Lifeway Foods, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; unaudited consolidated results. Lifeway manufactures probiotic cultured dairy products, principally kefir, and farmer cheese.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $29.60 million | $30.11 million | $89.04 million | $88.81 million |
| Gross profit | $9.06 million | $7.80 million | $24.45 million | $21.97 million |
| Gross margin | 30.6% | 25.9% | 27.5% | 24.7% |
| Operating income | $2.05 million | $2.19 million | $3.51 million | $4.34 million |
| Net income | $0.89 million | $1.01 million | $1.65 million | $1.98 million |
| Diluted EPS | $0.05 | $0.06 | $0.10 | $0.12 |
| Operating cash flow | Not provided for quarter | $4.38 million | $3.68 million |
Q3 gross sales rose 2.5%, but net sales fell 1.7% as discounts and promotional allowances increased 51.1% to $3.92 million. For the first nine months, gross sales rose 5.7%, while net sales increased only 0.3%; promotional allowances rose 62.2% to $13.87 million. Management attributed improved gross margins primarily to lower input costs, especially milk prices, partly offset by higher promotions.
Operating expenses pressured earnings: Q3 general and administrative expense rose 56.7% to $4.12 million, and nine-month expense rose 53.5% to $10.92 million. Management cited higher salaries, professional fees and, for the nine-month period, Wisconsin facility costs. Professional fees were partly associated with delayed SEC filings. Advertising expense also increased, including the company’s first national TV commercial in Q1.
Liquidity, debt and balance sheet
- At September 30, cash and cash equivalents were $5.01 million; investments were $2.51 million and certificates of deposit were $0.53 million. Current assets were $26.58 million and current liabilities $9.58 million.
- Total notes payable were $8.17 million, including $0.84 million current maturities. Debt declined from $9.00 million at December 31, 2014. The term loans carry variable rates; a 1 percentage-point rate increase would add about $82,000 of annualized interest expense, according to the filing.
- The $5 million revolving credit facility was unused at quarter-end and expires July 31, 2016. The company reported compliance with its loan covenants.
- Nine-month investing cash outflow was $1.80 million, chiefly reflecting $1.62 million of property and equipment purchases, partially offset by asset-sale proceeds. Cash increased $1.75 million during the period.
Outlook, risks and unusual items
- No specific financial guidance was provided. Management said it expected to fund foreseeable liquidity needs internally and was exploring industry acquisition opportunities.
- Two customers accounted for approximately 27% of gross sales in the first nine months of 2015, creating customer concentration exposure.
- Management concluded disclosure controls and procedures were not effective at September 30, 2015 because previously identified material weaknesses remained. It described remediation work, including stronger reconciliations, journal-entry review and period-end close procedures.
- The company recorded $205,000 of other-than-temporary impairment losses on structured notes in Q3 and approximately $180,000 in Q1. Management said it was probable certain issuers could settle below par at maturity.
- The nine-month 2015 effective tax rate was 50.8%. The filing attributes the elevated rate versus statutory rates to certain nondeductible operating expenses.
- Routine litigation was not expected by management to have a material adverse effect. The filing reported no material changes to the risk factors in the 2014 Form 10-K.
- The company authorized a repurchase program of up to $3.5 million, capped at 250,000 shares; no shares had been repurchased through September 30, 2015.
- Comparative 2014 interim financial statements were revised for prior-period errors, primarily involving income taxes and depreciation. The company said the revisions were not material to previously filed interim statements; nine-month 2014 net income was reduced by approximately $800,000.
Investor verification priorities
- Assess whether promotional allowances can be contained and translated into net sales growth, and whether lower milk costs and stronger gross margins persist.
- Track G&A growth, especially salaries and legal/accounting fees, and determine whether delayed-filing-related costs recur.
- Review the status and effectiveness of remediation for the disclosed material weaknesses and the accuracy of subsequent filings.
- Monitor structured-note valuations and potential additional impairment, as well as variable-rate debt exposure and the July 2016 revolver renewal.
- Evaluate customer concentration, inventory growth, and the company’s capacity to fund acquisitions or repurchases while maintaining liquidity.