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Item 2. Management’s Discussion and Analysis

2021-02-09 compared with 2020-11-10 · 58 added, 55 removed, 64 unchanged (64% 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 months ended September 30, 2020.

The following discussion and analysis is intended to help you understand our financial condition and results of operations for the three and six months ended December 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 2020 Annual Report and other reports and documents we file with the SEC.

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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, royalties from license agreements, and potentially additional contract manufacturing opportunities with licensees.

During the first six months of fiscal 2021, our net sales were 51% higher than in the first six months of fiscal 2020.

Private-label contract manufacturing sales increased 62% due to higher sales from a majority of our distribution channels worldwide primarily due to increased shipments of existing products and sales of newly awarded products.

This sales increase was partially offset by a reduction in sales as a result of a discontinued customer relationship.

Revenue concentration risk for our largest private-label contract manufacturing customer as a percentage of our total net sales increased from 46% for the first six months of fiscal 2020 to 56% for the first six months of fiscal 2021.

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

During the first six months of fiscal 2021, CarnoSyn® beta-alanine revenue decreased 27% to $5.4 million, compared to revenue of $7.5 million for the first six 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, with such decrease being partially offset by higher average sales prices.

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 ongoing 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 $0.7 million during the first six months of fiscal 2021 as compared to $1.4 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 on the 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 received from our customers, we continue to expect our annualized fiscal 2021 net sales to increase between 30% and 50% as compared to fiscal 2020.

We also expect to generate operating income between 5% and 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.

Currently 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.

Impact of COVID-19 on Our Business

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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:

Factors that derive from COVID-19 and the accompanying regulatory and market 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 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.

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.

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.

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;

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 developing relationships with additional quality oriented customers;

Expanding the commercialization of our beta-alanine patent estate through raw material sales, developing a new sales distribution channel under the Wellness and Healthy Aging category for our sustained release form of beta-alanine marketed under our SR CarnoSyn® trademark, exploiting new contract manufacturing opportunities license and royalty agreements, and protecting our proprietary rights;

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Results of Operations

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

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

Three Months Ended

September 30,

Six Months Ended

Private label contract manufacturing

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% of net sales

Income (loss) from operations

Income from operations

% of net sales

Total other (expense) income

Total other (loss) income

Income before income taxes

% of net sales

(Benefit) provision for income taxes

Provision for income taxes

% of net sales

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:

Private-label contract manufacturing net sales increased 83% during the three months ended December 31, 2020 and 62% during the six months ended December 31, 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 product to existing customers, partially offset by a reduction due to a discontinued customer relationship.

Net sales from our patent and trademark licensing segment decreased 35% during the three months ended December 31, 2020 and 27% during the six months ended December 31, 2020, when compared to the same period in the prior year.

The decrease in beta-alanine sales during the three and six months ended December 31, 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 average sales price.

The change in gross profit margin for the three and six months ended December 31, 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 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.

Private-label contract manufacturing gross profit margin as a percentage of consolidated net sales increased 7.6 percentage points during the three months ended December 31, 2020 and 5.2 percentage points during the six months ended December 31, 2020, when compared to the comparable prior year period.

Patent and trademark licensing gross profit margin as a percentage of consolidated net sales decreased 4.9 percentage points during the three months ended December 31, 2020 and 3.5 percentage points during the six months ended December 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.

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.

Selling, general and administrative expenses decreased $0.1 million, or 2%, during the three months ended December 31, 2020, and decreased $0.6 million, or 7%, during the six months ended December 31, 2020, as compared to the comparable prior year period.

Selling, general, and administrative expenses decreased primarily due to reduced litigation costs associated with our patent and trademark licensing business.

Other income, net, decreased $0.7 million during the three months ended December 31, 2020, and decreased $1.2 million during the six months ended December 31, 2020, when compared to the comparable period during the prior year.

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.

Our income tax expense increased $0.9 million during the three months ended December 31, 2020, and increased $0.4 million during the six months ended December 31, 2020.

The increase for the three months ended December 31, 2020 was primarily related to an increase in pre-tax income, as compared to the three months ended December 31, 2019.

The increase for the first six months of fiscal year 2021 as compared to the comparable period in fiscal year 2020 was primarily related to an increase in pre-tax income that was partially offset by a discrete tax benefit of $0.9 million recorded during the six months ended December 31, 2020.

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 $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.

Net cash provided by operating activities was $4.7 million for the six months ended December 31, 2020 compared to net cash provided by operating activities of $4.8 million in the comparable period in the prior fiscal year.

At December 31, 2020, changes in accounts receivable, consisting of amounts due from our private-label contract manufacturing customers and our patent and trademark licensing activities, used $0.1 million in cash compared to providing $1.7 million of cash during the comparable six month period in the prior year.

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

Days sales outstanding was 36 days during the six months ended December 31, 2020 as compared to 48 days for the same period during the prior year.

Changes in inventory used $6.5 million in cash during the six months ended December 31, 2020 compared to providing $3.4 million in the comparable prior year period.

The change in cash related to inventory during the six months ended December 31, 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 $1.0 million in cash during the six months ended December 31, 2020 compared to using $2.7 million during the three months ended December 31, 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 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.

Cash used in investing activities during the six months ended December 31, 2020 was $3.0 million compared to $1.6 million in the comparable period during the prior year.

The primary reason for the change was due to increased capital equipment purchases during the six months ended December 31, 2020 as compared to the six months ended December 31, 2019.

Capital expenditures during fiscal 2021 and fiscal 2020 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.

Cash used in financing activities for the six months ended December 31, 2020, was $3.5 million, compared to $1.3 million used in the comparable period during the prior year.

This is due to increased repurchases of our stock.

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

During the six months ended December 31, 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.

As of December 31, 2020, we had $28.6 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.

On February 2, 2021 we repaid the entire balance of our $10.0 million credit line with Wells Fargo Bank, N.A.

bringing our outstanding debt under the line to zero and increasing our amount available for borrowing to $10.0 million.

Off-Balance Sheet Arrangements

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.

As of December 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.

Recent Accounting Pronouncements

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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