NATURAL ALTERNATIVES INTERNATIONAL INC MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (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, 2022 and 2021 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 2022, our consolidated net sales were 4% lower than in fiscal
2021. Private-label contract manufacturing sales decreased 6% primarily due to
lower sales to our largest customer. Sales to this customer decreased 40% as
compared to the prior year with a majority of the decrease associated with an
inventory reduction program mostly related to their European business. The
decrease in sales to our largest customer was partially offset by increased
sales to other existing customers and a new customer. Revenue concentration from
our largest private-label contract manufacturing customer as a percentage of our
total net sales decreased to 32% in fiscal 2022 from 51% in fiscal 2021. We
expect this percentage to remain consistent in fiscal 2023.



During fiscal 2022, patent and trademark licensing revenue increased 14% to
$16.2 million as compared to $14.2 million for fiscal 2021. The increase in
patent and trademark licensing revenue was primarily due to sales to new
customers, higher average sales prices, and increased shipments to existing
customers related in part to athletic activities and gyms reopening in
accordance with easing COVID-19 restrictions across the USA as compared to
significant restrictions in athletic activities in the prior year. We believe
the increase experienced in fiscal year 2022 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 2023.



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 $0.2 million during fiscal 2022 and $1.2 million
during fiscal 2021. 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 be
consistent with the amount incurred in fiscal 2022. 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 2023, 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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Based on our current sales order volumes, sales backlog and forecasts we have
received from our customers, we anticipate our fiscal 2023 consolidated net
sales will increase between 10.0% and 15.0% as compared to fiscal 2022. We also
anticipate we will generate operating income between 5.0% and 7.0% of net sales
for our fiscal year ending June 30, 2023. While sales are expected to increase
during fiscal 2023 when compared to fiscal 2022, we anticipate operating income
will be negatively impacted by changes in sales mix and increased operational
costs primarily impacted by increased labor and supply chain costs and other
inflationary factors. We anticipate current inflation rates will have a negative
impact on our fiscal 2023 operations and we are monitoring the drivers and
working with suppliers and customers to mitigate the impact on our results. We
are actively working to identify additional sales opportunities and we are
evaluating various options for minimizing the impact of continuing inflationary
pressures. There can be no assurance our expectations will result in the
currently anticipated increase in net sales or operating income levels.



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 procure from

manufacturers, the materials included in the products we sell, or to meet

  delivery requirements and commitments;
? Limitations on the ability of our employees to perform their work due to

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

keep them safe and the increased cost of measures taken to ensure employees

health and safety; ? Limitation on the availability of qualified individuals to adequately staff our

manufacturing facilities; ? Limitations on the ability of our suppliers to manufacture and meet timelines

  associated with capital improvement projects;
? Limitations on the ability of our customers to conduct their business and
  purchase our products and services; and
? Limitations on the ability of our customers 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.



During fiscal 2023, we 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 assist us in 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; and



• Improving operational efficiencies and managing costs and business risks to

    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 our 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 A, Organization 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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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, 2022                June 30, 2021               Increase (Decrease)
Private-label
contract
manufacturing           $ 154,798            91 %    $ 164,310            92 %    $     (9,512 )            (6 )%
Patent and trademark
licensing                  16,168             9 %       14,210             8 %           1,958              14 %
Total net sales           170,966           100 %      178,520           100 %          (7,554 )            (4 )%
Cost of goods sold        140,457            82 %      148,078            83 %          (7,621 )            (5 )%
Gross profit               30,509            18 %       30,442            17 %              67               0 %
Selling, general &
administrative
expenses                   16,830            10 %       16,770             9 %              60               0 %
Income from
operations                 13,679             8 %       13,672             8 %               7               0 %
Other (loss), net             (20 )          (0 )%      (1,547 )          (1 )%          1,527             (99 )%
Income before income
taxes                      13,659             8 %       12,125             7 %           1,534              13 %
Provision for income
taxes                       2,947             2 %        1,357             1 %           1,590             117 %
Net income              $  10,712             6 %    $  10,768             6 %    $        (56 )            (1 )%




Private-label contract manufacturing sales decreased 6% primarily due to lower
sales to our largest customer. Sales to this customer decreased 40% as compared
to the prior year with a majority of the decrease associated with an inventory
reduction program mostly related to their European business. The decrease in
sales to our largest customer was partially offset by increased sales to other
existing customers and a new customer. Revenue concentration from our largest
private-label contract manufacturing customer as a percentage of our total net
sales decreased to 32% in fiscal 2022 from 51% in fiscal 2021. We expect this
percentage to remain consistent in fiscal 2023.



Net sales from our patent and trademark licensing segment increased 14% during
fiscal 2022. The increase in patent and trademark licensing revenue was
primarily due to sales to new customers, higher average sales prices, and
increased shipments to existing customers related in part to athletic activities
and gyms reopening in accordance with easing COVID-19 restrictions across the
USA as compared to significant restrictions in athletic activities in the prior
year. We believe the increase experienced in fiscal year 2022 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 2023.



The change in gross profit margin for the year ended June 30, 2022, was as
follows:



                                      Percentage
                                        Change
Contract manufacturing(1)                    (0.3 )
Patent and trademark licensing(2)             1.1
Total change in gross profit margin           0.8




1 Private-label contract manufacturing gross profit margin contribution decreased

0.3 percentage points in fiscal 2022 as compared to fiscal 2021. The decrease

in gross profit as a percentage of sales for private-label contract

manufacturing is primarily due to an increase in per unit manufacturing costs

Partially offset by favorable product and customer sales mix.

2 During fiscal 2022, patent and trademark licensing gross profit margin

contribution increased 1.1 percentage points as compared to fiscal 2021. The

increase in margin contribution during the year ended June 30, 2022 was

primarily due to increased patent and trademark licensing net sales as a

percentage of total consolidated net sales, higher average sales prices, and a

  change in estimate regard certain volume rebate programs.



Selling, general and administrative expenses were flat in fiscal 2022 as compared to fiscal 2021 at $16.8 million.



Other loss, net, decreased $1.5 million during fiscal 2022 as compared to fiscal
2021. The decreases were primarily due to favorable fiscal 2022 foreign exchange
revaluation activity associated with our balance sheet and the fluctuations in
unhedged foreign currency rates when compared to the same activity in fiscal
2021.



Our income tax expense increased $1.6 million during fiscal 2022 as compared to
fiscal 2021. The increase was primarily due to discrete tax benefit items
recorded in fiscal 2021, with no corresponding discrete tax benefits recorded in
fiscal 2022.



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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 facilities. Net cash provided by operating activities was $11.9 million in fiscal 2022 compared to net cash provided by operating activities of $20.8 million in fiscal 2021.



At June 30, 2022, 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, provided $0.6 million in
cash compared to using $0.8 million in fiscal 2021. The change in cash used by
accounts receivable during fiscal 2022 primarily resulted from timing of sales
and the related collections at the end of fiscal 2022 as compared to fiscal
2021. Days sales outstanding increased to 38 days during fiscal 2022 compared to
36 days during fiscal 2021, primarily due to customer sales mix and timing of
sales and the related collections.



Inventory used $5.5 million in cash during fiscal 2022 compared to providing
$1.0 million in fiscal 2021. The change in cash activity from inventory was
primarily related to the difference in amount and timing of sales at the end of
fiscal 2022 and anticipated sales for the beginning of fiscal 2023 as compared
to the same drivers at the end of fiscal 2021. Changes in accounts payable and
accrued liabilities provided $3.1 million in cash during fiscal 2022 compared to
providing $1.9 million during fiscal 2021. 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 2022 was $26.5 million compared to
$5.0 million in fiscal 2021. The primary reason for the change was due to the
purchase of a new manufacturing and warehouse facility in Carlsbad, CA during
the first quarter of fiscal 2022 along with expenditures made related to our
on-going efforts to retrofit this facility with powder storage and processing
capabilities.



Cash provided by financing activities in fiscal 2022 was $4.3 million, compared
to $14.1 million used in fiscal 2021. The activity in fiscal 2022 includes $10.0
million in borrowings used to finance a portion of the purchase of our new
manufacturing and warehouse facility in Carlsbad, CA and treasury stock
repurchases while fiscal 2021 included treasury stock repurchases and a payment
of $10.0 million against our line of credit that was originally 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.



At June 30, 2022 we had no outstanding balances due on our line of credit and
had $20.0 million available with this loan facility and we owed $9.8 million on
a term loan that was borrowed as part of the purchase of our new Carlsbad
manufacturing facility in August 2021. At June 30, 2021 we had no outstanding
balances due and $20.0 million available in connection with our loan facility.



During fiscal 2022 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, 2022, we had $21.8 million in cash and cash equivalents. Of these
amounts, $17.8 million of cash and cash equivalents were held by NAIE. Overall,
we believe our available cash, cash equivalents, potential cash flows from
operations, and credit facility will be sufficient to fund our current working
capital needs and capital expenditures through at least the next 12 months.



Off-Balance Sheet Arrangements



As of June 30, 2022, 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 2022 we experienced price increases in product raw material and
operational costs related to inflationary pressures. We currently believe
increasing raw material and product cost pricing pressures will continue
throughout fiscal 2023 as a result of limited supplies of various ingredients,
the effects of higher labor and transportation costs, rising interest rates,
higher global fuel and energy costs, and the continued impact of COVID-19. We
anticipate current inflation rates will have a negative impact on our fiscal
2023 operations and we are monitoring the drivers and working with suppliers and
customers to mitigate the impact on our results.



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Recent Accounting Pronouncements



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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