NATURAL ALTERNATIVES
INTERNATIONAL, INC.
CUSTOM CONTRACT MANUFACTURING
OF SUPPLEMENTS SINCE 1980
2017 ANNUAL REPORT
Fiscal Year Ended June 30, 2017
Natural Alternatives International, Inc.
Carlsbad, California
Dear Shareholder,
Our fiscal year ended June 30, 2017 was an excellent year based on a variety of metrics.
We have successfully undertaken facility and capacity expansion in order to take advantage of what
we believe will be an influx of new business by companies desiring to upgrade their supply chain
performance in terms of quality and the ability to meet scheduled or unanticipated demand. By
expanding our Swiss facility to just under 100,000 square feet with additional capacity for powder
processing and bagging, and by upgrading our blending, compression, encapsulation, and coating
capabilities in our 160,000 square foot California plants to handle more throughput, we are poised to
grow even more in the years ahead.
We accomplished these multi‐million dollar investments utilizing operating cash flow and
still ended the year with the highest cash balances ever, while remaining debt‐free. As our industry
wrestles with the various challenges associated with quality standards, we have established a
significant competitive advantage by being nimble both in our capacity, and by refraining to date from
incurring any debt. I believe our balance sheet is one of the most robust in our industry and we are
proud of that achievement.
With a clean balance sheet, significant assets in cash and high quality processing, packaging,
production and testing equipment, we are able to seize opportunities when they present themselves to
secure long term relationships with companies who are interested in aligning with a best‐in‐class
manufacturing partner, while they focus their attention on marketing and sales expansion, allowing
NAI to do what it does best – namely produce excellent products meeting consumers’ needs and
expectations. We believe this is evident with the recent new business award from The Juice Plus+®
Company allowing NAI to produce the majority of their nutraceutical products and effectively adding
an estimated $25 million in annual new business beginning this month.
Fiscal Year Ended June 30, 2017
Natural Alternatives International, Inc.
Carlsbad, California
Our management team now has the experience and well‐earned reputation for performance,
and my role has further expanded over the past year having been elected to a three year term as the
Chairman of the venerable Natural Products Association (NPA), located not far from Capitol Hill in
Washington, D.C. This appointment allows me to be in a position to help shape the dialogue with the
regulatory and legislative communities, both within the United States as well as abroad. The
demographics of population aging and the emergence of supportive clinical science on a variety of
essential nutrients has given rise to a better understanding of the role of dietary supplements in the
potential mitigation of burgeoning health care costs in the US and abroad. Coupling the development
and enforcement of regulatory standards with consumer expectations and those of the regulators in
various states is a key component of NPA’s activities, and I am proud to lead a board of seasoned
veterans in the retail and producer communities in that effort.
With a 37 year history, NAI is really in a leadership role, and takes great pride in efforts to
help craft legislation and regulations that foster continued expansion of standards for excellence in
manufacturing with a keen eye on providing consumers access to the best products that have been
researched and tested for their value propositions. Major retailers have joined the effort to develop
the Supplement Safety Compliance Initiative, which is patterned after the Global Food Safety Initiative.
NPA leadership is taking an active role in helping this essential effort along with marquis brands and
suppliers, including NAI.
The years ahead hold great promise for your company, and I want to thank you for your
continued support of our global efforts as we endeavor to fulfill our promise to enrich the world with
the best of nutrition.
Sincerely,
Mark A. LeDoux
Chairman and Chief Executive Officer
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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, 2017
000-15701
(Commission file number)
NATURAL ALTERNATIVES INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State of incorporation)
1535 Faraday Ave
Carlsbad, CA 92008
(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, or an emerging
growth company.
Large accelerated filer
Non-accelerated filer
☐
☐
Accelerated filer
Smaller reporting company
☐
☒
Emerging Growth Company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new
or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether NAI is a shell company (as defined in Rule 12b-2 of the Exchange Act): ☐ Yes ☒ 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, 2016) was approximately $60,286,268 (based on the closing sale price of $11.30 reported by Nasdaq on December 31, 2016).
For this purpose, all of NAI’s officers and directors and their affiliates were assumed to be affiliates of NAI.
As of September 15, 2017, 7,437,018 shares of NAI’s common stock were outstanding, net of 1,044,659 treasury shares.
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 5, 2017, to be filed on or before October 28, 2017.
DOCUMENTS INCORPORATED BY REFERENCE
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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 ............................................................................................................................................................
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(i)
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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 patent and trademark licensing revenues;
our ability to develop new products, develop relationships with new customers and maintain or improve existing
customer relationships;
our ability to protect our intellectual property;
the outcome of 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;
our ability to improve operation efficiencies, manage costs and business risks and improve or maintain
profitability;
the costs associated with defending and resolving potential legal 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 raw material and other inventory levels to meet future customer demand
and the adequacy and intended use of our facilities;
• 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;
our ability to operate within the standards set by the U.S. Food and Drug Administration’s (FDA) Good
Manufacturing Practices;
our ability to successfully expand our operations, including outside the United States (U.S.);
the adequacy of our reserves and allowances;
1
•
•
•
•
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 and longer;
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 own a patent estate related to the ingredient known as beta-alanine, which is
primarily commercialized through the direct sale of this raw material and proprietary formulations of this raw material under
our CarnoSyn® and SR CarnoSyn® trademarks.
History
Originally founded in 1980, Natural Alternatives International, Inc. reorganized as a Delaware corporation in 1989. Our
principal executive offices are located at 1535 Faraday Ave, Carlsbad, CA 92008.
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 in Manno, Switzerland, which has grown
over the ensuing years and currently possesses manufacturing capability in encapsulation, powders, and tablets, finished
goods packaging, quality control, laboratory testing, warehousing, distribution and administration.
Historically, as part of our business strategy, we have sought to commercialize our patent estate through contract
manufacturing, royalty and license agreements. From March 2009 through March 31, 2015, we had an agreement with
Compound Solutions, Inc. (CSI) to grant a license to CSI to manufacture, offer for sale and/or sell products incorporating,
using or made in accordance with our patent rights and grant a similar sub-license to customers of CSI who purchased beta-
alanine from CSI under the CarnoSyn® trademark. During the term of this agreement, we received a fee from CSI that varied
based on the quantity and source of beta-alanine sold by CSI. We terminated our relationship with CSI effective April 1,
2015 and began directly selling beta-alanine, and licensing our related patent and trademark rights, in order to take advantage
of strategic opportunities, including opportunities to provide additional contract manufacturing services, further
commercialize our patent estate, and to increase our top-line revenue and profit profile.
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, to NAIE.
Overview of our Facilities and Operations
Our U.S.-based operations are located in Vista and Carlsbad, 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 November 8, 2016 by the Therapeutic Goods Administration (TGA) of Australia after its audit of our
Good Manufacturing Practices (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. During August 2016, TGA completed an
inspection of our facility and quality systems for compliance with good manufacturing practices, and a renewed 36 months
GMP clearance was issued with an expiry of August 3, 2020.
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.
Our U.S. operations have also 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 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 high 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 most recent
renewal in December 2016. Not only does this approval demonstrate another level of regulatory compliance for NAI, it may
also ease the approval process for our customers who import products into Canada.
During March 2015, our California facilities became certified as an Organic Processor and Handler by Natural Food Certifiers
(NFC). This certification demonstrates that we meet the USDA National Organic Program standards and allows us to expand
our contract manufacturing and packaging services to include Organic labeled products. The certification requires annual
renewal and was last renewed in September 2016. We are registered with the State of California, Department of Public Health
Food and Drug Branch as an organic processor. Additionally, we are certified by various Rabbinical and Halal authorities to
produce Kosher and Halal certified products. These certifications guarantee that the facility, processes, and ingredients of
certified products have been reviewed and found to be in compliance with the strict dietary laws of the respective Jewish and
Muslim communities
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 improve our ability to develop relationships with new customers.
Our Swissmedic licenses are valid until February 2019.
In addition to our operations in the U.S. and Switzerland, we have had a representative in Japan for many years 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 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;
expand the commercialization of our beta-alanine patent estate through raw material sales, introduction of new
products, new contract manufacturing opportunities, license and sub-license agreements, and protecting our
proprietary rights;
4
•
provide strategic partnering services to our private-label contract manufacturing customers, as described below
under “Products, Principal Markets and Methods of Distribution”; 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 customer’s nutritional
supplements and their adherence to label claims through the education provided by direct sales and direct-to-consumer
marketing programs. We believe our GMP and TGA certified manufacturing operations, science based product formulations,
peer-reviewed clinical studies and regulatory expertise provide us with a sustainable competitive advantage by providing our
customers with a high degree of confidence in the products we manufacture.
While today’s consumer may have access to a variety of information, we believe many consumers remain uneducated about
nutrition and nutritional supplementation, uncertain about the relevance or reliability of the information 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.
We also believe there is significant opportunity with the commercialization of our patent estate through the introduction of
CarnoSyn® and SR CarnoSyn® beta-alanine into additional markets and with the introduction of new beta-alanine product
offerings. Currently, a majority of our sales of CarnoSyn® are to companies that operate in the sports nutrition channel and
are focused on products containing the instant release form of beta-alanine. We believe there are several other markets and
distribution channels that represent growth opportunities for the distribution of CarnoSyn® and SR CarnoSyn® beta-alanine.
We have also recently introduced SR CarnoSyn®, which we believe is a superior delivery system of CarnoSyn® beta-alanine
based on its sustained release profile that allows for increased daily dosing and improved muscle retention of carnosine. We
believe the introduction of SR CarnoSyn® beta-alanine is an important step in the further commercialization of our patent
estate outside of the sports nutrition channel. Our remaining patents related to instant release beta-alanine expire in 2023
while our patents for SR CarnoSyn® extend through 2026.
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 our
customer’s preferences.
We provide strategic partnering services to our private-label contract manufacturing customers, including the following:
•
•
customized product formulation;
clinical studies;
• manufacturing;
• marketing support;
•
international regulatory and label law compliance;
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•
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international product registration; and
packaging in multiple formats and labeling design.
We also seek to commercialize our patent and trademark through direct distribution and sale of CarnoSyn® and SR
CarnoSyn®, new contract manufacturing opportunities, and 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 ..................................
Total Net Sales ...................................................... $
Research and Development
2017
$
95,024
26,922
121,946
%
78 $
22
100 $
2016
$
92,420
21,781
114,201
%
81
19
100
We are committed to quality research and development. We focus on the development of new science based products and
the improvement of existing products. We periodically test and validate our products to help ensure their stability, potency,
efficacy and safety. We maintain quality control procedures to verify that our products comply with applicable specifications
and standards established by the FDA and other regulatory agencies. We 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 fiscal year ended June 30, 2017 increased to $1.6 million, compared to $1.1
million for the fiscal year ended June 30, 2016.
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 2017, we had one supplier, Scientific Living, which 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 2017. However, there continues to be significant pricing pressures associated with various
vitamins, minerals and herbs in the raw material marketplace. Throughout fiscal 2018, we expect upward pricing pressures
for raw materials and other costs will continue as a result of limited supplies of various ingredients and the effects of higher
labor and transportation costs.
Customers
We have one private-label contract manufacturing customer that individually represents more than 10% of our consolidated
net sales. The loss of this customer could result in a significant negative impact to our financial position and results of
operations. 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.
6
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).
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, our commitment to quality and safety, and our research and development activities.
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:
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the continued acceptance of our products by our customers and consumers;
our ability to protect our proprietary rights in our patent estate and the continued validity of such patents;
our ability to successfully expand our product offerings related to our patent and trademark estate;
our ability to maintain adequate inventory levels to meet our customer’s demands;
our ability to expand;
our ability to continue to manufacture high quality products at competitive prices;
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 may 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 state and local agencies in areas where 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 these and other authorities regulate include, among others:
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•
•
•
product claims and advertising;
product labels;
product ingredients; and
how we manufacture, package, distribute, import, export, sell and store our products.
7
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 GMP’s 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 GMP.
The FDA also regulates the labeling and marketing of dietary supplements and nutritional products, including the following:
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the identification of dietary supplements or nutritional products and their nutrition and ingredient labeling;
requirements related to the wording used for claims about nutrients, health claims, and statements of nutritional
support;
labeling requirements for dietary supplements or nutritional products for which “high potency” and “antioxidant”
claims are made;
notification procedures for statements on dietary supplements or nutritional products; and
premarket notification procedures for new dietary ingredients in nutritional supplements.
The Dietary Supplement Health and Education Act of 1994 (DSHEA) revised the provisions of the Federal Food, Drug and
Cosmetic Act concerning the composition and labeling of dietary supplements and defined dietary supplements to include
vitamins, minerals, herbs, amino acids and other dietary substances. 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 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 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 this Act.
We are also subject to a variety of other regulations in the U.S., including those relating to health, safety, 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 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 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, adversely impact our financial
position and results of operations.
8
Intellectual Property
Trademarks. We have developed and use trademarks in our business, particularly relating to corporate, brand and product
names. We own 37 trademark registrations, including eight registrations in the U.S. Six of these U.S. registrations are
incontestable. Federal registration of a trademark in the United States affords the owner nationwide exclusive trademark
rights in the registered mark and the ability to prevent subsequent users from using the same or similar mark. However, to
the extent a common law user has developed trademark patent rights in a mark in connection with similar goods or services
in a particular geographic area, the nationwide rights conferred by federal registration can be subject to that user’s prior rights
in that geographic area. In addition, rights in a registered mark are dependent upon the continued use of the mark in connection
with the goods and/or services set forth in the registration.
We have 27 foreign trademark registrations covering 41 countries including, registrations for CarnoSyn and SR CarnoSyn in
Australia, Brazil, Canada, China, Cuba, the European Union Intellectual Property Office, Hong Kong, Israel, Japan, Mexico,
New Zealand, Poland, and South Korea. Registrations have also been obtained for SR CarnoSyn and the CarnoSyn logo in
Switzerland, for Carnosyn SR in Australia and the European Union. We currently have three U.S. trademark applications
pending and three International applications pending. We also claim common law ownership and protection of certain
unregistered trademarks and service marks based upon our continued use of the marks under common law. In some countries
such as, the United States, common law 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 current or future trademark applications will be granted or our current
trademarks or registrations will be maintained.
Trade Secrets. We own certain intellectual property, including trade secrets, which we seek to protect, in part, through
confidentiality agreements with employees and other parties. We regard our proprietary technology, trade secrets, trademarks
and similar intellectual property as critical to our success, and we rely on a combination of trade secrets, contract, patent,
copyright and trademark law to establish and protect the rights in our products and technology. The laws of certain foreign
countries may not protect our intellectual property rights to the same extent as the laws of the U.S.
Patents and Patent Licenses. We currently own seven U.S. patents and seventeen 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 the prior owners for
certain uses that are covered by the patents. The royalty payments and license continue until the expiration of the patents. We
also sell beta-alanine, and license our patent and trademark rights related to beta-alanine. We have a patent expiring in each
of 2023, 2024, and 2025, and twenty-one patents expire in 2026.
Beginning in fiscal 2009, the licensing, raw material sales, and revenues we have received associated with the sale and
licensing of beta-alanine under the CarnoSyn® trade name have grown steadily from $515,000 in fiscal 2009 to $26.9 million
in fiscal 2017. During fiscal 2017, our revenues included $856,000 of royalties and $26.1 million related to the direct sale of
beta-alanine. We incurred intellectual property litigation and patent compliance expenses of approximately $4.2 million
during fiscal 2017 primarily in connection with our efforts to protect our proprietary rights and patent estate. We expect to
continue to incur these types of litigation expenses during fiscal 2018.
Employees
As of June 30, 2017, we employed 158 full-time employees in the U.S., three of whom held executive management positions.
Of the remaining full-time employees, 32 were employed in research, laboratory and quality control, 9 in sales and marketing,
and 114 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, 2017, we
had 11 temporary personnel.
As of June 30, 2017, NAIE employed an additional 52 full-time employees, 4 part time employees, and 2 temporary
personnel. 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.
9
Seasonality
Although we believe there is little if any 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 and CarnoSyn® and SR CarnoSyn® beta-alanine raw material orders.
Financial Information about Our Business Segments and Geographic Areas
Our operations are comprised of two reportable segments:
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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 raw material sales associated with the sale and license of beta-alanine under our
CarnoSyn® and SR CarnoSyn® trademarks.
Our private-label contract manufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe,
Australia and Asia, as well as Canada, Mexico and South Africa. Our primary market outside the U.S. is Europe. Our patent
and trademark 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.
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, 2017, sales to our largest customer, The Juice Plus+ Company, were
approximately 50% of our consolidated net sales. No other customers represented more than 10% of our consolidated net
sales. The loss of this customer or other major customers, a significant decrease in sales to these customers, or a significant
change in their business or personnel, could materially affect our financial condition and results of operations. Furthermore,
the timing of our customers’ orders is impacted by, among others, their marketing programs, their customer demand, their
raw material suppliers we are sometimes required to use, their supply chain management, entry into new markets and their
new product introductions, all of which are outside of our control. All of these attributes have had and are expected to have
a significant impact on our business.
10
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 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. 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 not generate material 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 currently derive significant revenues and income from sales of beta-alanine and licensing our patents. Our ability to
maintain or grow our sales of beta-alanine and license revenue from our other patents is contingent on our ability to
continue to defend our patents, and commercialize the sale of beta-alanine under our remaining instant release
CarnoSyn® patents and trademark and our SR Carnosyn® patents and trademark.
We own multiple patents and trademarks related to the use of beta-alanine in food and nutritional supplements. A majority
of our revenue and income from this segment is currently derived from activity related to licensing our patents associated
with instant release beta-alanine, sold under our trade name CarnoSyn®. We had fifteen patents related to CarnoSyn® expire
in August 2017 and currently only have two remaining patents for this version of CarnoSyn®, which expire in August 2023.
There is no assurance we will be successful maintaining our historical CarnoSyn® instant release beta-alanine sales levels or
grow future sales volumes with our remaining CarnoSyn® instant release patent estate. If we are not successful it could have
a material adverse effect on our business, results of operations, and financial condition.
We believe SR CarnoSyn® is a superior delivery system of CarnoSyn® beta-alanine based on its sustained release profile
that allows for increased daily dosing and improved muscle retention of carnosine. Our patents related to SR CarnoSyn®
extend through 2026 and we believe the introduction of SR CarnoSyn® beta-alanine is an important step in the further
commercialization of our patent estate. There can be no assurance we will be successful in getting the market to transition to
this new form of beta-alanine or we will be successful launching new products utilizing SR CarnoSyn® beta-alanine in
existing and new product channels and markets. If we are not successful it could have a material adverse effect on our
business, results of operations, and financial condition.
We have incurred, and may continue to incur significant costs defending our intellectual property. We may 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. We may continue to incur significant patent and trademark litigation costs associated
with defending this intellectual property. During fiscal 2017, we incurred approximately $4.2 million in patent litigation and
prosecution expense and may incur significant similar expenses during fiscal 2018. 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
could 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. Such litigation, even if successful, could
result in substantial additional costs and diversion of resources and could have a material adverse effect on our business,
results of operations and financial condition. If such infringement 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 a license would be available on terms
acceptable or favorable to us, if at all.
11
Our operating results will vary. We have experienced a decline in net sales and incurred losses in past years and there is
no guarantee our sales will improve or 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 2017 as compared to fiscal 2016 but there can be no assurance our net sales will continue
to improve in the near term, or 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 may 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
2018, 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 GMP 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 and services. 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 a governmental agency could
materially adversely affect our ability and our customers’ ability to successfully market and continue selling those products.
Before commencing operations of marketing our products in 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. 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 could 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, could have, and at certain times in the past have 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 and products sold or manufactured by others using our licensed patent rights. Any decline in
economic conditions in the U.S. and the various foreign markets in which our customers operate could negatively impact our
customers’ businesses and our operations. A significant enough decline in consumer demand and the level of business activity
of our customers due even if only in part to economic conditions could have a material adverse effect on our revenues and
profit margins.
12
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 2017, we had one supplier, Scientific Living, that
represented more than 10% of our raw material purchases. During fiscal 2016, we did not have any suppliers that represented
more than 10% of our raw material purchases. Still, 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 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 with our customer’s consent to substitute different materials from alternative sources.
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. Increasing raw material and product cost pricing pressures
have continued throughout fiscal 2017 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 2018. 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 negative effects of cost increases on our results of operations or financial condition.
There can be no assurance 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, terrorism, natural disasters, or other catastrophic events.
In addition, our efforts to commercialize our patent estate and the revenues we receive from related 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 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 revenue and product margin we earn from the sale of beta-alanine.
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. Our competitors may not stress the level of quality we provide and could
manufacture at lower costs, they are largely private and not subject to the same disclosure requirements of us as a publicly
traded company. Increased competition could result in price reductions, reduced gross profit margins or loss of market share,
any of which could have a material adverse effect on our financial condition and results of operations. There can be no
assurance that we will be able to compete in this intensely competitive environment.
We could be exposed to product liability claims or other litigation, which may be costly and could materially adversely
affect our operations.
We could face financial liability due to product liability claims if the use of our products results in significant loss or injury.
Additionally, the manufacture and sale of our products involves the risk of injury to consumers from tampering by
unauthorized third parties or product contamination. We could be exposed to future product 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 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 we will in fact
be able to continue such insurance coverage, or that our insurance will be adequate to cover any liability we may incur, or
our insurance will continue to be available at an economically reasonable cost.
13
Additionally, it is possible 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, or the failure of a customer to honor indemnification agreements 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 could 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
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:
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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. may increase.
Our business is subject to the effects of adverse publicity, which could negatively affect our sales and revenues.
Our business can be affected by adverse publicity or negative public perception about our competitors, our customers, or our
industry generally. 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 could have a
material adverse effect on our business, financial condition and results of operations. Our business, financial condition and
results of operations 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 and unwanted health consequences.
14
If we are unable to attract and retain qualified management personnel, our business may 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, has been increasing in recent years, 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. Any 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, including those of our suppliers,
are subject to power failures, blackouts, telecommunications failures, computer viruses, human error, breakdown, failure or
substandard performance of our leased facilities, our equipment, the improper installation or operation of equipment,
terrorism, natural or other disasters, intentional acts of violence, and the need to comply with the requirements or directives
of governmental agencies, including the FDA. In addition, we may in the future determine to expand or relocate our facilities,
which may result in slowdowns or delays in our operations. While we have implemented and are evaluating various
emergency, contingency and disaster recovery plans and maintain business interruption insurance, there can be no assurance
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 our contingency plans will prove to be adequate or successful if needed or 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 beta-alanine fulfillment and distribution activities and certain contract manufacturing 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 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 pursue acquisitions of other companies that, if not successful, could adversely affect our business, financial
condition and results of operations.
We may pursue acquisitions of companies 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:
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potential difficulties related to integrating the products, personnel and operations of the acquired company;
failure to operate efficiently as a combined organization utilizing common information and communication
systems, operating procedures, financial controls and human resources practices;
diverting management’s attention from the other 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.
15
There can be no assurance that acquisitions 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 23% of our
outstanding shares of common stock as of June 30, 2017, including approximately 17% of our outstanding shares of common
stock beneficially owned by Mark LeDoux, our Chief Executive Officer and 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:
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transactions resulting in a change in control;
• mergers and acquisitions;
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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.
We may not be able to raise additional capital or obtain additional financing if needed.
It is possible our cash from operations could become insufficient to meet our working capital needs and/or to implement our
business strategies. In such an event, there can be no assurance our existing line of credit would be sufficient to meet our
working capital needs. Furthermore, if we fail to maintain certain loan covenants we may no longer have access to our credit
line. Our credit line terminates in February 2020 and there is no guarantee 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, if we did not have any
alternate funds we might not be able to develop or enhance our products, execute our business plan, take advantage of future
opportunities, respond to competitive pressures or meet unanticipated customer requirements.
At any given time, it could be difficult for us to raise capital due to a variety of factors, some of which may be outside of 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, or in the businesses of our customers. 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 would
be diluted. Similarly, there can be no assurance 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.
16
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 certain provisions of our Certificate of Incorporation, Bylaws and Delaware law are triggered, the market for our shares
may decrease.
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. Those provisions include one that
authorizes our Board of Directors, 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 and the number of investors willing to own our common stock.
Our stock price could fluctuate significantly.
Stock prices in general can be 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 industry;
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 could decline, perhaps substantially.
From time to time our shares may be listed for trading on one or more foreign exchanges, with or without our prior knowledge
or consent. Certain foreign exchanges may have less stringent listing requirements, rules and enforcement procedures than
the Nasdaq Global Market or other markets in the U.S., which may increase the potential for manipulative trading practices
to occur. These practices, or the perception by investors that such practices could occur, may increase the volatility of our
stock price or result in a decline in our stock price, which in some cases could be significant.
17
ITEM 2.
PROPERTIES
This table summarizes our facilities as of June 30, 2017. We believe our facilities are adequate to meet our operating
requirements for the foreseeable future.
Nature of Use
Location
Vista, CA USA(1),(2) ........ Manufacturing, warehousing, packaging
and distribution
Manno, Switzerland(3) ..... Manufacturing, warehousing, packaging
and distribution
Carlsbad, CA USA(4) ....... NAI corporate headquarters
Square
Feet
How Held
Lease
Expiration
Date
162,000
Leased
March 2024
94,217
20,981
Leased
Owned
June 2019
N/A
(1) This facility is used by NAI primarily for its private-label contract manufacturing segment.
(2) We use approximately 93,000 square feet for production, 60,000 square feet for warehousing and 9,000 square feet for
administrative functions.
(3) This facility is used by NAIE, our wholly owned Swiss subsidiary, in connection with our private-label contract
manufacturing segment.
(4) We purchased the Carlsbad facility in March 2016 and began to occupy as our new corporate headquarters during
August 2016.
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 we do not expect.
As of September 15, 2017, except as described below, neither NAI nor its subsidiary were a party to any material pending
legal proceeding nor was any of our property the subject of any material pending legal proceeding. We are currently involved
in several matters in the ordinary course of our business, each of which is related to enforcing our intellectual property rights.
Some of these matters are summarized below.
In 2011, NAI filed a lawsuit against Woodbolt Distribution, LLC, also known as Cellucor (“Woodbolt”), and both NAI and
Woodbolt filed additional lawsuits and countersuits against each other. NAI and Woodbolt subsequently settled all of the
lawsuits between them, but not before the United States Patent and Trademark Office (“USPTO”) at Woodbolt’s request
rejected the claims of two NAI patents. The rulings rejecting the claims of two NAI patents were subsequently confirmed
by the Patent Trial and Appeal Board (PTAB) at the USPTO. NAI has filed a Notice of Appeal with the U.S. Court of Appeals
for the Federal Circuit requesting that certain findings of the PTAB's be reversed. No hearing date has been set by the
Court. Both NAI patents rejected by the USPTO expired in August 2017.
On September 18, 2015, the Company filed a complaint against Creative Compounds, LLC, alleging various claims including
(1) violation of Section 43 of the Lanham Act, (2) violation of California's Unfair Competition Law, (3) violation of
California's False Advertising Law, (4) Trade Libel and Business Disparagement and (5) Intentional Interference with
Prospective Economic Advantage. Subsequently, the Company and defendant resolved their disputes and entered into
settlement and the case was dismissed.
On August 24, 2016, the Company filed a separate complaint against Creative Compounds, LLC, alleging infringement of
U.S. patent 7,825,084. On October 5, 2016, Creative filed its answer and counterclaims. On January 19, 2017, the Company
filed a Motion to Amend the Complaint, to add allegations of infringement of U.S. patents 5,965,596, 7,504,376, 8,993,610
18
and 8,470,865, and additional parties, Core Supplement Technology, Inc., Honey Badger LLC, and Myopharma, Inc. The
Court granted the Company's motion. On May 2, 2017, the Court issued a revised scheduling order and set a trial date for
July 31, 2018. On July 19, 2017, Creative filed a motion for judgment on the pleadings to dismiss the patent infringement
claims with prejudice, On September 5, 2017, the Court granted Creative's motion, which is a non-final decision and subject
to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will appeal the District Court
rulings. The remaining non-patent claims pending against other defendants were not affected.
On July 1, 2016, the Company filed a complaint in U.S. District Court for the Southern District of California against
Cenegenics, LLC, alleging infringement of U.S. patents 7,504,376 and 7,825,084. On August 3, 2016, the Company filed an
amended complaint to assert infringement of the same patents against Cenegenics' contract manufacturer, Atlantic-Pro
Nutrients d/b/a Xymogen, LLC. Subsequently the Company and defendants resolved their disputes and entered into
settlement and license agreements, and the case was dismissed.
On July 6, 2016, the Company filed a complaint against Allmax Nutrition, Inc. in U.S. District Court for the Southern District
of California, alleging (1) infringement of U.S. patents 5,965,596, 6,172,098, 7,825,084 and RE 45,947, (2) violation of
Section 32 of the Lanham Act, and (3) copyright infringement. On October 19, 2016, the Company filed an amended
complaint adding HBS International Corp., Allmax's exclusive distributor, as a co-defendant and to add a civil conspiracy
claim. On May 2, 2017, the Court issued a scheduling order setting a trial date for July 31, 2018. On April 25, 2017,
defendants filed a motion for judgment on the pleadings and a motion to dismiss as to the Company's trademark and patent
infringement and civil conspiracy claims. On June 26, 2017, the Court granted Defendants’ motions, dismissing the
Company's patent infringement claim with prejudice and dismissing the trademark and civil conspiracy claims without
prejudice. The Company filed a Second Amended Complaint on July 10, 2017. On August 29, 2017, the Court denied the
Company's motion to partially reconsider the dismissal of the patent infringement claim, which is a non-final decision and
subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will appeal the District
Court rulings. On August 30, 2017, the Court denied Defendants' motion to dismiss the Company's trademark and conspiracy
claims.
On August 2, 2016, the Company filed a complaint against Muscle Sports Products, LLC in U.S. District Court for the
its CarnoSyn® and CarnoSyn Beta Alanine®
Southern District of California, alleging
trademarks. Subsequently the Company and defendant resolved their disputes and entered into settlement and license
agreements, and the case was dismissed.
infringement of
On September 15, 2016, the Company filed a complaint against Arnet Pharmaceutical Corporation in the U.S. District Court
for the Southern District of California alleging Breach of Contract. On May 2, 2017, the Court issued a scheduling order
setting a trial date for July 31, 2018. Subsequently, the Company and defendant resolved their disputes and entered into
settlement and license agreements, and the case was dismissed.
On September 16, 2016, the Company filed a complaint against Hi-Tech Pharmaceuticals, Inc. d/b/a ALR Industries, APS
Nutrition, Innovative Laboratories, Formutech Nutrition, LG Sciences and Sports 1 in U.S. District Court for the Southern
District of California, alleging (1) infringement of U.S. patents 5,965,596, 7,825,084, 8,993,610 and RE 45,947, (2) violation
of Section 32 of the Lanham Act and (3) breach of contract. On May 2, 2017, the Court issued a scheduling order setting a
trial date for July 31, 2018. On July 10, 2017, Defendants filed a motion for judgment on the pleadings to dismiss the patent
infringement claims with prejudice. On September 5, 2017, the Court granted Defendants' motion, which is a non-final
decision and subject to later appeal to the U.S. Court of Appeals for the Federal Circuit. The Company has stated it will
appeal the District Court rulings. The remaining non-patent claims pending against the Defendants were not affected.
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 not be greater than anticipated.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
19
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, 2017 and
2016:
First Quarter .............................................................. $
Second Quarter .......................................................... $
Third Quarter ............................................................. $
Fourth Quarter ........................................................... $
13.62 $
14.40 $
12.40 $
11.00 $
9.63 $
11.0 $
8.25 $
8.80 $
6.41 $
10.74 $
13.80 $
14.50 $
5.60
5.40
6.72
10.05
Fiscal 2017
Fiscal 2016
High
Low
High
Low
Holders
As of September 15, 2017, there were approximately 210 stockholders of record of our common stock. On that same date,
the last sales price of our common stock as reported on Nasdaq was $10.45 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, 2017, we did not sell or otherwise issue any unregistered securities.
Repurchases
During the quarter ended June 30, 2017, we did not repurchase any shares of our common stock.
20
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, 2017:
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))
Plan Category
(a)
(b)
(c)
(d)
(e)
Equity compensation plans approved by
stockholders ...........................................
140,000 $
6.36
330,665
N/A
389,000
Equity compensation plans not approved
by stockholders ......................................
Total ...........................................................
N/A
140,000 $
N/A
6.36
N/A
330,665
N/A
N/A
N/A
389,000
ITEM 6.
SELECTED FINANCIAL DATA
As a smaller reporting company, we are not required to provide Item 6 disclosure in this Annual Report.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion and analysis is intended to help you understand our financial condition and results of operations as
of June 30, 2017 and 2016 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 customer’s orders, which in turn is impacted
by such customers’ internal marketing programs, supply chain management, entry into new markets, new product
introductions, the demand for such customers’ products, and general industry and economic conditions. Our revenue also
includes raw material sales, royalty and licensing revenue generated from our patent estate pursuant to license and supply
agreements with third parties for the distribution and use of the ingredient known as beta-alanine sold under our CarnoSyn®
and SR Carnosyn® trademarks.
21
A cornerstone of our business strategy is to achieve long-term growth and profitability and to diversify our sales base. We
have sought and expect to continue to seek to diversify our sales by developing relationships with additional, quality-oriented,
private-label contract manufacturing customers, and commercializing our patent estate through sales of beta-alanine under
our Carnosyn® and SR Carnosyn® trade names, contract manufacturing and license agreements.
On August 7, 2017, NAI extended its partnership with our largest contract manufacturing customer ,The Juice Plus+
Company ("Juice Plus+"), through the execution of a five year exclusive manufacturing agreement covering capsule and
powder products sold in over 24 markets around the world. Sales from this new exclusive manufacturing agreement are
expected to begin shipping during our second fiscal quarter of 2018 and are estimated to increase our sales to Juice Plus+ by
over $25.0 million on an annualized basis.
During fiscal 2017, our net sales were 7% higher than in fiscal 2016. Private-label contract manufacturing sales increased
3% due primarily to the sale of higher volumes of existing products to existing customers and new product sales to new and
existing customers. Beginning in the third quarter of fiscal 2017 our contract manufacturing sales were unfavorably impacted
due to reductions in orders related to the Asian and European markets as a result of lower customer product demand and
discontinued customer relationships. Our international sales improved during our fourth quarter of fiscal 2017 and we expect
this sales trend to continue during fiscal 2018.
Revenue concentration from our largest private-label contract manufacturing customer as a percentage of our total net sales
increased to 50% in fiscal 2017 from 43% for fiscal 2016. We expect our fiscal 2018 revenue concentration as a percentage
of consolidated net sales for this customer to be consistent with fiscal 2017.
On June 6, 2017, we received a new patent from the U.S. Patent and Trademark Office related to a broad range of improved
methods of beta-alanine intake. These 28 allowed patent claims target such benefits as delaying muscle fatigue, increasing
anaerobic capacity, increasing muscle strength and increasing muscle endurance. This new patent became part of our global
portfolio covering our CarnoSyn® beta-alanine and SR CarnoSyn® products, but more importantly, we believe it
significantly lengthens the patent coverage around our instant release CarnoSyn® beta-alanine to 2023. We intend to continue
to file additional beta-alanine patent applications to further broaden our intellectual property protection.
During fiscal 2017, CarnoSyn® beta-alanine revenue increased 24% to $26.9 million as compared to $21.8 million for fiscal
2016. This increase was primarily the result of growth in our customer base and increased raw material sales. To protect our
CarnoSyn® business and its underlying patent estate, we incurred litigation and patent compliance expenses of approximately
$4.2 million during fiscal 2017 and $2.0 million during fiscal 2016. The increase in these legal expenses on a year over year
basis is primarily due to our efforts to enforce compliance with our existing patents, fees and expenses related to new patent
applications and to protect our trade name in the marketplace against parties who are using it without our consent. We describe
our efforts to protect our patent estate in more detail under Item 1 of Part II of this report. We currently expect our litigation
and patent compliance expenses to decline during fiscal 2018 to an annual rate of approximately $2.0 to $3.0 million. Our
ability to maintain or further increase our beta-alanine royalty and licensing revenue will depend in large part on our ability
to enforce compliance of our instant release CarnoSyn® patents, maintain our patent rights and develop a market for our
sustained release form of beta-alanine marketed under our SR Carnosyn® trademark.
During fiscal 2018, we plan to continue our focus on:
• Leveraging our state-of-the-art, certified facilities to increase the value of the goods and services we provide to
our highly valued private-label contract manufacturing customers, and assist us in developing relationships with
additional quality oriented customers;
• Expanding the commercialization of our beta-alanine patent estate through raw material sales, developing a
market for our sustained release form of beta-alanine marketed under our SR Carnosyn® trademark, new contract
manufacturing opportunities, license agreements and protecting our proprietary rights;
•
Improving operational efficiencies and managing costs and business risks to improve profitability.
22
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. Some of 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. The estimated
returns are based on the trailing six months of private-label contract manufacturing gross sales and our historical experience.
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 currently own certain U.S. patents, and in some cases that patent’s corresponding foreign patent applications. All of these
patents and patent rights relate to the ingredient known as beta-alanine marketed and sold by us under our CarnoSyn® and
SR Carnosyn® trademarks, combined with a license to our patent estate. We recorded beta-alanine raw material sales and
royalty and licensing income as a component of revenue in the amount of $26.9 million during fiscal 2017 and $21.8 million
during fiscal 2016. These royalty income and raw material sale amounts resulted in royalty expense paid to the original patent
holders from whom NAI acquired its patents and patent rights. We recognized royalty expense as a component of cost of
goods sold in the amount of $1.0 million during fiscal 2017 and $865,000 during fiscal 2016.
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. 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.
23
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, 2017 and June 30, 2016, 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. As of June 30, 2017,
we have recorded no valuation allowance against deferred tax assets. During the fourth quarter of fiscal 2016, we concluded
that it was more likely than not that we would be able to realize the benefit of our federal and state deferred tax assets in the
future. We based this conclusion on historical and projected operating performance, as well as our expectation that our
operations will generate sufficient taxable income in future periods to realize the tax benefits associated with the deferred tax
assets. As a result, we reduced the valuation allowance on our net deferred tax assets by $193,000 at June 30, 2016. We will
continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative
evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the income
statement for the period that the adjustment is determined to be required.
We 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.
24
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, 2017, 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, 2017, the notional amounts of our foreign exchange
contracts were $26.1 million (EUR 23.1 million). These contracts will mature over the next 14 months.
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, 2017
June 30, 2016
Private-label contract manufacturing ..... $
Patent and trademark licensing...............
Total net sales .........................................
Cost of goods sold ..................................
Gross profit ............................................
Selling, general & administrative
expenses .............................................
Income from operations .........................
Other income, net ...................................
Income before income taxes ...................
Provision for income taxes .....................
Net income ............................................. $
95,024
26,922
121,946
95,742
26,204
16,502
9,702
409
10,111
2,876
7,235
78% $
22%
100%
78%
22%
92,420
21,781
114,201
88,943
25,258
14%
8%
0%
8%
2%
6% $
13,000
12,258
1,314
13,572
4,026
9,546
Increase (Decrease)
2,604
5,141
7,745
6,799
946
81 % $
19 %
100 %
78 %
22 %
3%
24%
7%
8%
4%
11 %
11 %
1 %
12 %
4 %
8 % $
3,502
(2,556)
(905)
(3,461)
(1,150)
(2,311)
27%
(21)%
(69)%
(26) %
(29)%
(24)%
Private-label contract manufacturing net sales increased 3% primarily due to the sale of higher volumes of existing products
to existing customers and new product sales to new and existing customers partially offset by reductions in orders related to
certain domestic customers and related to the Asian market.
Net sales from our patent and trademark licensing segment increased 24% during fiscal 2017. During fiscal 2017, patent and
trademark licensing sales included $0.9 million of royalty income, $26.0 million in direct beta-alanine raw material sales,
and zero license fees. During fiscal 2016, patent and trademark licensing sales included $0.2 million of royalty income, $21.6
million in direct beta-alanine raw material sales, and zero license fees. The increase in beta-alanine raw material sales was a
result of growth in our customer base and increased raw material sales.
The change in gross profit margin for the year ended June 30, 2017 was as follows:
Percentage
Change
Contract manufacturing(1) ......................................................................................................................
Patent and trademark licensing(2) ..........................................................................................................
Total change in gross profit margin ......................................................................................................
(3.3)
2.7
(0.6)
1 Private-label contract manufacturing gross profit margin contribution decreased 3.3 percentage points in fiscal 2017 as
compared to fiscal 2016. The decrease in gross profit as a percentage of sales in fiscal 2017 is primarily due to a shift in
product sales mix and a marginal increase in per unit manufacturing costs.
2 During fiscal 2017, patent and trademark licensing gross profit margin contribution increased 2.7 percentage points due
primarily to increased revenues and decreased supply chain costs.
Selling, general and administrative expenses increased $3.5 million, or 27%, during fiscal 2017 as compared to fiscal 2016.
This increase was primarily due to increased litigation and patent compliance expenses and increased compensation costs
associated with the growth in sales. The increase in expenses associated with our patent and trademark licensing segment are
primarily associated with our efforts to enforce compliance with our patents related to instant release CarnoSyn® beta-
alanine, new patent applications, and to protect our trade name in the marketplace against parties who are use or misuse them
25
without our consent. We expect to continue these efforts during fiscal 2018 as we launch SR CarnoSyn® in existing and new
markets.
Other income, net decreased $905,000 during fiscal 2017 as compared to fiscal 2016. The decrease for fiscal 2017 is due
primarily to the fiscal 2016 sale of our domestic corporate headquarters in San Marcos, CA which resulted in a one-time pre-
tax gain of $1.6 million partially offset by favorable interest income associated with the amortization of forward points
associated with our foreign exchange hedge contracts.
Our income tax expense decreased $1.2 million during fiscal 2017 as compared to fiscal 2016. The decrease is primarily due
to decreased consolidated pre-tax income.
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 $14.1 million in fiscal 2017 compared
to net cash provided by operating activities of $9.3 million in fiscal 2016.
Net income decreased by $2.3 million to $7.2 million during fiscal 2017 as compared to net income of $9.5 million in the
prior fiscal year. At June 30, 2017, changes in accounts receivable, consisting primarily of amounts due from our private-
label contract manufacturing customers and our patent and trademark raw material sales activities, provided $4.8 million in
cash compared to using $3.3 million in fiscal 2016. The increase in cash provided by accounts receivable during fiscal 2017
was primarily due to increased sales and the timing of collection of sales year over year. The average number of days our
accounts receivable were outstanding was 32 days during fiscal 2017, as compared to 37 days for fiscal 2016.
Decreases in inventory provided $7.0 million in cash during fiscal 2017 compared to using $8.2 million in fiscal 2016. The
change in cash activity from inventory during fiscal 2017 was primarily related to the conversion of private-label contract
manufacturing inventory into sales versus growth in inventory during fiscal 2016. Changes in accounts payable and accrued
liabilities used $8.0 million in cash during fiscal 2017 compared to providing $8.0 million during fiscal 2016. The change in
cash flow activity related to accounts payable and accrued liabilities is primarily due to the timing of inventory receipts and
payments.
Approximately $6.1 million of our operating cash flow was generated by NAIE in fiscal 2017. As of June 30, 2017, NAIE’s
undistributed retained earnings of $20.9 million were considered indefinitely reinvested.
Cash used in investing activities in fiscal 2017 was $5.3 million compared to $7.4 million in fiscal 2016. Capital expenditures
were $5.4 million during fiscal 2017 compared to $10.4 million in fiscal 2016. Capital expenditures during fiscal 2017 and
fiscal 2016 were primarily for manufacturing equipment in our Vista, California and Manno, Switzerland facilities.
Additionally, capital expenditures during fiscal 2016 included the purchase of our new corporate headquarters in Carlsbad,
California. The capital expenditures during fiscal 2016 were partially offset by proceeds from the sale of equipment and sale
of our former headquarters of $3.0 million versus proceeds from the sale of equipment of $25,000 in fiscal 2017.
At June 30, 2017 and June 30, 2016, on a consolidated basis, we had no outstanding balances due in connection with loan
facilities.
On March 28, 2017, we executed an amendment to our credit facility with Wells Fargo Bank, N.A. to extend the maturity
date for our working line of credit from January 31, 2019 to February 1, 2020. The Credit Agreement provides us with a
credit line of up to $10.0 million. The line of credit may be used to finance working capital requirements. There was no
commitment fee required as part of this amendment. There are no amounts currently drawn under the line of credit.
Under the terms of the Credit Agreement, borrowings are subject to eligibility requirements including maintaining (i) a ratio
of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time; and (ii) a ratio of total current assets to total
current liabilities of not less than 1.75 to 1.0 at each fiscal quarter end. Any amounts outstanding under the line of credit will
bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the
outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of
interest. If elected, the fluctuating rate per annum would be equal to 1.25% above the daily one month LIBOR rate as in effect
from time to time. If a fixed rate is elected, it would equal a per annum rate of 1.25% above the LIBOR rate in effect on the
first day of the applicable fixed rate term. Any amounts outstanding under the line of credit must be paid in full on or before
the maturity date. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without
26
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
January 31, 2019, and with Bank of America, N.A. in effect until August 15, 2019.
On June 30, 2017, we were in compliance with all of the financial and other covenants required under the Credit Agreement.
Our wholly owned subsidiary, NAIE, formerly had a credit facility with Credit Suisse that would provide NAIE with a credit
line of up to CHF 500,000, or approximately $522,000. We terminated this line of credit in December 2016 as we determined
that it was unnecessary as we believe our current cash position and ongoing cash from operations are sufficient to support
our cash requirements.
As of June 30, 2017, we had $27.8 million in cash and cash equivalents and $10.0 million available under our credit facilities.
Of these amounts, $8.8 million of cash and cash equivalents 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, 2017, 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 2017 and 2016, we did not experience any significant increases in product raw material or operational costs we
attributed to inflationary factors. We currently believe increasing raw material and product cost pricing pressures will exist
throughout fiscal 2018 as a result of limited supplies of various ingredients and the effects of higher labor and transportation
costs. We do not believe current inflation rates will have a material impact on our fiscal 2018 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.
27
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Stockholders of Natural Alternatives International, Inc.
We have audited the accompanying consolidated balance sheets of Natural Alternatives International, Inc. (the “Company”)
as of June 30, 2017 and 2016, and the related consolidated statements of operations and comprehensive income, stockholders’
equity, and cash flows for the years then ended. The Company’s management is responsible for these consolidated financial
statements. Our responsibility is to express an opinion on these consolidated 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
consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we
engaged to perform, an audit of its 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 consolidated financial statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial
position of Natural Alternatives International, Inc. as of June 30, 2017 and 2016, and the consolidated results of its operations
and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States
of America.
/s/ Haskell & White LLP
HASKELL & WHITE LLP
San Diego, California
September 18, 2017
28
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 $18 at June 30,
2017 and $45 at June 30, 2016 ..............................................................................
Inventories, net ..........................................................................................................
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 ....................................................................................................................
Other noncurrent liabilities, net ........................................................................................
Total liabilities ...................................................................................................
Commitments and contingencies ......................................................................................
Stockholders’ equity:
Preferred stock; $.01 par value; 500,000 shares authorized; none issued or
2017
2016
27,843 $
19,747
8,410
13,729
261
1,456
51,699
18,136
2,002
774
72,611 $
5,116 $
2,353
1,594
1,207
10,270
557
537
99
11,463
13,217
20,768
14
2,136
55,882
15,167
2,227
899
74,175
12,821
2,242
2,802
1,340
19,205
758
486
—
20,449
outstanding ............................................................................................................
—
—
Common stock; $.01 par value; 20,000,000 shares authorized at June 30, 2017
and June 30, 2016, issued and outstanding (net of treasury shares) 6,937,018 at
June 30, 2017 and 6,868,628 at June 30, 2016 ......................................................
Additional paid-in capital ..........................................................................................
Retained earnings ......................................................................................................
Treasury stock, at cost, 1,044,659 shares at June 30, 2017 and 958,049 at June 30,
2016 .......................................................................................................................
Accumulated other comprehensive loss ....................................................................
Total stockholders’ equity ..................................................................................
Total liabilities and stockholders’ equity ........................................................... $
79
22,260
45,788
(6,074)
(905)
61,148
72,611 $
77
21,138
38,553
(5,362)
(680)
53,726
74,175
See accompanying notes to consolidated financial statements.
29
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 and administrative expenses ..................................................................
Income from operations ..................................................................................................
Other income (expense):
Interest income .........................................................................................................
Interest expense ........................................................................................................
Foreign exchange loss ..............................................................................................
Other, net ..................................................................................................................
Total other income (expense) ..........................................................................................
Income before income taxes ............................................................................................
Provision for income taxes ..............................................................................................
Net income ...................................................................................................................... $
Change in minimum pension liability, net of tax ............................................................ $
Unrealized (loss) gain resulting from change in fair value of derivative instruments,
net of tax .....................................................................................................................
Comprehensive income ................................................................................................... $
Net income per common share:
Basic ......................................................................................................................... $
Diluted ..................................................................................................................... $
Weighted average common shares outstanding:
2017
2016
121,946 $
95,742
26,204
16,502
9,702
459
(3 )
(28)
(19)
409
10,111
2,876
7,235 $
284 $
(509 )
7,010 $
1.10 $
1.09 $
114,201
88,943
25,258
13,000
12,258
131
2
(425)
1,606
1,314
13,572
4,026
9,546
(132)
218
9,632
1.46
1.44
Basic .........................................................................................................................
Diluted .....................................................................................................................
6,576,711
6,655,573
6,523,555
6,640,728
See accompanying notes to consolidated financial statements.
30
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 Shares
29,007
20,258 $
Treasury Stock
Amount
Income (Loss) Total
875,584 $
(4,714) $
(766) $
43,860
Accumulated
Other
Comprehensive
(2)
—
—
—
—
—
724
—
—
—
—
724
—
—
82,465
(648)
—
(648)
158
—
—
—
—
158
—
—
—
—
—
—
(132)
(132)
—
—
77
2
—
—
—
—
—
21,138
—
9,546
38,553
—
—
958,049
—
—
(5,362)
218
—
(680)
218
9,546
53,726
(2)
—
—
—
—
—
1,032
—
—
—
—
1,032
—
92
—
86,610
(712)
—
(712)
—
—
—
—
92
75 $
2
—
—
—
Balance, June 30, 2015 ... 7,618,677 $
Issuance of common
stock for restricted
stock grants ................
208,000
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 gain resulting
from change in fair
value of derivative
instruments, net of tax
—
Net income ......................
—
Balance, June 30, 2016 ... 7,826,677
Issuance of common
stock for restricted
stock grants ................
155,000
Compensation expense
related to stock
compensation plans ....
Repurchase of common
stock ...........................
Tax effect of stock
compensation .............
Change in minimum
pension liability, net
of tax ..........................
—
—
—
—
—
—
—
—
—
—
—
—
284
284
Unrealized loss resulting
from change in fair
value of derivative
instruments, net of tax
—
Net income ......................
—
Balance, June 30, 2017 ... 7,981,677 $
—
—
79 $
—
—
22,260 $
—
7,235
—
—
45,788 1,044,659 $
—
—
(6,074) $
(509)
—
(905) $
(509)
7,235
61,148
See accompanying notes to consolidated financial statements.
31
Natural Alternatives International, Inc.
Consolidated Statements Of Cash Flows
For the Years Ended June 30
(in thousands)
Cash flows from operating activities
Net income ..................................................................................................................... $
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts receivable ......................................................
Depreciation and amortization ................................................................................
Deferred income taxes ............................................................................................
Non-cash compensation ..........................................................................................
Pension expense ......................................................................................................
Gain 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 and equipment ..............................................................
Net cash used in investing activities ...............................................................................
Cash flows from financing activities
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 (loss) gain resulting from change in fair value of derivative
instruments, net of tax ......................................................................................... $
2017
2016
7,235 $
9,546
—
2,384
349
1,032
244
(24)
4,807
7,039
580
(8,013)
(288)
(1,208)
14,137
(5,354)
25
(5,329)
(712)
(712)
8,096
19,747
27,843 $
2,889 $
— $
284 $
(509) $
9
1,772
(197)
724
106
(1,866)
(3,331)
(8,204)
131
7,983
1,272
1,340
9,285
(10,441)
3,000
(7,441)
(648)
(648)
1,196
18,551
19,747
3,359
—
(132)
218
See accompanying notes to consolidated financial statements.
32
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 direct raw
material sales and 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.
Recent Accounting Pronouncements
In March 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which
amends existing standards for leases to increase transparency and comparability among organizations by requiring
recognition of lease assets and liabilities on the balance sheet and requiring disclosure of key information about such
arrangements. ASU 2016-02 will be effective for us beginning in our first quarter of fiscal 2020. Early adoption is permitted.
We are currently evaluating the impact of adopting the new standard on our consolidated financial statements and the timing
and presentation of our adoption.
In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation-Stock Compensation (Topic
718) (ASU 2016-09), which provides guidance improvements to employee share-based payment accounting. The standard
amends several aspects of current employee share-based payment accounting including income taxes, forfeitures, and
statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 will be effective
for us beginning in our first quarter of fiscal 2018. We do not expect the new standard to have a material impact on our
consolidated financial statements.
In April 2016, the FASB issued Accounting Standards Update No. 2016-10, Revenue from Contracts with Customers (Topic
606)(ASU 2016-10), which amends and adds clarity to certain aspects of the guidance set forth in the upcoming revenue
standard (ASU 2014-09) related to identifying performance obligations and licensing. In May 2016, the FASB issued
Accounting Standards Update No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)
(ASU 2016-11), which amends and rescinds certain revenue recognition guidance previously released within ASU 2014-09.
In May 2016 the FASB issued Accounting Standards Update No. 2016-12, Revenue from Contracts with Customers (Topic
606) (ASU 2016-12), which provides narrow scope improvements and practical expedients related to ASU 2014-09. ASU
2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible that more judgment and
estimates may be required within the revenue recognition process than is required under present U.S. GAAP. These may
include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the
transaction price, and allocating the transaction price to each separate performance obligation. The new standard also requires
additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer
contracts, including significant judgments and changes in judgments. All of these new standards will be effective for us
concurrently with ASU 2014-09, beginning in our first quarter of fiscal 2019. Early adoption is not permitted. Currently, we
do not expect our annual revenue to be materially different under Topic 606. The most significant change will be to our
quarterly and annual financial statement disclosures. We are continuing to evaluate the impact of adopting the new standard.
33
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to
Accounting for Hedging Activities. The ASU is intended to improve and simplify accounting rules around hedge accounting
and improve the disclosures of hedging arrangements. We are currently evaluating the impact of adopting the new standard
on our consolidated financial statements. ASU 2017-12 will be effective for us beginning in our first quarter of fiscal 2020.
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, 2017 and June 30, 2016, we did not have any financial assets or liabilities classified as Level 1, except for
assets and liabilities related to our pension plan. We classify derivative forward exchange contracts as Level 2 assets and
liabilities. The fair value of our forward exchange contracts as of June 30, 2017 was a net liability of $521,000 and the value
as of June 30, 2016 was a net asset of $250,000. 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, 2017 and June 30, 2016, 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 2017.
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
34
conditions. Based on this evaluation, we record adjustments to cost of goods sold to adjust inventory to its net realizable
value.
Property and Equipment
We state property and equipment at cost. Depreciation of property and equipment is provided using the straight-line method
over their estimated useful lives, generally ranging from 1 to 39 years. We amortize leasehold improvements using the
straight-line method over the shorter of the life of the improvement or the term of the lease. Maintenance and repairs are
expensed as incurred. Significant expenditures that increase economic useful lives are capitalized.
Impairment of Long-Lived Assets
We periodically evaluate the carrying value of long-lived assets to be held and used when events and circumstances indicate
that the carrying amount of an asset may not be recovered. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair
value less costs to sell. We did not recognize any impairment losses during fiscal 2017 or fiscal 2016.
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, 2017, 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, 2017, the notional amounts of our foreign exchange
contracts were $26.1 million (EUR 23.1 million). These contracts will mature over the next 14 months.
Defined Benefit Pension Plan
We formerly sponsored 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
35
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 beta-alanine
raw material sales. The estimated returns are based on the trailing six months of gross sales and our historical experience for
both private-label contract manufacturing and beta-alanine raw material 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 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® and SR CarnoSyn®
trade names. We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the
amount of $26.9 million during fiscal 2017 and $21.8 million during fiscal 2016. These royalty income and raw material sale
amounts resulted in royalty expense paid to the original patent holders from whom NAI acquired its patents and patent rights.
We recognized royalty expense as a component of cost of goods sold in the amount of $1.0 million during fiscal 2017 and
$865,000 during fiscal 2016.
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. 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.
Research and development costs are expensed when incurred. Our research and development expenses for the last two fiscal
years ended June 30 were $1.6 million for fiscal 2017 and $1.1 million for fiscal 2016. 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 $598,000 during the fiscal year ended June 30, 2017 and $334,000 during fiscal 2016.
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. For each of the
jurisdictions in which we operate, deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment
date.
36
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, 2017 and June 30, 2016, 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. There was no change
in the valuation allowance during fiscal 2017. During the fourth quarter of fiscal 2016, we concluded that it was more likely
than not that we would be able to realize the benefit of our federal and state deferred tax assets in the future. We based this
conclusion on historical and projected operating performance, as well as our expectation that our operations will generate
sufficient taxable income in future periods to realize the tax benefits associated with the deferred tax assets. As a result, we
reduced the valuation allowance on our net deferred tax assets by $193,000 at June 30, 2016. We will continue to assess the
need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist.
Any adjustment to the net deferred tax asset valuation allowance would be recorded in the income statement for the period
that the adjustment is determined to be required.
We 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 2009 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 use 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 2017 or 2016.
We did not have any options exercised during fiscal 2017 or fiscal 2016. All remaining outstanding stock options are fully
vested and all related compensation cost was fully recognized at June 30, 2014. No options vested during the fiscal years
ended June 30, 2017 and June 30, 2016.
During fiscal 2017, we granted a total of 155,000 restricted stock shares to the members of our Board of Directors and certain
key members of our management team pursuant to the 2009 Plan. During fiscal 2016, we granted a total of 208,000 restricted
stock shares to the members of our Board of Directors and certain key members of our management team pursuant to the
2009 Plan. These restricted stock grants will vest over three or five years from the date of grant and the unvested shares
cannot be sold or otherwise transferred and the rights to receive dividends, if declared by our Board of Directors, are
forfeitable until the shares become vested. There were 319,335 vested restricted stock shares as of June 30, 2017 and there
37
were 193,012 vested restricted stock shares as of June 30, 2016. The total remaining unrecognized compensation cost related
to unvested restricted stock shares amounted to $2.5 million at June 30, 2017 and the weighted average remaining requisite
service period of unvested restricted stock shares was 2.4 years. The weighted average fair value of restricted stock shares
granted during fiscal 2017 was $8.82 per share. The weighted average fair value of restricted stock shares granted during
fiscal 2016 was $9.86 per share.
Use of Estimates
Our management has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenue
and expenses, and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in
conformity with GAAP. Actual results could differ from those estimates.
Net Income per Common Share
We compute basic net income per common share using the weighted average number of common shares outstanding during
the period, and diluted net income per common share using the additional dilutive effect of all dilutive securities. The dilutive
impact of stock options and restricted shares account for the additional weighted average shares of common stock outstanding
for our diluted net income per common share computation. We calculated basic and diluted net income per common share as
follows (in thousands, except per share data):
Numerator
Net income .............................................................................................................. $
Denominator
Basic weighted average common shares outstanding ..............................................
Dilutive effect of stock options and restricted stock shares ....................................
Diluted weighted average common shares outstanding ..........................................
Basic net income per common share ....................................................................... $
Diluted net income per common share .................................................................... $
No shares related to stock options were excluded for the year ended June 30, 2017.
Concentrations of Credit Risk
For the Years Ended June 30,
2017
2016
7,235 $
6,577
79
6,656
1.10 $
1.09 $
9,546
6,524
117
6,641
1.46
1.44
Financial instruments that subject us to concentrations of credit risk consist primarily of cash and cash equivalents and
accounts receivable. We place our cash and cash equivalents with highly rated financial institutions. Credit risk with respect
to receivables is concentrated with our three largest customers, whose receivable balances collectively represented 65.6% of
gross accounts receivable at June 30, 2017 and 58.7% at June 30, 2016. Additionally, amounts due related to our beta-alanine
raw material sales were 21.3% of gross accounts receivable at June 30, 2017, and 14.6% of gross accounts receivable at June
30, 2016. Concentrations of credit risk related to the remaining accounts receivable balances are limited due to the number
of customers comprising our remaining customer base.
38
B. Inventories
Inventories, net, consisted of the following at June 30 (in thousands):
Raw materials ................................................................................................ $
Work in progress ...........................................................................................
Finished goods ..............................................................................................
Reserve ..........................................................................................................
Total inventories ............................................................................................ $
9,469 $
1,312
3,562
(614)
13,729 $
14,751
3,487
2,832
(302)
20,768
2017
2016
C. Property and Equipment
Property and equipment consisted of the following at June 30 (dollars in thousands):
Land ...............................................................................................
Building and building improvements .............................................
Machinery and equipment ..............................................................
Office equipment and furniture ......................................................
Vehicles ..........................................................................................
Leasehold improvements ................................................................
Total property and equipment ........................................................
Less: accumulated depreciation and amortization ..........................
Property and equipment, net ...........................................................
Depreciable
Life In Years
NA
7
3
3
– 39
– 12
– 5
3
– 15
1
2017
2016
$
$
1,200 $
3,706
24,194
3,954
209
17,038
50,301
(32,165)
18,136 $
1,200
3,324
23,846
2,994
209
15,261
46,834
(31,667)
15,167
Depreciation expense was approximately $2.3 million in fiscal 2017 and $1.8 million in fiscal 2016.
D. Other comprehensive loss
Other comprehensive (loss) income (“OCL” and “OCI”) consisted of the following at June 30 (dollars in thousands):
Year Ended June 30, 2017
Unrealized
Gains (Losses)
on Cash Flow
Hedges
Defined Benefit
Pension Plan
Total
Balance as of June 30, 2016 ....................................................... $
(775) $
OCI/OCL before reclassifications ..............................................
Amounts reclassified from OCI .................................................
Tax effect of OCI activity ..........................................................
Net current period OCI/OCL ......................................................
Balance as of June 30, 2017 ....................................................... $
271
175
(162)
284
(491) $
95 $
(110)
(685)
286
(509)
(414) $
(680)
161
(510)
124
(225)
(905)
39
Year Ended June 30, 2016
Unrealized
(Losses) Gains
on Cash Flow
Hedges
Defined Benefit
Pension Plan
Total
Balance as of June 30, 2015 ....................................................... $
OCI/OCL before reclassifications ..............................................
Amounts reclassified from OCI .................................................
Tax effect of OCI activity ..........................................................
Net current period OCI/OCL ......................................................
Balance as of June 30, 2016 ....................................................... $
(643) $
(232)
19
81
(132)
(775) $
(123) $
414
(74)
(122)
218
95 $
(766)
182
(55)
(41)
86
(680)
E. Debt
On March 28, 2017, we executed an amendment to our credit facility with Wells Fargo Bank, N.A. to extend the maturity for
our working line of credit from January 31, 2019, to February 1, 2020. The Credit Agreement provides us with a credit line
of up to $10.0 million. The line of credit may be used to finance working capital requirements. There was no commitment
fee required as part of this agreement. There are no amounts currently drawn under the line of credit.
Under the terms of the Credit Agreement, borrowings are subject to eligibility requirements including maintaining (i) a ratio
of total liabilities to tangible net worth of not greater than 1.25 to 1.0 at any time; and (ii) a ratio of total current assets to total
current liabilities of not less than 1.75 to 1.0 at each fiscal quarter end. Any amounts outstanding under the line of credit will
bear interest at a fixed or fluctuating interest rate as elected by NAI from time to time; provided, however, that if the
outstanding principal amount is less than $100,000 such amount shall bear interest at the then applicable fluctuating rate of
interest. If elected, the fluctuating rate per annum would be equal to 1.25% above the daily one month LIBOR rate as in effect
from time to time. If a fixed rate is elected, it would equal a per annum rate of 1.25% above the LIBOR rate in effect on the
first day of the applicable fixed rate term. Any amounts outstanding under the line of credit must be paid in full on or before
the maturity date. Amounts outstanding that are subject to a fluctuating interest rate may be prepaid at any time without
penalty. Amounts outstanding that are subject to a fixed interest rate may be prepaid at any time in minimum amounts of
$100,000, subject to a prepayment fee equal to the sum of the discounted monthly differences for each month from the month
of prepayment through the month in which the then applicable fixed rate term matures.
Our obligations under the Credit Agreement are secured by our accounts receivable and other rights to payment, general
intangibles, inventory, equipment and fixtures. We also have a foreign exchange facility with Wells Fargo Bank, N.A. in
effect until January 31, 2019, and with Bank of America, N.A. in effect until August 15, 2019.
On June 30, 2017, we were in compliance with all of the financial and other covenants required under the Credit Agreement.
Our wholly owned subsidiary, NAIE, formerly had a credit facility with Credit Suisse that would provide NAIE with a credit
line of up to CHF 500,000, or approximately $522,000. We terminated this line of credit in December 2016 as we determined
that it was unnecessary as we believe our current cash position and ongoing cash from operations are sufficient to support
our cash requirements.
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, 2017. As of June 30, 2017, we had $10.0 million available under our credit facilities.
F. Income Taxes
During fiscal 2017, we recorded U.S.-based domestic tax expense of $2.2 million. During fiscal 2016, we recorded U.S.-
based domestic tax expense of $3.6 million on U.S.-based income, which was offset by the release of our deferred tax asset
valuation of $193,000 resulting in a net domestic tax expense of $3.4 million. The release of our deferred tax asset valuation
was based on historical and projected operating performance, as well as our expectation that our operations will generate
sufficient taxable income in future periods to realize the tax benefits associated with the deferred tax assets. The valuation
allowance activity did not have any impact on the tax expense and related liability recorded for operating income recognized
by NAIE during the years ended June 30, 2017 or June 30, 2016.
40
The provision for income taxes for the years ended June 30 consisted of the following (in thousands):
2017
2016
Current:
Federal ................................................................................................... $
State .......................................................................................................
Foreign ...................................................................................................
Total current ..................................................................................................
Deferred:
Federal ...................................................................................................
State .......................................................................................................
Valuation allowance ...............................................................................
Total deferred ................................................................................................
Total provision for income taxes ................................................................... $
1,791 $
90
646
2,527
305
44
—
349
2,876 $
Net deferred tax assets and deferred tax liabilities as of June 30 were as follows (in thousands):
2017
2016
Deferred tax assets:
Inventory capitalization .......................................................................... $
Inventory reserves ..................................................................................
Pension liability .....................................................................................
Accrued bonus .......................................................................................
Net operating loss carry forward ............................................................
Deferred rent ..........................................................................................
Accumulated depreciation and amortization ..........................................
Stock-based compensation .....................................................................
Tax credit carry forward.........................................................................
Accrued vacation expense ......................................................................
Other, net ................................................................................................
Total gross deferred tax assets ......................................................................
Deferred tax liabilities:
Prepaid expenses ....................................................................................
Other, net ................................................................................................
Deferred tax liabilities ...................................................................................
Valuation allowance ......................................................................................
Net deferred tax assets................................................................................... $
438 $
178
241
114
240
193
8
195
176
111
256
2,150
(148)
—
(148)
—
2,002 $
3,339
138
629
4,106
46
67
(193)
(80)
4,026
576
103
403
391
298
175
158
154
138
130
15
2,541
(260)
(54)
(314)
—
2,227
At June 30, 2017, we had state tax net operating loss carry forwards of approximately $4.1 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 fiscal 2032, 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, 2017 and June 30, 2016.
We are subject to taxation in the U.S., Switzerland and various state jurisdictions. Our tax years for the fiscal year ended
June 30, 2014 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,
2015 and forward are subject to examination by the Switzerland tax authorities.
NAIE’s effective tax rate for Swiss federal, cantonal and communal taxes is approximately 17.5%. NAIE had net income of
$3.1 million for the fiscal year ended June 30, 2017. Undistributed earnings of NAIE amounted to approximately $20.9
41
million at June 30, 2017. These earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S.
federal taxes has been provided thereon.
A reconciliation of income tax provision computed by applying the statutory federal income tax rate of 34% to net income
before income taxes for the year ended June 30 is as follows (dollars in thousands):
2017
2016
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 ..........................................................................
Adjust state deferred due to change in apportionment .................................
Change in valuation allowance ....................................................................
Other, net .....................................................................................................
Income tax provision as reported ................................................................. $
Effective tax rate ..........................................................................................
G. Employee Benefit Plans
$
3,438
95
29
(613)
6
—
(79)
$
28.4%
2,876
4,614
179
19
(514)
(18)
(193)
(61)
4,026
29.7%
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 $248,000 for fiscal 2017 and
$229,000 for fiscal 2016.
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 $1.0 million for the fiscal year ended June 30,
2017 and $847,000 for the fiscal year ended June 30, 2016.
We formerly sponsored 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.
42
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):
2017
2016
Change in Benefit Obligation:
Benefit obligation at beginning of year ..................................................... $
Interest cost ...............................................................................................
Actuarial (gain) loss ..................................................................................
Benefits paid ..............................................................................................
Benefit obligation at end of year ................................................................... $
Change in Plan Assets:
Fair value of plan assets at beginning of year ............................................ $
Actual return on plan assets .......................................................................
Benefits paid ..............................................................................................
Plan expenses ............................................................................................
Fair value of plan assets at end of year ......................................................... $
Reconciliation of Funded Status:
Difference between benefit obligation and fair value of plan assets ......... $
Unrecognized net actuarial loss in accumulated other comprehensive
income....................................................................................................
Net amount recognized ................................................................................. $
Projected benefit obligation .......................................................................... $
Accumulated benefit obligation .................................................................... $
Fair value of plan assets ................................................................................ $
2,329 $
70
(189)
(406)
1,804 $
1,571 $
117
(406)
(35)
1,247 $
(557) $
671
114 $
1,804 $
1,804 $
1,247 $
2,080
87
272
(110)
2,329
1,642
74
(112)
(33)
1,571
(758)
1,117
359
2,329
2,329
1,571
The weighted-average discount rate used for determining the projected benefit obligations for the defined benefit pension
plan was 3.9% for the year ended June 30, 2017 and 3.6% during the year ended June 30, 2016.
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 ............................................................................. $
2017
2016
70 $
(74 )
93
155
244 $
87
(105)
68
55
105
We did not make any contributions to our defined benefit pension plan in fiscal 2017 and do not expect to make any
contributions in fiscal 2018.
The following is a summary of changes in plan assets and benefit obligations recognized in other comprehensive income (in
thousands):
Net (gain) loss .............................................................................................. $
Settlement loss .............................................................................................
Amortization of net loss ...............................................................................
Plan expenses ...............................................................................................
Total recognized in other comprehensive income (loss) ..................................... $
Total recognized in net periodic benefit cost and other comprehensive income . $
(233) $
(155)
(93)
35
(446) $
(202) $
304
(55)
(68)
32
213
318
2017
2016
43
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 $38,000. 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):
2018 ..................................................................................................................................................... $
2019 .....................................................................................................................................................
2020 .....................................................................................................................................................
2021 .....................................................................................................................................................
2022 .....................................................................................................................................................
2023-2027 ...........................................................................................................................................
Total benefit payments expected to be paid ........................................................................................ $
45
65
103
114
113
650
1,090
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 .................................................................................
3.87%
6.5%
N/A
3.61%
7.00%
N/A
2017
2016
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 ....................................................
2017
2016
Target
Allocation
41%
44%
2%
13%
100%
50%
47%
—
3%
100%
49%
46%
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.
44
The fair values by asset category of our defined benefit pension plan at June 30, 2017 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 ................ $
Commodities and other ........................... $
Equity securities(1) ................................... $
Debt securities(2) ...................................... $
Total ............................................... $
157 $
27 $
517 $
546 $
1,247 $
157 $
27 $
517 $
546 $
1,247 $
— $
— $
— $
— $
— $
—
—
—
—
—
(1) This category is comprised of publicly traded funds, of which 26% are large-cap funds, 46% are mid-cap and small-cap,
17% are developed market funds, 10% are emerging markets equity funds, and 1% are specialty funds.
(2) This category is comprised of publicly traded funds, of which 28% are REITs, 25% are high-yield fixed income funds,
24% are U.S. fixed income funds, 12% are developed market fixed income funds, and 11% 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. On February
6, 2015, the Board of Directors authorized a $1.0 million increase to our stock repurchase plan bringing the total authorized
repurchase amount to $3.0 million. On May 11, 2015, the Board of Directors authorized a $2.0 million increase to our stock
repurchase plan bringing the total authorized repurchase amount to $5.0 million. On March 28, 2017, the Board of Directors
authorized a $2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $7.0
million. Under the repurchase plan, we may, from time to time, purchase shares of our common stock, depending upon market
conditions, in open market or privately negotiated transactions.
During the twelve months ended June 30, 2017, we purchased 39,547 shares at a weighted average cost of $8.74 per share
and a total cost of $345,000 including commissions and fees. During the twelve months ended June 30, 2016, we purchased
52,603 shares at a weighted average cost of $6.26 per share and a total cost of $329,000 including commissions and fees.
During fiscal 2017, we acquired 38,729 shares in connection with restricted stock shares that vested during that year at a
weighted average cost of $9.47 per share and a total cost of $367,000. During fiscal 2016 we acquired 27,195 shares from
employees in connection with restricted stock shares that vested during the year at a weighted average cost of $11.70 per
share and a total cost of $319,000. These shares were returned to the Company by the related employees and in return the
Company paid each employee’s required tax withholding. The valuation of the shares acquired and thereby the number of
shares returned to the Company was calculated based on the closing share price on the date the shares vested.
Stock Option Plans
Effective as of October 15, 2009, our Board of Directors approved the 2009 Plan. The 2009 Plan was approved by our
stockholders at the Annual Meeting of Stockholders held on November 30, 2009. Under the 2009 Plan, we may grant
nonqualified and incentive stock options and other stock-based awards to employees, non-employee directors and consultants.
Between October 15, 2009, and June 30, 2017, a total of 1.2 million shares of common stock have been authorized under the
2009 Plan for issuance to our employees, non-employee directors and consultants. As of June 30, 2017, there were 389,000
remaining shares available for grant under the 2009 Plan.
45
Stock option activity for the year ended June 30, 2017 was as follows:
2009
Plan
Weighted
Average
Exercise Price
Weighted
Average
Contractual
Term
(in years)
Aggregate
Intrinsic
Value
Exercised ........................................................
Forfeited .........................................................
Granted ...........................................................
Vested and exercisable at June 30, 2016 ............... 140,000 $
— $
— $
— $
Outstanding at June 30, 2017 ................................ 140,000 $
Vested and exercisable at June 30, 2017 ............... 140,000 $
6.36
—
—
—
6.36
6.36
Restricted stock activity for the year ended June 30, 2017 was as follows (2009 Plan):
3.58 $
3.58 $
502,000
502,000
Number of
Shares
Weighted
Average
Grant Date
Fair Value
Nonvested at June 30, 2016 ............................................................................
Granted ....................................................................................................
Vested ......................................................................................................
Forfeited ...................................................................................................
Nonvested at June 30, 2017 ............................................................................
310,321 $
155,000 $
(126,323 ) $
(8,333 ) $
330,665 $
8.43
8.82
7.77
9.96
8.83
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 through March 2024.
During February 2016, we sold our former corporate headquarters in San Marcos, CA and the property was leased though a
sale-leaseback agreement through August 2016. The property was vacated during August 2016. We purchased the Carlsbad
facility in March 2016 and began to occupy as our new corporate headquarters during August 2016.
NAIE leases facility space in Manno, Switzerland. The leased space totals approximately 94,217 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, 2017 (in thousands):
Gross minimum rental commitments . $
2,816 $
2,812 $
1,394 $ 1,429 $ 1,092 $
3,022 $ 12,565
2018
2019
2020
2021
2022
Thereafter Total
Rental expense totaled $3.0 million for the fiscal year ended June 30, 2017 and $3.1 million for the fiscal year ended June
30, 2016.
46
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 consolidated net sales were as follows (dollars in thousands):
Customer 1 ................................................................................................... $
Customer 2 ...................................................................................................
$
Fiscal 2017
Fiscal 2016
60,532 $
(a)
60,532 $
49,442
13,952
63,394
(a) Sales were less than 10% of the respective period’s consolidated net sales.
Accounts receivable from these customers totaled $1.5 million at June 30, 2017 and $8.1 million at June 30, 2016.
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. Raw material purchases from any one supplier
representing 10% or more of the respective period’s total raw material purchases were as follows (dollars in thousands):
Year ended June 30,
2017
2016
Raw Material
Purchases by
Supplier
% of Total
Raw
Material
Purchases
Raw Material
Purchases by
Supplier
Supplier 1 ................................................................ $
$
6,694
6,694
12%
12%
(a)
(a)
(a) Purchases were less than 10% of the respective period’s total raw material purchases.
K. Derivatives and Hedging
% of Total
Raw
Material
Purchases
(a)
(a)
We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to forecasted
product sales denominated in foreign currencies and transactions of NAIE, our foreign subsidiary. As part of our overall
strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, we may use foreign
exchange contracts in the form of forward contracts. There can be no guarantee any such contracts, to the extent we enter
into such contracts, will be effective hedges against our foreign currency exchange risk.
During the year ended June 30, 2017 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 2018. 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 income or 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, 2017, we recorded a $189,000 gain related to the
ineffective portion of our hedging instruments to other income. We did not have any losses or gains related to the ineffective
portion of our hedging instruments during the year ended June 30, 2016. 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, 2017, the notional amounts of our foreign exchange contracts were $26.1 million (EUR 23.1 million). As of
June 30, 2017, a net liability of approximately $646,000, offset by $232,000 of deferred taxes, related to derivative
47
instruments designated as cash flow hedges was recorded in OCI. As of June 30, 2016, a net asset of approximately $149,000,
offset by $54,000 of deferred taxes, related to derivative instruments designated as cash flow hedges was recorded in OCI. It
is expected that $541,000 of the gross loss, as of June 30, 2017, will be reclassified into earnings in the next 12 months along
with the earnings effects of the related forecasted transactions.
As of June 30, 2017, $422,000 of the fair value of our cash flow hedges was classified in accrued liabilities, and $99,000 was
classified other noncurrent liabilities, net in our Consolidated Balance Sheets. During the year ended June 30, 2017, we
recognized $110,000 of losses in OCI and reclassified $685,000 of gains from OCI to revenue. During the year ended June 30,
2016, we recognized $414,000 of losses in OCI and reclassified $74,000 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 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.
M. Segment Information
Our business consists of two segments for financial reporting purposes. The two 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 direct raw material sales and royalty income from our license and supply agreements
associated with the sale and use of beta-alanine under our CarnoSyn® trade name.
We evaluate performance based on a number of factors. The primary performance measures for each segment are net sales
and income or loss from operations before corporate allocations. Operating income or loss for each 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. Transfers of raw
materials between segments are recorded at cost. The accounting policies of our segments are the same as those described in
the summary of significant accounting policies in Note A.
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 ..............................................................
Total net sales ............................................................................................... $
95,024 $
26,922
121,946 $
92,420
21,781
114,201
2017
2016
Income from Operations
Private-label contract manufacturing ..................................................... $
Patent and trademark licensing ..............................................................
Income from operations of reportable segments ....................................
Corporate expenses not allocated to segments .......................................
Total income from operations ....................................................................... $
2017
2016
8,569 $
7,534
16,103
(6,401)
9,702 $
12,184
6,153
18,337
(6,079 )
12,258
48
Assets
Private-label contract manufacturing ..................................................... $
Patent and trademark licensing ..............................................................
Total assets .................................................................................................... $
60,489 $
12,122
72,611 $
66,375
7,800
74,175
2017
2016
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.
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 sale
$
$
2017
2016
63,104 $
58,842
121,946 $
50,575
63,626
114,201
Products manufactured by NAIE accounted for 59% of consolidated net sales in markets outside the U.S. in fiscal 2017 and
61% in fiscal 2016. No products manufactured by NAIE were sold in the U.S. during the fiscal years ended June 30, 2017
and 2016.
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):
2017
United States ............................................................. $
Europe .......................................................................
$
Long-Lived
Assets
Total
Assets
Capital
Expenditures
10,753 $
7,383
18,136 $
47,777 $
24,834
72,611 $
2,365
2,989
5,354
2016
United States ............................................................. $
Europe .......................................................................
$
Long-Lived
Assets
Total
Assets
Capital
Expenditures
9,678 $
5,489
15,167 $
49,755 $
24,420
74,175 $
6,423
4,018
10,441
N. Subsequent Events
On August 7, 2017, we entered into three agreements (“Agreements”), with The Juice Plus+ Company LLC (“Juice Plus+”).
The Agreements are an Exclusive Manufacturing Agreement, a Restricted Stock Award Agreement, and an Irrevocable
Proxy. Pursuant to the Exclusive Manufacturing Agreement Juice Plus+ has granted us exclusive rights to manufacture and
supply Juice Plus+ with certain Juice Plus+ products within 24 countries that Juice Plus+ currently sells those products.
Pursuant to the Restricted Stock Award Agreement, NAI has agreed to grant 500,000 shares of NAI common stock to Juice
Plus+, (the “Shares”), and Juice Plus+ has agreed the Shares are subject to certain restrictions and risk of forfeiture. Pursuant
to the Irrevocable Proxy, Juice Plus+ has granted to the NAI Board of Directors Juice Plus+’s right to vote the Shares as long
as they are subject to the associated risk of forfeiture. The Agreements are for a term of 5 years, and may be terminated by
either party only on the occurrence of specified events.
On July 3, 2017, we purchased 24 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 24
contracts expire monthly beginning September 2017 and ending August 2019. The forward contracts had a notional amount
of 26.2 million Euros and a weighted average forward rate of $1.16.
49
On August 4, 2017, we purchased 11 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 11
contracts expire monthly beginning October 2017 and ending August 2018. The forward contracts had a notional amount of
12.5 million Euros and a weighted average forward rate of $1.18.
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, 2017. 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, 2017.
(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,
2017. 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, 2017 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, 2017 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.
50
(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, 2017 that
have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
The information called for under Items 10- 14 of this Part III will be incorporated by reference from our definitive proxy
statement for our Annual Meeting of Stockholders to be held on December 5, 2017, to be filed on or before October 28, 2017.
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, 2017 and 2016;
• Consolidated Statements of Operations and Comprehensive Income for the years ended June 30, 2017 and 2016;
• Consolidated Statements of Stockholders’ Equity for the years ended June 30, 2017 and 2016;
• Consolidated Statements of Cash Flows for the years ended June 30, 2017 and 2016; and
• Notes to Consolidated Financial Statements.
(2) Exhibits. The following exhibit index shows those exhibits filed with this report and those incorporated by reference:
51
Description
Exhibit
Number
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
10.9
2009 Omnibus Incentive Plan*
10.5
10.6
10.7
10.8
10.11
10.12
10.13
10.14
10.15
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
between NAI and each of its directors
into
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
Manufacturing Agreement by and between Mannatech,
Inc. and NAI dated April 22, 1998
First Amendment to Manufacturing Agreement by and
between Mannatech, Incorporated and NAI dated May
23, 2003
Second Amendment to Manufacturing Agreement by and
between Mannatech, Incorporated and NAI dated July 1,
2003
Third Amendment to Manufacturing Agreement by and
between Mannatech, Incorporated and NAI dated July 1,
2004
Fourth Amendment to Manufacturing Agreement by and
among Mannatech, Incorporated, Mannatech Swiss
International GmbH and NAI dated January 1, 2008
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
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
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
Attachment D of NAI’s definitive Proxy Statement filed
with the commission on October 16, 2009
Exhibit 10.44 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
Exhibit 10.45 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
Exhibit 10.46 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
Exhibit 10.47 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
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
10.16 Manufacturing Sales Agreement by and between
Mannatech, Incorporated and NAI dated November 19,
2004
10.17 Amendment to Manufacturing Sales Agreement by and
among Mannatech, Incorporated, Mannatech Swiss
International GmbH and NAI dated January 1, 2008
10.21 License and Fee Agreement effective November 10, 2010
by and among Roger Harris, Mark Dunnett, Kenny
Johansson and NAI
10.23 ISDA 2002 Master Agreement dated as of March 10,
2011 by and between Bank of America N.A. and NAI
(with Schedule dated March 10, 2011)
Exhibit 10.49 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
Exhibit 10.50 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2009, filed
with the commission on February 16, 2010
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 10.31 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
52
10.30 Third amendment to the Lease of Facilities in Vista,
California between NAI and CWCA Vista Distribution
77, LLC, a Delaware limited liability company
10.33 Credit Agreement by and between NAI and Wells Fargo
Bank, N.A. effective as of November 1, 2014
10.37 Agreement to License by and between NAI and
Compound Solutions, Inc. effective as of April 1, 2014
10.38 Lease of Facilities in Manno, Switzerland between NAIE
and Mr. Silvio Tarchini effective July 1, 2014 (English
translation)
10.39 Amended and Restated Employment Agreement, by and
between NAI and Mark A. LeDoux, effective October 1,
2015*
10.40 Amended and Restated Employment Agreement, by and
between NAI and Kenneth E. Wolf, effective October 1,
2015*
10.41 Amended and Restated Employment Agreement, by and
between NAI and Michael E. Fortin, effective October 1,
2015*
10.42 First Amendment to Credit agreement by and between
NAI and the Wells Fargo Bank N.A. effective as of
February 1, 2016
to
10.44 First amendment
the Amended and Restated
Employment Agreement, by and between NAI and
Michael E. Fortin, effective September 1, 2016*
10.45 Second Amendment to the Credit agreement by and
between NAI and the Wells Fargo Bank N.A. effective as
of March 28, 2017
10.46 Revolving Line of Credit Note made by NAI for the
benefit of Wells Fargo Bank N.A. dated March 28, 2017
in the amount of $10,000,000
10.47 Exclusive Manufacturing Agreement by and between
NAI and the Juice Plus+ Company dated August 7, 2017
10.48 Restricted Stock Agreement by and between NAI and the
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 10.1 of NAI’s Current Report on Form 8-K dated
December 22, 2014, filed with the commission on
December 24, 2014
Exhibit 10.37 of NAI’s Annual Report on Form 10-K for
the fiscal year ended June 30, 2014, filed with the
commission on September 25, 2014.
Exhibit 10.38 of NAI’s Annual Report on Form 10-K for
the fiscal year ended June 30, 2014, filed with the
commission on September 25, 2014.
Exhibit 10.1 of NAI’s Current Report on Form 8-K dated
October 1, 2015, filed with the commission on October 1,
2015
Exhibit 10.2 of NAI’s Current Report on Form 8-K dated
October 1, 2015, filed with the commission on October 1,
2015
Exhibit 10.3 of NAI’s Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 2015, filed with
the commission on November 12, 2015.
Exhibit 10.01 of NAI’s Quarterly Report on Form 10-Q
for the quarterly period ended December 31, 2015, filed
with the commission on February 9, 2016.
Exhibit 10.44 of NAI’s Current Report on Form 8-K
dated September 1, 2016, filed with the commission on
September 6, 2016
Exhibit 10.1 of NAI’s Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2017, filed with the
commission on May 15, 2017
Exhibit 10.1 of NAI’s Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2017, filed with the
commission on May 15, 2017
Exhibit 10.45 of NAI’s Current Report on Form 8-K filed
with the commission on August 11, 2017
Exhibit 10.46 of NAI’s Current Report on Form 8-K filed
with the commission on August 11, 2017
Juice Plus+ Company dated August 7, 2017
53
21
23.1
31.1
31.2
32
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
Section 1350 Certification
Filed herewith
Filed herewith
Filed herewith
Filed herewith
Filed herewith
101.INS XBRL Instance Document
Furnished herewith
101.SCH XBRL Taxonomy Extension Schema Document
Furnished herewith
101.CAL XBRL Taxonomy Extension Calculation Linkbase
Furnished herewith
Document
101.DEF XBRL Taxonomy Extension Definition Linkbase
Furnished herewith
Document
101.LAB XBRL Taxonomy Extension Label Linkbase Document Furnished herewith
101.PRE XBRL Taxonomy Extension Presentation Linkbase
Furnished herewith
Document
* Indicates management contract or compensatory plan or arrangement.
54
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 18, 2017
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/ Michael E. Fortin
(Michael E. Fortin)
/s/ Joe E. Davis
(Joe E. Davis)
/s/ Alan G. Dunn
(Alan G. Dunn)
/s/ Alan J. Lane
(Alan J. Lane)
/s/ Lee G. Weldon
(Lee G. Weldon)
Chief Executive Officer and
Chairman of the Board of Directors
(principal executive officer)
Chief Financial Officer
(principal financial officer and
principal accounting officer)
Director
Director
Director
Director
September 18, 2017
September 18, 2017
September 18, 2017
September 18, 2017
September 18, 2017
September 18, 2017
55
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CORPORATE INFORMATION
OFFICERS
Mark LeDoux
Chairman and Chief Executive
Officer
INVESTOR RELATIONS
Natural Alternatives International, Inc.
1535 Faraday Avenue
Carlsbad, California 92078 USA
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Haskell & White LLP
300 Spectrum Center Drive, Suite 300
Irvine, California 92618
Kenneth Wolf
President, Chief Operating
Officer and Secretary
Michael Fortin
Chief Financial Officer
BOARD OF DIRECTORS
Mark LeDoux
Joe Davis
Alan Dunn
Alan Lane
Lee Weldon
ANNUAL MEETING
The annual meeting of the
stockholders will be held at
11:00 a.m. PST on Tuesday,
December 5, 2017 at
Natural Alternatives International, Inc.
Manufacturing Facility
1215 Park Center Drive
Vista, California 92081
CORPORATE COUNSEL
FisherBroyles LLP
12707 High Bluff Drive, Suite 200
San Diego, California 92130
TRANSFER AGENT & REGISTRAR
Computershare, Inc.
PO Box 505000
Louisville, Kentucky 40233-5000
T: 800-522-6645
www.Computershare.com/investor
TRADEMARKS
NAI®, CarnoSyn®, SR CarnoSyn® are registered trademarks of Natural Alternatives International, Inc.
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
1535 Faraday Avenue ● Carlsbad, California 92008 USA ● T: 760-736-7700 ● F: 760-727-5325 ● E: info@nai-online.com
NAI EUROPE
Centro Galleria 1 ● Via Cantonale ● 6928 Manno ● Switzerland ● T: 41-91-610-8460 ● F: 41-91-610-8470
NAI JAPAN
Yokohama City ● Kanagawa-Ku ● Japan
1-800-VITAMIN WWW.NAI-ONLINE.COM
004CTN211B