Lifeway Foods, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. Unaudited consolidated results are presented in thousands of dollars, except per-share data. Lifeway manufactures cultured dairy products, principally kefir, and reports one operating segment.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $32.117 million | $32.570 million | Down 1.4% |
| Gross profit | $8.457 million | $8.700 million | Down 2.8% |
| Gross margin | 26.3% | 26.7% | Down 0.4 percentage points |
| Operating income | $266,000 | $1.614 million | Down 83.5% |
| Net income | $124,000 | $955,000 | Down 87.0% |
| Diluted EPS | $0.01 | $0.06 | Down $0.05 |
- Cost of goods sold was $23.660 million, compared with $23.870 million. Selling expense rose 43.0% to $4.238 million; selling expense was 13.2% of sales versus 9.1%. Total operating expenses increased 15.6% to $8.191 million.
- Management attributed lower gross margin to higher milk costs and increased trade promotion, partly offset by lower manufacturing overhead. Selling expense increased with advertising and marketing campaigns, coupon production, trade shows, and higher salesforce costs. General and administrative expense declined 4.1% to $3.785 million, primarily due to lower professional fees.
- Cash provided by operations was $2.250 million, versus $1.016 million used in Q1 2016. The filing cites non-cash charges, including stock-based compensation, and working-capital timing; higher receivables partly offset favorable supplier-payment timing and lower inventory.
- Capital expenditures were $1.078 million, versus $336,000, primarily reflecting investment in production equipment. Investing cash outflow was $1.044 million; financing cash outflow was $210,000, including debt repayment.
Balance sheet and liquidity
- At March 31, 2017, cash was $9.808 million, current assets were $30.615 million, and current liabilities were $12.601 million. Total assets were $68.572 million and stockholders’ equity was $48.506 million.
- Total notes payable were $6.909 million, including $840,000 current maturities; the loans bear variable rates, reported at 3.28%, and are secured by substantially all company assets. The company reported compliance with its financial covenants.
- A $5 million revolving credit facility had no borrowings at quarter-end and, unless renewed, expires in July 2017. Management said it expected to fund foreseeable liquidity needs internally and anticipated continued covenant compliance.
- Cash increased by $996,000 during the quarter, from $8.812 million at year-end 2016. The company reported no share repurchases in Q1 2017; approximately $1.2 million remained under its authorized repurchase program.
Changes, outlook, and notable items
- Management attributed the 1.4% sales decline to higher trade promotion (a 1.4% sales impact) and lower volume/mix (0.6%), partly offset by pricing (0.6%). Lower branded drinkable kefir volumes were partly offset by private-label sales and new items.
- Drinkable kefir sales were $27.760 million versus $28.067 million; cheese products were $2.598 million versus $2.637 million; ProBugs kefir was $1.452 million versus $1.641 million; frozen kefir was $307,000 versus $225,000. Two major customers accounted for approximately 23% of sales in both periods.
- Advertising expense increased to $1.768 million from $942,000. The company accrued $818,000 under its 2017 incentive plan in Q1, including $389,000 of cash bonus expense and $429,000 of stock-based compensation expense.
- No specific financial guidance was provided. Lifeway said it continued exploring potential acquisitions to increase sales and leverage its distribution system. The filing cautions that results may be affected by milk and other input costs, supply disruptions, competition, new-product execution, regulation, litigation, and liquidity or loan-covenant issues.
- Management said outstanding legal matters were not expected to have a material adverse effect, but noted outcomes and potential losses cannot be predicted or estimated with reasonable certainty.
- Disclosure controls and procedures were concluded to be ineffective at March 31, 2017 because of a previously identified material weakness in internal control over financial reporting. Remediation was ongoing; management stated additional procedures supported fair presentation of the reported financial statements.
- The company adopted certain accounting updates in 2017 without material financial-statement impact. It expected to adopt the new revenue-recognition standard on January 1, 2018, using the modified retrospective method; its impact assessment was still in progress.
Investor verification points
- Confirm the status and remediation of the material weakness and whether disclosure controls become effective.
- Monitor sales trends, promotional spending, advertising efficiency, and whether margins and earnings recover.
- Verify renewal or replacement of the revolving credit facility before its stated July 2017 expiration, and review covenant headroom and variable-rate exposure.
- Assess cash conversion and working-capital quality, particularly the increase in accounts receivable and the role of supplier-payment timing in operating cash flow.
- Review acquisition plans, customer concentration, legal contingencies, and the completed assessment of the upcoming revenue-recognition standard.