
11,256
10,960
47,468
% of Total
Net Sales
Net Sales by
Customer
% of Total
Net Sales
38% $
17%
16%
71% $
28,404
10,638
(a)
39,042
50%
19%
(a)
69%
2014
2013
(a) Sales were less than 10% of the respective period’s total private label contract manufacturing net sales
Accounts receivable from these customers totaled $3.1 million at June 30, 2014 and $3.0 million at June 30, 2013.
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 2014 and 2013, we did not
have any suppliers that individually represented greater than 10% of our raw material purchases.
K. 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.
53
During the year ended June 30, 2014 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 2015. 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, 2014, 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, 2014, the notional amounts of our foreign exchange contracts were $9.7 million (EUR 7.1 million). As of
June 30, 2014, a net gain of approximately $28,000, offset by $10,000 of deferred taxes, related to derivative instruments
designated as cash flow hedges was recorded in OCI. 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. It is
expected that $24,000 of the gross gain, as of June 30, 2014, will be reclassified into earnings in the next 12 months along
with the earnings effects of the related forecasted transactions.
As of June 30, 2014, $46,000 of the fair value of our cash flow hedges was classified in prepaids and other current assets,
$4,000 was classified in other non-current assets, net and $74,000 was classified in accrued liabilities in our Consolidated
Balance Sheets. During the year ended June 30, 2014, we recognized $508,000 of losses in OCI and reclassified $474,000
of losses from OCI to revenue. 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.
L. Contingencies
From time to time, we become involved in various investigations, claims and legal proceedings that arise in the ordinary
course of our business. These matters may relate to product liability, employment, intellectual property, tax, regulation,
contract or other matters. The resolution of these matters as they arise will be subject to various uncertainties and, even if
such claims are without merit, could result in the expenditure of significant financial and managerial resources. While
unfavorable outcomes are possible, based on available information, we generally do not believe the resolution of these
matters will result in a material adverse effect on our business, consolidated financial condition, or results of 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 July 6, 2014, the Court partially stayed the case. NAI, CSI and DNP settled the case, which was dismissed with
prejudice on July 29, 2014. As part of the settlement, DNP agreed to exit the beta-alanine business.
On December 21, 2011, NAI filed a lawsuit in the U.S. District Court for the Southern District of Texas, Houston Division,
alleging infringement by 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 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
54
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 no. 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. On September 4,
2013, NAI moved to have Woodbolt’s counterclaims dismissed from the case. 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-examine the ’381 patent. On August 17, 2012, the USPTO accepted the
request to re-exam the ’422 patent. On December 6, 2013, the USPTO rejected the claims of the ‘381 patent and issued a
right of appeal notice. On January 6, 2014, the Company filed its notice of appeal. The parties have filed briefs with the
USPTO and the '381 reexamination is pending. On August 8, 2014, the USPTO rejected the claims of the ‘422 patent and
issued a right of appeal notice.
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 CSI’s insurance company. Additionally, the
Company has sought indemnification from co-defendant USPLabs, LLC. The Company is not involved in the formulation,
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. On October 11, 2013, the Court granted a motion by co-defendant, USPLabs’, to transfer
the case to the U.S. District Court for the Western District of Texas. The Court has set a trial date for March 26, 2015. The
Company moved to dismiss the case. On May 28, 2014, the claims against the Company were dismissed with prejudice.
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 CSI’s insurance company. Additionally, the
Company has sought indemnification from co-defendant USPLabs. The Company is not involved in the formulation,
manufacture, distribution or sale of the product at issue in the lawsuit. On June 28, 2013, the Company filed a demurrer
seeking dismissal of the allegations against it. On May 27, 2014, the claims against the Company were dismissed with
prejudice.
On November 1, 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 Reed v. USPLabs, LLC,
Case No. 37-2013-00074052. 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 CSI’s insurance
company. Additionally, the Company has sought indemnification from co-defendant USPLabs. The Company is not
involved in the formulation, manufacture, distribution or sale of the product at issue in the lawsuit. The case has been
removed to U.S. District Court for the Southern District of California. On December 27, 2013, the Company filed a motion
to dismiss the allegations against it. On June 13, 2014, the claims against the Company were dismissed with prejudice.
55
On November 1, 2013, several entities, including the Company, were sued for various causes of action pertaining to
product liability in U.S. District Court for the Western District of Texas captioned Ogbonna v. USPLabs, LLC, Case No.
13-cv-340. While the Company is named in the caption, the complaint does not contain any specific allegations against the
Company. The Company has been provided with defense counsel by CSI’s insurance company. Additionally, the Company
has sought indemnification from co-defendant USPLabs. The Company is not involved in the formulation, manufacture,
distribution or sale of the product at issue in the lawsuit. The case has been removed to U.S. District Court for the Southern
District of California. On January 28, 2014, the Company filed a motion to dismiss the allegations against it. On February
19, 2014, the Company’s motion to dismiss was granted by the Court.
On January 24, 2014, 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 Little v. USPLabs, LLC, Case No.
BC534065. 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 CSI’s insurance company. Additionally, the
Company has sought indemnification from co-defendant USPLabs. The Company is not involved in the formulation,
manufacture, distribution or sale of the product at issue in the lawsuit. The Company is not involved in the formulation,
manufacture, distribution or sale of the product at issue in the lawsuit. On February 28, 2014, USPLabs filed a Notice of
Removal from the Superior Court for the State of California to the U.S. District Court for the Central District of California.
On March 7, 2014, the Company filed a Motion to Dismiss. On March 17, 2014, plaintiffs filed a Motion to Remand the
case back to Superior Court. On April 25, 2014, the District Court granted plaintiffs’ Motion to Remand based on a lack of
subject matter jurisdiction and therefore also denied the Company’s Motion to Dismiss as moot. On May 27, 2014, the
claims against the Company were dismissed with prejudice.
M. 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, and (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.
Due to the steady decline in sales of our Pathway to Healing® product line over the prior several years, we decided to
discontinue the product line. Pursuant to the License Agreements, Dr. Cherry and Cherry Ministries licensed to NAI the
name, likeness, style, persona and other attributes of Dr. Cherry in connection with the sale of nutritional products that
were marketed by NAI under its Pathway to Healing brand. Pursuant to the License Agreements, NAI was permitted to
terminate the License Agreements by written notice at any time. We have notified Dr. Cherry and Cherry Ministries of our
decision to discontinue the product line and the termination of the related license agreement was effective as of September
15, 2014. We anticipate that all termination activities related to the Pathway to Healing® product line will be complete by
the end of our second quarter of fiscal 2015. We did not change the financial presentation in this report to reflect the
branded products segment as “Discontinued Operations” as the wind down of this product line did not meet the criteria for
discontinued operations presentation as prescribed by ASC 205-20.
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 ................................................................................................
$
67,339 $
5,444
1,159
73,942 $
56,672
4,799
1,326
62,797
2014
2013
Operating Income
Private-label contract manufacturing .................................................................. $
Patent and trademark licensing ...........................................................................
Branded products ................................................................................................
Income from operations of reportable segments .................................................
Corporate expenses not allocated to segments ....................................................
$
5,559 $
2,281
(235)
7,605
(4,828)
2,777 $
5,137
1,519
67
6,723
(4,570)
2,153
2014
2013
Total Assets
Private-label contract manufacturing .................................................................. $
Patent and trademark licensing ...........................................................................
Branded products ................................................................................................
$
50,424 $
1,632
202
52,258 $
45,032
1,388
220
46,640
2014
2013
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, South Africa 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 .................................................................................................... $
2014
2013
38,729 $
35,213
73,942 $
36,710
26,087
62,797
Products manufactured by NAIE accounted for 57% of net sales in markets outside the U.S. in fiscal 2014 and 67% in
fiscal 2013. No products manufactured by NAIE were sold in the U.S. during the fiscal years ended June 30, 2014 and
2013.
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):
2014
United States ............................................................................... $
Europe .........................................................................................
$
Long-Lived
Assets
Total
Assets
Capital
Expenditures
6,648 $
2,163
8,811 $
36,618 $
15,640
52,258 $
2,297
382
2,679
2013
United States ............................................................................... $
Europe .........................................................................................
$
Long-Lived
Assets
Total
Assets
Capital
Expenditures
6,728 $
2,477
9,205 $
32,450 $
14,190
46,640 $
838
783
1,621
57
N. Subsequent Events
On July 7, 2014, we purchased twelve forward contracts designated and effective as cash flow hedges to protect against the
foreign currency exchange risk inherent in a portion of our forecasted sales transactions denominated in Euros. The twelve
contracts expire monthly beginning September 2014 and ending August 2015. The forward contracts had a notional amount
of 10.2 million Euros and a weighted average forward rate of $1.36.
58
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, 2014. 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, 2014.
(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,
2014. 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.
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, 2014 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, 2014 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, 2014 that
have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
59
ITEM 9B. OTHER INFORMATION
None.
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 10, 2014, to be filed on or before October 28,
2014.
PART III
60
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, 2014 and 2013;
• Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2014
and 2013;
• Consolidated Statements of Stockholders’ Equity for the years ended June 30, 2014 and 2013;
• Consolidated Statements of Cash Flows for the years ended June 30, 2014 and 2013; and
• Notes to Consolidated Financial Statements.
61
(2) Exhibits. The following exhibit index shows those exhibits filed with this report and those incorporated by
reference:
Exhibit
Number
Description
EXHIBIT INDEX
Incorporated By Reference To
3(i)
3(ii)
Amended and Restated Certificate of Incorporation of Natural
Alternatives International, Inc. filed with the Delaware
Secretary of State on January 14, 2005
Amended and Restated By-laws of Natural Alternatives
International, Inc. dated as of February 9, 2009
4(i)
Form of NAI’s Common Stock Certificate
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
Exhibit 3(ii) of NAI’s Current Report on Form 8-K dated
February 9, 2009, filed with the commission on February 13,
2009
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
10.8
1999 Omnibus Equity Incentive Plan as adopted effective May
10, 1999, amended effective January 30, 2004, and further
amended effective December 3, 2004*
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 10.1 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
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.
Lease of Facilities in Vista, California between NAI and
Calwest Industrial Properties, LLC, a California limited liability
company (lease reference date June 12, 2003)
Form of Indemnification Agreement entered into between NAI
and each of its directors
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
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
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
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
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
10.9
2009 Omnibus Incentive Plan*
Exhibit D of NAI’s definitive Proxy Statement filed with the
10.10 Manufacturing Agreement by and between NSA, Inc. and NAI
Exhibit 10.43 of NAI’s Quarterly Report on Form 10-Q for
commission on October 16, 2009
dated April 1, 2005
the quarterly period ended December 31, 2009, filed with the
commission on February 16, 2010
10.11 Manufacturing Agreement by and between Mannatech, Inc. and
Exhibit 10.44 of NAI’s Quarterly Report on Form 10-Q for
NAI dated April 22, 1998
10.12
First Amendment to Manufacturing Agreement by and between
Mannatech, Incorporated and NAI dated May 23, 2003
10.13
Second Amendment to Manufacturing Agreement by and
between Mannatech, Incorporated and NAI dated July 1, 2003
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
10.14
10.15
Third Amendment to Manufacturing Agreement by and between
Mannatech, Incorporated and NAI dated July 1, 2004
Fourth Amendment to Manufacturing Agreement by and among
Mannatech, Incorporated, Mannatech Swiss International GmbH
and NAI dated January 1, 2008
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
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
62
10.16 Manufacturing Sales Agreement by and between Mannatech,
Exhibit 10.49 of NAI’s Quarterly Report on Form 10-Q for
Incorporated and NAI dated November 19, 2004
the quarterly period ended December 31, 2009, filed with the
commission on February 16, 2010
10.17 Amendment to Manufacturing Sales Agreement by and among
Exhibit 10.50 of NAI’s Quarterly Report on Form 10-Q for
10.18
Mannatech, Incorporated, Mannatech Swiss International GmbH
and NAI dated January 1, 2008
Exclusive Manufacturing Agreement by and between NSA, Inc.,
NAI and NAIE dated as of April 1, 2005
10.19 Amended and Restated Employment Agreement dated as of
August 31, 2010, by and between NAI and Mark A. LeDoux*
10.20 Amended and Restated Employment Agreement dated as of
August 31, 2010, by and between NAI and Kenneth E. Wolf
License and Fee Agreement effective November 10, 2010 by
and among Roger Harris, Mark Dunnett, Kenny Johansson and
NAI
Credit Agreement by and between NAI and Wells Fargo Bank,
N.A. effective as of December 1, 2010
the quarterly period ended December 31, 2009, filed with the
commission on February 16, 2010
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
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
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)
First Amendment to Credit Agreement by and between NAI and
Wells Fargo Bank, N.A. effective as of November 28, 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
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
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.
Second Amendment to Credit Agreement by and between NAI
and Wells Fargo Bank, N.A. effective as of December 7, 2012
Exhibit 10.2 of NAI’s Current Report on Form 8-K dated
December 27, 2011, filed with the commission on December
30, 2011
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 10.38 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
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
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*
Third Amendment to Credit Agreement by and between NAI
and Wells Fargo Bank, N.A. effective as of November 1, 2013
Revolving Line of Credit Note made by NAI for the benefit of
Wells Fargo Bank, N.A. dated November 1, 2013 in the amount
of $5,000,000
Third amendment to the Amended and Restated Employment
Agreement, by and between NAI and Mark A. LeDoux,
effective July 7, 2014*
Third amendment to the Amended and Restated Employment
Agreement, by and between and Kenneth E. Wolf, effective July
7, 2014*
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
Exhibit 10.40 of NAI’s Annual Report on Form 10-K for the
fiscal year ended June 30, 2013, filed with the commission on
September 19, 2013
Exhibit 10.41 of NAI’s Annual Report on Form 10-K for the
fiscal year ended June 30, 2013, filed with the commission on
September 19, 2013
Exhibit 10.42 of NAI’s Annual Report on Form 10-K for the
fiscal year ended June 30, 2013, filed with the commission on
September 19, 2013
Exhibit 10.43 of NAI’s Quarterly Report on Form 10-Q for
the quarterly period ended December 31, 2013 filed with the
commission on February 12, 2014.
Exhibit 10.44 of NAI’s Quarterly Report on Form 10-Q for
the quarterly period ended December 31, 2013 filed with the
commission on February 12, 2014.
Filed herewith
Filed herewith
63
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37 Agreement to License by and between NAI and Compound
Filed herewith
10.38
21
23.1
31.1
31.2
32
Solutions, Inc. effective as of April 1, 2014
Lease of Facilities in Manno, Switzerland between NAIE and Mr.
Silvio Tarchini effective July 1, 2014 (English translation)
Subsidiaries of the Company
Consent of Independent Registered Public Accounting Firm
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer Filed herewith
Filed herewith
Section 1350 Certification
Filed herewith
Filed herewith
Filed herewith
Filed herewith
Furnished herewith
101.INS XBRL Instance Document
Furnished herewith
101.SCH XBRL Taxonomy Extension Schema Document
Furnished herewith
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
Furnished herewith
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document
Furnished herewith
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document Furnished herewith
* Indicates management contract or compensatory plan or arrangement.
64
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 25, 2014
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)
September 25, 2014
September 25, 2014
September 25, 2014
September 25, 2014
September 25, 2014
September 25, 2014
Chief Executive Officer and
Chairman of the Board of Directors
(principal executive officer)
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Director
Director
Director
Director
65
This page intentionally left blank
Financial Highlights 2014
Numbers From Our Fiscal Year End
Natural Alternatives International, Inc.
Custom Contract Manufacturing of Supplements Since 1980
cGMP
Manufacturing
Facility
Corporate Information
OFFICERS
Mark LeDoux
Chairman and
Chief Executive Officer
Kenneth Wolf
Chief Operating Officer,
Chief Financial Officer
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
Wednesday, December 10, 2014 at
Natural Alternatives International, Inc.
Vista Manufacturing Facility
1215 Park Center Drive
Vista, California 92081
CORPORATE COUNSEL
K & L Gates LLP
1 Park Plaza, 12th Floor
Irvine, California 92614
TRANSFER AGENT & REGISTRAR
Computershare, Inc.
211 Quality Circle, Suite 210
College Station, Texas 77845
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 financial and operating results, including the amount of our future revenue and profits and our
future financial 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, including our major 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 differ materially from any forward-looking statement or cause actual
results and outcomes for future periods to differ materially from any forward-looking statement or views expressed herein. Our financial performance and the forward-
looking statements contained herein are further qualified by other risks including those set forth from time to time in the documents filed by us with the Securities and
Exchange Commission, including our most recent 2014 Annual Report on Form 10-K.
Natural Alternatives International, Inc.
Custom Formulating • Blending • Tablets • Capsules • Enteric Coating • Powders
Pre-Blends • Packaging Solutions Including High Speed Bottling, Packets and Blister Packs
Domestic and International Regulatory Support
CORPORATE HEADQUARTERS
1185 Linda Vista Drive • San Marcos, California 92078 USA • T: 760-744-7340 • F: 760-744-9589 • E: info@nai-online.com
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
1-800-VITAMIN • www.nai-online.com
NAI Annual Report 2014 To Print.indd 2
10/8/14 12:54 PM
Natural Alternatives
International, Inc.
Custom Contract Manufacturing
of Supplements Since 1980
ANNUAL REPORT
2 0 1 4
INTRODUCING SRCARNOSYN®
SUSTAINED RELEASE BETA-ALANINE
BUILDING A BETTER MUSCLE*
SRCarnoSyn® delivers the same ability to avoid muscle fatigue
for longer periods of time as the instant release beta-alanine
described in peer-reviewed articles.*
n
Increased muscle carnosine can lead to decreased muscle
fatigue and improved exercise performance.*
n Sustained release beta-alanine can increase muscle
carnosine content with no symptoms of parasthesia or
impact upon blood clinical chemistry.1*
n
n
Increased Muscle Carnosine.* A 10-week study
demonstrated an 80% increase in muscle carnosine levels.2
Increased Total Work Capacity.* A 28-day study
demonstrated an increase of 16.9% in physical working
capacity for men and a 12% increase in the working capacity
of women.3
n
Increased Endurance.* Cyclists saw an average increase of
11.4% in increased peak power output after 8 weeks.4
n Advanced Sports Supplement Technology. A breakthrough
in muscle science, SRCarnoSyn® beta-alanine delivers a
critical advantage for athletes of all types.
OVER 55 SCIENTIFIC STUDIES
n The benefits of beta-alanine have been researched in over
55 scientific studies, 53 of which have been published in
peer-reviewed journals.
22 GLOBAL PATENTS
n NAI is the owner of a global patent portfolio directed to
beta-alanine. NAI rigorously enforces adherence to its global
patent portfolio, ensuring guaranteed quality and exclusivity
for your product formulations.
ZERO BANNED SUBSTANCES
Exclusive distributor of CarnoSyn® beta-alanine:
Compound Solutions, Inc.
1930 Palomar Point Way, Suite 105, Carlsbad, California 92008
T: 760-739-9881 • F: 760-739-9886 • E: sales@compoundsolutions.com
Custom contract manufacturer and patent holder of SRCarnoSyn® and
CarnoSyn® beta-alanine:
Natural Alternatives International. Inc.
T: 760-744-7340 • E: info@nai-online.com • www.carnosyn.com
1 Stellingwerff et al. Amino Acids (2012).
2 Hill C A. et al, Amino Acids (2007).
3 Stout et al. J Strength Cond Res (2006).
4 Van Thienen et al. Med Sci Sports Exerc (2009).
* These statements have not been evaluated by
the Food and Drug Administration. This prod-
uct is not intended to diagnose, treat, cure, or
prevent any disease.
NAI Annual Report 2014 To Print.indd 1
10/8/14 12:54 PM