NATURAL ALTERNATIVES INTERNATIONAL INC - Quarter Report: 2020 March (Form 10-Q)

 

 

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

---

FORM 10-Q

  

☒ QUARTERLY REPORT pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2020

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM _________ TO __________

 

000-15701

(Commission file number)

 

---

NATURAL ALTERNATIVES INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	84-1007839
(State of incorporation)	(IRS Employer Identification No.)
1535 Faraday Ave Carlsbad, CA 92008	(760) 736-7700
(Address of principal executive offices)	(Registrant’s telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
Common Stock, $0.01 par value per share	NAII	Nasdaq Stock Market

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that NAI was required to submit such files).    ☒  Yes     ☐  No

 

Indicate by check mark whether NAI is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.

 

Large accelerated filer	☐	Accelerated filer	☐	Emerging Growth Company	☐
Non-accelerated filer	☐	Smaller reporting company	☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether NAI is a shell company (as defined in Rule 12b-2 of the Exchange Act): ☐ Yes ☒ No

 

As of May 14, 2020, 6,788,366 shares of NAI's common stock were outstanding, net of 2,068,311 treasury shares.

 

 

 

TABLE OF CONTENTS

 

		Page
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS		1
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	2
	Condensed Consolidated Statements of (Loss) Income and Comprehensive (Loss) Income	3
	Condensed Consolidated Statements of Stockholders’ Equity	4
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4.	Controls and Procedures	18
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	19
Item 1A.	Risk Factors	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.	Defaults Upon Senior Securities	20
Item 4.	Mine Safety Disclosures	20
Item 5.	Other Information	20
Item 6.	Exhibits	20
SIGNATURES		21

 

 

 

 

		March 31, 2020				June 30, 2019
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	33,315			$	25,040
Accounts receivable - less allowance for doubtful accounts of $3,282 at March 31, 2020 and $25 at June 30, 2019			12,379				15,964
Inventories, net			26,111				26,003
Income tax receivable			1,623				901
Forward contracts			1,587				1,978
Prepaids and other current assets			1,973				1,500
Total current assets			76,988				71,386
Property and equipment, net			21,398				21,085
Operating lease right-of-use assets			18,881				—
Other noncurrent assets, net			1,088				1,019
Total assets		$	118,355			$	93,490
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	10,674			$	8,634
Accrued liabilities			2,398				2,782
Accrued compensation and employee benefits			1,308				1,615
Income taxes payable			1,425				1,219
Line of credit – current			10,000				—
Total current liabilities			25,805				14,250
Long-term liability – operating leases			19,230				—
Long-term pension liability			267				246
Deferred rent			—				543
Income taxes payable, noncurrent			1,349				1,349
Deferred income taxes			955				1,018
Total liabilities			47,606				17,406
Commitments and contingencies (Note L)
Stockholders’ equity:
Preferred stock; $.01 par value; 500,000 shares authorized; none issued or outstanding			—				—
Common stock; $.01 par value; 20,000,000 shares authorized; issued and outstanding (net of treasury shares) 6,791,396 at March 31, 2020 and 7,225,072 at June 30, 2019			87				87
Additional paid-in capital			27,631				26,280
Retained earnings			54,485				57,380
Treasury stock, at cost, 2,065,281 shares at March 31, 2020 and 1,626,605 June 30, 2019			(11,437	)			(7,955	)
Accumulated other comprehensive (loss) gain			(17	)			292
Total stockholders’ equity			70,749				76,084
Total liabilities and stockholders’ equity		$	118,355			$	93,490

 

		Three Months Ended								Nine Months Ended
		March 31,								March 31,
		2020				2019				2020				2019
Net sales		$	25,482			$	35,455			$	83,780			$	108,030
Cost of goods sold			22,588				29,128				71,441				88,104
Gross profit			2,894				6,327				12,339				19,926
Other selling, general and administrative			3,835				4,492				12,637				13,160
Provision for uncollectible accounts receivable			3,282				—				3,282				—
Total selling, general and administrative			7,117				4,492				15,919				13,160
(Loss) income from operations			(4,223	)			1,835				(3,580	)			6,766
Other (expense) income:
Interest income			47				411				176				1,495
Interest expense			(5	)			(11	)			(16	)			(23	)
Foreign exchange (loss) gain			(91	)			232				(144	)			191
Other, net			1				(10	)			(11	)			(1	)
Total other (expense) income			(48	)			622				5				1,662
(Loss) income before income taxes			(4,271	)			2,457				(3,575	)			8,428
(Benefit) provision for income taxes			(256	)			463				(132	)			1,694
Net (loss) income		$	(4,015	)		$	1,994			$	(3,443	)		$	6,734
Unrealized gain (loss) resulting from change in fair value of derivative instruments, net of tax			335				424				(181	)			1,659
Comprehensive (loss) income		$	(3,680	)		$	2,418			$	(3,624	)		$	8,393
Net (loss) income per common share:
Basic		$	(0.61	)		$	0.29			$	(0.51	)		$	0.99
Diluted		$	(0.61	)		$	0.27			$	(0.51	)		$	0.95
Weighted average common shares outstanding
Basic			6,564,765				6,800,375				6,733,781				6,791,105
Diluted			6,564,765				7,394,600				6,733,781				7,119,589

 

		Common Stock								Additional Paid-in				Retained				Treasury Stock								Accumulated Other Comprehensive
		Shares				Amount				Capital				Earnings				Shares				Amount				Gain (Loss)				Total
Balance, December 31, 2019			8,856,677			$	87			$	27,172			$	58,500				1,801,273			$	(9,287	)		$	(352	)		$	76,120
Compensation expense related to stock compensation plans			—				—				459				—				—				—				—				459
Repurchase of common stock			—				—				—				—				264,008				(2,150	)			—				(2,150	)
Unrealized gain resulting from change in fair value of derivative instruments, net of tax			—				—				—				—				—				—				335				335
Net loss			—				—				—				(4,015	)			—				—				—				(4,015	)
Balance, March 31, 2020			8,856,677			$	87			$	27,631			$	54,485				2,065,281			$	(11,437	)		$	(17	)		$	70,749
Balance, December 31, 2018			8,676,677			$	85			$	25,823			$	55,579				1,147,755			$	(7,014	)		$	657			$	75,130
Issuance of common stock for restricted stock grants			175,000				2				(2	)			—				—				—				—				—
Forfeiture of restricted stock			—				—				4				—				400,000				(4	)			—				—
Compensation expense related to stock compensation plans			—				—				(8	)			—				—				—				—				(8	)
Repurchase of common stock			—				—				—				—				44,866				(511	)			—				(511	)
Unrealized gain resulting from change in fair value of derivative instruments, net of tax			—				—				—				—				—				—				424				424
Net income			—				—				—				1,994				—				—				—				1,994
Balance, March 31, 2019			8,851,677			$	87			$	25,817			$	57,573				1,592,621			$	(7,529	)		$	1,081			$	77,029

		Common Stock								Additional Paid-in				Retained				Treasury Stock								Accumulated Other Comprehensive
		Shares				Amount				Capital				Earnings				Shares				Amount				Gain (Loss)				Total
Balance, June 30, 2019			8,851,677			$	87			$	26,280			$	57,380				1,626,605			$	(7,955	)		$	292			$	76,084
Issuance of common stock for restricted stock grants			5,000				—				—				—				—				—				—				—
Compensation expense related to stock compensation plans			—				—				1,351				—				—				—				—				1,351
Repurchase of common stock			—				—				—				—				423,676				(3,482	)			—				(3,482	)
Forfeiture of restricted stock			—				—				—				—				15,000				—				—				—
Cumulative-effect adjustment pursuant to adoption of ASU 2016-02 (Note E)			—				—				—				420				—				—				—				420
Reclassification pursuant to adoption of ASU 2018-02 (Note D)			—				—				—				128				—				—				(128	)			—
Unrealized loss resulting from change in fair value of derivative instruments, net of tax			—				—				—				—				—				—				(181	)			(181	)
Net loss			—				—				—				(3,443	)			—				—				—				(3,443	)
Balance, March 31, 2020			8,856,677			$	87			$	27,631			$	54,485				2,065,281			$	(11,437	)		$	(17	)		$	70,749
Balance, June 30, 2018			8,656,677			$	85			$	24,486			$	50,839				1,098,268			$	(6,584	)		$	(578	)		$	68,248
Issuance of common stock for stock option exercise			5,000				—				38				—				—				—				—				38
Issuance of common stock for restricted stock grants			190,000				2				(2	)			—				—				—				—				—
Forfeiture of restricted stock			—				—				4				—				405,000				(4	)			—				—
Compensation expense related to stock compensation plans			—				—				1,291				—				—				—				—				1,291
Repurchase of common stock			—				—				—				—				89,353				(941	)			—				(941	)
Unrealized gain resulting from change in fair value of derivative instruments, net of tax			—				—				—				—				—				—				1,659				1,659
Net income			—				—				—				6,734				—				—				—				6,734
Balance, March 31, 2019			8,851,677			$	87			$	25,817			$	57,573				1,592,621			$	(7,529	)		$	1,081			$	77,029

 

		Nine Months Ended March 31,
		2020				2019
Cash flows from operating activities
Net (loss) income		$	(3,443	)		$	6,734
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts receivable			3,282				—
Depreciation and amortization			2,975				2,529
Non-cash lease expense			2,051				—
Non-cash sales discount			—				82
Non-cash compensation			1,351				1,209
Pension expense, net of contributions			21				37
Loss on disposal of assets			118				9
Changes in operating assets and liabilities:
Accounts receivable			303				(2,169	)
Inventories, net			(108	)			(3,449	)
Operating lease liabilities, net			(1,825	)			—
Forward contracts			354				(1,258	)
Prepaids and other assets			(748	)			(174	)
Accounts payable and accrued liabilities			1,656				4,088
Accrued compensation and employee benefits			(307	)			(116	)
Income taxes			(516	)			58
Net cash provided by operating activities			5,164				7,580
Cash flows from investing activities
Purchases of property and equipment			(3,432	)			(4,149	)
Proceeds from sale of property and equipment			25				19
Proceeds from collection of notes receivable			—				1,500
Net cash used in investing activities			(3,407	)			(2,630	)
Cash flows from financing activities
Repurchase of common stock			(3,482	)			(941	)
Borrowings on lines of credit			10,000				—
Issuance of common stock			—				38
Net cash provided by (used in) financing activities			6,518				(903	)
Net increase in cash and cash equivalents			8,275				4,047
Cash and cash equivalents at beginning of period			25,040				23,613
Cash and cash equivalents at end of period		$	33,315			$	27,660
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest		$	16			$	19
Taxes		$	370			$	1,747

 

A. Basis of Presentation and Summary of Significant Accounting Policies

 

The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and applicable rules and regulations. Pursuant to such rules and regulations certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) have been condensed or omitted. In management’s opinion, all adjustments necessary for a fair presentation of the financial position, results of operations, stockholders’ equity, and cash flows have been included and are of a normal, recurring nature. The results of operations for the three months and nine months ended March 31, 2020 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

 

You should read the financial statements and these notes, which are an integral part of the financial statements, together with our audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019 (“2019 Annual Report”). The accounting policies used to prepare the financial statements included in this Report are the same as those described in the notes to the consolidated financial statements in our 2019 Annual Report unless otherwise noted below.

 

Recently Issued Accounting Pronouncements

 

On December 18, 2019, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This new standard eliminates certain exceptions in Accounting Standards Codification ("ASC") 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2020, with early adoption permitted in any interim period within that year. This ASU will be effective for us beginning in our first quarter of fiscal 2022. We are currently evaluating the impact this ASU will have on our consolidated financial statements.

 

Net (Loss) Income per Common Share

 

We compute net (loss) 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 unvested restricted stock accounts 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 (loss) income per common share as follows (in thousands, except per share data):

 

 

In periods where we have a net loss, stock options and restricted stock are excluded from our calculation of diluted net (loss) income per common share, as their inclusion would have an antidilutive effect. We excluded shares related to stock options totaling 130,000 for the three months and for the nine months ended March 31, 2020. We excluded shares related to restricted stock totaling 356,998 for the three months ended March 31, 2020. We excluded shares related to restricted stock totaling 388,988 for the nine months ended March 31, 2020. No shares related to stock options or restricted stock were excluded for the three and nine months ended March 31, 2019.

 

Revenue Recognition

 

We record revenue based on a five-step model which includes: (1) identifying a contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price among the performance obligations; and (5) recognizing revenue as each of the various performance obligations are satisfied.

 

Revenue is measured as the net amount of consideration expected to be received in exchange for fulfilling one or more performance obligations. We identify purchase orders from customers as contracts. The amount of consideration expected to be received and revenue recognized includes estimates of variable consideration, including estimates for early payment discounts and volume rebates. Such estimates are calculated using historical averages adjusted for any expected changes due to current business conditions and experience. We review and update these estimates at the end of each reporting period and the impact of any adjustments is recognized in the period the adjustments are identified. In assessing whether collection of consideration from a customer is probable, we consider both the customer's ability and intent to pay that amount of consideration when it is due. Payment of invoices is due as specified in the underlying customer agreement, which is typically 30 days from the invoice date. Invoices are generally issued on the date of transfer of control of the products ordered to the customer.

 

Revenue is recognized at the point in time that each of our performance obligation is fulfilled, and control of the ordered products is transferred to the customer. This transfer occurs when the product is shipped, or in some cases, when the product is delivered to the customer, depending on the point at which risk of loss transfers to the customer.

 

 

We provide early payment discounts to certain customers. Based on historical payment trends, we expect that these customers will take advantage of these early payment discounts. The cost of these discounts is reported as a reduction to the transaction price. If the actual discounts differ from those estimated, the difference is also reported as a change in the transaction price.

 

Except for product defects, no right of return exists on the sale of our products. We estimate returns based on historical experience and recognize a returns liability for any estimated returns. As of March 31, 2020, we have no liability recorded for estimated returns of products.

 

On August 7, 2017, we entered into three agreements (“Agreements”), with The Juice Plus+ Company LLC (“Juice Plus+”). The Agreements are an Exclusive Manufacturing Agreement, a Restricted Stock Award Agreement, and an Irrevocable Proxy. Pursuant to the Exclusive Manufacturing Agreement, Juice Plus+ has granted us exclusive rights to manufacture and supply them with certain of their products within 24 countries where Juice Plus+ currently sells those products. Pursuant to the Restricted Stock Award Agreement, NAI granted 500,000 shares of NAI common stock to Juice Plus+ (the “JP Shares”), and Juice Plus+ agreed the JP Shares are subject to certain restrictions and risk of forfeiture. Pursuant to the Irrevocable Proxy, Juice Plus+ also granted the NAI Board of Directors the right to vote the JP Shares that remain subject to risk of forfeiture. Each Agreement is for a term of 5 years, and each may be terminated by either party only upon the occurrence of specified events.

 

On March 31, 2019, we amended our original Agreements with Juice Plus+ and extended the term of the Exclusive Manufacturing Agreement through August 6, 2025. In addition, pursuant to that Amended and Restated Exclusive Manufacturing Agreement, Juice Plus+ returned 400,000 shares of restricted common stock in exchange for an annual cash sales discount. The expense associated with the return of those shares and the related cash discount granted to Juice Plus+ were each recorded as a reduction to sales. As a result of the amendments contained in the Amended and Restated Exclusive Manufacturing Agreement, we made a one-time adjustment to reverse the expense associated with unvested shares that were returned as a result of such amendments. Amounts associated with the new cash discount began to be recorded in our fourth quarter of fiscal 2019 and will be amortized ratably over extended remaining life of the Amended and Restated Exclusive Manufacturing Agreement based on the full value of the cash discount expected to be given over the same period. We recorded $395,000 of “Cash Sales Discount” during the three months ended March 31, 2020 and $1.2 million for the nine months ended March 31, 2020. We recognized $408,000 of “Non-cash Sales Income” during the three months ended March 31, 2019 and $82,000 of “Non-cash Sales Discount” during the nine months ended March 31, 2019.

 

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”, which is marketed and sold under our CarnoSyn® and SR CarnoSyn® trade names. We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of $2.8 million during the three months ended March 31, 2020 and $10.3 million during the nine months ended March 31, 2020. We similarly recorded $3.7 million during the three months ended March 31, 2019 and $13.5 million during the nine months ended March 31, 2019.  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 $103,000 during the three months ended March 31, 2020 and $462,000 during the nine months ended March 31, 2020. We similarly recognized $156,000 of royalty expense during the three months ended March 31, 2019 and $597,000 during the nine months ended March 31, 2019.

 

Stock-Based Compensation

 

We had an omnibus equity incentive plan that was approved by our Board of Directors effective October 15, 2009 and approved by our stockholders at the Annual Meeting of Stockholders held on November 30, 2009 ("2009 Plan"). Under the 2009 Plan, we granted nonqualified and incentive stock options and restricted stock grants to employees, non-employee directors and consultants. The 2009 Plan expired on October 15, 2019. The Board of Directors approved a new omnibus equity incentive plan effective October 15, 2019 (“2019 Plan”), subject to stockholder approval. However, the 2019 Plan was not approved by our stockholders and therefore did not become effective. We currently do not have an equity incentive plan but may still be recording exercises and forfeitures under the 2009 Plan.

 

We did not grant any options during each of the three and nine month periods ended March 31, 2020 and March 31, 2019. All remaining outstanding stock options are fully vested. No options were exercised during the three or nine month period ended March 31, 2020. No options were exercised during the three month period ended March 31, 2019. During the nine months ended March 31, 2019, 5,000 options were exercised. There were no option forfeitures during the three or nine month periods ended March 31, 2020 or March 31, 2019.

 

During the three months ended March 31, 2020 we did not grant any shares of restricted stock shares. During the nine months ended March 31, 2020, we granted 5,000 shares of restricted stock shares to a new member of our management team. During the three months ended March 31, 2019, we granted a total of 175,000 restricted stock shares to members of our Board of Directors and certain key members of our management team. During the nine months ended March 31, 2019, we granted a total of 190,000 restricted stock shares to members of our Board of Directors and certain key members of our management team. During the three months ended March 31, 2020, there were no restricted stock forfeitures. During the nine months ended March 31, 2020, 15,000 restricted stock shares were forfeited. During the three months ended March 31, 2019, there were no restricted stock forfeitures. During the nine months ended March 31, 2019, 5,000 restricted stock shares were forfeited.

 

Our net loss included stock based compensation expense in connection with prior restricted stock grants of approximately $459,000 for the three months ended March 31, 2020, and $1.4 million for the nine months ended March 31, 2020. Our net income included stock based compensation expense in connection with prior restricted stock grants of approximately $400,000 for the three months ended March 31, 2019 and $1.2 million for the nine months ended March 31, 2019.

 

Fair Value of Financial Instruments

 

Except for cash and cash equivalents and assets related to our pension plan, as of March 31, 2020, and June 30, 2019, we did not have any financial assets or liabilities classified as Level 1. We classify derivative forward exchange contracts as Level 2 assets and liabilities. The fair value of our forward exchange contracts as of March 31, 2020 was a net asset of $1.7 million. The fair value of our forward exchange contracts as of June 30, 2019 included a net asset of $2.3 million. The fair values were determined based on obtaining pricing from our bank and corroborating those values with a third party bank. We classify our outstanding line of credit balance as a Level 2 liability, as the fair value is based on inputs that can be derived from information available in publicly quoted markets. As of March 31, 2020, and June 30, 2019, we did not have any financial assets or liabilities classified as Level 3. We did not transfer any assets or liabilities between Levels during fiscal 2019 or during the three or nine months ended March 31, 2020. 

 

COVID-19 Pandemic

 

The Company continues to monitor and evaluate the risks to public health and the slowdown in overall business activity related to the COVID-19 pandemic, including potential impacts on our employees, customers, suppliers and financial results.  As the situation remains fluid, it is difficult to predict the duration and scope of the pandemic and its impact on the Company’s business. However, it may result in a material adverse impact to the Company’s financial position, operations and cash flows if conditions persist or worsen.

 

 

B. Inventories, net

 

Inventories, net consisted of the following (in thousands):

 

 

The inventory reserve as of March 31, 2020 included a reserve of $1.0 million related to one of our former customers, Kaged Muscle. We are working with this former customer to deliver the remaining products we completed, and to transition to a replacement manufacturer, including the transfer of inventory items we hold specific to this customer. However, due to the uncertainty regarding the future operations of this former customer, we recorded a reserve against inventory specific to this customer equal to the estimated net realizable value of those items. The inventory reserve as of June 30, 2019, included a reserve of $686,000, related to our first generation SR CarnoSyn® powder.

 

C. Property and Equipment

 

Property and equipment consisted of the following (in thousands):

 

 

 

D. Other Comprehensive (Loss) Income

 

Other comprehensive (loss) income (“OCL” and “OCI”) consisted of the following during the three and nine months ended March 31, 2020 and March 31, 2019 (in thousands):

 

 

 

On July 1, 2019, we adopted ASU 2018-02, “Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. ASU 2018 allows for a reclassification from accumulated other comprehensive income (OCI) to retained earnings for stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act. Under this ASU, we reclassified $128,000 of gains from OCI to retained earnings.

 

E. Leases

 

On July 1, 2019, we adopted FASB Accounting Standards Codification, or ASC, Topic 842, Leases, or ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the balance sheet. As permitted by ASC 842, we elected the adoption date of July 1, 2019, which is the date of initial application. As a result, the consolidated balance sheet prior to July 1, 2019 was not restated and continues to be reported under ASC Topic 840, Leases, or ASC 840, which did not require the recognition of operating lease assets or liabilities on the balance sheet, and is not comparative. Under ASC 842, all leases are required to be recorded on the balance sheet and are classified as either operating leases or finance leases. The lease classification affects the expense recognition in the income statement. Operating lease expenses are recorded entirely in operating expenses. Finance lease charges are split, where amortization of the right-of-use asset is recorded in operating expenses and an implied interest component is recorded in interest expense. The expense recognition for operating leases and finance leases under ASC 842 is substantially consistent with ASC 840. As a result, there is no material difference in our results of operations presented in our Condensed Consolidated Statement of Income and Comprehensive Income for each period presented.

 

We adopted ASC 842 using a modified retrospective approach for all leases existing at July 1, 2019. The adoption of ASC 842 had a substantial impact on our balance sheet. The most significant impact was the recognition of the operating lease right-of-use assets and the liability for operating leases. As of July 1, 2019, we had no finance leases. Upon adoption, leases that were previously classified as operating leases under ASC 840 were classified as operating leases under ASC 842, and we recorded an adjustment of $20.7 million to operating lease right-of-use assets and an adjustment of $20.9 million to the related lease liability. The lease liability is based on the present value of the remaining minimum lease payments, determined under ASC 840, discounted using our secured incremental borrowing rate at the effective date of July 1, 2019, and using the expected lease term, including any optional renewals, as the tenor. As permitted under ASC 842, we elected several practical expedients that permit us to not reassess (1) whether existing contracts are or contain a lease, (2) the classification of existing leases, and (3) whether previously capitalized costs continue to qualify as initial indirect costs. The application of the practical expedients did not have a significant impact on the measurement of the operating lease liability.

 

The impact of the adoption of ASC 842 on the balance sheet at June 30, 2019 was (in thousands):

 

 

We lease substantially all of our product manufacturing and support office space used to conduct our business. For contracts entered into on or after that effective date, at the inception of a contract we assess whether the contract is, or contains, a lease. Our assessment is based on: (1) whether the contract involves the use of a distinct identified asset, (2) whether we obtain the right to substantially all the economic benefit from the use of the asset throughout the period of the contract, and (3) whether we have the right to direct the use of the asset during such time period. At inception of a lease, we allocate the consideration in the contract to each lease component based on its relative stand-alone price to determine the lease payments.

 

Leases are classified as either finance leases or operating leases. A lease must be classified as a finance lease if any of the following criteria are met: the lease transfers ownership of the asset by the end of the lease term, the lease contains an option to purchase the asset that is reasonably certain to be exercised, the lease term is for a major part of the remaining useful life of the asset or the present value of the lease payments equals or exceeds substantially all of the fair value of the asset. A lease is classified as an operating lease if it does not meet any of these criteria. Substantially all our operating leases are comprised of payments for the use of manufacturing space leases.

 

For all leases at the lease commencement date, a right-of-use asset and a lease liability are recognized. The right-of-use asset represents the right to use the leased asset for the lease term. The lease liability represents the present value of the lease payments under the lease.

 

The right-of-use asset is initially measured at cost, which primarily comprises the initial amount of the lease liability, plus any initial direct costs incurred, consisting mainly of brokerage commissions, less any lease incentives received. All right-of-use assets are reviewed for impairment. The lease liability is initially measured at the present value of the lease payments, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, our secured incremental borrowing rate for the same term as the underlying lease. For our real estate and other operating leases, we use our secured incremental borrowing rate.

 

Lease payments included in the measurement of the lease liability comprise the following: the fixed noncancelable lease payments, payments for optional renewal periods where it is reasonably certain the renewal period will be exercised, and payments for early termination options unless it is reasonably certain the lease will not be terminated early.

 

Some of our manufacturing leases contain variable lease payments, including payments based on an index or rate. Variable lease payments based on an index or rate are initially measured using the index or rate in effect at lease commencement and separated into lease and non-lease components based on the initial amount stated in the lease or standalone selling prices. Lease components are included in the measurement of the initial lease liability. Additional payments based on the change in an index or rate, or payments based on a change in our portion of the operating expenses, including real estate taxes and insurance, are recorded as a period expense when incurred. Lease modifications result in remeasurement of the lease liability.

 

Lease expense for operating leases consists of the lease payments plus any initial direct costs, primarily brokerage commissions, and is recognized on a straight-line basis over the lease term. Included in lease expense are any variable lease payments incurred in the period that were not included in the initial lease liability. Lease expense for finance leases consists of the amortization of the right-of-use asset on a straight-line basis over the lease term and interest expense determined on an amortized cost basis. The lease payments are allocated between a reduction of the lease liability and interest expense.

 

We have elected not to recognize right-of-use assets and lease liabilities for short-term leases that have a term of 12 months or less. The effect of short-term leases on our right-of-use asset and lease liability was not material.

 

 

F. Debt

 

On July 1, 2019, 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 February 1, 2021, to November 1, 2022. 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.

 

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 us 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 between payment under a fixed rate versus payment under the variable rate for each month from the month of prepayment through the month in which the then applicable fixed rate term matures. On March 31, 2020, we were in compliance with all of the financial and other covenants required under the Credit Agreement.

 

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 credit approval with Wells Fargo Bank, N.A. which allows us to hedge foreign currency exposures up to 30 months in the future. We also have credit approval with Bank of America which allows us to hedge foreign currency exposures up to 24 months in the future.

 

In light of the current global economic uncertainty related to COVID-19 and as a measure to provide our business with liquidity, and out of an abundance of caution, we withdrew $10 million from our credit facility with Wells Fargo during the three months ended March 31, 2020. While we have not yet experienced any significant negative effects related to COVID-19 and notwithstanding our belief that our cash position and working capital excluding this $10.0 million borrowing is sufficient to support our ongoing operations, we deemed it prudent to borrow against our line of credit to ensure that such funds would be available to us if and when we need them. As of March 31, 2020, we did not have any remaining availability under our credit facilities.

 

G. Economic Dependency

 

We had substantial net sales to certain customers during the periods shown in the following table. The loss of any of these customers, or a significant decline in (i) sales to these customers, (ii) the growth rate of sales to these customers, or (iii) these customers’ ability to make payments when due, each individually could have a material adverse impact on our net sales and net income. Net sales to any one customer representing 10% or more of the respective period's consolidated net sales were as follows (in thousands):

 

 

We buy certain products, including beta-alanine, from a limited number of raw material suppliers who meet our quality standards. The loss of any of these suppliers could have a material adverse impact on our net sales and net income. Raw material purchases from any one supplier representing 10% or more of the respective period’s total raw material purchases were as follows (dollars in thousands):

 

 

(a)          Purchases were less than 10% of the respective period’s total raw material purchases.

 

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 two of our largest customers, whose receivable balances collectively represented 65.5% of gross accounts receivable at March 31, 2020 and 59.4% at June 30, 2019. Additionally, amounts due related to our beta-alanine raw material sales were 8.6% of gross accounts receivable at March 31, 2020, and 8.0% of gross accounts receivable at June 30, 2019.

 

As of March 31, 2020, we terminated our ongoing relationship with one customer, Kaged Muscle. We are working with this former customer to deliver the remaining products we completed, and to assist them with their obligations to us, transition to a replacement manufacturer, and the transfer of inventory items we hold specific to this customer. Due to uncertainty regarding the future operations of this former customer as of March 31, 2020, we reserved $3.3M, or 100% of their outstanding accounts receivable balance. Concentrations of credit risk related to the remaining accounts receivable balances are limited due to the number of customers comprising our remaining customer base.

 

H. 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® and SR CarnoSyn® trade names.

 

 

We evaluate performance based on a number of factors. The primary performance measures for each segment are net sales and income or loss from operations before the allocation of certain corporate level expenses. 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 above and in the consolidated financial statements included in our 2019 Annual Report.

 

Our operating results by business segment were as follows (in thousands):

 

 

 

 

Our private-label contract manufacturing products are sold both in the U.S. and in markets outside the U.S., including Europe, Canada, Australia, New Zealand, and Asia. Our primary markets outside the U.S. are Europe and Asia. Our patent and trademark licensing activities are primarily based in the U.S.

 

Net sales by geographic region, based on the customers’ location, were as follows (in thousands):

 

 

Products manufactured by our Swiss subsidiary ("NAIE") accounted for 88% of net sales in markets outside the U.S. for the three months ended March 31, 2020 and 90% for the nine months ended March 31, 2020. Products manufactured by NAIE accounted for 74% of net sales in markets outside the U.S. for the three months ended March 31, 2019 and 78% for the nine months ended March 31, 2019. No products manufactured by NAIE were sold in U.S. markets during the three or nine month periods ended March 31, 2020 and 2019.

 

Long-lived assets by geographic region, based on the location of the company or subsidiary at which they were located or made, were as follows (in thousands):

 

 

As a result of the implementation of ASC 842, operating lease right-of-use assets are now recorded as part of long-lived assets for segment reporting.

 

Total assets by geographic region, based on the location of the company or subsidiary at which they were located or made, were as follows (in thousands):

 

 

 

Capital expenditures by geographic region, based on the location of the company or subsidiary at which they were located or made, were as follows (in thousands):

 

 

 

I. Income Taxes

 

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted on March 27, 2020 in the United States. The CARES Act and related notices include several significant provisions, including delaying certain payroll tax payments, mandatory transition tax payments under the Tax Cuts and Jobs Act (“TCJ Act”), and estimated income tax payments. We do not currently expect the CARES Act to have a material impact on our financial results, including on our annual estimated effective tax rate, or on our liquidity. We will continue to monitor and assess the impact the CARES Act, and similar legislation in other countries, with respect to what impact they may have on our business and financial results.

 

The effective tax rate for the three months ended March 31, 2020 was a benefit of 6.0% and the effective tax rate for the nine months ended March 31, 2020 was a benefit of 3.7%. The rates differ from the U.S. federal statutory rate of 21% due to our net loss and permanent book to tax differences for the three and nine months ended March 31, 2020. We have recorded our tax benefit commensurate with the tax benefit we expect on an annual basis. The effective tax rate for the three months ended March 31, 2019 was 18.9% and the effective tax for the nine months ended March 31, 2019 was 20.1%.

 

To determine our quarterly provision for income taxes, we use an estimated annual effective tax rate, which is based on expected annual income, statutory tax rates and tax planning opportunities available in the various jurisdictions to which we are subject. Certain significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rate from quarter to quarter. We recognize interest and penalties related to uncertain tax positions, if any, as an income tax expense. As of March 31, 2020, and June 30, 2019, we had not recorded any liabilities for any uncertain tax positions. In the three months ended March 31, 2020, we recognized a discrete tax expense of $74,000 related to employee restricted stock vesting. In the nine months ended March 31, 2020, we recognized a discrete tax expense of $64,000 related to employee restricted stock vesting. There were no other significant discrete items for the three and nine months ended March 31, 2020. There were no significant discrete items for the three or nine months ended March 31, 2019.  

 

We record valuation allowances to reduce our deferred tax assets to an amount we believe is more likely than not to be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the three or nine months ended March 31, 2020, there was no change to our valuation allowance for our deferred tax assets.

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are measured using enacted tax rates, for each of the jurisdictions in which we operate, expected to apply to taxable income in the years in which 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 as income or expense in the period that includes the enactment date for such new rates.

 

We are subject to taxation in the U.S., Switzerland and various state jurisdictions. Our tax years for the fiscal year ended June 30, 2017 and forward are subject to examination by the U.S. tax authorities. Our tax years for the fiscal years 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, 2018 and forward are subject to examination by the Swiss tax authorities.

 

It is our policy to establish reserves based on management’s assessment of exposure for certain positions taken in previously filed tax returns that may become payable upon audit by tax authorities. Our tax reserves are analyzed quarterly and adjustments are made as events occur that we believe warrant adjustments to those reserves. There were no adjustments to reserves in the three or nine month periods ended March 31, 2020.

 

J. Treasury Stock

 

On January 8, 2020, the Board of Directors authorized a $2.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $9.0 million. On March 13, 2020, the Board of Directors authorized an additional $1.0 million increase to our stock repurchase plan bringing the total authorized repurchase amount to $10.0 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 three months ended March 31, 2020 we repurchased 210,832 shares at a weighted average cost of $8.46 and a total cost of $1.8 million under this repurchase plan. During the nine months ended March 31, 2020 we repurchased 362,170 shares at weighted average cost of $8.40 and a total cost of $3.0 million under this repurchase plan. During the three months ended March 31, 2019, we repurchased 5,748 shares at a weighted average cost of $10.17 and a total cost of $58,000 under this repurchase plan. During the nine months ended March 31, 2019, we repurchased 42,697 shares at a weighted average cost of $9.74 and a total cost of $416,000 under this repurchase plan.

 

During the three months ended March 31, 2020 we acquired 53,176 shares from employees in connection with restricted stock shares that vested during that period at a weighted average cost of $6.91 per share and a total cost of $367,000. During the nine months ended March 31, 2020, we acquired 61,506 shares from employees in connection with restricted stock shares that vested during that year at a weighted average cost of $7.14 per share and a total cost of $439,000. During the three months ended March 31, 2019, we acquired 39,118 shares from employees in connection with restricted stock shares that vested during the period at a weighted average cost of $11.58 per share and a total cost of $453,000. During the nine months ended March 31, 2019, we acquired 46,656 shares in connection with restricted stock shares that vested during that period at a weighted average cost of $11.27 per share and a total cost of $525,000. These shares were returned to us by the subject employees and in exchange we paid each employee’s required tax withholding liability incurred due to the vesting of their restricted stock shares during that period. The valuation of the shares acquired and the number of shares returned to us was calculated based on the closing share price on the date the shares vested.

 

K. Derivatives and Hedging

 

We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to forecasted product sales denominated in foreign currencies and to other transactions of NAIE, our Swiss 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. To the extent we enter into such contracts, there can be no guarantee any such contracts will be effective hedges against our foreign currency exchange risk.

 

 

As of March 31, 2020, we had forward contracts designated as cash flow hedges primarily to protect against the foreign exchange risks inherent in our forecasted sales of products at prices denominated in currencies other than the U.S. Dollar. These contracts are expected to be settled through August 2021. 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 as well as ensuring the assumptions we made at hedge inception have not materially changed. No hedging relationships were terminated as a result of ineffective hedging for the three or nine months ended March 31, 2020 and March 31, 2019.

 

We monitor the probability of forecasted transactions as part of the hedge effectiveness testing on a quarterly basis. During the three and nine months ended March 31, 2020 and March 31, 2019, we did not have any losses or gains related to the ineffective portion of our hedging instruments.

 

As of March 31, 2020, the notional amounts of our foreign exchange contracts designated as cash flow hedges were approximately $30.4 million (EUR 26.0 million). As of March 31, 2020, a net gain of approximately $713,000 related to derivative instruments designated as cash flow hedges was recorded in OCI. It is expected that $633,000 will be reclassified into earnings in the next 12 months along with the earnings effects of the related forecasted transactions.

 

As of March 31, 2020, the fair value of our cash flow hedges was an asset of $1.7 million, of which $1.6 million was classified as forward contracts, and $100,000 was classified in other non-current assets in our Consolidated Balance Sheets. During the three months ended March 31, 2020, we recognized $990,000 of net gains in OCI, and reclassified $554,000 of gains and forward point amortization from OCI to Net Sales. During the nine months ended March 31, 2020, we recognized $1.9 million of net gains in OCI, reclassified $2.1 million of gains and forward point amortization from OCI to Net Sales, and reclassified $54,000 of gains from OCI to Other Income. As of June 30, 2019, $2.0 million of the fair value of our cash flow hedges was classified in forward contracts, and $312,000 was classified in other non-current assets in our Consolidated Balance Sheets. During the three months ended March 31, 2019, we recognized $1.4 million of net gains in OCI, reclassified $450,000 of gains from OCI to Net Sales, and reclassified $490,000 of gains from OCI to Other Income. During the nine months ended March 31, 2019, we recognized $4.1 million of net gains in OCI, reclassified $619,000 of gains from OCI to Net Sales and reclassified $1.4 million of gains from OCI to Other Income.

 

On July 1, 2019, we adopted ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The ASU attempts to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. We applied ASU No. 2017-12 using a modified retrospective approach for cash flow and fair value hedges existing at the date of adoption and prospectively for the presentation and disclosure guidance. As a result of the adoption of this ASU, amortization of forward points is now included as a component of net sales while it was previously included as a component of other income. We included $209,000 of forward point amortization in Net Sales for the three months ended March 31, 2020, and $707,000 of forward point amortization in Net Sales for the nine months ended March 31, 2020. We included $368,000 of forward point amortization in Other Income for the three months ended March 31, 2019, and $1.3 million of forward point amortization in Other Income for the nine months ended March 31, 2019.

 

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, regulatory, contract or other matters. The resolution of these matters as they arise may 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 currently 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 be greater than we currently anticipate and if they were they 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.

 

M. Subsequent Events

 

In January 2020, the World Health Organization (the “WHO”) announced a global health emergency because of a new strain of coronavirus COVID-19 originating in Wuhan, China and the risks to the international community as the virus spread globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic based on the rapid increase in global exposure.

 

As of the date of issuance of these unaudited Condensed Consolidated Financial Statements, our operations have not been significantly impacted. However, the full impact of the COVID-19 pandemic will continue to evolve subsequent to the three and nine months ended March 31, 2020 and as of the date these unaudited Condensed Consolidated Financial Statements are issued. As such, the full magnitude that the COVID-19 pandemic will have on our financial condition and future results of operations is uncertain. Management is actively monitoring the situation on our financial condition, operations, suppliers, industry, customers, and workforce. As the spread of COVID-19 continues, our ability to meet customer demands for products may be impacted or our customers may experience adverse business consequences due to COVID-19. Reduced demand for products or ability to meet customer demand (including as a result of disruptions at our suppliers and vendors) could have a material adverse effect on our business operations and financial performance.