What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-10 compared with 2020-05-14 · 69 added, 82 removed, 50 unchanged (75% of the section changed)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and nine months ended March 31, 2020.

You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to the condensed consolidated financial statements included under Item 1 in this Report, as well as the risk factors and other information included in our 2019 Annual Report and other reports and documents we have filed and will file with the SEC.

The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three months ended September 30, 2020.

You should read the following discussion and analysis together with our unaudited condensed consolidated financial statements and the notes to the condensed consolidated financial statements included under Item 1 in this Report, as well as the risk factors and other information included in our 2020 Annual Report and other reports and documents we file with the SEC.

Our future financial condition and results of operations will vary from our historical financial condition and results of operations described below based on a variety of factors.

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The following overview does not address all of the matters covered in the other sections of this Item 2 or other items in this Report nor does it 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 2 and with 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.

You should read this overview in conjunction with the other sections of this Item 2 and this Report .

Our primary business activity is providing 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.

Historically, our revenue has been largely dependent on sales to two or three private-label contract manufacturing customers and subject to variations in the timing of such customers’ orders, which in turn is impacted by such customers’ internal marketing programs, supply chain management, entry into new markets, new product introductions, the demand for such customers’ products, and general industry and economic conditions.

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Significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic.

The Company’s facilities, located both in the United States and Europe continue to operate as an essential and critical manufacturer in accordance with federal, state, and local regulations, however, there can be no assurance our facilities will continue to operate without interruption.

Factors that derive from the COVID-19 and the accompanying response and that have or may negatively impact sales and gross margin in the future include, but are not limited to the following:

Our facilities, located both in the United States and Europe, continue to operate as an essential and critical manufacturer in accordance with applicable federal, state, and local regulations, however, there can be no assurance our facilities will continue to operate without interruption.

Factors that derive from COVID-19 and the accompanying response, and that have or may negatively impact sales and gross margin in the future include, but are not limited to the following:

Limitations on the ability of our suppliers to manufacture, or procure from manufacturers, the products we sell, or to meet delivery requirements and commitments;

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Limitations on the ability of our customers to pay us on a timely basis.

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.

We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders.

While we are unable to determine or predict the nature, duration, or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we are hopeful we will be able to remain operational and our working capital will be sufficient for us to remain operational as the longer term consequences of this pandemic become known.

Analysis of Financial Condition

During the first nine months of fiscal 2020, our net sales were 22% lower than in the first nine months of fiscal 2019.

Private-label contract manufacturing sales decreased 22% due primarily to lower sales to our largest customer partially offset by increased sales to other new and existing customers.

Sales to our largest private-label contract manufacturing customer declined over 38%.

Revenue concentration risk for our largest private-label contract manufacturing customer as a percentage of our total net sales decreased from 54% to 43% for the nine months ended March 31, 2020 compared to the nine months ended March 31, 2019.

We expect our annualized fiscal 2020 revenue concentration for this customer to be lower than fiscal 2019.

Effective March 31, 2020, we terminated our ongoing relationship with one private-label contract manufacturing 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 100% of their outstanding accounts receivable balance and a majority of the inventory we hold for their products, for a total reserve of $4.3 million.

During the first nine months of fiscal 2020, CarnoSyn® beta-alanine revenue decreased 24% to $10.3 million, compared to revenue of $13.5 million for the first nine months of fiscal 2019.

The decrease in beta-alanine revenue was primarily due to decreased material shipments resulting from market and seasonal factors and lower average sales prices.

We believe this decline was impacted by certain of our customers discontinuing the use of our CarnoSyn® beta-alanine in favor of generic beta-alanine and lower overall consumer demand for our customers’ CarnoSyn® products.

As a preventative measure to provide our business with potentially needed liquidity, and out of an abundance of caution, we withdrew $10 million from our credit facility with Wells Fargo in the third quarter of fiscal 2020.

We will continue to actively monitor the situation and may take further actions to alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders.

While we are unable to determine or predict the nature, duration, or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we believe we will be able to remain operational and our working capital will be sufficient for us to remain operational even as the longer term consequences of this pandemic become known.

During the first three months of fiscal 2021, our net sales were 36% higher than in the first three months of fiscal 2020.

Private-label contract manufacturing sales increased 42% due primarily to higher sales to our largest customer including increased shipments of existing products and sales of a newly awarded product, as well as sales of new products to other new and existing customers, partially offset by a reduction due to a discontinued customer relationship.

A significant portion of these increased sales was directly related to higher sales of immune and wellness products sold by our customers during the COVID-19 pandemic period.

We currently believe this sales trend will continue for at least the remainder of our fiscal 2021.

Sales to our largest private-label contract manufacturing customer increased 67% as compared to the same period in the prior year.

Revenue concentration risk for our largest private-label contract manufacturing customer as a percentage of our total net sales increased from 49% to 60% for the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

We expect our annualized fiscal year 2021 revenue concentration for this customer to be higher than fiscal year 2020.

During the first three months of fiscal 2021, CarnoSyn® beta-alanine revenue decreased 16% to $2.7 million, compared to revenue of $3.2 million for the first three months of fiscal 2020.

The decrease in beta-alanine revenue was due to decreased material shipments primarily resulting from certain of our former customers discontinuing the use of CarnoSyn® beta-alanine in favor of generic beta-alanine and the negative impact COVID-19 has had on the sports nutrition industry due to continued limitations on athletic activities and gyms, partially offset by an increase in royalty income.

We continue to invest in research and development for our SR CarnoSyn® sustained release delivery system.

We believe SR CarnoSyn® may provide a unique opportunity within the growing Wellness and Healthy Aging markets.

We believe our recent efforts to refine our formulations and product offerings will be positively received and result in significant opportunity for increased SR CarnoSyn® sales in the future.

To protect our CarnoSyn® business and our patents, trademarks and other intellectual property, we incurred litigation and patent compliance expenses of approximately $1.7 million during the first nine months of fiscal 2020 as compared to $1.6 million during the comparable period in fiscal 2019.

Our ability to maintain or further increase our beta-alanine licensing revenue will depend in large part on our ability to develop a market for our sustained release form of beta-alanine marketed under our SR CarnoSyn® trademark, maintain our patent rights, obtain the raw material beta-alanine when and in the amounts needed, expand distribution of beta-alanine to new and existing customers, and further commercialize our existing patents, and will also depend on the continued compliance by third parties with our license agreements and our patent, trademark and other intellectual property rights.

There can be no assurance that our customer’s sales and marketing activities as well as our own sales and marketing and litigation efforts will reverse or decelerate potential future sales declines.

We are also closely monitoring the impact of the COVID-19 pandemic but we cannot reasonably estimate the length of time or severity of the pandemic and cannot currently estimate the impact this pandemic may have on our consolidated financial results for the remainder of fiscal 2020 and beyond.

During the remainder of fiscal 2020, we plan to continue our focus on:

We believe our recent efforts to refine our formulations and product offerings will be positively received and result in significant opportunity for increased SR CarnoSyn® sales.

To protect our CarnoSyn® business and our patents, trademarks and other intellectual property, we incurred litigation and patent compliance expenses of approximately $0.4 million during the first three months of fiscal 2021 as compared to $0.8 million during the comparable period in fiscal 2020.

The decrease in these legal expenses on a year over year basis was primarily due to the successful resolution of several cases that were settled.

Our ability to maintain or further increase our beta-alanine royalty and licensing revenue will depend in large part on our ability to develop a market for our sustained release form of beta-alanine marketed under our SR CarnoSyn® trademark, maintain our patent rights, obtain the raw material beta-alanine when and in the amounts needed, expand distribution of beta-alanine to new and existing customers, and continued compliance by third parties with our license agreements and our patent, trademark and other intellectual property rights.

During the remainder of fiscal 2021, we will continue our sales and marketing activities to consumers, customers, potential customers, and brand owners on multiple platforms to promote and reinforce the features and benefits of utilizing CarnoSyn® and SR CarnoSyn® beta-alanine.

Based on our current sales order volumes and future period sales forecasts we have received from our customers, we expect our annualized fiscal 2021 net sales to increase between 30% to 50% as compared to fiscal 2020.

We also expect to generate operating income between 5% to 7% of net sales for our fiscal year ending June 30, 2021.

There can be no assurance our expectations will result in the currently anticipated increase in net sales, or operating income.

Notwithstanding we are closely monitoring the impact of the COVID-19 pandemic, we cannot reliably estimate the length of time or severity of the pandemic, and cannot reliably estimate the total impact this pandemic may have on our consolidated financial results for the remainder of fiscal 2021 and beyond.

During the remainder of fiscal year 2021, we also 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 to assist us in developing relationships with additional quality oriented customers;

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Critical Accounting Policies and Estimates

The preparation of our financial statements requires that we make estimates and assumptions that affect the amounts reported in our financial statements and the accompanying notes.

The preparation of our financial statements requires we make estimates and assumptions that affect the amounts reported in our financial statements and the accompanying notes.

We have identified certain policies we believe are important to the accurate and complete portrayal of our financial condition and results of operations.

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An adverse effect on our financial condition, changes in financial condition, and results of operations could occur if circumstances change that alter the various assumptions or conditions used in such estimates or assumptions.

Our critical accounting policies are discussed under Item 7 of our 2019 Annual Report and recently adopted and issued accounting pronouncements are discussed in the Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report.

Our critical accounting policies are discussed under Item 7 of our 2020 Annual Report and recently adopted and issued accounting pronouncements are discussed under Item 1, Note A to our Notes to Condensed Consolidated Financial Statements contained in this Report.

Results of Operations

The results of our operations for the three and nine months ended March 31 were as follows (dollars in thousands):

The results of our operations for the three months ended September 30 were as follows (dollars in thousands):

Three Months Ended

Nine Months Ended

September 30,

Private-label contract manufacturing

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% of net sales

(Loss) income from operations

Income (loss) from operations

% of net sales

Total other (loss) income

(Loss) income before income taxes

Total other (expense) income

Income before income taxes

% of net sales

Provision for income taxes

Net (loss) income

(Benefit) provision for income taxes

% of net sales

Private-label contract manufacturing net sales decreased 29% during the three months ended March 31, 2020 and 22% during the nine months ended March 31, 2020, when compared to the same periods in the prior year.

The decrease was due primarily to lower sales to our largest customer.

Net sales from our patent and trademark licensing segment decreased 23% during the three months ended March 31, 2020 and decreased 24% during the nine months ended March 31, 2020, when compared to the same periods in the prior year.

The decrease in beta-alanine sales during the three and nine months ended March 31, 2020 was primarily due to decreased material shipments resulting from market and seasonal factors and lower average sales prices.

We believe this decline was due in part by certain of our customers discontinuing the use of our CarnoSyn® beta-alanine in favor of generic beta-alanine and lower overall consumer demand for our customer’s CarnoSyn® products.

The change in gross profit margin for the three and nine months ended March 31, 2020, was as follows:

Private-label contract manufacturing net sales increased 42% during the three months ended September 30, 2020 when compared to the same period in the prior year.

The increase was due primarily to sales of new products to new and existing customers and higher sales of existing products to existing customers, partially offset by a reduction due to a discontinued customer relationship.

Net sales from our patent and trademark licensing segment decreased 16% during the three months ended September 30, 2020 when compared to the same period in the prior year.

The decrease in beta-alanine sales during the three months ended September 30, 2020 was due to decreased material shipments primarily resulting from certain of our former customers discontinuing the use of CarnoSyn® beta-alanine in favor of generic beta-alanine and the negative impact COVID-19 has had on the sports nutrition industry due to continued limitations on athletic activities and gyms, partially offset by an increase in royalty income.

The change in gross profit margin for the three months ended September 30, 2020, was as follows:

Contract manufacturing (1)

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Total change in gross profit margin

Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales decreased 8.0 percentage points during the three months ended March 31, 2020 and decreased 3.5 percentage points during the nine months ended March 31, 2020 when compared to the comparable prior year period.

The decrease in gross profit as a percentage of consolidated net sales is primarily due to a $4.3 million accounts receivable and inventory reserve related to a former customer and a marginal increase in per unit manufacturing costs, partially offset by favorable product sales mix and inclusion of the amortization of forward points from cash flow hedge instruments in the three and nine month results of fiscal 2020 and none in the same periods of fiscal 2019.

As a result of the adoption of ASU No.

2017-12, amortization of forward points are now included as a component of net revenues while they were previously included as a component of other income.

Patent and trademark licensing gross profit margin as a percentage of consolidated net sales increased 1.6 percentage points during the three months ended March 31, 2020 when compared to the comparable prior year period.

The increase was primarily due to an increase in patent and trademark licensing net sales as a percentage of consolidated net sales partially offset by lower average net sales prices.

Patent and trademark licensing gross profit as a percentage of consolidated net sales decreased 0.2 percentage points during the nine months ended March 31, 2020 when compared to the comparable prior year period.

The decrease was primarily due to decreased patent and trademark licensing net sales as a percentage of total consolidated net sales and lower average sales prices.

Selling, general and administrative expenses increased by 58% for the three months ended March 31, 2020 when compared to the comparable prior year period.

The increase was primarily due to $3.3 million of bad debt expense recorded related to the receivable from a former customer, partially offset by a decrease in advertising, consulting, and litigation.

Selling, general and administrative expenses increased by 21% for the nine months ended March 31, 2020 when compared to the comparable prior year periods.

The increase was primarily due to $3.3 million of bad debt expense recorded related to the receivable from a former customer.

This bad debt expense was partially offset by a decrease in compensation and consulting.

Other income, net, decreased $670,000 during the three months ended March 31, 2020, and decreased $1.7 million during the nine months ended March 31, 2020, when compared to the comparable prior year periods.

The decrease was primarily due to the exclusion of the amortization of forward points from cash flow hedge instruments during the three and nine months ended March 31, 2020 as compared to including $368,000 and $1.3 million, respectively, in the comparable periods of fiscal 2019.

This change in classification of forward points is the result of the adoption of ASU No.

2017-12 that now requires the amortization of forward points be included as a component of net revenues while they were previously included as a component of other income.

The remaining portion of the decrease primarily related to foreign currency exchange losses associated with fluctuations in various foreign exchange rates used to revalue our balance sheet.

Our income tax expense decreased $719,000, or 155%, during the three months ended March 31, 2020, and decreased $1.8 million, or 108%, during the nine months ended March 31, 2020, primarily related to the decrease in income before taxes when compared to the comparable prior year periods.

Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales increased 2.1 percentage points during the three months ended September 30, 2020 when compared to the comparable prior year period.

The increase in gross profit as a percentage of sales for private-label contract manufacturing is primarily due to a marginal decrease in per unit manufacturing costs due to increased sales and a favorable sales mix.

Patent and trademark licensing gross profit margin as a percentage of consolidated net sales decreased 2.0 percentage points during the three months ended September 30, 2020 when compared to the comparable prior year period.

The decrease was primarily due to decreased patent and trademark licensing net sales as a percentage of total consolidated net sales.

Selling, general and administrative expenses decreased $0.5 million, or 12%, during the three months ended September 30, 2020, as compared to the comparable prior year period, primarily due to decreased litigation costs associated with our patent and trademark licensing business.

Other income, net, decreased $0.5 million during the three months ended September 30, 2020, when compared to the comparable prior year period.

The decrease was primarily due to the unfavorable foreign exchange revaluation activity associated with our balance sheet and the fluctuations in unhedged foreign currency rates.

Our income tax expense decreased $0.5 million, during the three months ended September 30, 2020, primarily related to a discrete tax benefit of $0.9 million recorded in the three months ended September 30, 2020, offset by higher taxable income for the three months ended September 30, 2020, as compared to the three months ended September 30, 2019.

Liquidity and Capital Resources

Our primary sources of liquidity and capital resources are cash flows provided by operating activities and the availability of borrowings under our credit facility.

Net cash provided by operating activities was $5.2 million for the nine months ended March 31, 2020 compared to net cash provided by operating activities of $7.6 million in the comparable period in the prior fiscal year.

At March 31, 2020, changes in accounts receivable, consisting of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, provided $303,000 in cash compared to using $2.2 million of cash during the comparable nine month period in the prior fiscal year.

The decrease in cash provided by accounts receivable during the nine months ended March 31, 2020 primarily resulted from timing of sales and related collections.

Days sales outstanding was 47 days during the nine months ended March 31, 2020 as compared to 40 days for the prior year period.

Changes in inventory used $108,000 in cash during the nine months ended March 31, 2020 compared to using $3.5 million in the comparable prior year period.

The change in cash related to inventory during the nine months ended March 31, 2020 was primarily related to the timing of sales and new order activity and includes a $1.0 million reserve associated with a former customer recorded during the nine months ended March 31, 2020.

Changes in accounts payable and accrued liabilities provided $1.7 million in cash during the nine months ended March 31, 2020 compared to providing $4.1 million during the nine months ended March 31, 2019.

Net cash provided by operating activities was $0.1 million for the three months ended September 30, 2020 compared to net cash provided by operating activities of $4.6 million in the comparable period in the prior fiscal year.

At September 30, 2020, changes in accounts receivable, consisting of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, used $2.2 million in cash compared to providing $2.2 million of cash during the comparable three month period in the prior year.

The decrease in cash provided by accounts receivable during the three months ended September 30, 2020 primarily resulted from increased sales and the timing of sales and related collections.

Days sales outstanding was 42 days during the three months ended September 30, 2020 as compared to 47 days for the prior year period.

Changes in inventory used $7.2 million in cash during the three months ended September 30, 2020 compared to providing $1.2 million in the comparable prior year period.

The change in cash related to inventory during the three months ended September 30, 2020 was primarily related to the difference in the amount and timing of orders and anticipated sales as compared to same period in the prior year.

Changes in accounts payable and accrued liabilities provided $6.6 million in cash during the three months ended September 30, 2020 compared to providing $0.8 million during the three months ended September 30, 2019.

The change in cash flow activity related to accounts payable and accrued liabilities was primarily due to the timing of inventory receipts and payments.

Cash used in investing activities during the nine months ended March 31, 2020 was $3.4 million compared to $2.6 million in the comparable prior year period.

The primary reason for the change was due the collection of a note receivable during the nine months ended March 31, 2019, as well as a decrease in capital equipment purchases during the nine months ended March 31, 2020 as compared to the comparable prior year period.

Cash provided in financing activities for the nine months ended March 31, 2020 was $6.5 million compared to $903,000 used in the comparable prior year period.

This change is primarily due to $10.0 million in proceeds from our line of credit, withdrawn as a measure to provide our business with liquidity out of an abundance of caution due to the COVID-19 pandemic, offset by increased repurchases of our stock.

At March 31, 2020 we had $10.0 million due in connection with our loan facility.

As of June 30, 2019, we had no outstanding balances due in connection with our loan facility.

During the nine months ending March 31, 2020, we were in compliance with all of the financial and other covenants required under the Credit Agreement.

Refer to Note F, "Debt," in this Quarterly Report, for terms of our Credit Agreement and additional information.

As of March 31, 2020, we had $33.3 million in cash and cash equivalents.

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.

Cash used in investing activities in the three months ended September 30, 2020 was $1.5 million compared to $1.1 million in the comparable prior year period.

The primary reason for the change was due to increased capital equipment purchases during the three months ended September 30, 2020 as compared to the three months ended September 30, 2019.

Capital expenditures during fiscal 2020 and fiscal 2019 were primarily for manufacturing equipment used in our Vista, California and Manno, Switzerland facilities.

Cash used in financing activities for the three months ended September 30, 2020, was $1.7 million, compared to $15,000 used in the comparable prior year period.

This is primarily due to increased repurchases of our stock.

At September 30, 2020 we had $10.0 million due in connection with our loan facility.

During the three months ending September 30, 2020, we were in compliance with all of the financial and other covenants required under the Credit Agreement.

Refer to Item 1, Note F., "Debt," in this Quarterly Report, for terms of our Credit Agreement and additional information.

As of September 30, 2020, we had $27.4 million in cash and cash equivalents.

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 the next 12 months.

Off-Balance Sheet Arrangements

As of March 31, 2020, we did not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that have or are reasonably likely to have a material current or future 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.

As of September 30, 2020, we did not have any off-balance sheet debt nor did we have any transactions, arrangements, obligations (including contingent obligations) or other relationships with any unconsolidated entities or other persons that have or are reasonably likely to have a material current or future 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.

Recent Accounting Pronouncements

Recent accounting pronouncements are discussed in the notes to our consolidated financial statements included under Item 1 of this Report.

Recent accounting pronouncements are discussed in the notes to our consolidated financial statements included under Item 1, Note A.

of this Report.

Other than those pronouncements, we are not aware of any other pronouncements that materially affect our financial position or results of operations.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a smaller reporting company, we are not required to provide item 3 disclosure in this Quarterly Report.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis