A. Basis of Presentation and Summary of Si

gnificant Accounting Policies

The accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form

-Q and applicable rules and regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles

(U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. In management’s opinion, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows have been included and are of a normal, recurring nature. The results of operations for the

three

and

nine

months ended

March

31,

2017

are not necessarily indicative of the operating results for the full fiscal year or any future periods.

You should read the financial statements and these notes, which are an integral part of the financial statements, together with our audited financial statements included in our Annual Report on Form

-K for the fiscal year ended

June

30,

2016

(“2016

Annual Report”). The accounting policies used to prepare the financial statements included in this report are the same as those described in the notes to the consolidated financial statements in our

2016

Annual Report unless otherwise noted below.

Net Income per Common Share

We compute net income per common share using the weighted average number of common shares outstanding during the period, and diluted net income per common share using the additional dilutive effect of all dilutive securities. The dilutive impact of stock

options account for the additional weighted average shares of common stock outstanding for our diluted net income per common share computation. We calculated basic and diluted net income per common share as follows (in thousands, except per share data):

	Three Months Ended March 31,				Nine Months Ended March 31,
	201 7		201 6		201 7		201 6
Numerator
Net income	$	745	$	3,023	$	5,701	$	6,104
Denominator
Basic weighted average common shares outstanding		6,582		6,511		6,569		6,514
Dilutive effect of stock options		32		52		79		115
Diluted weighted average common shares outstanding		6,614		6,563		6,648		6,629
Basic net income per common share	$	0.11	$	0.46	$	0.87	$	0.94
Diluted net income per common share	$	0.11	$	0.46	$	0.86	$	0.92

shares related to stock options were excluded for the

three

nine

months ended

March

31,

201

and

March

31,

2016.

Revenue Recognition

To recognize revenue,

four

basic criteria must be met:

(1)

there is evidence that an arrangement exists;

(2)

delivery has occurred;

(3)

the fee is fixed or determinable; and

(4)

collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (a) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (b) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (c) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (d) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (e) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (f) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.

We record reductions to gross revenue for estimated returns of private label contract manufacturing products and

beta-alanine raw material sales. The estimated returns are based on the trailing

six

months of private-label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and beta-alanine raw material product returns. However, the estimate for product returns does not reflect the impact of a potential large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable.

We currently own certain U.S. patents, and each patent

’s corresponding foreign patent applications. All of these patents and patent rights relate to the ingredient known as beta-alanine marketed and sold under the CarnoSyn® and SR Carnosyn® trademarks. We recorded royalty and licensing income as a component of revenue in the amount of

$6.6

million during the

three

months ended

March

31,

2017

and

$20.0

million during the

nine

months ended

March

31,

2017.

We recorded beta-alanine raw material sales and royalty and licensing income as a component of revenue in the amount of

$5.5

million during the

three

months ended

March

31,

2016

and

$16.1

million during the

nine

months ended

March

31,

2016.

These royalty income and raw material sale amounts resulted in royalty expense paid to the original patent holders from whom NAI acquired its patents and its patent rights. We recognized royalty expense as a component of cost of goods sold in the amount of

$233,000

during the

three

months ended

March

31,

2017

and

$799,000

during the

nine

months ended

March

31,

2017.

We recognized royalty expense as a component of cost of goods sold in the amount of

$193,000

during the

three

months ended

March

31,

2016

and

$666,000

during the

nine

months ended

March

31,

2016.

Stock-Based Compensation

We have an omnibus incentive plan that was approved by our Board of Directors effective as of

October

15,

2009

and approved by our stockholders at the Annual Meeting of Stockholders held on

November

30,

2009.

Under the plan, we

may

grant nonqualified and incentive stock options and other stock-based awards to employees, non-employee directors and consultants.

We estimate the fair value of stock option awards at the date of grant using the Black-Scholes option valuation model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions. Black-Scholes uses assumptions related to volatility, the risk-free interest rate, the dividend yield (which we assume to be

zero,

as we have not paid any cash dividends) and employee exercise behavior. Expected volatilities used in the model are based on the historical volatility of our stock price. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect in the period of grant. The expected life of stock option grants is derived from historical experience. The fair value of restricted stock shares granted is based on the market price of our common stock on the date of grant. We amortize the estimated fair value of our stock awards to expense over the related vesting periods.

March

28,

2017,

the Board of Directors approved the grant of

140,000

shares of restricted stock to the members of our Board of Directors and certain key members of our management team pursuant to our

2009

Omnibus Incentive Plan. On

March

23,

2016,

the Board of Directors approved the grant of

130,000

shares of restricted stock to the members of our Board of Directors and certain key members of our management team pursuant to our

2009

Omnibus Incentive Plan. These restricted stock grants will vest over

three

years and the unvested shares cannot be sold or otherwise transferred and the rights to receive dividends, if declared by our Board of Directors, are forfeitable until the shares become vested.

Our net income included stock based compensation expense of

approximately

$223,000

for the

three

months ended

March

31,

2017

and approximately

$729,000

for the

nine

months ended

March

31,

2017.

Our net income included stock based compensation expense of approximately

$183,000

for the

three

months ended

March

31,

2016

and approximately

$463,000

for the

nine

months ended

March

31,

2016.

Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a

three

-level hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs are inputs that reflect our assumptions about the inputs that market participants would use in pricing the asset or liability and are developed based on the best information available under the circumstances.

The fair value hierarchy is broken down into

three

levels based on the source of inputs. In general, fair values determined by Level

inputs use quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. We classify cash, cash equivalents, and marketable securities balances as Level

assets. Fair values determined by Level

inputs are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and models for which all significant inputs are observable or can be corroborated, either directly or indirectly by observable market data. Level

inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. These include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

As of

March

31,

2017

and

June

30,

2016,

we did

not

have any financial assets or liabilities classified as Level

We classify derivative forward exchange contracts as Level

assets. The fair value of our forward exchange contracts as of

March

31,

2017

was a net asset of

$1.1

million. The fair value of our forward exchange contracts as of

June

30,

2016

was a net asset of

$250,000.

As of

March

31,

2017

and

June

30,

2016,

we did

not

have any financial assets or liabilities classified as Level

We did not transfer any assets or liabilities between Levels during fiscal

2016

or the

three

and

nine

month periods ended

March

31,

2017.