Lifeway Foods, Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Lifeway Foods manufactures and sells cultured dairy products, led by drinkable kefir, primarily in the United States. This unaudited filing covers the three and six months ended June 30, 2020; balance-sheet comparisons are with December 31, 2019. Unless noted, dollar amounts below are in millions.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $25.014 | $23.153 | $50.402 | $47.768 |
| Gross profit | $6.928 | $5.563 | $12.925 | $11.866 |
| Gross margin | 27.7% | 24.0% | 25.6% | 24.8% |
| Operating income (loss) | $1.438 | ($0.066) | $1.676 | ($0.467) |
| Net income (loss) | $0.980 | ($0.141) | $1.126 | ($0.529) |
| Diluted earnings (loss) per share | $0.06 | ($0.01) | $0.07 | ($0.03) |
- Sales increased 8.0% in Q2 and 5.5% in the first half, primarily on higher branded drinkable kefir volumes. Lower cream sales reflected a decline in butterfat market prices.
- Gross margin improved year over year in both periods. Management attributed the improvement mainly to favorable milk pricing, and for the first half also to lower freight costs. COVID-related hourly wage premiums and higher depreciation partly offset these benefits.
- First-half operating cash flow was $1.911 million, versus $2.008 million a year earlier. Investing cash outflow was $0.723 million, including $0.728 million of capital spending; financing cash outflow was $0.405 million, principally treasury-stock purchases. Cash rose $0.783 million to $4.619 million.
- At June 30, current assets were $20.710 million and current liabilities $11.023 million. The company reported $2.757 million drawn on its revolving credit facility, net of deferred financing costs, and approximately $6.223 million of borrowing-base availability. The facility bears interest at 2.43%, matures May 7, 2021, and is secured by substantially all company assets. Lifeway reported covenant compliance and intends to obtain a replacement facility before maturity.
- Total assets were $57.233 million, total liabilities $12.596 million, and stockholders’ equity $44.637 million. The filing classifies the entire outstanding credit-facility balance as current at June 30.
Material changes versus the prior comparable period
- Q2 operating results moved from a $0.066 million operating loss to $1.438 million operating income; first-half results moved from a $0.467 million operating loss to $1.676 million operating income.
- First-half selling expenses fell 9.2%, mainly because trade shows and other marketing events were postponed and in-store demonstration spending was lower. General and administrative expenses declined 8.0%, primarily due to lower compensation and incentive costs, partly offset by higher professional fees.
- First-half net income included a $0.245 million tax benefit related to CARES Act net operating loss carryback provisions. The effective tax rate was 29.0%, compared with (7.2%) in the prior-year period.
- Capital spending increased to $0.728 million from $0.290 million. The company repurchased 178,417 shares for $0.405 million during the first half and reported no remaining authorization under the amended repurchase plan.
Outlook, commentary, risks and unusual items
- COVID-19: Management said increased retail orders, associated with more food consumed at home, supported demand. It reported that advance planning enabled operations to avoid production, transportation, and sales disruption, and said full production capacity was available with no near-term manufacturing or staffing disruption anticipated. The company continued employee-safety measures and said it would monitor liquidity and discretionary spending. No quantified forward guidance was provided.
- Risks and contingencies: The filing identifies uncertainty around COVID-19’s effects on customers, suppliers, employees, and operations; supply-chain and distribution disruption; competition and pricing; commodity costs; and customer decisions. Lifeway also disclosed ordinary-course litigation and said it could not reliably estimate possible losses or ranges. Management did not expect the matters to have a material adverse effect, while noting an adverse outcome could be material.
- Customer concentration: Two major customers together represented approximately 21% of net sales in both the second quarter and first half of 2020.
- Related parties: The board chairperson earned $0.500 million for consulting services and $0.300 million in product royalties during the first half; both amounts were recorded in operating expenses.
- Accounting and controls: Management reported disclosure controls were effective as of June 30, 2020, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the higher retail demand and improved gross margins persist, including the effects of milk, butterfat, freight, and labor costs.
- Progress toward replacing the revolving credit facility before its May 2021 maturity, and continued covenant compliance and borrowing availability.
- How COVID-19 conditions affect sales channels, staffing, production, suppliers, and liquidity after the reporting date.
- The sustainability of earnings given the CARES Act tax benefit, valuation-allowance changes, and non-deductible executive compensation.
- Customer concentration, unresolved legal matters, and the terms and governance implications of chairperson consulting and royalty payments.