Lifeway Foods, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Lifeway produces dairy products, led by Kefir, and distributes primarily through food retailers in the United States and internationally. Unaudited consolidated results include the company and its wholly owned subsidiaries.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Gross sales | $25.84 million | $22.71 million | $53.43 million | $44.26 million |
| Net sales | $23.08 million | $20.55 million | $47.46 million | $39.95 million |
| Gross profit | $7.60 million | $7.62 million | $16.04 million | $13.71 million |
| Operating income | $2.49 million | $3.13 million | $6.22 million | $5.00 million |
| Net income | $1.40 million | $2.05 million | $3.77 million | $3.14 million |
| Diluted EPS | $0.09 | $0.13 | $0.23 | $0.19 |
| Operating cash flow | Not provided separately | Not provided separately | $5.03 million | $4.13 million |
- Margins: Q2 gross, operating, and net margins were approximately 32.9%, 10.8%, and 6.1%, respectively, versus 37.1%, 15.2%, and 10.0% a year earlier. First-half margins were approximately 33.8%, 13.1%, and 7.9%, versus 34.3%, 12.5%, and 7.9%.
- Cash and liquidity at June 30: Cash was $4.94 million; current assets were $26.29 million and current liabilities $10.03 million (current ratio approximately 2.6). Investments were $2.48 million and certificates of deposit $0.12 million. Operating cash flow less property-and-equipment purchases was approximately $4.48 million for the first half.
- Debt: Notes payable totaled $5.27 million, including $0.55 million current and $4.73 million long-term, down from $5.77 million at June 30, 2012. The company reported $41.69 million in stockholders’ equity.
Changes and management commentary
- Q2 net sales increased 12% year over year; first-half net sales rose 19%. Management attributed growth primarily to Lifeway Kefir, ProBugs Organic Kefir, and BioKefir.
- Despite higher Q2 sales, gross profit was nearly flat and operating income fell 21%; net income declined 32%. Management cited a roughly 20% increase in milk costs, the company’s largest raw material. Cost of goods sold, excluding depreciation, rose to about 65% of Q2 net sales from 61%; the comparable first-half measure was about 64% in both years.
- Q2 operating expenses increased 14%. General and administrative expense included $300,000 of professional fees for the Golden Guernsey plant acquisition, described by management as nonrecurring. First-half G&A increased 32%.
- Q2 effective tax rate was approximately 45%, compared with 34% in Q2 2012; the first-half rates were 40.4% and 36.7%. The filing attributes the higher first-half rate in part to state and local taxes.
- First-half operating cash flow increased, with management attributing the change primarily to higher accounts payable. Inventories also rose to $7.81 million from $5.94 million at year-end 2012.
Outlook, risks, and notable items
- Management said it expects to fund foreseeable liquidity needs internally; the filing provides no quantified earnings or revenue guidance.
- In May 2013, Lifeway refinanced its Private Bank term note, extending maturity to May 31, 2018, and renewed its revolving credit facility with borrowing capacity increased to $5 million and maturity of May 31, 2014. No revolver borrowings were outstanding at June 30. Loan agreements include minimum fixed-charge coverage and tangible-net-worth thresholds; covenant headroom is not stated.
- The Golden Guernsey dairy plant acquisition closed July 2, 2013, after quarter-end, for approximately $7.4 million. Management said it will add about 170,000 square feet of production capacity.
- Two customers represented approximately 35% of gross sales for the first half; those customers represented 25% of accounts receivable at June 30. This concentration creates customer and collection exposure.
- The company restated its 2012 comparative income statements to reclassify production costs from G&A to cost of goods sold. The restatement changed gross profit and operating-expense presentation, but not net income, balance sheets, or cash flows.
- Management reported disclosure controls were not effective at the reasonable-assurance level at June 30 because of a material weakness involving classification of costs and expenses. Remediation efforts were underway; management said additional procedures supported the financial statements.
- Ordinary-course litigation was not expected by management to have a material adverse effect. The filing reports no material pending legal proceedings.
Investor verification points
- Assess whether sales growth can offset milk-cost inflation and the Q2 margin decline.
- Track the Golden Guernsey acquisition’s funding, integration, capacity utilization, and contribution to results after closing.
- Review customer concentration, receivables collection, inventory growth, and the extent to which operating cash flow depends on payment timing to suppliers.
- Verify compliance with bank covenants and the availability and terms of the $5 million credit facility.
- Monitor remediation of the material weakness and whether cost-classification controls prevent further reporting errors.
- Reconcile the share count: the balance sheet reports 16,346,017 shares outstanding at June 30, while the cover page reports 16,386,017 as of August 8.