The following discussion and analysis is intended to help you understand our financial condition and results of operations as of
June 30, 2021and 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 CarnoSynÂ® and SR CarnoSynÂ® 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 CarnoSynÂ® and SR CarnoSynÂ® 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 millionprimarily 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, CarnoSynÂ® beta-alanine revenue increased 13% to $14.2 millionas compared to $12.6 millionfor fiscal 2020. The increase in CarnoSynÂ® 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 CarnoSynÂ® sustained release delivery system. We believe SR CarnoSynÂ® 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 CarnoSynÂ® sales. To protect our CarnoSynÂ® business, we incurred litigation and patent compliance expenses of approximately $1.2 millionduring fiscal 2021 and $2.0 millionduring 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 millionto $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 CarnoSynÂ® 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 CarnoSynÂ® and SR CarnoSynÂ® beta-alanine. 17
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 Statesand 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
? 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:
â¢ 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;
â¢ 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 CarnoSynÂ® brand, operating a new contract
manufacturing opportunities, license and royalty agreements and protection
our proprietary rights; and
â¢ Improve operational efficiency and manage costs and business risks for
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. 18
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
$ 164,31092 % $ 106,29189 % $ 58,01955 % 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) $ 10,7686 % $ (1,645 )(1 )% $ 12,413755 % 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
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
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 millionof 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 CarnoSynÂ® beta-alanine patent estate, and decreased CarnoSynÂ® advertising and research expenses. These decreases were partially offset by increased employee compensation costs.
Other income, net, down
Our income tax expense increased
$1.5 millionduring 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. 19
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
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 millionin cash compared to using $4.3 millionin 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 millionin fiscal 2021 as compared to using $3.3 millionfor 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 millionin cash during fiscal 2021 compared to using $2.0 millionin 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 millionin cash during fiscal 2021 compared to providing $2.7 millionduring 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 millioncompared to $4.5 millionin fiscal 2020. Capital expenditures were $5.1 millionduring fiscal 2021 compared to $4.5 millionin fiscal 2020. Capital expenditures during fiscal 2021 and fiscal 2020 were primarily for manufacturing equipment used in our Vista, Californiaand Manno, Switzerlandfacilities. Cash used by financing activities in fiscal 2021 was $14.1 million, compared to providing $6.3 millionin fiscal 2020. This change is primarily due to $10.0 millionin 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 millionin fiscal 2021 as compared to $3.7 millionin fiscal 2020. At June 30, 2021we had no outstanding balances due and $20.0 millionavailable in connection with our loan facility. At June 30, 2020we had $10.0 milliondue 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 millionin cash and cash equivalents. Of these amounts, $15.6 millionof cash and cash equivalents were held by NAIE. In August 2021we used $7.5 millionof 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
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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