| NATURAL ALTERNATIVES INTERNATIONAL INC ITEM 1A RISK FACTORS You should carefully consider the risks described below, as well as the other information in this report, when evaluating our business and future prospects |
| If any of the following risks actually occur, our business, financial condition and results of operations could be seriously harmed |
| In that event, the market price of our common stock could decline and you could lose all or a portion of the value of your investment in our common stock |
| Because we derive a significant portion of our revenues from a limited number of customers, our revenues would be adversely affected by the loss of a major customer or a significant change in its business, personnel or the timing of its orders |
| We have in the past, and expect to continue, to derive a significant portion of our revenues from a relatively limited number of customers |
| During the fiscal year ended June 30, 2006, sales to one customer, NSA International, Inc, were approximately 38prca of our total net sales |
| Our second largest customer was Mannatech, Incorporated, which accounted for approximately 29prca of our net sales during fiscal 2006 |
| Our third largest customer, Arbonne International, a new customer in fiscal 2006, accounted for approximately 10prca of our net sales |
| The loss of one of these customers or other major customers, a significant decrease in sales or the growth rate of sales to these customers, or a significant change in their business or personnel, would materially affect our financial condition and results of operations |
| Furthermore, the timing of our customers’ orders is impacted by their marketing programs, supply chain management, entry into new markets and new product introductions, all of which are outside of our control |
| All of these attributes have had and will have a significant impact on our business |
| Based on press releases issued by Mannatech, Incorporated, Mannatech achieved record sales in each of its fiscal years ended December 31, 2005 and 2004, and in the first quarter of its fiscal 2006 |
| There can be no assurance that such results will continue |
| Our future growth and stability depends, in part, on our ability to diversify our sales |
| Our efforts to establish new products, brands, markets and customers could require significant initial investments, which may or may not result in higher sales and improved financial results |
| Our business strategy depends in large part on our ability to develop new products, marketing strategies, brands and customer relationships |
| These activities often require a significant up-front investment including, among others, customized formulations, regulatory compliance, product registrations, package design, product testing, pilot production runs, marketing, brand development and the build up of initial inventory |
| We may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time we generate net sales from new products or customers, and it is possible that we may never generate any revenue from new products or customers after incurring such expenditures |
| If we incur significant expenses and investments in inventory that we are not able to recover, and we are not able to compensate for those expenses, our operating results could be adversely affected |
| On December 5, 2005, we acquired RHL and may, in the future, pursue acquisitions of other companies that, if not successful, could adversely affect our business, financial condition and results of operations |
| On December 5, 2005, we completed our acquisition of RHL, an integrated direct marketer of nutritional supplements and other lifestyle products |
| RHL’s business is subject to all of the operational risks that normally arise for a direct marketing company, including those related to competition, profitability, economic conditions, suppliers, customers, adverse publicity, product liability claims and other litigation, regulation, personnel, and intellectual property rights |
| In the future, we may pursue additional acquisitions of other companies as part of our strategy focused on long-term growth and diversification of sales and our customer base |
| Acquisitions, including the RHL acquisition, involve numerous risks, including: • potential difficulties related to integrating the products, personnel and operations of the acquired company; • failure to operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices; • diverting management’s attention from the normal daily operations of the business; 9 ______________________________________________________________________ [34]Table of Contents • entering markets in which we have no or limited prior direct experience and where competitors in such markets have stronger market positions; • potential loss of key employees of the acquired company; • potential inability to achieve cost savings and other potential benefits expected from the acquisition; • an uncertain sales and earnings stream from the acquired company; and • potential impairment charges, which may be significant, against goodwill and purchased intangible assets acquired in the acquisition due to changes in conditions and circumstances that occur after the acquisition, many of which may be outside of our control |
| There can be no assurance that our acquisition of RHL or other acquisitions that we may pursue will be successful |
| If we pursue an acquisition but are not successful in completing it, or if we complete an acquisition but are not successful in integrating the acquired company’s employees, products or operations successfully, our business, financial position or results of operations could be adversely affected |
| Fluctuations in our operating results may adversely affect the share price of our common stock |
| While our net sales and income from operations have both improved during the past three fiscal years, there can be no assurance that they will continue to improve, or that we will earn a profit in any given year |
| We have experienced losses in the past and may incur losses in the future |
| Our operating results may fluctuate from year to year or from quarter to quarter due to various factors including differences related to the timing of revenues and expenses for financial reporting purposes and other factors described in this report |
| At times, these fluctuations may be significant |
| Fluctuations in our operating results may adversely affect the share price of our common stock |
| A significant or prolonged economic downturn could have a material adverse effect on our results of operations |
| Our results of operations are affected by the level of business activity of our customers, which in turn is affected by the level of consumer demand for their products |
| A significant or prolonged economic downturn may adversely affect the disposable income of many consumers and may lower demand for the products we produce for our private label contract manufacturing customers, as well as our own branded products |
| A decline in consumer demand and the level of business activity of our customers due to economic conditions could have a material adverse effect on our revenues and profit margins |
| Because our direct-to-consumer sales rely on the marketability of key personalities, the inability of a key personality to perform his or her role or the existence of negative publicity surrounding a key personality may adversely affect our revenues |
| These products may be marketed with a key personality through a variety of distribution channels |
| The inability or failure of a key personality to fulfill his or her role, or the ineffectiveness of a key personality as a spokesperson for a product, a reduction in the exposure of a key personality or negative publicity about a key personality may adversely affect the sales of our product associated with that personality and could affect the sale of other products |
| A decline in sales would negatively affect our results of operations and financial condition |
| Our industry is highly competitive and we may be unable to compete effectively |
| Increased competition could adversely affect our financial condition |
| The market for our products is highly competitive |
| Many of our competitors are substantially larger and have greater financial resources and broader name recognition than we do |
| Our larger competitors may be able to devote greater resources to research and development, marketing and other activities that could provide them with a competitive advantage |
| Our market has relatively low entry barriers and is highly sensitive to the introduction of new products that may rapidly capture a significant market share |
| Increased competition could result in price reductions, reduced gross profit margins or loss of market share, any of which could have a material adverse effect on our financial condition and results of operations |
| There can be no assurance that we will be able to compete in this intensely competitive environment |
| 10 ______________________________________________________________________ [35]Table of Contents We may not be able to raise additional capital or obtain additional financing if needed |
| Our cash from operations may not be sufficient to meet our working capital needs and/or to implement our business strategies |
| Although we amended our credit facility to increase our working capital line of credit to dlra12dtta0 million, there can be no assurance that this line of credit will be sufficient to meet our needs |
| Furthermore, if we fail to maintain certain loan covenants we may no longer have access to the credit line |
| As a result, we may need to raise additional capital or obtain additional financing |
| In recent years, it has been difficult for companies to raise capital due to a variety of factors including the overall poor performance of the stock markets and the economic slowdown in the United States and other countries |
| Thus, there is no assurance we would be able to raise additional capital if needed |
| To the extent we do raise additional capital, the ownership position of existing stockholders could be diluted |
| Similarly, there can be no assurance that additional financing will be available if needed or that it will be available on favorable terms |
| Under the terms of our credit facility, there are limits on our ability to create, incur or assume additional indebtedness without the approval of our lender |
| Our inability to raise additional capital or to obtain additional financing if needed would negatively affect our ability to implement our business strategies and meet our goals |
| This, in turn, would adversely affect our financial condition and results of operations |
| The failure of our suppliers to supply quality materials in sufficient quantities, at a favorable price, and in a timely fashion could adversely affect the results of our operations |
| We buy our raw materials from a limited number of suppliers |
| The loss of any of our major suppliers could adversely affect our business operations |
| Although we believe that we could establish alternate sources for most of our raw materials, any delay in locating and establishing relationships with other sources could result in product shortages, with a resulting loss of sales and customers |
| In certain situations we may be required to alter our products or to substitute different materials from alternative sources |
| We rely solely on one supplier to process certain raw materials that we use in the product line of our largest customer |
| The loss of or unexpected interruption in this service would materially adversely affect our results of operations and financial condition |
| A shortage of raw materials or an unexpected interruption of supply could also result in higher prices for those materials |
| Although we may be able to raise our prices in response to significant increases in the cost of raw materials, we may not be able to raise prices sufficiently or quickly enough to offset the negative effects of the cost increases on our results of operations |
| There can be no assurance that suppliers will provide the quality raw materials needed by us in the quantities requested or at a price we are willing to pay |
| Because we do not control the actual production of these raw materials, we are also subject to delays caused by interruption in production of materials based on conditions outside of our control, including weather, transportation interruptions, strikes and natural disasters or other catastrophic events |
| Our business is subject to the effects of adverse publicity, which could negatively affect our sales and revenues |
| Our business can be affected by adverse publicity or negative public perception about our industry, our competitors, or our business generally |
| This adverse publicity may include publicity about the nutritional supplements industry generally, the efficacy, safety and quality of nutritional supplements and other health care products or ingredients in general or our products or ingredients specifically, and regulatory investigations, regardless of whether these investigations involve us or the business practices or products of our competitors |
| There can be no assurance that we will be able to avoid any adverse publicity or negative public perception in the future |
| Any adverse publicity or negative public perception will likely have a material adverse effect on our business, financial condition and results of operations |
| Our business, financial condition and results of operations also could be adversely affected if any of our products or any similar products distributed by other companies are alleged to be or are proved to be harmful to consumers or to have unanticipated health consequences |
| 11 ______________________________________________________________________ [36]Table of Contents We could be exposed to product liability claims or other litigation, which may be costly and could materially adversely affect our operations |
| We could face financial liability due to product liability claims if the use of our products results in significant loss or injury |
| Additionally, the manufacture and sale of our products involves the risk of injury to consumers from tampering by unauthorized third parties or product contamination |
| We could be exposed to future product liability claims that, among others: our products contain contaminants; we provide consumers with inadequate instructions about product use; or we provide inadequate warning about side effects or interactions of our products with other substances |
| We maintain product liability insurance coverage, including primary product liability and excess liability coverage |
| The cost of this coverage has increased dramatically in recent years, while the availability of adequate insurance coverage has decreased |
| While we currently expect to be able to continue our product liability insurance, there can be no assurance that we will in fact be able to continue such insurance coverage, that our insurance will be adequate to cover any liability we may incur, or that our insurance will continue to be available at an economically reasonable cost |
| Additionally, it is possible that one or more of our insurers could exclude from our coverage certain ingredients used in our products |
| In such event, we may have to stop using those ingredients or rely on indemnification or similar arrangements with our customers who wish to continue to include those ingredients in their products |
| A substantial increase in our product liability risk or the loss of customers or product lines could have a material adverse effect on our results of operations and financial condition |
| If we continue to expand into markets outside the United States our business would become increasingly subject to political and economic risks in those markets, which could adversely affect our business |
| Our future growth may depend, in part, on our ability to continue to expand into markets outside the United States |
| There can be no assurance that we will be able to expand our presence in our existing markets outside the United States, enter new markets on a timely basis, or that new markets outside the United States will be profitable |
| There are significant regulatory and legal barriers in markets outside the United States that we must overcome |
| We will be subject to the burden of complying with a wide variety of national and local laws, including multiple and possibly overlapping and conflicting laws |
| We also may experience difficulties adapting to new cultures, business customs and legal systems |
| Our sales and operations outside the United States are subject to political, economic and social uncertainties including, among others: • changes and limits in import and export controls; • increases in custom duties and tariffs; • changes in government regulations and laws; • coordination of geographically separated locations; • absence in some jurisdictions of effective laws to protect our intellectual property rights; • changes in currency exchange rates; • economic and political instability; and • currency transfer and other restrictions and regulations that may limit our ability to sell certain products or repatriate profits to the United States |
| Any changes related to these and other factors could adversely affect our business, profitability and growth prospects |
| If we continue to expand into markets outside the United States, these and other risks associated with operations outside the United States are likely to increase |
| Our products and manufacturing activities are subject to extensive government regulation, which could limit or prevent the sale of our products in some markets and could increase our costs |
| The manufacturing, packaging, labeling, advertising, promotion, distribution, and sale of our products are subject to regulation by numerous national and local governmental agencies in the United States and in other countries |
| Failure to comply with governmental regulations may result in, among other things, injunctions, product withdrawals, recalls, product seizures, fines, and criminal prosecutions |
| Any action of this type by a governmental agency could materially adversely affect our ability to successfully market our products |
| In addition, if the governmental agency 12 ______________________________________________________________________ [37]Table of Contents has reason to believe the law is being violated (for example, if it believes we do not possess adequate substantiation for product claims), it can initiate an enforcement action |
| Governmental agency enforcement could result in orders requiring, among other things, limits on advertising, consumer redress, divestiture of assets, rescission of contracts, and such other relief as may be deemed necessary |
| Violation of these orders could result in substantial financial or other penalties |
| Any action by the governmental agency could materially adversely affect our ability and our customers’ ability to successfully market those products |
| In markets outside the United States, before commencing operations or marketing our products, we may be required to obtain approvals, licenses, or certifications from a country’s ministry of health or comparable agency |
| Approvals or licensing may be conditioned on reformulation of products or may be unavailable with respect to certain products or product ingredients |
| We must also comply with product labeling and packaging regulations that vary from country to country |
| Furthermore, the regulations of these countries may conflict with those in the United States and with each other |
| The sale of our products in certain European countries is subject to the rules and regulations of the European Union, which may be interpreted differently among the countries within the Union |
| The cost of complying with these various and potentially conflicting regulations can be substantial and can adversely affect our results of operations |
| We cannot predict the nature of any future laws, regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations, when and if adopted, would have on our business |
| They could include requirements for the reformulation of certain products to meet new standards, the recall or discontinuance of certain products, additional record keeping, expanded or different labeling, and additional scientific substantiation |
| Any or all of these requirements could have a material adverse effect on our operations |
| If we are unable to attract and retain qualified management personnel, our business will suffer |
| Our executive officers and other management personnel are primarily responsible for our day-to-day operations |
| We believe our success depends largely on our ability to attract, maintain and motivate highly qualified management personnel |
| Competition for qualified individuals can be intense, and we may not be able to hire additional qualified personnel in a timely manner and on reasonable terms |
| Our inability to retain a skilled professional management team could adversely affect our ability to successfully execute our business strategies and achieve our goals |
| Our manufacturing, fulfillment and call center activities are subject to certain risks |
| Currently, we manufacture the vast majority of our products at our manufacturing facility in California and our fulfillment and call center activities are centralized at RHL’s facility also in California |
| As a result, we are dependent on the uninterrupted and efficient operation of these facilities |
| Our manufacturing, fulfillment and call center operations are subject to power failures, the breakdown, failure or substandard performance of equipment, the improper installation or operation of equipment, natural or other disasters, and the need to comply with the requirements or directives of governmental agencies, including the FDA In addition, we may in the future determine to expand or relocate our facilities, which may result in slow downs or delays in our operations |
| While we maintain business interruption insurance, there can be no assurance that the occurrence of these or any other operational problems at our facilities in California or at NAIE’s facility in Switzerland would not have a material adverse effect on our business, financial condition and results of operations |
| Furthermore, there can be no assurance that our insurance will continue to be available at a reasonable cost or, if available, will be adequate to cover any losses that we may incur from an interruption in our manufacturing and distribution operations |
| We may be unable to protect our intellectual property rights or may inadvertently infringe on the intellectual property rights of others |
| We possess and may possess in the future certain proprietary technology, trade secrets, trademarks, tradenames, licenses and similar intellectual property |
| There can be no assurance that we will be able to protect our intellectual property adequately |
| In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States |
| Litigation in the United States or abroad may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement |
| This litigation, even if successful, could result in substantial costs and diversion of resources and could have a material adverse effect on our business, results of operation and financial condition |
| If any such claims are asserted against us, we may seek to obtain a license under the third party’s intellectual property rights |
| There can be no assurance, however, that a license would be available on terms acceptable or favorable to us, if at all |
| 13 ______________________________________________________________________ [38]Table of Contents Collectively, our officers and directors own a significant amount of our common stock, giving them influence over corporate transactions and other matters and potentially limiting the influence of other stockholders on important policy and management issues |
| Our officers and directors, together with their families and affiliates, beneficially owned approximately 25dtta4prca of our outstanding shares of common stock as of June 30, 2006, including approximately 20dtta1prca of our outstanding shares of common stock beneficially owned by Mark LeDoux, our Chief Executive Officer and the Chairman of the Board, and his family and affiliates |
| As a result, our officers and directors, and in particular Mr |
| LeDoux, could influence such business matters as the election of directors and approval of significant corporate transactions |
| Various transactions could be delayed, deferred or prevented without the approval of stockholders, including: • transactions resulting in a change in control; • mergers and acquisitions; • tender offers; • election of directors; and • proxy contests |
| There can be no assurance that conflicts of interest will not arise with respect to the officers and directors who own shares of our common stock or that conflicts will be resolved in a manner favorable to us or our other stockholders |
| If our information technology system fails, our operations could suffer |
| Our business depends to a large extent on our information technology infrastructure to effectively manage and operate many of our key business functions, including order processing, customer service, product manufacturing and distribution, cash receipts and payments and financial reporting |
| A long term failure or impairment of any of our information technology systems could adversely affect our ability to conduct day-to-day business |
| If certain provisions of our Certificate of Incorporation, Bylaws and Delaware law are triggered, the future price investors might be willing to pay for our common stock could be limited |
| Certain provisions in our Certificate of Incorporation, Bylaws and Delaware corporate law help discourage unsolicited proposals to acquire our business, even if the proposal benefits our stockholders |
| Our Board of Directors is authorized, without stockholder approval, to issue up to 500cmam000 shares of preferred stock having such rights, preferences, and privileges, including voting rights, as the board designates |
| The rights of our common stockholders will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future |
| Our stock price could fluctuate significantly |
| Stock prices in general have been historically volatile and ours is no different |
| The trading price of our stock may fluctuate in response to: • broad market fluctuations and general economic and/or political conditions; • fluctuations in our financial results; • future offerings of our common stock or other securities; • the general condition of the nutritional supplement industry; • increased competition; • regulatory action; • adverse publicity; • manipulative or illegal trading practices by third parties; and • product and other public announcements |
| 14 ______________________________________________________________________ [39]Table of Contents The stock market has historically experienced significant price and volume fluctuations |
| There can be no assurance that an active market in our stock will continue to exist or that the price of our common stock will not decline |
| Our future operating results may be below the expectations of securities analysts and investors |
| From time to time our shares may be listed for trading on one or more foreign exchanges, with or without our prior knowledge or consent |
| Certain foreign exchanges may have less stringent listing requirements, rules and enforcement procedures than the Nasdaq Global Market or other markets in the United States, which may increase the potential for manipulative trading practices to occur |
| These practices, or the perception by investors that such practices could occur, may increase the volatility of our stock price or result in a decline in our stock price, which in some cases could be significant |