Lifeway Foods, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial statement amounts are in thousands of dollars, except per-share data. Lifeway manufactures probiotic cultured dairy products, principally drinkable kefir, and reports one operating segment.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $28,786 | $29,990 | $92,636 | $93,691 |
| Gross profit / margin | $7,837 / 27.2% | $7,979 / 26.6% | $25,573 / 27.6% | $26,414 / 28.2% |
| Operating income / margin | $514 / 1.8% | $189 / 0.6% | $2,678 / 2.9% | $4,852 / 5.2% |
| Net income (loss) | $243 | $(64) | $1,403 | $2,998 |
| Diluted EPS | $0.02 | $0.00 | $0.09 | $0.19 |
| Operating cash flow | Not separately reported for quarter | $4,189 | $4,513 |
- Q3: Sales declined 4.0%; lower branded drinkable kefir volume/mix was partly offset by pricing, promotional allowances and new/private-label products. Gross margin improved 0.6 percentage points, while lower selling and administrative expenses helped operating income rise to $514 and Lifeway returned to quarterly profitability.
- Nine months: Sales declined 1.1%, but operating income fell 44.8% and net income fell 53.2%. Gross margin contracted 0.6 percentage points. Management cited higher milk costs and trade promotion, increased selling costs (including salesforce salaries), and higher G&A costs, including compensation, as pressures.
- Product mix: Nine-month drinkable kefir sales were $80,382 versus $80,135; ProBugs sales declined to $3,586 from $4,962. Cheese sales increased to $7,750 from $7,579.
Cash, debt and liquidity
- At September 30, cash was $7,264, current assets $27,509, and current liabilities $13,336. Cash was down $1,548 from year-end 2016.
- Total notes payable were $6,489, down from $7,119 at December 31, 2016. Of the September balance, $3,292 was current; the loans carried a 3.74% rate at quarter-end and are secured by substantially all company assets. The current term loan matures in May 2018, with another loan due May 2019.
- A $5 million revolving credit facility was undrawn at September 30 and expires in July 2018. Lifeway reported covenant compliance and said it expected to fund foreseeable needs internally, using cash and/or new financing for current maturities.
- Nine-month operating cash flow was $4,189; investing cash outflow was $3,920, including $3,932 of property and equipment purchases; financing cash outflow was $1,817, including $1,187 of treasury-share purchases. Capital spending mainly reflected investment in production equipment.
Outlook, risks and notable items
- No quantified revenue or earnings guidance was provided. Management said it was exploring acquisition opportunities to boost sales and leverage its distribution system, and expected to maintain liquidity and comply with loan covenants.
- Management identified risks including dairy and other input-cost changes, supply disruptions, food-industry regulation, competition and product launches, liquidity/covenant compliance, and legal or investigative proceedings.
- Disclosure controls and procedures were reported ineffective at September 30 because of a previously identified material weakness in internal control over financial reporting. Remediation was ongoing, including accounting staffing, ERP access controls, payment controls and tax-reporting support. Management said additional procedures were performed to support the reported statements.
- The company continued cooperating with an SEC Division of Enforcement informal inquiry, begun in 2016, concerning controls and reporting for 2013 through the inquiry date. The SEC stated that the inquiry was not an indication of a violation. Lifeway said its legal matters were not material in aggregate, but could not estimate a possible loss or range for contingencies.
- Two major customers represented approximately 22% of nine-month sales. Related-party payments to the board chair included $750 for consulting and $450 in product royalties during the nine months.
- On November 1, 2017, after quarter-end, the board amended the share-repurchase authorization, increasing it to the lesser of $5,185 or 625 shares, exclusive of prior authorizations. The program does not require purchases.
Investor verification priorities
- Track branded kefir volume/mix and whether pricing, new items and private-label sales can offset continuing weakness.
- Assess milk and promotional costs, gross-margin trends, and the rising nine-month selling and administrative expense base.
- Review cash generation against equipment spending, repurchases, and the $3,292 current debt maturity; confirm refinancing or repayment plans before May 2018.
- Monitor remediation and any subsequent conclusions regarding the material weakness and SEC inquiry.
- Review customer concentration, related-party consulting and royalty arrangements, and the terms and actual use of the expanded repurchase authorization.