Lifeway Foods, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; filed August 19, 2019. Lifeway makes cultured dairy products, principally drinkable kefir, and reports one operating segment. Unless stated otherwise, amounts below are in millions of dollars; the filing presents financial statements in thousands.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $23.153 | $27.096 | $47.768 | $55.838 |
| Gross profit / margin | $5.563 / 24.0% | $6.876 / 25.4% | $11.866 / 24.8% | $14.913 / 26.7% |
| Operating income (loss) | $(0.066) | $0.333 | $(0.467) | $0.484 |
| Net income (loss) | $(0.141) | $0.170 | $(0.529) | $0.240 |
| Basic and diluted EPS | $(0.01) | $0.01 | $(0.03) | $0.02 |
- Revenue and earnings: Sales declined 14.6% in Q2 and 14.5% for the first half year over year. Management attributed the decline mainly to lower volumes of branded drinkable kefir, cupped kefir and Skyr, amid weaker consumption in dairy and cultured dairy categories; new product introductions partly offset the decline.
- Margins and expenses: Gross margin fell 1.4 percentage points in Q2 and 1.9 points for the first half. Management cited lower sales relative to fixed costs; first-half results also reflected increased freight costs. Selling expenses decreased 20.5% in Q2 and 21.2% year to date, in part from reduced advertising and marketing, organizational changes and lower broker commissions. First-half operating expenses were 25.8% of sales, unchanged year over year.
- Cash flow: First-half operating cash flow was $2.008 million, compared with $2.109 million in 2018. Investing cash outflow was $0.269 million versus $1.989 million, including capital spending of $0.290 million versus $2.024 million. Financing cash outflow was $1.715 million, including $1.330 million of revolver repayments and $0.385 million of treasury-stock purchases. Cash increased by $0.024 million to $3.022 million.
Financial position and liquidity
- At June 30, 2019, current assets were $20.106 million and current liabilities $9.663 million; working capital was approximately $10.443 million. Total assets were $57.657 million and stockholders’ equity $42.243 million.
- Revolver debt was $4.677 million, net of unamortized financing costs; approximately $4.280 million was available under the borrowing base. The modified facility has a $9 million revolving commitment, plus an incremental facility of up to $5 million subject to approval, and matures May 7, 2021. The average rate on outstanding debt in Q2 was 5.04%.
- The company reported compliance with applicable minimum EBITDA and fixed-charge coverage covenants at June 30, 2019. Management expects to meet foreseeable liquidity needs through operating cash flows, the revolving facility and cash.
Outlook, risks and other notable items
- The filing provides no quantified sales, earnings or margin guidance. Management described ongoing sales softness and cited lower category consumption, fixed-cost deleverage, freight costs, milk and other input-price changes, supply-chain disruptions, competition, product launches and regulatory developments as relevant risks.
- Operating lease accounting adoption on January 1, 2019 added approximately $0.944 million of right-of-use assets and $0.997 million of lease liabilities, with a $0.053 million reduction to opening retained earnings. The filing says adoption materially affected the balance sheet but not the statements of operations or cash flows.
- Management concluded disclosure controls and procedures were not effective at quarter-end because of a previously identified material weakness in review of a third-party goodwill impairment analysis. Remediation had begun but was not complete; management stated it performed additional procedures and believed the financial statements fairly presented the results.
- Lifeway disclosed ordinary-course legal matters; it said no current accruals were material and it could not reasonably estimate possible losses or ranges. An adverse outcome could nevertheless materially affect the company.
- Two major customers together represented approximately 22% of first-half net sales. Related-party payments to the board chair included $0.500 million in consulting fees and $0.298 million in product royalties for the first half.
Most important facts for investors to verify
- Whether sales volumes and demand in drinkable kefir, cupped kefir and Skyr stabilize, and whether new products offset declines.
- Whether gross margins recover despite sales softness, fixed-cost deleverage and freight or input-cost pressures.
- Cash conversion, working-capital needs, remaining borrowing-base availability and ongoing compliance with lender covenants.
- Progress in remediating the goodwill-impairment review control weakness and any resulting effect on impairment assessments or reporting.
- Developments in legal contingencies, customer concentration and the disclosed related-party consulting and royalty arrangements.