NATURAL ALTERNATIVES INTERNATIONAL: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND OPERATING RESULTS (Form 10-K)

The following discussion and analysis is intended to help you understand our
financial condition and results of operations as of June 30, 2021 and 2020 and
for each of the last two fiscal years then ended. You should read the following
discussion and analysis together with our audited consolidated financial
statements and the notes to the consolidated financial statements included under
Item 8 in this report. Our future financial condition and results of operations
will vary from our historical financial condition and results of operations
described below based on a variety of factors. You should carefully review the
risks described under Item 1A and elsewhere in this report, which identify
certain important factors that could cause our future financial condition and
results of operations to vary.



Executive Overview



The following overview does not address all of the matters covered in the other
sections of this Item 7 or other items in this report or contain all of the
information that may be important to our stockholders or the investing public.
You should read this overview in conjunction with the other sections of this
Item 7, the financial statements and accompanying notes, and this report.



Our primary business activity is providing private-label contract manufacturing
services to companies that market and distribute vitamins, minerals, herbs and
other nutritional supplements, as well as other health care products, to
consumers both within and outside the U.S. Historically, our revenue has been
largely dependent on sales to 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. Our
revenue also includes raw material sales, royalty and licensing revenue
generated from our patent estate pursuant to license and supply agreements with
third parties for the distribution and use of the ingredient known as
beta-alanine sold under our CarnoSyn® and SR CarnoSyn® trademarks.



A cornerstone of our business strategy is to achieve long-term growth and
profitability and to diversify our sales base. We have sought and expect to
continue to seek to diversify our sales by developing relationships with
additional, quality-oriented, private-label contract manufacturing customers,
and commercializing our patent estate through sales of beta-alanine under our
CarnoSyn® and SR CarnoSyn® trade names, royalties from license agreements, and
potentially additional contract manufacturing opportunities with licensees.



During fiscal 2021, our consolidated net sales were 50% higher than in fiscal
2020. Private-label contract manufacturing sales increased 55% due to higher
sales from a majority of our distribution channels worldwide. A significant
portion of our increased contract manufacturing sales related to higher sales of
immune and wellness products which is in line with the trend being experienced
by the dietary supplement industry and is being driven by consumers taking a
more active role in their health and wellness as a result of the COVID-19
pandemic.  Our contract manufacturing sales also increased due to sales of newly
awarded products from new and existing customers. This sales increase was
partially offset by a reduction in sales as a result of a discontinued customer
relationship. Revenue concentration from our largest private-label contract
manufacturing customer as a percentage of our total net sales increased to 51%
in fiscal 2021 from 44% in fiscal 2020. We expect this percentage to decrease in
fiscal 2022.



Effective March 31, 2020, we terminated our ongoing relationship with one
private-label contract manufacturing customer, Kaged Muscle. During fiscal 2020
we reserved 100% of their accounts receivable and a majority of the inventory
held for their products resulting in a total reserve of $4.3 million. During
fiscal 2021, we recovered $0.8 million primarily associated with sales of
inventory previously reserved. As of June 30, 2021, all remaining inventory
amounts have been converted to accounts receivables and our balance sheet now
includes a reserve of $3.5 million. We continue working with this former
customer to assist them with completing their obligations to us.



During fiscal 2021, CarnoSyn® beta-alanine revenue increased 13% to $14.2
million as compared to $12.6 million for fiscal 2020. The increase in CarnoSyn®
revenue was primarily due to an increase in material shipments primarily
resulting from higher sales to existing customers, which we believe was
primarily influenced by the increase in athletic activities as gyms and athletic
facilities began to reopen during the second half of fiscal 2021 in accordance
with easing COVID-19 guidelines for various cities and states across the USA. We
believe the increase experienced in the second half of our fiscal year 2021
included larger than usual orders associated with our customer's refilling their
distribution channels and we anticipate these sales levels will normalize to
historical trend in fiscal 2022.



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 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, we incurred litigation and patent compliance
expenses of approximately $1.2 million during fiscal 2021 and $2.0 million
during 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. We currently expect our litigation and patent compliance expenses to
decrease during fiscal 2022 to an annual rate of approximately $0.5 million to
$1.0 million. Our ability to maintain or further increase our beta-alanine
royalty and licensing revenue will depend in large part on our ability to
develop a market for our sustained release form of beta-alanine marketed under
our SR CarnoSyn® trademark, maintain our patent rights, the availability and the
cost of the raw material when and in the amounts needed, the ability to 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 fiscal 2022, 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.



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Contents

Based on our current sales order volumes and forecasts we have received from our
customers, we anticipate our fiscal 2022 consolidated net sales will increase
between 5.0% and 10.0% as compared to fiscal 2021. We also anticipate we will
generate operating income between 7.0% and 9.0% of net sales for our fiscal year
ending June 30, 2022. Sales and profitability during the first half of fiscal
2022 are anticipated to decline when compared to the same period of fiscal 2021.
Our expectations for the first half of fiscal 2022 are being driven by
continuing supply chain, labor and logistical constraints, all of which are
expected to result in a backlog of existing orders that may not get fully
cleared until the second half of fiscal 2022. We currently anticipate these
manufacturing challenges will mostly resolve themselves during the second half
of fiscal 2022. As a result, we expect sales and profitability in the second
half of fiscal 2022 to exceed the comparable period in fiscal 2021, with the
overall fiscal 2022 results reflecting an increase in both sales and
profitability on a full year basis. There can be no assurance our expectations
will result in the currently anticipated increase in net sales or operating
income. Notwithstanding, we are also closely monitoring the impact of the
COVID-19 pandemic. Currently, we cannot reasonably estimate the length of time
or severity of the pandemic and cannot currently reliably estimate the impact
this pandemic may have on our consolidated financial results for fiscal 2022 and
beyond.

Impact of COVID-19 on our business

The COVID-19 pandemic has resulted, and is likely to continue to result, in
significant economic disruption and has and will likely continue to affect our
business. Significant uncertainty exists concerning the magnitude of the impact
and duration of the COVID-19 pandemic. 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 source from

manufacturers, the products we sell, or to meet delivery requirements and

commitments;

? Limitations on the ability of our employees to perform their jobs due to

illness caused by the pandemic or due to other restrictions imposed on our employees

to ensure their safety and the increased cost of measures taken to ensure that employees

health and security;

? Limitation of the availability of qualified people to hire adequately

our manufacturing facilities;

? Local, state or federal ordinances requiring employees to stay at home;

? Limitations on the ability of carriers to deliver materials to us or deliver

our products to customers;

? Limitations on our clients’ ability to conduct their business and

purchase our products and services; and

? Limitations on our customers’ ability to pay us on a timely basis.

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.

In fiscal 2022, we plan to continue to focus on:

• Leverage our certified state-of-the-art facilities to increase the value of

the goods and services we provide under our highly regarded private label contract

    manufacturing customers, and assist us in developing relationships with
    additional quality-oriented customers;

• Expand the commercialization of our beta-alanine patent area through

sale of materials, development of a new sales distribution channel under welfare

and the Healthy Aging category for our extended-release form of beta-alanine

marketed under our SR CarnoSyn® brand, operating a new contract

manufacturing opportunities, license and royalty agreements and protection

    our proprietary rights; and

• Improve operational efficiency and manage costs and business risks for

    improve profitability.

Discussion of critical accounting estimates

We have identified the following as our most critical accounting estimates,
which are those that are most important to the portrayal of the Company's
financial condition and results, and that require management's most subjective
and complex judgments. Information regarding our other significant accounting
estimates and policies are disclosed in Note 1, Nature of Operations and Summary
of Significant Accounting Policies, of the notes to the consolidated financial
statements.



Revenue Recognition - Revenue is measured as the net amount of consideration
expected to be received in exchange for fulfilling one or more performance
obligations.  For certain contracts with volume rebates, our estimates of future
sales used to assess the volume rebate estimates are subject to a high degree of
judgement and may differ from actual sales due to, among other things, changes
in customer orders and raw material availability.



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  Table of Contents



Results of Operations



The following table sets forth selected consolidated operating results for each
of the last two fiscal years, presented as a percentage of net sales (dollars in
thousands).



                                         Fiscal Year Ended
                             June 30, 2021                June 30, 2020              Increase (Decrease)
Private-label
contract
manufacturing           $ 164,310            92 %    $ 106,291            89 %    $    58,019             55 %
Patent and trademark
licensing                  14,210             8 %       12,585            11 %          1,625             13 %
Total net sales           178,520           100 %      118,876           100 %         59,644             50 %
Cost of goods sold        148,078            83 %      100,005            84 %         48,073             48 %
Gross profit               30,442            17 %       18,871            16 %         11,571             61 %
Selling, general &
administrative
expenses                   16,770             9 %       20,380            17 %         (3,610 )          (18 )%
Income (loss) from
operations                 13,672             8 %       (1,509 )          (1 )%        15,181          1,006 %
Other (loss), net          (1,547 )          (1 )%        (229 )           - %         (1,318 )         (576 )%
Income (loss) before
income taxes               12,125             7 %       (1,738 )          (2 )%        13,863            798 %
Provision (benefit)
for income taxes            1,357             1 %          (93 )           - %          1,450              - %
Net income (loss)       $  10,768             6 %    $  (1,645 )          (1 )%   $    12,413            755 %




Private-label contract manufacturing sales increased 55% due to higher sales
from a majority of our distribution channels worldwide. A significant portion of
our increased contract manufacturing sales related to higher sales of immune and
wellness products which is in line with the trend being experienced by the
dietary supplement industry and is being driven by consumers taking a more
active role in their health and wellness as a result of the COVID-19 pandemic.
Our contract manufacturing sales also increased due to sales of newly awarded
products from new and existing customers. This sales increase was partially
offset by a reduction in sales as a result of a discontinued customer
relationship. Revenue concentration from our largest private-label contract
manufacturing customer as a percentage of our total net sales increased to 51%
in fiscal 2021 from 44% in fiscal 2020. We expect this percentage to decrease in
fiscal 2022.



Net sales from our patent and trademark licensing segment increased 13% during
fiscal 2021. The increase in patent and trademark licensing revenue was
primarily due to an increase in material shipments primarily resulting from
higher sales to existing customers, which we believe was primarily influenced by
the increase in athletic activities as gyms and athletic facilities began to
reopen during the second half of fiscal 2021 in accordance with easing COVID-19
guidelines for various cities and states across the USA. We believe the increase
experienced in the second half of our fiscal year 2021 included larger than
usual orders associated with our customer's refilling their distribution
channels and we anticipate these sales levels will normalize to historical trend
in fiscal 2022.



The change in gross profit margin for the year ended June 30, 2021, was as
follows:



                                      Percentage
                                        Change
Contract manufacturing(1)                     3.0
Patent and trademark licensing(2)            (1.8 )
Total change in gross profit margin           1.2

1 Increase in the contribution to the gross profit margin of toll manufacturing

3.0 percentage points in fiscal year 2021 compared to fiscal year 2020. The increase

in gross margin as a percentage of turnover for private label contracts

manufacturing is mainly due to a decrease in manufacturing costs per unit

thanks to increased sales as well as a $ 1.0 million inventory reserve

recognized during the previous financial year, without a comparable provision in the

current exercise. These decreases were partially offset by

mix of product and customer sales.

2 In fiscal year 2021, gross profit margin from patent and trademark licenses

the contribution decreased by 1.8 percentage points in fiscal year 2021 compared to

fiscal year 2020. The decrease in the contribution to the margin during the fiscal year ended June 30th,

2021 is mainly due to lower net sales of patent and trademark licenses

a percentage of total consolidated net sales and lower average selling prices.

Selling, general and administrative expenses decreased $3.6 million, or 18%,
during fiscal 2021 as compared to fiscal 2020. This decrease was primarily due
to $3.3 million of bad debt expense recorded during fiscal 2020 related to a
receivable from a former contract manufacturing customer with no such comparable
reserve during fiscal 2021, decreased litigation and patent compliance expenses
associated with our CarnoSyn® beta-alanine patent estate, and decreased
CarnoSyn® advertising and research expenses. These decreases were partially
offset by increased employee compensation costs.

Other income, net, down $ 1.3 million during fiscal year 2021 compared to fiscal year 2020. The decreases are mainly due to unfavorable currency revaluation activity due to the volatility of the euro and Swiss franc impacting our balance sheet.

Our income tax expense increased $1.5 million during fiscal 2021 as compared to
fiscal 2020. The increase was primarily due to the increase in income before
taxes when compared to a loss in fiscal 2020.



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Liquidity and capital resources

Our primary sources of liquidity and capital are cash flow generated from operating activities and the availability of borrowings under our credit facilities. The net cash provided by operating activities was $ 20.8 million during fiscal year 2021 compared to the net cash flows generated by the operating activities of $ 3.7 million during fiscal year 2020.

At June 30, 2021, changes in accounts receivable, consisting primarily of
amounts due from our private-label contract manufacturing customers and our
patent and trademark raw material sales activities, used $0.8 million in cash
compared to using $4.3 million in fiscal 2020. The decrease in cash used by
accounts receivable during fiscal 2021 primarily resulted from timing of sales
and the related collections at the end of fiscal 2021 as compared to fiscal
2020. In addition, provision for uncollectible accounts receivable provided $0.1
million in fiscal 2021 as compared to using $3.3 million for fiscal 2020. The
change in provision for uncollectible accounts receivable was primarily
associated with a reserve recorded for a former contract manufacturing customer
in fiscal 2020 while the activity in fiscal 2021 reflected an amount recovered
against the same receivable. Days sales outstanding decreased to 36 days during
fiscal 2021 compared to 51 days during fiscal 2020, primarily due to customer
sales mix and timing of sales and the related collections.



Inventory provided $1.0 million in cash during fiscal 2021 compared to using
$2.0 million in fiscal 2020. The change in cash activity from inventory was
primarily related to the difference in amount and timing of sales at the end of
fiscal 2021 and anticipated sales for the beginning of fiscal 2022 as compared
to the same drivers at the end of fiscal 2020. Changes in accounts payable and
accrued liabilities provided $1.9 million in cash during fiscal 2021 compared to
providing $2.7 million during fiscal 2020. The change in cash flow activity
related to accounts payable and accrued liabilities is primarily due to the
timing of inventory receipts and payments.



Cash used in investing activities in fiscal 2021 was $5.0 million compared to
$4.5 million in fiscal 2020. Capital expenditures were $5.1 million during
fiscal 2021 compared to $4.5 million in fiscal 2020. Capital expenditures during
fiscal 2021 and fiscal 2020 were primarily for manufacturing equipment used in
our Vista, California and Manno, Switzerland facilities.



Cash used by financing activities in fiscal 2021 was $14.1 million, compared to
providing $6.3 million in fiscal 2020. 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 during fiscal 2020 that was paid off in February 2021. Financing
activities also included an increase in repurchases of our stock, which
increased to $4.1 million in fiscal 2021 as compared to $3.7 million in fiscal
2020. At June 30, 2021 we had no outstanding balances due and $20.0 million
available in connection with our loan facility. At June 30, 2020 we had $10.0
million due and no amount available in connection with our loan facility.



During fiscal 2021 we were in compliance with all of the financial and other
covenants required under our Credit Agreement. Refer to Note F, "Debt," in Item
8 of this report, for terms of such Credit Agreement and additional information.



As of June 30, 2021, we had $32.1 million in cash and cash equivalents. Of these
amounts, $15.6 million of cash and cash equivalents were held by NAIE. In August
2021 we used $7.5 million of cash related to the building purchase further
disclosed in our subsequent events footnote. Overall, we believe our available
cash, cash equivalents and potential cash flows from operations will be
sufficient to fund our current working capital needs and capital expenditures
through at least the next 12 months.

Off-balance sheet provisions

As of June 30, 2021, we did not have any significant off-balance sheet debt nor
did we have any transactions, arrangements, obligations (including contingent
obligations) or other relationships with any unconsolidated entities or other
persons, in each case that have or are reasonably likely to have a material
current or future effect on our financial condition, changes in financial
condition, results of operations, liquidity, capital expenditures, capital
resources, or significant components of revenue or expenses material to
investors.



Inflation



During fiscal 2021 we experienced price increases in product raw material and
operational costs related to inflationary pressures. During fiscal 2020, we did
not experience any significant increases in product raw material or operational
costs we attributed to inflationary factors. We currently believe increasing raw
material and product cost pricing pressures will continue throughout fiscal 2022
as a result of limited supplies of various ingredients, the effects of higher
labor and transportation costs, and the impact of COVID-19. We believe current
inflation rates will have an impact on our fiscal 2022 operations and we are
monitoring the drivers and working with suppliers and customers to mitigate the
impact on our results.

Recent accounting positions

A discussion of recent accounting pronouncements is included under Note A in the
notes to our consolidated financial statements which are included under Item 8
of this report.

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